Manufacturers face growing FX challenges: how can they adapt?

The past 12 months has been a difficult period for the UK manufacturing sector. Amidst rising inflation, persistent supply chain problems and increased red tape as a result of Brexit, many manufacturing firms have had to constantly adjust their operations to navigate an uncertain environment.

One of the most serious, yet often overlooked challenges facing the industry is the threat of negative currency movements. Although we may not typically associate the manufacturing sector with foreign exchange (FX), FX is an essential component of the way in which many manufacturers trade and do business given the major role the industry holds in the importing and exporting of goods overseas.

Despite this, many manufacturers may traditionally see the task of FX risk management as second order. They transact in FX not because they ‘want’ to, but because they ‘have to’ given their international coverage.

However, with FX volatility set to persist, we believe it is vital that manufacturers have effective FX risk management strategies in place to mitigate this threat.

What are the FX challenges for manufacturers?

Supply chains are typically global by nature, meaning manufacturers that export and import goods to and from other countries are especially exposed to the risks associated with exchange rate fluctuations.

A sudden drop in a domestic currency will increase the cost of oversees imports, meaning the pound’s fall to a record low last year put serious pressure on manufacturers that source components from outside of the UK. This can be especially problematic for firms that purchase large quantities of components and raw materials overseas. Automotive manufacturers, for example, on average buy 60% of their parts from abroad and assemble them in the UK, meaning they run a particularly high risk of being negatively impacted by currency fluctuations.

As a result, many manufacturers that import from overseas may now be evaluating the effectiveness of their FX hedging strategies.

How can manufacturers implement a strategic approach to FX risk management?

With headwinds set to persist throughout 2023, we believe manufacturers must begin implementing a robust risk-management strategy to minimise their exposure to foreign currency movements. Fortunately, there are a number of steps that manufacturing firms can take to achieve this. These include:

1. Compare the market - having the ability to put trades up for competition is central to ensuring access to the best price, which is key to effective risk management. However, many manufacturing firms may be hampered by their inability to access Tier 1 FX liquidity, meaning they often rely on a single bank or broker to meet their hedging requirements. A new generation of FinTech businesses are tackling this problem, enabling insurers to access rates from multiple banks whilst reducing the operational burden associated with this kind of market access.

2. Use of Transaction Cost Analysis (TCA) - TCA was specifically created to highlight hidden costs and enables manufacturers to understand how much they are being charged for the execution of their FX transactions. Ongoing, quarterly TCA from an independent TCA provider can be embedded as a new operational practice to ensure consistent FX execution performance

3. Outsourcing - there is a growing recognition that outsourcing does not necessarily mean less transparency or reduced quality of FX activities, but when using the right partner can improve transparency and execution quality. Outsourcing can enable manufacturers to dedicate more time to core business matters, which is all the more important amidst inflationary and volatility pressure.

4. Strong governance – Supply chains are complex and include several steps. These include the sourcing of raw materials, manufacturing these materials into basic parts, refining basic parts into finished products and selling finished products to end users. It is therefore difficult to increase transparency due to the number of different partnerships and processes in the trade network. Harnessing solutions which can strengthen governance will help manufacturers improve the cost, quality and transparency of their FX execution.

Navigate 2023 with MillTechFX

As the manufacturing industry continues to face an uncertain landscape, we believe it is vital that manufacturers get the right tools and processes in place to protect their bottom lines against the threat of currency movements.

MillTechFX’s market access, pricing power and operational resource enables it to deliver a tech-enabled integrated solution that delivers transparency, cost reduction and operational burden reduction for manufacturing firms.

We provide access to a transparent marketplace for comparative FX execution from up to 15 counterparty banks, while harnessing unique and significant pricing efficiency for our clients. Rather than spending months setting up multiple FX facilities with different counterparties, manufacturers can sign up and often begin transacting within weeks.

Get in touch with us to find out more about how we can help you navigate your FX challenges in 2023.