EU Referendum Campaign Survival Guide
by Lucy Lillicrap, FX risk management solutions, AFEX
Since David Cameron announced a UK referendum on membership of the EU on 20 February, volatility has been the dominant feature of sterling’s performance in the currency markets. Sentiment towards the currency has been driven by this one event with macroeconomic figures taking a back seat to poll results and the intervention of key protagonists in the debate. As a result, the currency has not been moving in a definitive direction but is essentially range-bound - albeit within a very volatile range.
With less than a month left to go before the vote, volatility will continue and, if anything, become even more pronounced. Although recent polls suggest the ‘Remain’ camp is edging ahead, the result is still too close to call with any certainty. In the currency markets, speculators that have been short on sterling throughout the campaign are now busily buying it back with a ‘Remain’ vote looking more likely, which is pushing sterling up. But any upside will be tempered by lingering doubt about the accuracy of the polls and the potential downside for sterling in the event of a Brexit.
This may not make for particularly edifying reading for those corporate treasurers and CFOs that have already lost plenty of sleep in recent months considering how to react and mitigate their risks against this volatility. Many will have considered revising their strategies but in the vast majority of cases firms should stay on policy and continue to plan for the knowns rather than the unknowns.
The outcome, not just of the referendum result itself, but for the UK economy as a whole, is so uncertain that to move away from a pre-agreed policy is an incredibly risky move. If you have a comprehensive plan in place, the best course of action is almost certainly to stick to it. You shouldn’t be carrying open exposures across referendum day unless you would always have them open. For the majority of firms, the event risk is too great to take any chances.
There is, of course, a possibility that, despite having hedged for all the right reasons, the referendum could deliver a result that puts their trades out of the money, leading to liquidity risks. In the event of a Brexit, we estimate that sterling could fall to as low as $1.20 and many firms with standing commitments in place to sell dollars at much higher rates may be left exposed in the short term and risk being margin called by their brokers. Rather than focusing on what the currency markets are doing, firms should be evaluating their existing currency commitments and talking to their banks and brokers to ensure covenants wouldn’t be broken and to ensure that they have adequate cash cover in place for all possible outcomes.
For firms that have a solid currency risk mitigation strategy in place, focusing on the short-term volatility in the markets is unnecessary and can act as a distraction from following the policy and the commitments within it. The outcome of the EU referendum is uncertain, for corporate treasurers and CFOs, the challenge is to focus on the certainties of their risk mitigation policies.