Fighting the Brexit fallout – mitigation strategies

On June 23, 2016, the UK voted for Brexit, resulting in the pound falling to its lowest value since 1985, and global markets jumping into a state of turmoil; as a result, companies may face significant exposure to currency, workforce, supply chain, and other risks in a post-Brexit reality

Brexit Becomes Reality

On June 23, 2016, the UK voted to leave the EU. This news was followed by David Cameron’s (UK’s Prime Minister) resignation, while the pound fell to its lowest value (against the USD) since 1985. As a result, global markets were thrown into a state of turmoil, suggesting a period of uncertainty for the world economy in the near term.

Amid this turbulent scenario, it is essential for corporations to adopt robust measures to tackle potential challenges and stay a step ahead of the game. Based on our experience and a careful review of organisational approaches, The Smart Cube suggests the following strategies to mitigate exposure to currency, workforce, supply chain, and other risks arising in a post-Brexit reality.

Combating Currency Volatility

• • • • Agree on baseline exchange rates in contracts with suppliers

      • Understand suppliers’ exposure to foreign currency

        • This knowledge allows executives to renegotiate prices during strong FX fluctuations

        • Knowledge of FX risk exposure on account of suppliers can better prepare executives to enter into financial hedges

      • Maintain multiple suppliers – both local and non-local

        • Switch suppliers depending on which supplier represents the best value as per prevailing FX movements

      • Measure FX currency risk across the entire supply chain

        • This allows for greater visibility into cost factors and enhances supply chain agility

      • Assess transacting in currencies that are pegged to the company’s domestic currency or the fluctuations which correlate closely with that of the domestic currency

      • Evaluate adopting natural hedging by balancing selling and purchasing in the same currency

• • • • Use risk management tools/models and data analytics

        • This involves using mathematical risk management tools and predictive models to analyze the company’s exposure to FX volatility and assist future decision-making

        • Leverage data analytics to get accurate, complete, and timely visibility into which currencies impact the company the most and why

      • Assess using in-house banks to improve visibility and control over FX risk, by enabling better use of internal balances to create a natural hedge

      • Consider adopting commodity hedging techniques by taking a short or long position in futures contracts

        • This strategy does carry additional risks in cases wherein commodity prices drop or currencies move in a favorable direction, and hence, a thorough analysis of the industry is required before making the hedge

“~60% of the AirAsia fleet is hedged. Oil is a very big component of our costs, and that has tumbled (beyond our hedging level). Thus, we will not be hedging next year.” – Tan Sri Tony Fernandes, Group CEO, Air Asia (August 2015)

Countering Workforce-related Risks

• • • • Assess the at-risk portion of the company’s workforce (EU nationals working in the UK and vice versa)

“Several banks have said that Brexit will force them to rethink their attachment to the UK and review investment decisions. Almost straightaway, a leading global bank has announced that it would need to move 1,000 jobs to Paris, where it already has a large operation.” – The Guardian (June 2016)

• • • • For UK firms, assess the cost increase associated with employing only UK nationals and evaluate to what extent will this additional cost be passed on to the company’s customers

“Businesses relying heavily on migrants could switch to employing UK nationals in case the government opts for a points-based system to limit immigration post Brexit. That means more UK nationals in London coffee houses and picking carrots in Lincolnshire, but only if wages increase. It is a shot in the dark as to whether consumers will pay more for goods or whether farmers and cafe owners will be priced out of business.” – The Guardian (June 2016)

• • • • As Brexit is likely to result in shortage of migrant labor in the UK, domestic firms may evaluate the following measures to ensure the continuity of operations:

        • Evaluate outsourcing or offshoring manufacturing operations to emerging European countries (such as Slovakia) to leverage abundant labor, as well as low-cost production opportunities and easier/cheaper access to the EU markets in the long term

“Jaguar Land Rover’s proposed manufacturing unit in Slovakia will hedge it against Brexit. The company has signed an agreement with the Slovakian government to build a new plant with an initial capacity of 150,000 units.” – Joseph George, Analyst, IIFL (June 2016)

• • • • Include terms that ensure continuous supply of labor, even during shortage, at minimal or no cost to the company in contracts with labor agency

Confronting Supply Chain Risks

• • • • Include terms that ensure that any additional expenses due to delivery delays, unforeseen border tariffs, or the use of emergency solutions (such as airfreight transport) are absorbed by the logistics provider at minimal or no cost to the company in supplier contracts

      • Understand suppliers’ financial positions to identify the critical suppliers that are most vulnerable during times of financial uncertainty and pose risk to supply continuity

        • This knowledge also allows the company to understand any potential impact on suppliers once the post-Brexit regulations are established

      • Identify and maintain multiple suppliers – both local and foreign

        • Switch suppliers depending on which supplier represents the best value as per border tariffs and transportation costs

        • Evaluate switching to local sourcing in case of cross-border (between the EU and the UK) delivery delays and increased logistical expenses

Tackling Miscellaneous Strategy-related Risks

• • • • Assess the optimal location for the company’s base to better target the European market from a sales, finance, and marketing perspectives, especially in case the post-Brexit regulations curb the movement of employees, capital, and goods for the company

“For industry players, this starts a period of uncertainty, and some might look for alternative jurisdictions, such as Luxembourg or Ireland.” – Camille Thommes, Director-General, Association of the Luxembourg Fund Industry (June 2016)

Assess which customer segments (if any) are at risk or under financial pressure; align the product portfolio to include offerings perceived as “value for money” to entice such customers during recessionary or uncertain times

• • • • Evaluate offering rebates/discounts to distributors/retailers/customers to compensate for increased end prices as a result of currency movements

“With Sterling’s steep fall, our wine has suddenly become more expensive for the UK, our biggest market. To compensate, I’ll have to give rebates to my British distributor at the end of the year. I’ve already called him and told him nothing would change between us.” – Pierre-Emmanuel Taittinger, Chairman, Champagne Taittinger (June 2016)

• • • • In case of an M&A deal under consideration, assess the impact of Brexit and consequent impact of market volatility on the two companies, and move forward only after attaining clarity on all aspects (such as launch of planned capital increase)

“We have a cross-border (EU–UK) transaction that was supposed to get signed today, and it was delayed until Monday. I suspect they want to take the time to think about whether they want to do the deal right now.”
– Michael Kendall, Partner and Co-head of Private Equity, Goodwin Procter (June 2016)

If you are an industry professional, the following questions could be worth exploring:

• • • Have you assessed the potential impact of Brexit on your company? How will your current and future earnings be affected?

    • Which business function(s) (sales, procurement, etc.) will be most heavily impacted?

    • Which of the above mentioned strategies are suitable for your company to mitigate potential risks?

    • What are the key best practices regarding risk management of aspects such as currency, workforce, and supply chain followed in your industry?