The challenges faced by UK businesses paying staff overseas

Head of FX Risk Management and Derivatives, Rehan Ansari puts together an article about the challenges faced by UK businesses paying staff overseas.

The challenges faced by UK businesses paying staff overseas  

Businesses with foreign currency exposure are constantly challenged by volatility in exchange rate movements. Both economic factors and political issues have a huge part to play in driving these fluctuations. Swings are often sudden and unexpected and can have a rippling effect on financial markets worldwide. Consequently, this kind of uncertainty makes it difficult for business executives to forecast market demand, operating costs, and sales volumes in order to determine underlying profits. In fact, our research shows that three quarters of UK financial directors surveyed are concerned about their company’s ability to manage the risks posed by currency volatility, and its impact on the bottom line (1).

 

Foreign payroll

UK companies employ nearly 5 million people overseas according to figures from the Office for National Statistics (ONS).  As regular salary payments need to be made for these employees, managing the exposure to currency risk is an endless battle and places an additional burden on financial controllers who are at the mercy of the markets.  Fluctuations between countries’ foreign exchange rates can wreak havoc on even the most accurately predicted payroll expenses.  The challenges faced by businesses when employing workers in foreign countries means that they need to consistently monitor labour costs, inflation, unemployment rates, laws and regulations, and local and foreign tax liabilities to stay ahead of the markets.

 

Some businesses face even bigger hurdles when having to fund payroll in emerging market countries that do not allow physical settlement of their currency through forward contracts, for example in India and Brazil. Unhedged, it would mean businesses carry the risk of exchange rate movement for the period they are exposed. There are however strategies that can be implemented to mitigate currency risk when exposed to emerging market currencies.

 

Exchange rates 

Not all countries are part of a monetary or currency union that involves sharing a single common currency and opposing exchange rates are rarely at parity, hence the rates between two countries – a business’s home country and the overseas staff payroll country - can be vastly unpredictable. This unpredictability can mean that a business’ annual profits can be wiped out instantly if exposure risks are not fully considered and properly managed. A business cannot choose to withhold pay from its employees for a week or a month if foreign exchange rates are at an unfavourable level – its foreign payroll must still be funded and paid, even if the foreign exchange rate means that the amount to be paid is much higher in the business’s home currency.

 

Solutions to manage foreign exchange rate fluctuations

More and more businesses are now implementing a robust plan to manage exchange rate volatility by ordering currency in advance and locking in a set value for peace of mind and to control cash flow.

 

Hedging techniques are widely used to mitigate risks of trading currencies. Nearly two-thirds (65%) of the financial directors, controllers and managers responsible for expenses and FX payments in companies we questioned in our research claimed that having a strategy had the positive impact they’d anticipated.  The majority of these companies review their strategy on a weekly (35%) or monthly (39%) basis.

 

An established international currency service provider like Caxton, can help businesses implement a hedging strategy to address its foreign payroll obligations, as well as execute the currency transfers necessary for businesses to ensure foreign payroll requirements are met on time.

 

The same foreign currency service provider should also assist in transferring revenues from clients in those foreign markets back to the businesses home currency as every transaction will have an exposure to FX market fluctuations.

 

Moreover, changes in mid-year forecasts may require businesses to adjust their workforce for various reasons. For example, if a business has employees in a foreign country, the business will have an accurate estimate of the number of employees required and how much each employee costs the firm, in terms of their payroll expense. If the workforce is reduced by 25%, the business may need to adjust an existing hedge to account for the reduced foreign currency requirements - having a flexible strategy that allows for such circumstances can be beneficial.

 

Hedging strategies can help with so much more than just managing payroll. For example, some businesses may require a hedge to boost their profitability by participating in favourable market movements to enable businesses to reduce costs.

 

In conclusion, where a business is exposed to overseas payroll and requires a level of certainty to protect against FX fluctuations and ultimately the businesses profitability, the use of a currency hedge is an ideal solution to offset potential losses against volatility.   

 

 

 

By Rehan Ansari - Head of FX Risk Management & Derivatives, and Kevin Bottwood – Head of Bulk Payments at Caxton Business

References

1)    Caxton Report - Currency Risk Management in 2020 – The impact of FX volatility and the use of hedging techniques in the UK  - https://www.caxtonfx.com/business-affiliate/sm/p-risk-management-guide-2020/

 

2)    The number of overseas employees working for UK companies has increased by 13 percent from 4.39 million to 4.98 million according to new figures from the Office of National Statistics.