The Swiss National Bank (SNB) sent shockwaves across global financial markets on January 15, 2015, when it abandoned its exchange rate floor that had up to the point pegged the Swiss franc (CHF) to the euro.
In this article, we look back on the "SNB crisis," the impact that it has left on currency exchange, and what businesses can do to avoid future fallouts.
The SNB Crisis: What happened exactly?
The SNB decision came without any warning or indication that it was in unhappy with the peg. And so the overnight decision understandably led to nothing short of outright panic among traders and brokers around the world, spooked that a major currency could move more than 25% in mere minutes.
At the time, the euro was in a precarious position. It had depreciated a lot against the U.S. dollar and the European Central Bank was unleashing its massive quantitative easing program as a last resort to kickstart the embattled euro zone, which was up to that point unable to shake off its sovereign debt crisis and return to any meaningful growth.
To add to nonexistent growth, political instability was quickly taking shape, with Grexit in particular soon to be on the horizon, as well as a wave of populism sweeping across the continent.
Before the SNB crisis began, the Bank was steadily selling Swiss francs to buy seemingly ever more euros. With its euro reserves growing fast, and the single currency in a decidedly dicey position, the SNB simply lost confidence. So it chose to pull the Swiss franc from the peg that kept it at no more than 1.20 per euro.
How has it impacted foreign exchange since?
Foreign exchange speculators have taken precautionary measures since the SNB crisis so as not to be exposed to such an event again. If something of a similar magnitude were to happen to the U.S. dollar or euro, it would impact speculators and businesses around the world.
Finance professionals must be aware of the risks associated with currencies that are pegged to a reserve currency. Such pegs carry more FX risk and there is a need to be prepared for the unexpected. Part of this preparedness has seen a greater demand for forex brokerages to offer negative balance protection.
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How can businesses prepare for events like this in future?
Central bank decisions like the SNB's are "black swan" events for a reason—they are uncommon and unpredictable. However, there are tactics business can arm themselves with to minimize exposure.
The good news is that, by and large, central banks are predictable, cautious, and actively seek to avoid shocks. Such sudden events are few and far between, but history teaches us that they will likely happen again. So how can businesses prepare?
1. Know your exposure
Carrying out a comprehensive review into your currency exposure and the volumes involved sets the foundation for your subsequent risk strategy. It should include all currencies and all accounts receivable and accounts payable. Read more on FX risk management here.
2. Diversify your exposure
If, for instance, importers are exposed to any one currency in particular, they are at serious risk should their home currency depreciate. For a perfect example, look at the U.K. right now: Since Brexit, U.K. businesses relying on imports from the euro zone have had to pay around 12% more in pound sterling, whereas imports in U.S. dollars cost about 5% more.
All this despite the pound being categorized as a major currency and regarded as more stable. If your company works with minor or exotic currencies, you need to be even more careful.
3. Use hedging products
Your business can protect its margins with financial products that essentially act as insurance policies against FX risk. Forward and options contracts are two simple tools that lock in rates for a defined period of time. So if an unexpected event occurs or, more likely, a currency gradually weakens/strengthens, your exchange rate won't be affected. Hedging products are an excellent means to manage FX risk when doing business abroad.
The SNB crisis is a reminder of how seemingly calm currency markets can get turned upside down in the blink of an eye. The lesson is to be prepared for the worst.
Sudden events will continue to affect companies operations and bottom lines and even lead to businesses closing down altogether. With unpredictable political and economic developments happening more and more frequently, from the Russian rouble crisis in 2014 to the U.S. presidential election of Trump, and from Brexit to developing international trade wars, preparing your company with an effective risk management strategy is not just important. It's mission critical.