Initial Situation
Despite a postponement of the House of Commons vote, the British
Prime Minister Theresa May has not yet achieved the necessary majority
for her Brexit plan negotiated with the EU Commission. In its vote on
January 15th, the House of Commons clearly decided against it. As a
result, there is still a very high degree of uncertainty regarding the
timetable and modalities of Brexit: Will it proceed as planned, be
postponed or even cancelled? In addition, it is completely unclear
whether the current government will be able to shape the course of
events at all.
The EUR-GBP spot rate has hardly moved in the last few weeks and has
only briefly left the range of 0.8900 GBP/EUR to 0.9100 GBP/EUR. But is
the market really so calm about a disorderly Brexit or is it just the
infamous “calm before the storm”? With high forward premiums, exporters
to the United Kingdom (GBP recipients) are faced with the difficult
decision of either hedging well above spot today, or continuing to take
it step by step and accepting the risk of being left out in the cold in
case of a sudden, considerable shift in the spot rate. Besides, how
would the volumes of UK exports (and the related GBP inflows) develop,
if the Brexit negotiations were to fail?
In this situation, the current Geistesblitz describes a medium-term
exchange rate hedge for 3 years. It offers exporters to the United
Kingdom emergency cover without having to pay a premium.
The following chart shows the evolution of the EUR-GBP spot rate over the last 5 years.
Market Overview (January 11th 2019):
-
EUR-GBP spot rate:
0.8960 GBP/EUR
- EUR-GBP forward (12.01.2022):
0.9360 GBP/EUR
- Ø EUR-GBP forward (10.01.20202 12.01.2022):
0.9240 GBP/EUR
Multi-EUR-GBP hedge with limited minimum rate
Product description:
The exporter enters into a 3-year ‘multi-EUR-GBP hedge with limited
minimum rate’ from which the client receives a payout if the daily
average spot rate of the previous 12 months exceeds the guaranteed
maximum rate of 1.0000 GBP/EUR.
In return, the client is committed to make a payment if the spot
price at the end of a 12 month-period falls below 0.8700 GBP /EUR. The
minimum rate is only valid to a limited extent:
- The minimum rate is partial: In the first year it
affects 33% of the hedging volume and in the second and third year 67%
and 100% of the hedging volume respectively.
- The minimum price is conditional: It is cancelled
completely, if the EUR-GBP rate is determined at least once at or above
the maximum rate (continuously in 24-hour trading).
The minimum rate initially acts on a reduced notional in order to
avoid the risk of overhedging, especially in the particularly uncertain
early stage of the hedge. In addition, this minimum rate has a
knock-out, which means that it will no longer apply if the EUR-GBP spot
rate reaches or exceeds the maximum rate 1.0000 GBP/EUR.
Indicative terms and conditions:
- Notional of maximum rate:
i.e. 2.000 mio GBP p.a. (in total 6.000 mio GBP)
- Notional of minimum rate:
i.e. 0.660 mio GBP p.a. in year 1, 1.340 mio GBP in year 2 and 2.000 mio GBP in year 3 (in total 4.000 mio GBP)
- Value dates:
Annually over a period of three years (16.01.2020, 19.01.2021, 19.01.2022)
- Expiry dates:
For the maximum rate daily fixing, calculation of the average rate at the end of the year.
For the minimum rate at the end of the year. (14.01.2020, 15.01.2021, 14.01.2022)
- Maximum Rate:
1.0000 GBP/EUR
- Minimum Rate:
0.8700 GBP/EUR
Knock-Out Condition:
The minimum rate shall not apply, if the price threshold is reached or exceeded at least once during the term of the contract.
Barrier:
1.0000 GBP/EUR
Benefits and Risks from a client perspective:
Benefits:
- Securing a maximum average rate of 1.0000 GBP/EUR for GBP sales over the next 3 years without paying a premium.
- The minimum rate is only effective for a reduced notional.
- The minimum rate does not apply in the event of an increase of the spot rate to or above 1.0000 GBP/EUR.
Risks:
- For a part of the notional the customer commits to a minimum rate of 0.8700 GBP/EUR.
- The maximum average rate of 1.0000 GBP/EUR significantly exceeds the average forward rate of GBP 0.9240/EUR.
In a nutshell
With the Geistesblitz ‘multi-EUR-GBP hedge with limited minimum rate’
exporters to the United Kingdom have a strategy at hand to be prepared
in case of significant spot shifts in the medium term following a
potential disorderly Brexit.
In return, the customer commits to a minimum rate for a lower
notional amount, that accounts for the uncertainty of sales and hedging
volumes. The minimum rate does not apply in the event of a significant –
possibly only temporary – shift of the EUR-GBP spot rate.