After hitting an all-time low against the US dollar in 2022, the British pound reversed course and gained over 25%. The weakness that led to last year’s low originated in 2016 when Great Britain voted to leave the European Union. Economists have said that Brexit caused British GDP to underperform over the last seven years, a major reason that the pound experienced a period of prolonged weakness. Despite the recent recovery the pound is still approximately 10% lower than it was in 2016, and the big swings have presented significant challenges to companies that do business with Britain.
Looking Back at Brexit
On June 23, 2016, United Kingdom voters shocked the world and chose to leave the European Union. As a result, the British pound dropped sharply, losing over 10% of its value against the Euro and the U.S. dollar in 24 hours. Repercussions remain seven years after the vote as the pound has taken a roller coaster ride in Forex markets.
Politics and FX have something in common: we should always expect the unexpected. Going into the Brexit vote, pollsters and traders were confident that British citizens would elect to remain in the EU. The pound increased 6% against the dollar leading up to the referendum, but this proved to be fool's gold.
Companies doing business with the UK immediately felt the effects of the de facto devaluation of the pound. Many corporations took huge losses on pound-denominated assets, resulting in bankruptcy for countless businesses.
Negative Effects of Brexit
- The pound is now worth 10% less than the pre-Brexit price
- There has been higher inflation and lower growth in the UK.
- Corporate bankruptcies and job losses have increased.
- UK companies have increased the complexity and cost of doing business with euro-denominated countries.
Positive Effects of Brexit
- EU regulations (restrictions on electric appliances, licensing of health professionals, standards for food quality, labor rules, etc.) no longer bind the UK.
- The UK has political sovereignty.
- UK citizens have independent, non-EU passports.
Despite the benefits, most economists say they pale in comparison to the overall negative impact of Brexit.
Limiting “Brexidamage”
Brexit is a great use case for FX hedging. The vote was scheduled five months in advance, and anyone with pound risk had ample time to prepare. A vote to leave the EU was bound to cause a volatile move in the British currency, but employing the following strategies could have helped companies with exposure to pound risk.
- OTC or Exchange-Traded Options: Companies with downside risk could have purchased put options, while companies with upside risk could have bought call options. Options premiums were elevated due to the forecasted volatility, so buying options would have been more expensive than usual.
- Forex Forwards: These custom OTC products allow customers to lock in the current price of the pound for a future date.
- Futures Contracts: Futures contracts are an effective risk management tool as they precisely track the movement of a specific currency. Users of futures would have been subject to higher than normal margin requirements because the exchange raised margins in anticipation of a volatile event.
The magnitude of the pound’s move may have been a surprise, but analysts expected the pound’s price to react to the vote. Many businesses were caught flat-footed without any risk mitigation plan. But there is a solution to hedge risk on your forex currencies: Pangea Prime. Pangea’s platform combines Ai and world-class technology to help your business manage FX risk at the speed of markets. Pangea Prime uses decades of market data, ingesting millions of data points to calculate the best strategy, to analyze how currency fluctuations may impact your P&L.
With Pangea Prime, companies can leverage technology and Ai to maneuver the FX risks involved in geopolitical events.
Schedule a demo today and get the predictability and control you deserve in your business.
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