This combined with a major weakening of Sterling against the US Dollar and Euro Graph A will have a large impact on the valuation of assets and liabilities for UK companies with significant exposures in these currencies. Additionally, the high FX volatility is likely to cause substantial intraday valuation movements, further highlighting the importance of strong diligence around valuation cut-off times.

Determining a company’s functional currency

This should drive the adoption of a consistent approach mitigating the operational impact. FX forward curves represent the pricing of contracts exchanging currencies in the future, so should be interpreted as the cost of hedging future currency receivables, rather than as an accurate prediction of where exchange rates will be in the future. However, bearing that in mind, it can still serve as an informed reference point as to the market's perception of where exchange rates will be in the future.

Not surprisingly, between the year-end and the beginning of April, Sterling shows a significant fall in value against the US Dollar across the curve Graph C. However, the shape of the curve has also changed. At year-end the market was expecting Sterling to strengthen against the US Dollar in the 6-month to 2-year period and beyond although liquidity drops beyond 2 years. Winding the clock on to early April and the curve for the same 6-month to 2-year period is essentially flat suggesting that interest rates will remain low as the UK endures a slow and prolonged recovery. Yen and Euro reprice relative to the Dollar but have broadly similar curve shapes across the period.

Graph C. Evolution of majors forward curves Source: Refinitiv Datastream.

The Analyst: Will COVID-19 push some foreign exchange providers over the edge?

FX Forward contracts are the mainstream products for corporate and commercial banking hedging strategies against FX fluctuations. Additionally, the high FX volatility can result in substantial intra-day movements in the valuation of FX derivatives and foreign currency assets and liabilities. This emphasises the importance of strong diligence and consistency around valuation cut-off times and the performance of sensitivity analyses to identify the areas where this increased volatility can have a large valuation and hence operational impact.

The treatment of any derivatives under hedging arrangements should also be revisited.

Companies will now need to interpret the repricing illustrated in the forward curves, particularly the flatness of Sterling Graph C in the context of their underlying exposures as this may have implications for the volume of hedging needed, and determine whether the cost of hedging needs further consideration and is still consistent with their policy. The cross currency basis represents the amount by which the interest paid to borrow one currency by swapping it against another differs from the cost of directly borrowing this currency in the cash market.

Managing foreign exchange risk

It exists because FX derivatives, including forwards and cross currency swaps, involve an actual transfer of currency. In line with the overall trend in the FX markets, the basis adjustment for cross-currency swaps has become more volatile Graph D. During the first half of March, basis spreads of major non-USD currencies decreased further, highlighting market counterparties efforts to secure USD funding.

In general, the cross-currency basis is a measure of US Dollar shortage in the market. The more negative the basis becomes, the more severe the shortage.

The basis spread is a key component of the pricing and valuation of FX instruments. Consequently, strong diligence should be exercised around the reliability of the source of valuation inputs, including basis sourcing, on cross currency swaps to enable robust valuation reporting and mitigate any operational impact of mispricing. Access to curves that include and exclude the basis will allow them to quantify its impact.

Generally cross currency swaps are used to hedge long-dated contractual exposures, such as bonds or loans issued in a foreign currency. Given the ongoing volatility and repricing of the basis, companies should also consider whether there are now opportunities to benefit from the basis. For example presented through synthetic financing.

Thus, whether it is advantageous to issue debt in their domestic currency vs an equivalent issuing and servicing debt in a foreign currency followed by a cross-currency swap transaction. As the latter incorporates the impact of the relative basis between the two currencies it could present opportunities to some companies for lower-cost financing. Further for US Dollar-funded investors, negative basis can work in their favour when they hedge currency exposures i.

Thus through hedging foreign currency exposure, they can lend out US Dollars today and receive it back in the future, earning additional cross-currency basis spread on top of the yield of their foreign investments. Companies often avoid using options to hedge exposure given the upfront premium involved.

This will, generally, have become more expensive given the rise in implied FX volatilities. According to a briefing from PwC , Nigeria urgently needs a private sector funding policy initiative for mining to encourage banks to lend to the sector.

For part 2, click here. For part 3, c lick here. For part 4, click here. For part 5, click here. For part 6, click here. We believe that Africa is poorly represented, and badly under-estimated. Beyond the vast opportunity manifest in African markets, we highlight people who make a difference; leaders turning the tide, youth driving change, and an indefatigable business community. That is what we believe will change the continent, and that is what we report on.

Corporate Treasury Solutions | PwC

With hard-hitting investigations, innovative analysis and deep dives into countries and sectors, The Africa Report delivers the insight you need. In the second story of our series, we look at the impact of COVID on Nigeria's economy as it considers the outlook for banks who have lent to oil producers. The challenge is to protect small start-ups that represent the future of innovation. In the fourth story of our series on the impact of COVID on Nigeria's economy, we look at why the country's neglected gas reserves need to form part of the energy reforms.

In the sixth story of our series on the impact of COVID on the Nigerian economy, we look how the pandemic has affected agriculture. Give yourself a headstart: Get full access to The Africa Report on all your devices. Subscribe now. Naira Nightmares. In depth This article is part of the dossier: How will Nigeria navigate the pandemic.

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