The New Zealand dollar is a small, freely floating and heavily traded currency, which makes it more volatile than the size of the economy would suggest. For businesses buying or selling in foreign currency, that volatility is capable of consuming an entire trading margin between quote and settlement.
Where the exposure actually sits
Three types are worth distinguishing because they need different treatment:
- Transaction exposure — a committed payment or receipt in foreign currency at a future date. This is the exposure most businesses recognise and the one hedging tools address directly.
- Economic exposure — the effect of currency movements on competitiveness even where you trade in New Zealand dollars. A domestic manufacturer competing against imports has currency exposure without a single foreign currency transaction.
- Translation exposure — the effect on reported results of consolidating foreign subsidiaries. An accounting issue rather than a cash one.
The exposure also starts earlier than most businesses think. It begins when you quote, not when you invoice. A fixed-price quote in foreign currency valid for 30 days is an unhedged position for those 30 days.
The tools
Forward exchange contracts are the workhorse. You agree today to exchange a set amount at a set rate on a future date. Certainty is the benefit; the cost is that you cannot participate if the rate moves in your favour, and you are committed even if the underlying transaction falls over.
Foreign currency accounts let you hold receipts in the currency and use them to pay costs in the same currency — a natural hedge that costs nothing. An exporter selling in Australian dollars who also buys components in Australian dollars should be netting rather than converting twice.
Options give the right but not the obligation to exchange at a set rate, so you keep the upside. You pay a premium for that, and for many small businesses the premium is not justified relative to a forward.
Natural hedging through matching currency of revenue and costs, or through contract terms that share currency risk between buyer and seller, is under-used and often the cheapest answer.
Hedging is not speculation, and the distinction matters
A business that hedges a committed exposure has reduced risk. A business that takes a currency position because it expects the dollar to move has increased risk, whatever the instrument used.
The failure mode is a business that hedges when the rate looks good and does not when it does not — which is a view on the currency dressed as a policy. Almost nobody predicts exchange rates reliably, including the people paid to.
The alternative is a written policy: what proportion of exposure is hedged, over what horizon, and who is authorised to transact. A policy removes the temptation to time the market with the company’s working capital.
Practical guidance for smaller businesses
- Know your net exposure by currency and by month. Many businesses hedge gross when they have offsetting flows.
- Build currency into pricing. Either quote in New Zealand dollars, limit quote validity periods, or include a currency adjustment clause.
- Hedge a proportion rather than all or nothing. Covering 50 to 80 percent of committed exposure removes most of the risk without creating a problem if a transaction changes.
- Watch the margin requirements. Forward contracts may require collateral if the position moves against you, which is a cashflow event nobody budgets for.
- Compare the all-in rate, not the headline. The spread on smaller transactions varies substantially between providers, and non-bank foreign exchange providers are frequently cheaper than banks for straightforward conversions.
The interaction with Incoterms and payment terms
Currency risk compounds with the other terms of an international sale. A long payment term extends the exposure window, and an Incoterm that delays the point of transfer extends it further.
Where you have limited leverage on price, negotiating the currency of the contract or a shorter payment term can be worth more than the price difference — and is sometimes easier to obtain.
Accounting and tax
Foreign currency gains and losses have specific tax treatment, and the financial arrangements rules can apply to forward contracts and foreign currency debt. The treatment is not always intuitive, and a business with material exposure should confirm the position rather than assume gains and losses simply follow the accounting.
The Reserve Bank publishes exchange rate data, New Zealand Trade and Enterprise publishes exporter guidance, and MFAT publishes market reports covering trade conditions — all free.
General information only, not financial advice. Talk to your bank or a licensed adviser about your own exposure.
