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    INTERNATIONAL CORPORATE BANKING | INNOVATION EDGE

    Europe’s new trading partners: managing FX risks and shifts

    authorImage authorImage authorImage 
    Gibran Maqsood, Michael Hache, Olivier Chokron
    30 Sep 2024

    In recent years European trade patterns have shifted, with greater emphasis on emerging markets and local currency transactions. As this continues, corporate treasurers are encountering new challenges in FX risk management. Our treasury experts consider how companies can adapt their hedging strategies, international payments processes, trade finance arrangements, and technology stacks to thrive.

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    Europe’s new trading partners: managing FX risks and shifts
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    Several interesting changes have taken place in the European cross-border trade landscape in recent years. Although the majority (59.9%) of EU trade – imports and exports combined – still occurs within the single market, there has been a notable transition in the focus of bilateral trade towards emerging economies, especially China.1 Whereas trade interactions with long-standing partners have seen less fluctuation in the same period.  

    Trade statistics tell the story

    The shift in trading partners is especially noticeable on the imports side. China was the EU’s principal partner for imported goods in 2022 with 20.9% of the total share, up from 7.8 % in 2002, according to the most recent full-year data from Eurostat.2 The US came in significantly behind China at 11.9%, followed by the UK, Russia and Norway. 

    Meanwhile, the main destinations for goods exported from the EU included the US, the UK, China, Switzerland and Türkiye, among others. Again, China saw a huge leap in the two decades from 2002, with the value of the country’s share of EU exports growing by a staggering 603% in that time.3 Nevertheless, the EU posted a record trade deficit with China of €390bn in 2022 pointing to a significant imbalance between imports and exports.4

    Trading places

    Europe’s traditional trade relationships have experienced heavy disruption since 2020 due to Covid, the increase in geopolitical tensions, including the ongoing impact of Brexit, rising interest rates, terrorist attacks disrupting cargo routes, and international sanctions. 

    This uncertainty is leading to greater interest in trade solutions, with a marked uptick in the need for inventory finance, as well as ESG-compliant solutions. Corporates are looking to reinforce their supply chains against further possible disruptions, which means having sufficient raw materials on hand to produce their goods and enough inventory to fulfil demand in a timely manner. But higher inventory can weigh heavily on working capital, so inventory finance is experiencing a resurgence among European traders.

    Corporates are also making their supply chains more resilient by sourcing from new or additional locations. Alongside China, raw materials from countries such as Mexico and Türkiye are increasingly common in European supply chains. As a result, the currencies in which Europe’s trade transactions are carried out are also evolving at speed. 

    FX risk and hedging 

    As European trade with China, India, Brazil and many other smaller emerging market countries grows, treasurers are suddenly being exposed to a whole new basket of currencies, which have financial risk implications in terms of exchange rates on international payments and hedging strategies.

    Most treasury teams will be managing and monitoring these additional risks with the same resources. This has led many to adopt a systematic approach to hedging secondary exposures in order to focus efforts on managing their primary exposures. 

    But achieving this is not always easy. Hedging emerging market currencies can be much more complex than hedging the pound sterling, for example. It often requires understanding of local regulation, the factors affecting the value of the currency and liquidity conditions. It can also come at a higher cost.  

    Treasury teams can adapt to different environments by thinking smart about hedging: they can optimise the maturity of their hedges to keep hedging cost to a minimum, or selectively use options. 

    FX volatility is here to stay

    FX volatility is not going away. As almost half of the world’s population are experiencing an election this year, there be some FX upset along the way.5

    What’s more, some emerging market currencies have been performing well of late – Brazilian real and Mexican peso, for instance. But, as treasurers will know all too well, emerging market currencies are not as stable as those in developed nations. So, while the outlook may be positive, caution is required, especially when central bank policies across the globe are becoming more dovish. And as interest rates potentially fall again, those emerging market locations may become less attractive to investors – all of which will affect the currency market.

    Meanwhile, the ongoing conundrum of rising energy prices in Europe is weighing heavily on growth predictions. The skewed balance of trade with China is also a concern as Europe’s growth is now more closely tied with China’s own growth These many variables are precisely why a systematic approach to FX hedging is so important. 

    How will this come to bear? 

    2024 will likely see many more trade solutions deployed by European companies for their supplies in China, but also more in India and Vietnam, for example, given their relatively low manufacturing and import costs. They are also more distant from geopolitical tensions, making them more favourable to European buyers.

    Despite the willingness of corporates to explore new sourcing locations, it is likely many will still be cautious. With the ongoing global uncertainty, elections and ambitious energy transition plans in many nations, it is likely that treasurers will have greater scrutiny on country risk and counterparty credit risk in 2024.7

    If sovereign risk comes to bear, and defaults in that country rise, trading relationships will inevitably start to shift once again. As such, it is important to have flexibility in any trade arrangements that are put in place. 

    The increasingly digital nature of trade and the sophistication of trade platforms can help manage this, and a plethora of other risks treasurers may face. 

    1: https://factsanddetails.com/china/cat2/sub90/item50.html  

    2: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=International_trade_in_goods_by_partner#:~:text=A%20majority%20 of%20the%20EU%27s,2002%20to%2040.1%20%25%20by%202022T 

    3: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=International_trade_in_goods_by_partner#:~:text=A%20majority%20 of%20the%20EU%27s,2002%20to%2040.1%20%25%20by%202022 

    4: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Intra-EU_trade_in_goods_-_main_features 

    5: https://www.politico.eu/article/china-rejects-eus-trade-deficit-complaint/#:~:text=Von%20der%20Leyen%20on%20Tuesday,€390%20 billion%20in%202022 

    6: https://www.ebrd.com/news/2023/ebrd-researches-growing-role-of-new-currencies-in-international-trade.html#:~:text=The%20rise%20 in%20global%20geopolitical,and%20economic%20sanctions%2C%20recently%20published 

    7: https://time.com/6550920/world-elections-2024 

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