Radek Wierzbicki - Currency risk - how and why it is worth protecting yourself [INTERVIEW]

Foreign exchange risk is one of the many types of risk that individual investors also face on the stock exchange. If they place their funds abroad in a foreign currency, they feel its impact the most. Is there a golden mean in which an individual investor can control it? Or is the currency risk just a "penny" issue that is not worth worrying about? These and other questions will be answered by the currency risk specialist Radek Wierzbicki, who currently runs his own company specializing in supporting enterprises in this process.

Radek Wierzbicki is now here President of the Management Board of FX Solutions, previously the founder of Fintech Trends Poland. He is also an award winner CEE Capital Markets Awards in category FX & Payments and 50. Creative in Business according to the Brief Magazine. It is also a member Founders Academy by Google For Startups. He started his career at mBank, Noble Securities, Alior Bank and X-Trade Brokers. Together with Radek, we deliver to clients every week Trefix analyzes of major currencies, which we publish mainly on LinkedIn.

Radek Wierzbicki - About currency risk and ways to minimize it

At the outset, I would like to ask you, how did your adventure with the currency market begin?

My adventure with roaring began in high school. I was passionate about stocks and currencies. I remember going to Warsaw at that time for TMS Brokers training or the Stock Exchange Academy at the Warsaw School of Economics. All the time I imagined being a stockbroker and dreamed about such a professional career. Later, during my studies, I was active in various student organizations, I organized conferences on issues related to the stock exchange and continued training. I was able to get a summer internship at Citi Bank, and later X-Trade Brokers. Then I started working at Noble Securities. Then I was able to take up a job at mBank as a corporate dealer. My responsibilities included servicing medium-sized enterprises in terms of currency risk. Thanks to gathering experience from all these companies, I decided to go on my own. This is how the Trefix, which I have been running today, was born.

In your company blog, topics often appear that encourage the use of local currencies instead of EUR or USD. Is it a short-term incentive? Or maybe simplifying risk management? Will the investor investing capital there benefit more from the local currency?

As always, in such a situation, it should be said - it depends :). If you are buying something in a country where foreign exchange is still weak, you usually have to be prepared for high currency spreads. Of course, we can offer him local currency. Thanks to this, we avoid additional currency conversion costs, in other words, there is a chance that we will get a discount. It also all depends on the difference in interest rates. For example, if we buy something from a country in which interest rates are lower than ours (discount), then based on e.g. forward transactions for a future date, we will have a lower rate. You need to skillfully calculate everything and, above all, know the specification of the instruments.

Currency options are still an "exotic" subject and instrument, and traders are limited to speculating on contracts for exchange rate differences. Could you please explain some technical issues regarding their purchase and use?

Currency options are brilliant in their simplicity. The normal purchase option is comparable to purchasing third party liability insurance. We pay X (in the option, this fee is called a premium). If there is an event that we would like to avoid (e.g. in the case of a car we hit something, and in the case of the exchange rate it will go up significantly), we use the insurance / currency option. In the case of insurance, the insurer covers repair costs. In the case of options, we have the right to purchase the course at the rate we set earlier (we paid for this right at the beginning). Put options work exactly the opposite. If the price drops, we can exercise the right and sell it higher (at the previously agreed rate). What if the rate turns against us and we cannot earn on the option? The matter is generally simple, then we do not use the option - as the name suggests, it is only a right paid by us. We sell the currency "at the market price" at a higher rate.

The currency risk affects not only traders, but also investors who break down their capital into different currencies. Are there any instruments that an individual investor can use? Where to get them? Do I need any "special brokerage / bank accounts" for it?

Imagine an investor who buys stocks in the US, Germany and UK. In fact, it has three currency exposures to the US dollar, euro and pound in addition to its share price risk. If he has gradually bought stocks and bought a currency every few weeks, he may have a problem with estimating the average exchange rate for a given currency. Forward are instruments that allow us to sell a specific currency at a specific rate on a specific day.  Therefore, the investor can hedge both with forward transactions and currency options, but it is worth noting here that the first instrument must settle on a specific day (although it may move, but by a certain number of months). In the case of the second - he has to pay for it. He can use option strategies, i.e. for a combination of several currency options, thanks to which he does not have to pay for it, but in turn, as in the case of forwards - he will have a specific settlement day. These are quite complicated processes. Another disadvantage is that the offer is available in Poland only for corporate and private banking clients. Based on these needs, Trefix grew. We can help with Trefx, where you can monitor the profitability of your currency exposure on an ongoing basis. For example, if we buy EUR 50,000 for PLN 4,4400, and now we can sell on the market for PLN 4,50, we earn an extra PLN 3,000. If we buy a currency or currencies every few weeks and we partially hedge, we may have problems remembering what has already been secured, what is not and what is the profitability of my exposure. This is where Trefix comes in handy.

What do you think is the most affordable risk management foreign exchange instrument for a retail investor? Of course, from the point of view of profitability, simplicity of acquisition / disposal and management.

There is no perfect measure. In the case of banks, forward transactions are available to private banking customers. They are also available in some online exchange offices, but they are always fixed on a date (or with the possibility of changing, but only for a few months). The problem of concluding transactions in exchange offices for a "fixed" date lies in the fact that we will not want to sell shares at that time. We can do a swap (available only in the bank) and then we will avoid the so-called. double spread. It is only available to customers of the above-mentioned segment. On the other hand, we can only include option strategies in the bank. The options themselves - available on the market, but if we want to engage in them, we have to answer the question whether we want to open options every month and pay, for example, 3% of the invested amount as a fee for an option (premium).

Every day you deal with various cases of companies that, colloquially speaking, ignored the topic of risk in their activities. Would you like to share the situation you remember most?

Maybe I'll tell you otherwise. A common case for an importer who assumes that "I will not protect, because it keeps falling". Then, by some strange coincidence, the quotes of this currency pair begin to rise. The importer still fails to hedge until the business is no longer profitable. Then it happens that on the verge of this profitability, he makes a forward transaction and then ... he has a grudge against the bank that he "persuaded" him to extra product. There are few companies in Poland (but also in Europe) that apply a professional policy of hedging currency risk. I mean a systematic and well-thought-out policy consisting in the fact that, for example, when a new commercial order appears, they immediately make a forward transaction, e.g. on 75% of the exposure. Thus, from the very beginning they protect themselves against unfavorable changes in exchange rates. Why not 100%? Each forward transaction utilizes a treasury limit, above which the bank will not allow you to handle larger amounts. The limit is based on your ability to settle future transactions concluded.

Knowing that the currency of the investment is very important, I would like to finally ask you about the risk identification process itself, by planning how to protect yourself against it. I would like you to provide a small instruction, useful for a retail investor who does not know how to go about it.

If there is no hedge, we can, for example, choose a stock market where interest rates are in an increasing cycle. It is a "natural" hedge, over which we do not have to deal too much with various financial instruments.  It may be that then the local currency will strengthen (investors from all over the world buy bonds of this country) and then, for example, after a year we will earn additional money on the currency. For example, in Trefix, it is worth adding such transactions that say that we bought a currency (what was the rate then and what it is today). In this way, we observe the value and profitability of our exposure. We can also point out that we made a forward transaction for something. It is worth starting with this. From keeping a small "log" of transactions, in which we can keep track of how much it actually costs us to invest abroad. Then an exposure is created, the value of which (in the case of larger investments) should be secured. It is also worth taking into account the "trading limits" in which the currency fluctuates. Simply choose those that are less volatile and more stable (of course, within our investment horizon).

If we can make a transaction in the bank, we can do e.g. smaller forward for part of the exposure. It always protects us a bit from volatility :).

Thank you for your time.