ROGER HEWSON: The art of the hedge amid frightening freight headwinds
Demand recovery in the third quarter of 2020 created the conditions for the surge in freight charges
When much of the world was in lockdown and deep into recession in the second quarter of last year, it was hard to imagine that the world’s cargo trade would ever return to its prepandemic levels.
Clearly the world’s shipping lines did not expect so, which is why 40% of the industry’s capacity was taken out of service. But when demand began to recover rapidly in the third quarter of 2020, particularly in China and US, this created supply-demand imbalances that persisted into 2021, with the Suez Canal blockage in March and disruptions in key ports in southern China in June causing further cargo backlogs.
All of this has helped create the conditions for the surge in freight charges over the past year of more than 500% globally for standard container shipping rates. Problems in accessing containers have added to the challenges, as have SA’s own issues of disruption and dysfunction at the ports and on roads.
With little sign that the supply and demand dynamic of the freight market will come back into balance much before 2023, the question for importers and exporters is what to do to contain the ever steeper logistics costs they face.
They may not be able to do much about global freight disruptions and record global freight charges. But there is still much they can do to manage their risks and control their rand costs, given that the rand is one of the world’s most volatile currencies. Recent changes to the exchange control rules have provided a lot more flexibility, which allows them to optimise this.
There are three possible components to the risk management strategy an importer or exporter might consider. First are shipping costs. These are complicated to hedge because the variety of containers, carriers and charters means it is challenging to identify an underlying benchmark against which the exposure should be hedged. Such hedges would generally be customised, over-the-counter instruments that bankers would have to devise for their clients, and they would need to consider whether there is adequate liquidity in the underlying market. Ensuring transparency in the pricing is crucial so clients can ensure the costs of the transaction are not prohibitive. But if there is demand from clients banks could look at hedging freight costs, as they have done in the past.
The second component — hedging the rand-dollar exposure on the goods themselves — is a lot simpler and will be familiar to most importers and exporters. The rigid exchange control restrictions for cross-border payments of a decade ago have been replaced by a much more flexible and user-friendly system, with the SA Reserve Bank recognising that the rand is extremely volatile and those transacting across borders need to be able to hedge their risk. Clients no longer have to prove a “fixed and ascertainable” commitment, or have a firm delivery date, though they do still need to be able to demonstrate, and document, that there is an underlying transaction on pay-away. They need to be aware, also, that there is no carte blanche that allows people to speculate or punt on the currency.
A key change is that the Active Currency Management system was liberalised in October 2019 to extend the period between the cross-border transaction and the foreign payment from six months to 12 months. Few businesses would need to hedge for longer than 12 months and the new dispensation therefore makes it far easier to hedge, and indeed to trade in and out of hedges as needed.
Importantly, businesses may hedge exposures even where they are not directly paying the invoice themselves, though in this case Reserve Bank approval is required. As long as you can show exposure to an underlying transaction, you can request permission to hedge it even if, for example a freight forwarder or shipping agent is the entity directly paying the invoice. In effect, if someone is passing on the currency risk to you, you are permitted to hedge that risk.
Many businesses may be unaware of the third component, which is that customs and excise duties on the transaction can be hedged. The SA Revenue Service levies customs duties in rand, but on the day the goods are cleared it takes the dollar invoice and converts it at the prevailing spot exchange rate to give the rand-based duties. The principle is that the freight or duties are expressed in rand but they look back to the foreign currency in which the goods were invoiced. The importer therefore has an indirect underlying exposure to that foreign currency and can take out a hedge to lock in the rand exchange rate.
The range of products and instruments available to manage the currency risk on cross-border trading is wider than it ever has been, and the exchange control authorities have allowed clients more flexibility than ever to reduce their currency risk, and hence their costs. In an environment in which global shipping and the global container trade are likely to take at least another year or two to normalise after the unprecedented ructions triggered by the pandemic, managing all the other costs is more important than ever.
• Hewson is client structurer in RMB’s markets business.
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