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Welcome to the fifth edition of our Business Risk Report, which offers a unique insight into the attitudes and hedging approaches of UK businesses towards financial market risks.
Our focus for the Business Risk Report remains, as ever, to highlight the impact on UK businesses of four key economic considerations: interest rates, commodity prices, general inflation and FX and their approaches to risk management.
Business confidence in our survey dropped to its lowest level for more than two years, driven primarily by the European sovereign debt crisis in the latter half of 2011. More positively, businesses’ expectations regarding exports to territories outside of Europe remain relatively robust. Nevertheless, overall economic prospects continue to be highly uncertain.
The proportion of companies concerned about interest rate rises remains elevated, especially among smaller companies in our survey. At the same time, the share of companies concerned about currency movements has risen compared with six months ago, especially in the retail and manufacturing sectors.
Of the larger companies surveyed (with an annual turnover above £15m) 61% were concerned about their exposure to FX risks. However, only a quarter of these companies intended to put in place risk management strategies to protect their business, with most citing that they were ‘already sufficiently protected ’. For smaller companies, our survey shows that the single most important reason for not taking measures was ‘a lack of knowledge of how to protect against the risk’.
It is here that our expertise can really add value in our role of exploring ideas with you about risk mitigation. Building a trusted risk advisory capacity is key for us, so we can provide you with expert advice and tailored risk management solutions. In these uncertain times, companies can ensure that they are adequately covered against those risks that may threaten the financial performance of their businesses.
With this in mind, I hope the Business Risk Report serves as a useful reminder about the importance of pro-active risk management strategies.
Managing Director, Head of Sales
Lloyds Bank Wholesale Banking & Markets
The Business Risk Report offers a unique insight into businesses’ perceptions of key financial market risks – interest rates, currencies, inflation and commodity prices – and the degree to which companies have taken new or additional measures to protect themselves against such risks.
The Report draws from special questions in a survey of 1,811 companies in the Lloyds TSB Commercial Business in Britain report, published in January. The survey covers all industry sectors and regions of Great Britain. About a quarter of the companies have annual turnover of less than £1 million, two-thirds have turnover of £1-15 million and the remainder have turnover above £15 million.
TRENDS IN BUSINESS CONFIDENCE
Confidence about UK economic prospects fell among the companies to the weakest level for more than two years. The fall was driven primarily by the intensification of the euro sovereign debt crisis in the latter half of 2011.
Our measure of business confidence, which takes into account expectations for total orders, sales and profits in the next six months, fell further below the long-term average and is signalling a period of broad stagnation. According to the survey, domestic demand prospects remain fragile and exports to Europe are anticipated to fall sharply, while investment and employment trends are expected to remain weak. On a more positive note, businesses' expectations regarding exports to the rest of the world (outside Europe) remain relatively robust.
PERCEPTIONS OF KEY FINANCIAL MARKET RISKS
The intensification of the euro area sovereign debt crisis in he second half of 2011 has weakened the UK economic outlook. Prospects of an increase in official interest rates have been pushed back and swap rates have fallen to new lows. At the same time, the economic outlook remains highly uncertain and will to a large degree depend on progress in the resolution of the euro crisis, as well as on a successful deleveraging of both he public and private sectors in the coming years.
With interest rates expected to stay lower for longer, the proportion of companies in our survey concerned about the impact of interest rate rises on their business fell but remained elevated. In total, 63% of companies were either very concerned or somewhat concerned about interest rate rises, down from 76% in the previous survey.
There was a marked rise in the proportion of companies concerned abut the impact of currency movements on their business. Overall, 68% of companies were either very concerned or somewhat concerned about currency movements, up from 47% in the last survey.
Global commodity prices trended slightly lower in the second half of 2011 after reaching a high in the spring, while domestic inflation (CPI) peaked in September. Companies in our survey remained significantly concerned about the impact of inflation and commodity prices on their business, but marginally less so than the previous survey. Overall, 85% of companies were either very concerned or somewhat concerned about inflation, down from 89% in the last survey, while 78% were either very concerned or somewhat concerned about commodity prices, down from 79%.
INTENTION TO PROTECT AGAINST FINANCIAL MARKET RISKS
Given the large share of SMEs in our survey sample, the proportion of companies expecting to take new or additional steps to protect their business against financial market risks remains low, though there were some changes compared with the last survey.
There was a notable fall in the proportion of companies intending to guard against interest rate rises to 13%,compared with 22% in the previous survey. The proportion of companies expecting to insure against currency movements rose to 15% from 14%, though the rise was marginal despite the notable increase in concerns about this financial market risk.
The proportion of companies expecting to protect their business against inflation and commodity price risks fell in the latest survey. overall, 19% of companies intended to take new or additional measures to guard against inflation, down from 26% in the previous survey, while 26% expected to shield their business against commodity price risks, down from 28%.
REASONS FOR NOT PROTECTING AGAINST FOREIGN CURRENCY RISKS
Our topical question asks companies that have foreign currency exposure their single most important reason for not intending to take new or additional measures to protect their business against this risk.
The most important factor was a 'lack of knowledge of how to protect against the risk', cited by 22% of companies. The second most important factor was a 'preference to leave the risk unprotected', referred to by just below 22% of companies - perhaps reflecting a perception that the risk was small or that there was sufficient capacity to absorb the risk. The third most important factor was 'already sufficiently protected', referenced by 21% of companies. The 'cost' of protecting against currency risk was mentioned by 16% of companies, while 9% cited the 'availability of credit' and 10% referred to 'other' reasons.
Companies in the retail and manufacturing sectors were the most concerned about the impact of foreign currency movements on their business. Concerns about interest rate rises were the highest in hospitality & leisure, retail & wholesale and construction. Commodity price concerns were particularly high in manufacturing, construction and retail & wholesale, while inflation concerns were the highest in hospitality & leisure.
INTENTION TO PROTECT AGAINST FOREIGN CURRENCY RISKS
Intentions to take new or additional measures to guard against foreign currency movements mirror concerns about this risk. Overall, 24% of companies in retail and wholesale and 23% in manufacturing planned to protect their business against foreign currency risks. In contrast, only 3% of companies in construction and 10% in the hospitality & leisure and other services sectors intended to adopt new or additional measures to insure against adverse foreign currency movements.
For companies that have foreign currency exposure, the single most important reason for not guarding against this risk in the manufacturing sector is that they were either ‘already sufficiently protected ’ or that they ‘prefer to leave the risk unprotected ’. These factors are also important for companies in the retail & wholesale sector, though the ‘lack of knowledge of how to protect against the risk’ was the single most important reason. In the construction and hospitality & leisure sectors, the ‘lack of knowledge of how to protect against the risk’ was by far the most important reason for not insuring against foreign currency movements. The ‘cost’ of protecting against currency risk was cited by about 15-20% of companies across the sectors, but it was generally not the most important reason.
Larger companies in our survey tended to be more concerned about the impact of foreign currency and commodity price risks on their business than smaller companies. Overall, 61% of companies with an annual turnover above £15m were either very concerned or somewhat concerned about foreign currency risks, compared with 48% of companies with an annual turnover below £1m. However, smaller companies tended to be more concerned about the impact of interest rate rises, with 65% of companies with an annual turnover below £1m expressing a concern, compared with 58% of companies with an annual turnover above £15m. Concerns about inflation risks were similar across firm sizes.
Intentions to take new or additional measures to guard against financial market risks mirror concerns about these risks. Larger companies were more likely to protect their business against foreign currency and commodity price risks, while smaller companies were more likely to insure against interest rate rises. Mid-sized companies with an annual turnover between £1m and £15m were the more likely to guard against inflation risks than other firm sizes.
Small companies with an annual turnover below £1m that have foreign currency exposures were mostly likely to cite a ‘lack of knowledge of how to protect against the risk’ as the most important reason for not insuring against this risk. Mid-sized companies with an annual turnover between £1m and £15m were most likely to mention a ‘preference to leave the risk unprotected ’, though a ‘lack of knowledge’ and being ‘already sufficiently protected ’ were also important reasons. Larger companies with an annual turnover over £15m were most likely to say that they were ‘already sufficiently protected'.