Guest Post: How can the travel industry adapt to rising currency volatility?

Guest Post: How can the travel industry adapt to rising currency volatility?

Jason Gaywood, Head of Corporate Solutions at FX-as-a-Service provider MillTechFX, discusses why travel firms must begin prioritising FX risk management to protect their bottom lines against the rising threat of currency movements.

Travel companies have faced an increasingly challenging landscape over the past few years, and were some of the most hard-hit by the Covid-19 pandemic. According to the World Tourism Organisation, international travel plunged by 72% in 2020 - the worst year on record - causing the global tourism and travel sector an estimated $2 trillion in lost revenue in 2021.

While travel is gradually climbing back to pre-pandemic levels, inflationary pressures are hampering its recovery. Many people are now avoiding going on vacation because of the economic situation, and combined with rising operating costs, the World Tourism Organisation predicts that the industry won’t fully recovery until 2024.

Amongst the growing number of challenges facing these firms is the threat of adverse currency movements. Their overseas exposure makes them highly exposed to foreign exchange (FX) volatility, but many may have traditionally seen FX as second order. They transact in FX not because they ‘want to’, but because they ‘have to’ given their international nature.

However, with currency volatility looking set to stay, now is the time to assess the FX challenges that travel companies typically face and how best to implement effective risk management strategies against these threats.

What are the FX challenges?

Travel companies face several challenges on the FX front:

  • International service chain – They are particularly exposed to currency movements due to the international distribution of the tourism service chain. Tour operators, hotel chains and transport providers may all be based in different countries and therefore require payments in multiple currencies, heightening exposure to fluctuations in exchange rates.
  • Long invoice processing periods – When selling customers tours or flights, destination management companies and travel agencies often set their price well ahead of time, sometimes up to 18 months ahead. This means that if currencies fluctuate between a customer’s advance payment and the moment foreign suppliers need to be paid, the travel company may find itself having to cover the difference.
  • Visitor-weighted exchange – Visitor weighted-exchange measures a destination’s currency market with those of its primary visitor market. Countries that rely on a large proportion of tourists coming from one specific country are susceptible to changes in the exchange rate between these two countries. In Mexico, for example, the Word Travel and Tourism Council estimates that 84% of international arrivals come from countries using the US dollar. This means where the visitor-weighted exchange is high, fluctuations in exchange rate may have a particularly large impact on the destination country’s travel sector.

A more strategic approach to FX risk management

Whilst FX management cannot change the external environment, there are several steps that travel companies can take to reduce the associated costs and minimise volatility risk. These include:

  1. Use of Transaction Cost Analysis (TCA) - TCA was specifically created to highlight hidden costs and enables firms to understand how much they are being charged for the execution of their FX transactions. Ongoing, quarterly TCA from an independent TCA provider can be embedded as a new operational practice to ensure consistent FX execution performance.
  1. Compare the market - Many travel firms may be hampered by their inability to access Tier 1 FX liquidity, meaning they often rely on a single bank or broker to meet their hedging requirements which can be a barrier to best execution. Having the ability to put trades up for competition is central to ensuring access to the best price, which is key to effective risk management.
  1. Outsourcing – When using the right partner, outsourcing can improve transparency and execution quality. This can enable travel firms to dedicate more time to core business matters, which is all the more important given the current high operating costs.
  1. Strong governance – The tourism service chain can be logistically complex, from tour operators to accommodation and transport providers, with each potentially requiring payment in different currencies. Harnessing solutions which can strengthen governance may help travel firms improve the cost, quality and transparency of their FX execution.
  1. Diversification of liquidity providers - One of the big lessons from recent banking failures is the importance of having access to multiple counterparties. Many CFOs have taken this lesson onboard and are now making changes for the better, with one in four (28%) planning to diversify their deposits across more banks, according to Gartner. This means if one counterparty becomes unavailable, a travel company can continue to manage and execute FX trades.
  1. Automation - Despite the rising threat of currency movements, many travel firms may still lack the necessary tools to mitigate the impact of FX volatility and continue to rely on manual processes like phone and email to execute FX trades. Harnessing automated solutions can offer end to end workflow, greater transparency and faster onboarding, helping finance departments streamline their FX functions.

The travel industry has faced a tough few years, and with currency movements set to remain volatile for the foreseeable future, FX risk must no longer be considered second-order. Harnessing technology-driven tools and getting the right processes in place will help enable many travel companies to navigate mounting FX challenges and protect their bottom lines.