Are you au fait with Exchange Rates?

Welcome to the sixth edition of our newsletter ‘Spectrum in Occitanie, Finance in Focus’.

The Covid-19 pandemic is still dominating our thoughts and lives and will probably continue to do so for some time yet. Life must go on though, and we need to make sure that we are looking after our finances, as well as ourselves and our loved ones. Today we are going to take a slightly deeper than usual look at something that we might take for granted – exchange rates.

As a reminder, we are Rob Hesketh, Philip Oxley, Sue Regan and Derek Winsland. Together we form Spectrum’s team in the Occitanie, formerly of course the Languedoc Roussillon and Midi Pyrenees.

What is an exchange rate?
Ok, let’s start with the easy questions. It will get tougher as we go on. Obviously, the exchange rate is the rate at which one currency can be exchanged for another. Currently the rate at which holders of sterling can buy euros is 1.1100. Or is it 1.1000? or maybe 1.0925? It might even be less than 1 if you buy it at the wrong place. Then again, 0.9010 might be a very good rate. How can that possibly be right? How can 0.9010 be better than 1.1000? The answer lies in the fact that there are always two versions of every exchange rate.

We Brits tend to take the view that sterling is more important to us than any other currency, so we always want to know how much of any given currency we can get for £1. The rest of the world however are prone to taking a different view, so if you ask a French bank for the rate to convert sterling to euros you will get a rate that reflects how many pounds you can get for one euro. Confused? I do not blame you. To keep things simple, I recommend that when you see a rate expressed in that way, all you need to do is divide it into one. Thus 1/.9010 = 1.1099

Why so many different rates?
Well, obviously the rate can keep on changing every minute. The law of supply and demand applies here, but there are also many different rates at the same time. That is because volume plays a huge part. An exchange rate is a compromise between two parties, one of whom wants to sell, and the other to buy. Basically, if you are an international bank dealing in hundreds of millions of pounds per deal, you are going to get a very good rate; in fact, the best there is. Players (to many it is in fact a game) can either make a price or request a price. If the latter, they will never say to the market ‘I want to buy euros’. They will always ask for a two-way price, the idea being that the bank being asked for the rate does not know which side of the deal the other bank wants. The spread between the two prices may be a little as 3 basis points. That’s the fourth decimal point to you and me, so the rate quoted might be 1.1000 to 1.1003. The quoting bank sells euros at 1.1000 and buys them at 1.1003. Those three basis points represent the market spread, or profit margin on the deal. Still with me? If you are it will come as no surprise that the profit margin gets wider and wider as the amount you are dealing in gets smaller and smaller. At exactly the same time as a big bank is dealing at 1.1000, you might find that the rate you get for your €500 will be more like 1.0700, and if you go to a kiosk at an airport and ask for €500 cash for your weekend away in Paris, you might well get less than 1:1, so you would end up spending more than £500.

The indisputable fact is that whilst most of us arrive in France (or any other new home abroad for that matter) declaring that wild horses wouldn’t drag us back to the UK, or if they did we’d be in a box, the fact is that many of us end up back where we came from. We might hate the idea, but the facts are there. That means that there are four general phases that we will go through where exchange rates are going to have great bearing on our lives. Firstly the initial move phase, where we need to have enough euros to move here and buy property; secondly the sustenance phase, where we need to invest lump sums or exchange regular income such as pensions based in sterling; thirdly dealing with possible influxes of capital through inheritance or UK property sales, and fourthly the reversal of all of the above if we decide to go back.

The aim should always be to eliminate exchange rate risk, but it is a lot harder to do that than it seems. Yes, if you sell your property in the UK and move to France, you are going to need to convert a sizeable part of the proceeds into euro to buy a property here, but what if there is a good chunk of money left over? What if you were fortunate enough to get £800k for your des-res in Surrey, and managed to find the ideal pied-a-terre in the Aude for €300k? That leaves you with a decision to make about the £530k or so that you have left. Is the answer that you are going to live in euroland so your money should be in euro? – Yes. Is the answer that eventually you may want to go back to the UK so your reserves should stay in sterling? – Yes. Is the answer that the current exchange rate is terrible, and you should at least wait and see what happens? – Yes. So, which ‘Yes’ is the right one? You can have the same conversation about your pension funds if you are looking to consolidate them outside of UK jurisdiction (and political meddling). You can also have that same conversation when or if you decide to sell a second property that is currently let out, or Mum’s house which she left to you.

What is the answer?
Quite simply, the answer is planning; serious discussion with your partner/family about what the future will bring, and where it will be, and then serious discussion with your financial adviser (that’s us by the way) about how to manage the resulting risk. The inescapable fact is that no-one can accurately forecast exchange rate movements. In much the same way that financial/economic projections by experts are notoriously unreliable, so too are those made by F/X forecasters, but do you really want to convert all your assets into euro at 1.10 only to find that in fifteen years’ time you want to relocate to the UK and the rate is 1.50? In case you don’t have a calculator handy, that would result in an f/x loss of over £140k in the above scenario. What you really need is someone to help you decide where your future requirements will lie, not what the exchange rate will be when it happens.

Even funding a house purchase needs planning. In France it can take months before you can finally pay for and move into your new home. The exchange rate can move a long way in that time, and strangely, it usually moves against you! There is a way to eliminate that risk though, and it is called a Forward Contract. If you have a set date for your final payment, your financial adviser may well suggest that you speak to a good Foreign Exchange company who will be able to fix a rate for you, valid for that date, so that you know exactly how much your villa in the sun is going to cost you in sterling terms. These are legal contracts though, and you will have to accept that rate even if the market goes up. What you are doing is buying peace of mind against it going down, which could make your purchase uncomfortably more expensive.

Another product that may be useful to you is the Limit Order. If for example you decided to buy land abroad, and have a property built on it, you might well find yourself needing to make stage payments to your builder. If the rate goes up during this process you will be happy, but if it goes down markedly…?? You can place an order for a set period with your F/X company to buy a set amount at a chosen higher or lower rate. So, you might decide that you want to buy your euro at 1.25 if it gets there, but also if it starts going down, you don’t want to get a rate any lower than 1.05. This is basically a ‘take profit’ and ‘stop loss’ strategy combined, but you can just do one side of it if you choose to.

Part of our service to you is to monitor these companies and make a suitable introduction to you.

Our responsibilities don’t end there though…

We will discuss with you the choices you have regarding the investment of any left-over lump sums. Those discussions should leave you in no doubt that cash left uninvested is a loss-leader. Leaving your surplus cash invested in the UK in non-French tax compliant instruments such as ISAs is not the answer.

In France, the clear leader in terms of tax efficiency for capital gains, income and succession taxes is Assurance Vie, but you can make all those mistakes listed above by investing in the wrong policy. Flexibility is the key, along with portability.

What if we could offer you an Assurance Vie
that could start life in sterling?

Then change into Euro if the exchange rate moved up, and back again if it went down.

What if you could invest in both sterling and euro in the same policy?

And what if that policy could simply change into an ordinary investment bond if you went back to the UK, fully compliant with UK tax law?

Strangely enough…

We’d love to hear from you with any comments and/or questions, as well as suggestions as to future topics for discussion. Please feel free to pass this on to any friends or contacts who you think might find it interesting.