Layered Hedging - A practical guide for SMEs

Layered Hedging: A Practical Guide for UK SMEs

For many UK SMEs, currency volatility has become an unavoidable part of doing business—especially after years of complex and unpredictable macro economic activity [from politics, to interest rate wars and large scale conflicts]. While large corporates often have dedicated treasury teams to manage these risks, smaller businesses frequently face exposure without the same level of resources or expertise.

What Is Layered Hedging?

Layered hedging is a risk-management approach where a business hedges currency exposure gradually over time instead of in one large transaction.

Think of it as spreading your hedging decisions across multiple points, using a blend of forward contracts, each covering different portions of your future currency needs.

Rather than saying, “Let’s hedge 100% of our expected USD payments today,” a layered approach might hedge:

• 25% six months ahead
• 25% three months ahead
• 25% one month ahead
• 25% at the spot rate when needed

Each “layer” becomes a building block in a planned, rolling structure.

Why SMEs Use Layered Hedging

1. Reduces Timing Risk

Trying to hedge everything at the “right” moment is essentially trying to time the market. Layered hedging removes this pressure by averaging out rates over time—helping avoid the pain of locking in all your exposure at an unfavourable moment.

2. Improves Budget Certainty

UK SMEs often struggle with forecasting, especially when sales pipelines aren’t predictable. Layered hedging allows firms to gradually lock in rates as confidence in forecasts improves, helping to build a more flexible and reliable budget rate.

3. Offers Flexibility as Market Conditions Change

Instead of being “all-in” at one rate, SMEs can adjust each layer based on current market sentiment, cashflow changes, or updated sales forecasts.

4. Reduces Over-Hedging Risk

A common challenge for SMEs is forecasting too optimistically and ending up over-hedged. Layering reduces this risk by aligning the hedging structure more closely with actual, rolling demand.

How Layered Hedging Works in Practice

Here’s a simplified example for a UK SME that expects to pay €1 million per quarter:

Forecast 12 months ahead – create a rolling view of expected currency needs.

Build layers – hedge small portions across different time horizons.

Add new layers monthly or quarterly – maintaining a consistent structure.

Monitor variance – adjust layers as forecasts change.

Review hedge performance – ensuring the strategy aligns with your risk tolerance.

Over time, the SME ends up with a diversified book of hedges, each locked in at different levels, naturally smoothing out the overall exchange rate.

When Layered Hedging Makes Sense

Layered hedging is a strong fit for SMEs that:

• Have regular, repeat foreign currency flows (imports, exports, or overseas salaries)
• Don’t want to bet on where FX markets will go
• Need predictable margins but still value flexibility
• Have enough visibility to forecast 6–12 months ahead (even if imperfectly)

Common Mistakes SMEs Make

Even though layered hedging is simpler than many alternatives, pitfalls include:

• Too many layers, creating unnecessary admin and complexity
• Not reviewing cashflows, leading to over-hedging
• Using inconsistent hedge sizes, which distorts the smoothing effect
• Failing to adjust layers when market conditions materially change
• Treating layered hedging as “set and forget”, rather than an active strategy

A structured framework and periodic review eliminate most issues.

What Layered Hedging Is Not

It’s important to clarify what layered hedging does not do:

• It does not guarantee the best possible rate.
• It does not completely eliminate currency risk.
• It’s not a speculative strategy.

Its core purpose is risk smoothing, not speculation or market timing.

Tools Used in a Layered Hedging Strategy

SMEs typically use:

• Forward Contracts – the backbone of most layered strategies
• Window Forwards – adding flexibility around settlement dates
• Options or Participating Forwards – used selectively to retain upside exposure
• Structured overlays – for businesses requiring more optionality

Most SMEs find that simple forwards do 80% of the work.

Benefits for UK SMEs at a Strategic Level

Beyond operational clarity, layered hedging helps SMEs:

• Protect margins during volatile periods
• Quote customers with confidence
• Improve planning accuracy
• Strengthen supplier relationships through more predictable purchasing
• Demonstrate financial discipline to lenders or investors

In a world where the pound can swing dramatically in a matter of weeks, layered hedging provides the consistency SMEs need to grow sustainably.

In the example below, we can see a year to date performance chart of GBPEUR. A UK business purchasing chemicals from Italy wanted to deploy a rolling hedging program to give themselves sufficient cover, without being over committed. This saw them cover two months on January 2nd. On the 2nd March they took out another 2 months, repeating this cycle until they had 6 blocks of cover for the year. As you can see, the mechanical smoothing effect of this approach was very beneficial as GBP moved lower. This provided profit margin protection which was a key objective within their hedging mandate [see previous blog].

This is just one simple example of many layered strategies that could be deployed.

Conclusion

Layered hedging is a practical, disciplined, and accessible strategy for UK SMEs dealing with foreign currency risk. It offers the best of both worlds: protection from volatility and flexibility when forecasts or market conditions shift.

For SMEs looking to build resilience, improve budget certainty, and smooth FX exposure—without needing complex treasury systems—layered hedging is often an excellent place to start.