The better you can forecast the international liquidity requirements of your business and the currencies you anticipate to buy and sell, the better you can reduce your foreign exchange risk. Helping to prevent your business from hitting stumbling blocks later down the road which could stall your growth, or worse, cause a financial loss to your business.
Business Foreign Exchange – business payment optimization, FX risk management and currency hedging strategies – are critical aspects for businesses looking to minimise the potential negative impact on their bottom line. With international trade on a strong upward trajectory and the recent growth in the number of eCommerce businesses being established, coupled with powerful movements in the exchange rates, the stakes are higher than ever before. Effective FX risk management will prove crucial for a growing segment of SMEs and corporations in the UK, and globally.
Best FX Treasury Management Service for Business
If what your business needs is a team of experts which will assess your companies’ foreign exchange risk, guide on whether to use hedging strategies, and suggest on the cheapest way to make payments and receive money, then the below companies should be able to satisfy your FX risk management requirements. They also offer their advisory services completely free of charge and have no fixed money transfer fees. Nor do they charge anything to set up a multi-currency bank account. If you opt to use their services, these currency brokerages are making money off purely the currency exchange.
These fx treasury management selections have a particular focus on international payments and mitigating FX risk. They have a long track record of designing currency risk management / hedging strategies that are individually tailored to each business they work with. After all, every business will have a unique situation. The currencies they currently hold, the volatility between the currency pairs they are looking to trade and a company’s risk appetite will all influence the treasury management hedging strategy designed for them.
In the case of Global Reach Partners, their foreign exchange treasury management platform (GRG intelligence) enables clients to manage their FX hedging in one place. It provides a comprehensive overview of your current positions, as well as an aggregated Mark to Market view across multiple counterparties, allowing you to stress and scenario test the potential impact of future periods of volatility.
Does My Business Even Need Foreign Exchange Risk Management?
Currency mapping is a critical process that multinational businesses use to understand their overall currency exposure. This process involves identifying and tracking all transactions, assets, and liabilities across different currencies in which a company operates. The goal is to develop a comprehensive view of the company’s financial position in each individual currency, including its subsidiaries.
Unlike traditional functional currency reporting, which tends to focus on the currency where the majority of the company’s business activities are conducted, currency mapping offers a more nuanced and detailed perspective. It takes into account not only revenues but also costs and financial risks associated with each currency, thereby providing a fuller picture of a company’s financial health and exposure to foreign exchange (FX) risk.
For instance, a multinational company might generate a large part of its revenue in USD, which might lead it to believe that it is heavily exposed to USD. However, a thorough currency mapping process might reveal that a considerable proportion of its costs are also in USD across its subsidiaries, thereby offsetting the revenue exposure to some extent. This could significantly alter the company’s perceived FX risk and influence its hedging strategy.
Furthermore, currency mapping can reveal ‘natural hedges’ that exist within the company. A natural hedge occurs when a company’s foreign currency revenues are matched with its expenses in the same currency, thereby reducing its exposure to exchange rate fluctuations.
Implementing a robust currency mapping process can, therefore, provide multinational businesses with valuable insights that can inform their financial strategy, risk management, and decision-making processes. It allows businesses to anticipate and manage potential FX risks more effectively, contributing to more stable and predictable financial performance.
Remember, currency mapping is not a one-off process. Given the dynamic nature of global businesses and currency markets, it should be performed regularly to ensure the most current view of a company’s currency exposure. This continual assessment helps companies adapt their strategies in response to any changes in their currency profiles or in the broader economic and market conditions.
Streamlining Your Accounts Via Treasury Management
Adopting the correct account structure that matches your currency flows is important. You don’t want to open new currency accounts unnecessarily (particularly with a bank as this will incur unnecessary fees) but if you have requirements to both make and receive local payments in an international currency you don’t want to be constantly converting funds back and forth with your domestic currency either. You could be losing 3-4% of your transfer each time if doing this with a bank.
These FX companies offer multi-currency accounts that provide you with information on balances held in each individual currency and an estimation of total liquidity across all currency accounts.
FX Treasury for Small Business?!
When we think of treasury management, or specifically fx risk management, we can often think to FTSE100 or multinational corporations that have global liquidity operations. Yet, with smaller corporates becoming increasingly open to export opportunities, companies can soon find they are generating just as much revenue, if not more, in their export markets as they are in their domestic market. There’s nothing wrong with this of course, but with this in mind, having the correct treasury management services in place has become more important than ever for smaller corporates as well. Treasury management for small business is definitely a thing these days – on an absolute level, the sums involved for smaller corporates might be less than a multinational but relatively, the international exposure they face can make up just as large a percentage of total revenue.
Smaller businesses often carry out their currency risk management function on a much more localised scale. FX contracts could be stored on a local hard drive and excel spreadsheets might be used to model FX exposure. The FX companies we list on these pages have increasingly powerful online platforms that can easily allow businesses to set-up rate alerts, pull reports and schedule international transfers for up to two years in advance, in addition to handling all of a business’ international invoicing needs. Trades booked over the phone will feed into your transaction history too. With many of these companies now opening up their APIs, they are becoming increasingly easier to integrate into a company’s existing accounting and treasury management systems as well.
Building an FX Strategy
There are many internal and external factors to consider when building a foreign exchange strategy. Here we look at the different areas that currency can impact your business and how you can start to get a clearer picture of your current and expected future currency exposure.
As an international business, the chances are that you have both inflows and outflows in a number of different currencies. The ‘functional currency’ of your business is usually the currency that you trade in most and is the currency you maintain your accounting records. The US dollar has long been known as the ‘world’s reserve currency’ due to the fact it is the no.1 traded currency in the world and many countries opt to trade in USD for international and even domestic trade. We use USD as the functional currency in our case study.
When creating an FX risk management policy for an international business, there are broadly four primary areas to look at:
Each area then aligns with different stages of the currency planning process.
Case Study: A UK Multinational With Functional Currency Reporting in USD
Multinational businesses should seek to understand the net currency position of each individual currency in which they trade, each individual subsidiary they operate and then as the group as a whole. A process named ‘currency mapping’ can reveal a very different currency profile compared to traditional functional currency reporting.
We demonstrate the importance of currency mapping with this case study, in which the group trades in five currencies and the below values demonstrate the USD equivalent.
The group’s global turnover is $160 million. Traditional functional currency reporting shows a strong weighting to USD and the firm’s US subsidiary, as this is where the majority of the group’s revenue is derived – $100m.
However, the currency mapping process has revealed that all of the group’s subsidiaries face costs in USD ($50m across all subsidiaries) and that, as a result of these global costs in USD, GBP actually accounts for the majority of the group’s revenue. Thus, by looking at the global position of each currency, we can determine that a different hedging strategy is required.
By taking into account the global cost and revenue exposure, it’s also possible to identify any ‘natural hedges’ that may occur across some currencies. For example, the UK subsidiary generates EUR revenue equivalent to $10m, whilst the US subsidiary generates an EUR loss equivalent to $10m. When buying and selling EUR, this can be accounted for. The less FX trading that is required, the less a business will lose out on FX trading costs – whether that’s payment fees or in the foreign exchange margin that’s taken by the company’s FX provider.
This takes us unto the currency strategies which can be adopted in order to achieve the firm’s objectives. From a P&L perspective, the objective is generally always the same – maximise profit and reduce loss. But there are more intricate considerations in this area too – do the jurisdictions in which you operate tax FX gains/losses? Do subsidiaries have access to cash as and when it’s needed? Is there enough flexibility in your FX hedging strategy to deal with any unexpected expenses which may occur? Short term foreign currency hedging tools (such as forward contracts set to mature in under one year) can all be utilised as part of a P&L risk management strategy.
There are balance sheet considerations too – is it always best to borrow in the firm’s primary functional currency or do differences in interest rate make it more appealing to borrow in another currency? Exchange rate volatility would be a significant factor in this decision as currency movements against you could see the cost of this move outweigh any potential benefit.
Then there are strategic decisions to make for your business, which, if you’re trading internationally, will always be impacted by exchange rate movements. This fundamentally comes down to the question, how will changes in the exchange rate affect our competitiveness? And what effect will it have on our competition? If we go back to our case study, this UK multinational derives much of its revenue in GBP but faces a number of costs in USD so an increase in the value of USD may work against the firm if they’re frequently buying USD and selling GBP. Likewise an increase in the value of GBP will make the cost of goods in the US less expensive.
Lastly, it’s important to make special considerations for emerging markets. When operating in an emerging market, interest rates could be high, exchange rate volatility could be high, and, in some instances, the cost to trade these currencies in the FX market could be higher too. One common solution is to fix as much emerging market currency exposure as is possible with a forward contract. However, it’s important to remember that interest rate differentials between a currency pair will influence the forward contract exchange rate. Speak to a currency expert from a leading currency brokerage such as moneycorp to learn more about this.
In our case study, the Mexico subsidiary generates $10m equivalent in MXN but then faces $20m of costs in USD – this subsidiary will need to be funded to the tune of $10m and various decisions will be required around the source of this funding and the currency it should be sent from.
Once a multinational firm has decided on its financial reporting and strategic objectives, they have three options which can be grouped into:
- Doing nothing (this is a currency strategy in itself!) but simply accepting the FX rate on any given day will make it difficult to make strategic decisions for your business and could leave you financially worse off. For example, setting prices would prove tricky as a constantly fluctuating exchange rate will impact your profit margin. Fluctuating prices is likely to make you less attractive as a trading partner.
- Manage currency at a subsidiary and transaction level. One example of this could be booking each currency requirement a subsidiary has through a forward contract. Trading the firm’s functional currency (USD) into whatever currency is required at that moment, for example GBP.
- Manage currency at a group exposure level. If done right, this has the capability to best manage currency exposure. Maximising revenue earned within the group, avoiding unnecessary FX trading costs and trading in the FX markets when it is required and should reduce risk or bring a benefit to the firm.
Case Study 2: A UK Multinational With Functional Currency Reporting in USD
Consider the case of a U.S. tech company, XYZ Corp, that outsources its manufacturing to China, incurring substantial costs in Chinese Yuan (CNY). In 2015, the Chinese government unexpectedly devalued the Yuan against the USD by about 2%. This devaluation resulted in significant cost savings for XYZ Corp due to a stronger dollar. However, as part of its risk management strategy, the company had hedged its currency exposure using forward contracts based on the previous, higher exchange rate, thus failing to benefit from the Yuan’s devaluation. The example illustrates how hedging can protect against currency risk but can also limit potential benefits from favorable exchange rate movements.
Case Study 3: Impact of Currency Fluctuations on a Luxury Brand
Let’s look at a European luxury brand, Luxe Co, with a significant customer base in the United States. In 2014, the Euro (EUR) weakened significantly against the USD due to quantitative easing by the European Central Bank. This depreciation made Luxe Co’s products cheaper for U.S. consumers, potentially boosting sales. However, it also meant that when these USD revenues were converted back to EUR, they were worth less, negatively affecting the company’s profits. This example highlights how currency fluctuations can impact a company’s competitiveness and profitability in foreign markets.
Case Study 4: Strategic Decisions in the Automotive Industry
Take the case of Japanese automaker, Auto Japan Inc. In 2012, Japan faced a period of deflation which led to a strong Yen (JPY). As Auto Japan’s costs were primarily in JPY, the strong currency made its cars more expensive on the global market, affecting its competitiveness. To mitigate this risk, Auto Japan decided to move some of its manufacturing overseas, thus diversifying its currency exposure. This strategic decision was influenced by the exchange rate movements and shows how businesses can adapt their operations in response to currency risk.
FX Risk Management: Hedging Strategies
FX risk management is one of the key functions of a treasury, and implementing the correct treasury management hedging strategies is vital to successfully managing FX risk. 2022 has proved one of the more volatile periods for currency in recent times. For the last decade, FX volatility has been pretty low, but high inflation is causing central banks to respond with higher interest rates, and this is transferring into the currency markets. The Fed’s base rate of 2.5%, combined with USD being regarded as a safe haven in uncertain times, has seen USD either hit or nearly hit, 20-year highs against GBP, EUR, and JPY.
In this uncertain environment, understanding and implementing a variety of hedging strategies can provide a measure of protection against unfavorable currency movements. Here are some common hedging instruments:
1. Forward Contracts: These are agreements to buy or sell a certain amount of foreign currency at a future date, at a price agreed upon today. The benefit is that it provides certainty about future cash flows, helping to mitigate FX risk. However, the downside is that it doesn’t allow the company to benefit from favorable currency movements.
2. Futures: Similar to forward contracts, futures are standardized contracts traded on an exchange to buy or sell a currency at a specific future date at a predetermined price. They offer the same benefits as forward contracts, but they are more liquid due to being exchange-traded, making them easier to buy and sell. The downside is that they are standardized, and therefore may not perfectly match the company’s specific hedging needs.
3. Options: These are financial derivatives that give the holder the right, but not the obligation, to buy or sell a currency at a predetermined price within a specific time period. This allows companies to hedge against unfavorable movements while retaining the possibility to benefit from favorable ones. However, the company has to pay a premium to purchase an option, which increases the cost of hedging.
4. Currency Swaps: This involves exchanging principal and interest in one currency for the same in another currency. It helps companies manage exposure to currency fluctuations, particularly for long-term foreign investments or debts. The disadvantage is the complexity of these contracts, which requires a high level of expertise to manage effectively.
Remember, predicting future currency movements is extremely challenging, particularly with geopolitical uncertainties, fluctuating oil prices, and changing food supplies. While a specialist FX broker can’t tell you exactly where a currency pair is moving, they can guide you through different hedging strategies and FX solutions that can provide protection if the rate moves against you and potentially help you benefit from upside if the rate moves in your favor. To learn more about hedging products, see our foreign currency hedging guide.
Foreign Exchange Treasury Management Solutions
Large organisations adopt some of the most advanced treasury management solutions that are available on the market today (take Kyriba as example) but for smaller corporates the story is often quite different. Firstly, they may not even have a dedicated treasury function, and if they do, they aren’t likely to have the capital to invest in expensive SaaS treasury management products. They may have accounting software in place but this can lack the necessary tools to get a full picture of their FX exposure and how currency movements could impact their business.
For this reason, smaller corporates may not be able to employ the products of pure treasury management companies such as Kyriba but may work with a number of providers that can assist them in performing many of the roles a treasury function does. The FX companies listed on this page will not only tailor a treasury management hedging strategy for you, they can assist you in opening new currency accounts and improving the visibility of your global liquidity position as well.
Transaction Banks Reinventing Treasury Services
As corporates continue to demand solutions to enhance their corporate treasury activities, banks are increasingly partnering with fintechs and software providers to offer new products. The market opportunity is clear. A Mckinsey guide to how transaction banks are reinventing treasury services estimates that corporates spend $3.5 billion on treasury services annually.
Payments has been one of the core areas that banks and fintechs have collaborated on. SMEs can benefit from accessing new payment solutions just as much as large corporates. That’s the beauty of fintech providers, they don’t unfairly prohibit SMEs by only targeting large corporates – their solutions are designed to work for all.
Emerging Markets Considerations
Emerging markets often present unique challenges due to their economic and political environments. Here are five considerations to keep in mind when dealing with these markets:
- High Volatility: Emerging markets often experience higher currency volatility due to economic instability and political uncertainties. For instance, consider the case of Argentina in 2018-2019, when its currency, the Argentine Peso, experienced a massive devaluation due to an economic crisis. Businesses dealing with such countries must be prepared to navigate such volatility, potentially through hedging mechanisms.
- High Interest Rates: Emerging economies often have higher interest rates to attract investment and control inflation. For example, in 2020, Turkey had to raise its interest rates significantly to stabilize the Turkish Lira. Companies borrowing in such currencies need to factor these high costs into their financial planning.
- Regulatory Challenges: Emerging markets may have stringent capital controls and regulatory challenges. In 2015, China surprised global markets by devaluing the Yuan and introducing new controls to stem capital outflows. Businesses operating in such markets must be prepared to handle regulatory complexities and sudden policy changes.
- Limited Market Liquidity: Some emerging market currencies may not be freely convertible, and the FX market for them may be less liquid. In such a case, it could be challenging to execute large FX trades without causing significant price movements.
- Economic Indicators: It’s important to track economic indicators like inflation, GDP growth, and balance of trade, as they can give insights into the currency’s future direction. For example, high inflation could lead to currency depreciation, as seen in Zimbabwe in the late 2000s.
In conclusion, dealing with emerging markets can offer significant opportunities but also requires a detailed understanding of the unique risks associated with these markets. It’s crucial to have a well-thought-out strategy that includes these considerations when operating in or trading with emerging markets.
Treasury Management & Operational Risk in FX
2020 was a year everything changed – processes that may have once worked in a localised office were often found left wanting when remote working became more prominent. Before the coronavirus pandemic shook the global economy, there were few businesses who had taken the time to review their operational risk management processes and be prepared for this level of remote working.
When the UK and indeed the wider world went into lockdown, treasury functions were forced to make FX payments, deal with foreign currency receipts, and manage a company’s working capital in multiple currencies, all via remote channels. This highlighted the amount of manual work involved in FX transactions – whether this be the monthly payroll run to international employees (which almost always ends up with a few manual workarounds!), internal cross-currency transfers, or large international payments to suppliers.
The inherent risk involved in manual FX processes have been put into the spotlight over recent years – moving forward firms will see the benefit in cloud-based solutions that can automate as much of the FX payment flow as possible.
Certainly, let’s incorporate the impact of AI, like GPT, in the context of foreign exchange management:
The Role of Technology and AI in FX Management
In the rapidly evolving financial landscape, technology is transforming the way businesses manage their foreign exchange risk. A significant development in recent years has been the rise of artificial intelligence (AI), with sophisticated systems like GPT, a program created by Microsoft-backed company OpenAI. These AI models can analyze and interpret vast amounts of data, offering unique advantages in the world of FX management.
Algorithmic trading systems use intricate algorithms to execute trades with high precision and speed. As the markets respond to the most minor news and data in real-time, these systems help businesses react swiftly to currency fluctuations, thus reducing potential losses from volatile currency movements.
Risk Management Tools
Advanced software solutions offer real-time tracking of currency exposures and risks. These tools can simulate different scenarios and assess the potential impact of various hedging strategies, providing businesses with a comprehensive understanding of their FX risk profile.
AI systems can process vast amounts of data to derive valuable insights into market trends and potential currency movements. By recognizing patterns and trends that humans might miss, AI can help businesses make more informed decisions on their currency management strategies.
Blockchain and Cryptocurrencies
The advent of blockchain technology and cryptocurrencies offers a novel way to circumvent FX risk. Cryptocurrencies, not tied to any specific country, provide an alternative means of international transactions, while blockchain technology promises faster and more efficient cross-border transfers.
AI in FX Management AI technologies like GPT can process large chunks of text and data, generate convincing arguments, and deliver coherent replies to complex queries. This ability can help businesses formulate more effective currency management strategies. For instance, AI can generate scenarios based on historical data and predict potential outcomes, enabling businesses to prepare for different market situations. However, it is crucial to note that AI-generated content often requires fact-checking, as the accuracy might sometimes be compromised.
Robotic Process Automation (RPA)
RPA can automate manual and repetitive tasks in FX management, such as data entry and report generation. By reducing human errors and freeing up time for strategic tasks, RPA enhances the overall efficiency of FX management.
The sophisticated capabilities of AI, like GPT, have prompted a shift in the educational landscape. Universities and educational institutions are beginning to realize the potential implications of AI in academic work. With AI’s ability to generate convincing swaths of text, there is a growing concern about maintaining academic integrity. However, institutions are also exploring how these technologies can be used to enhance writing and creativity, indicating a potentially transformative role for AI in education and training for fields like FX management.
In conclusion, technology, particularly AI, is reshaping the landscape of FX management. While it offers numerous advantages, it’s also crucial to recognize its limitations and potential implications. As the technology continues to evolve, businesses and educational institutions must adapt and learn how to harness its potential effectively and ethically.
As we’ve explored throughout this article, foreign exchange risk management is a complex but crucial aspect of international business. In an increasingly interconnected world, the implications of currency fluctuations can significantly impact a company’s bottom line. Understanding the nuances of currency mapping, leveraging various hedging strategies, taking into account the specifics of emerging markets, appreciating the role of technology, and preparing for global events are all fundamental to effective FX risk management. Importantly, these tools are not only available to large multinational corporations but also to smaller businesses, thanks to the accessibility provided by dedicated currency brokers. This increased accessibility is a noteworthy breakthrough, further democratizing the global business arena.
For those interested in diving deeper into the topic, here are a few recommended resources:
- Foreign Exchange Risk Management: Which Way to Go? – A book by Dr. Ian H. Giddy that provides an in-depth look into FX risk management strategies.
- Global Financial Markets and Instruments – An online course offered by Coursera that covers a wide range of topics including FX risk.
- Currency Derivatives in Risk Management – A research paper that explores the use of currency derivatives in managing FX risk.
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