It is no secret that the finance world is expecting higher fx charges at some point if various proposed regulations in key markets come into play. But are companies prepared and do they even understand the real costs of their fx pricing now?
Legislation being mooted such as the Tobin tax could play havoc on the costs of foreign exchange. The suggested tax (named after economist James Tobin who first recommended a tax on spot conversions of currencies) has supporters in the French and German governments, eager to use receipts to invest in European growth – although the UK believes the tax would damage the City and UK GDP growth.
“Regulations like the Tobin tax would likely feed into margin,” says Chris Oulton, Managing Partner at Core Treasury Solutions, a UK-based company which conducts bespoke reviews of company FX arrangements. If the Tobin tax were implemented, it is widely expected that FX desks would move to Asia or the US, thereby reducing liquidity and widening spreads.
He points out that it isn’t just the transaction tax which is worrying the fx market; there is other legislation as well. If governments were to follow through on threats of forcing banks to change their business models – for example discouraging banks (particularly large custodian banks) from proprietary trading – again the net impact would be for spreads to widen.
Companies have faced unprecedented volatility in currency markets since 2008. This has impacted their fx costs and their bottom line. Oulton also cautions that volatility may further increase with any continued euro stress or even a euro break up. “Volatility in the past few years has made pricing of fx more difficult as well as making it more difficult for market makers to provide liquidity. Any significant event, like a euro break up, could cause a huge increase in volatility where spreads would widen and add even more costs,” he says.
So shouldn’t companies be revisiting their fx execution costs now in order to ensure they are getting best pricing before any potential increases further affect them? Companies generally execute in one of three ways: directly with their bank; via multibank platforms such as Fxall and Currenex which have traditionally catered to large corporations, and finally through independent third parties which are targeted more at the SME market (although they have begun to shift emphasis to larger companies too).
Companies, outside of the large multinationals which often use multi-bank platforms for better pricing, have never placed a huge emphasis on the visibility of foreign exchange costs. Price can be hidden because it is margin based and with treasury staff already overloaded, they are frequently focused on costs which are easier to manage, such as transaction banking fees. Plus for many companies the number of FX transactions is low, so the company incorrectly assumes cost savings would be minimal.
Core Treasury Solutions recently worked with a UK-based pension fund where an analysis of their trades relative to fair value at the time, showed that the average deviation was around six ticks, equivalent to $54m. The audit scrutinised the history of the FX trades with the type of order placed including timings and price compared to market data.
The message is clear: you may not be analysing an invoice of charges, but you need to look more closely at potential savings in benefiting from wholesale prices rather than paying ticks over the odds.