Foreign exchange is a significant cost for many businesses. A recent survey by Australian fintech Fluenccy suggested that SMEs in the UK paid more than ten times as much as corporates for FX when using their banks last year and lost an average of £17,000 on their international payments through a combination of excess fees and bad trades.
Fewer than 10% of the small businesses surveyed had access to a system that allowed them to monitor and control the impact of FX on their business. Fortunately, there are a number of steps companies can take to establish a full understanding of their exposure to foreign currencies.
FX risk can be divided into primary and secondary categories, the first of which being the actual cash flows of foreign subsidiaries and the second being the supply chains and macro risks driving FX exposure. An example of the latter is how exposure in Brazil can be affected by events in Argentina or Chile.
“In order to catalogue such risks, treasury teams need to think through the data they have on their outlays and receipts globally,” says Bob Savage, Head of FX Sales North America at BNY Mellon.
Companies should take the time to understand the main types of risks across their industry and identify best practices across their peer group to ensure alignment with competitors, suggests Standard Chartered’s Global Head of Financial Markets Sales, Sharad Desai.
“A global review of exposures at parent company and subsidiary level will ensure accurate understanding of group exposure,” he says. “Companies should also assess the hedging risk generated by foreign investments.”
Companies with multiple divisions, each with different pricing criteria, will have multiple sources of FX exposure. Within an industrial engineering firm, for instance, machine production, spare part provision, and service delivery will all generate different exposures.
Another important consideration is the forward discount/premium of the currencies involved. “European exporters typically sell in currencies with higher interest rates than the euro, such as the US dollar or the renminbi,” explains Antonio Rami, Co-Founder of currency management automation software provider Kantox. “In this case, currency hedging entails a forward discount that must be effectively managed.”
The scale of the company will also determine its ability to mitigate FX risk. A large corporate is likely to have a dedicated treasury management team with in-house experts as well as external partners, allowing it to implement a variety of risk management protocols.
“For a small business it is better to focus initially on the areas that are likely to affect the business the most and build from there,” suggests Laurent Descout, Co-Founder and CEO of treasury services platform Neo. “Integrating a modern treasury management system into the business operations is the next important step.”
Atlas FX is a provider of foreign exchange risk management services. The firm’s Vice President, Strategy and Operations, Scott Bilter, says corporates need to go beyond the data readily available from their ERP system, create a forecast of future FX exposures, and put proper results analytics in place to understand the sources of FX variance.
“Getting each of these steps right requires a lot of expertise and treasury teams are often understaffed and highly rotational,” he warns.