Managing FX Risk and International Payments: What Should be in Your Treasury Toolset for 2011?

The fluctuations in the marketplace throughout 2010 have highlighted the volatility of the currency markets, making the already challenging task of cash management daunting. The euro, for instance, declined by about 20% against the dollar in June before rebounding to regain most of its losses over the course of about five months. Recently, the US dollar had similarly plummeted to record lows against the Swiss franc and the Australian dollar, and to an 11-month low against a basket of six major currencies, caused by the Federal Reserve’s decision to pump hundreds of billions of dollars into the economy to help strengthen it. These signs of extreme currency volatility have placed an increased focus on the need for global treasurers to have risk measures in place to protect their business’ bottom line against losses resulting from currency fluctuations.

The risk to global treasurers is twofold. The first is the risk to the cash management process. Global currency fluctuations make it difficult to manage incoming and outgoing foreign currency obligations. This primarily happens as the home currency equivalent changes along with the market – creating somewhat of a moving target. Another risk is the actual execution of international payments. Companies dealing with international payments need to take into consideration multiple factors, which include monitoring market movements, reconciling foreign funds, managing varying types of payment options, and complying with international payment regulations.

Safeguarding Cash Management Procedures Against FX Volatility

If unprepared, currency volatility can place a serious strain on the traditional cash management processes. Internally managing international activity entails maintaining an extensive bank infrastructure with bank accounts in different countries, as well as holding foreign currency purchased through a foreign exchange (FX) broker or via an international banking relationship. Most organisations will need to employ both a cash manager and risk manager in order to manage these FX risks and dynamics on the traditional cash management process.

While many organisations have formalised international cash management procedures, going into 2011 it will be critical to review these procedures in order to keep up with market volatility. One can use tools such as spot transactions and forward contracts to assist in international cash management.

  • Foundation for international cash management: In order to execute FX transactions, one must have the counterparties and appropriate credit lines in place.
  • Spot transactions: Spot transactions involve the purchase of foreign currency at the time of booking the transaction. Spot transactions are beneficial because they give you instant access to the currency at the time of the transaction. However, they can only be used in situations where cash is available to fund the transaction.
  • Forward contracts: Forward contracts enable you to lock in an exchange rate for a set period of time in the future in order to protect your organisation from cross-currency risks. This enables you to lock in the exchange rate to guard against future currency movements. Forward contracts are useful in situations where your company needs to set a price in foreign currency for a specific good or service offering, but will not be paying for it right away – hence the need to fix the exchange rate despite not having the funds immediately available.

Easing the International Payments Headache

The tools outlined below should help to simplify your company’s international payables process and provide greater visibility in how to best manage your foreign currency transactions.

Cash management and real-time visibility into account movements

One tool to be on the lookout for when assessing international payment procedures is the ability to view your bank balances and transactions in real time. This will enable you to forecast your cash flow needs on a short-term basis, as well as ensure that you are covered for any upcoming disbursements. Real-time visibility also protects from the risk of fraudulent transactions flowing through your bank accounts, as early detection provides you the ability to react quickly. These factors together should foster improvements in cash forecasting and day-to-day liquidity and risk management.

International payment infrastructure requirements

There are a number of financial, physical, and regulatory requirements necessary to ensure a seamless international payment process. The first requirement is a platform for the payment execution itself. It is strongly recommended that any platform used contains an authorisation model that will guard against both deliberate fraud and errors which may occur from the manual processing of international payments. Additionally, you need to have the proper channels in place for efficient payment execution, such as access to the SWIFT network or another channel to connect to your international banks.

Finally, when dealing with international payments, it is critical to have knowledge of the formatting and regulatory regulations for international payments which vary, not only from country-to-country, but also from bank-to-bank. In Europe, for example, this means complying with the Payment Services Directive (PSD) on issues such as the transparency and timing of payments. In the US there is, among other regulations, the Travel Rule which states that certain information must travel with a payment. These regulations and various requirements vary by country and currency, and compliance and maintenance can be a complicated and timely process if trying to manage it within the organisation.

Reconciliation tools

When assessing your company’s international payables process, real-time reconciliation of cash flows and bank activity is highly recommended. Having the ability to reconcile bank accounts as payments come and go, rather than waiting for a monthly statement, is helpful from both a cash management and a risk management perspective. With today’s availability of information and systems, there is no reason to accept and work with delayed confirmation of payment activity.

Payment options

Ensure that the international payments process is being carried out in the most efficient way possible by using the most effective payment methods for your transactions. Often, an efficient method of payment will be via wire or local domestic routing.

Overall, using the tools outlined above could help to establish proper international payment infrastructures to guard against financial, physical and regulatory payment pains. Making the most of these payment tools will help to ease the common headaches associated with making international payments.

Reviewing the Options

While some of the tools outlined above may be available in-house, an increasing number of organisations are entrusting a third party specialist to manage their FX risks and international payment processing. For many businesses, the use of a third party provider with the bank infrastructure and knowledge base of formatting and regulations already in place is the best option. This provides them with the ability to lock into FX trades and execute payments in such a way that can both simplify and provide additional visibility into the process while at the same time mitigate the risk inherent in the volatile currency market.

Additionally, to ensure proper formatting and routing of international payments, some third party providers offer a platform that will link directly into a company’s accounts payable (A/P) system. From a security and risk perspective, this achieves the greatest possible degree of straight-through processing (STP) and is ideal as it reduces the amount of human intervention required. This will further streamline the process by providing a direct link to a complex global banking infrastructure complete with STP and low-cost routing of international payments via local clearing houses.

Therefore, using a third party with an international payments platform will not only provide access to the wide variety of tools outlined above, but also increase efficiencies and help to ensure headache-free international payment processing.

Conclusion

Overall, the currency volatility of 2010 highlighted the need for treasurers to assess traditional cash management and international payment procedures in order to better guard against the headaches caused by FX fluctuations. While losses due to currency exposure have traditionally been difficult to measure, a growing number of companies have put an increased focus on FX risk management, and have reaped the benefits from doing so. Going into 2011, it will be even more important to assess your company’s traditional cash management and international payment procedures to protect against currency movement, time wasted and inefficiencies in international payables.

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