Transactional FX Management: A New Horizon

In a recent unprecedented move, Standard & Poor’s (S&P) downgraded the US credit rating in August from AAA to AA+.  Since World War II, US government debt has been classified as the safest asset in the world. While many argue that the Congressional debate on whether or not to raise the debt ceiling was only about US politics, the point remains that the issue of the US potentially defaulting on its debt was debated for the first time ever. This debate, coupled with the fact that key stakeholders in Europe, namely Germany and France, are struggling to maintain their own credit ratings, has led to hugely fluctuating equity, currency and credit markets across the globe.

While private investors can rush to safe havens like gold and the reminbi (RMB), corporates are faced with a different dilemma, namely how to manage the risk of doing business in an extremely volatile environment. Furthermore, as companies look to expand their global presence, the demands faced by treasurers and chief financial officers (CFOs) are becoming ever more complex. Not only do they have to deal with challenges around international payments, but also with foreign exchange (FX) risks in highly volatile markets. Faced with this challenging environment, it is no surprise that corporates are increasingly looking to their financial services providers to help them effectively manage risk and streamline working capital cycles.

For example, from a FX risk perspective, the most important transactions for a corporate are cross-currency, cross-border transactional flows, as the company profits may fall if purchasing or selling prices are negatively affected by exchange rate fluctuations. This risk occurs when goods or services are imported or exported and payment is made in a foreign currency.

Many treasurers or companies prefer to hold accounts in different currencies, on the assumption that they are eliminating FX risks at a transaction level as they collect and make payments out of these accounts. Markets in the past two years have shown that this strategy does not work. Even major currencies such as the US dollar, euro, pound (GBP) and Japenese yen (JPY) have moved some 15-20% over this period. As such, a lot of companies holding cash in multiple currencies found their profitability eroded. Apart from exchange risks, this strategy also leads to additional indirect costs such as the reconciliation of multiple accounts and paying maintenance charges on these accounts.

Simplifying FX and Your Working Capital Management Strategy

So what do companies need to do in order to simplify their FX and make their working capital management strategy easier, to allow a greater focus on core business?

In theory, any company can eliminate exchange risks by entering into import and export contracts in their home currency. The contracts shift the problem to its trading partner. However, not many companies are able to adopt this considering the competitiveness of the marketplace. The reality of the situation is that companies need to work with banks that understand their working capital cycle and provide holistic solutions, taking into consideration the total volumes of payment flows rather than the amount of each transaction. One common misconception is that most banks will charge higher margins for individual smaller ticket payments. As such, most companies leave their foreign currency positions open for some time, as they wait for their accounts to reach a certain ‘tradeable’ level. This common myth can be eliminated by working with a financial institution which can provide transparent FX rates and that does not distinguish each transaction amount, but provides consistent pricing irrespective of transaction amount.

Additionally, most treasurers and CFOs are under immense pressure to release liquid assets tied up in the working capital cycle. The treasurer has a key role to play in reducing working capital requirements through active cash management – which includes rationalising multiple foreign currency accounts and managing FX risks at reasonable levels. Poor FX management results in ineffective working capital management, which in turn results in the company performing below its potential and realising smaller margins and profits

The lessons learnt from the recent economic crisis have left corporates vulnerable to market fluctuations, and the need to avoid risky positions is being felt all the more keenly. In an environment where doing business in US dollar means profitability is being eroded simply due to FX market fluctuations, corporates have to look to simplify the way they do business.

A bank’s transactional FX solution can help companies achieve two significant objectives: reducing complexity and improving working capital management. A transaction banking platform can offer clients transparent and pre-agreed bid/offer spreads that work for all transactions, irrespective of size and on an automated basis, which will allow treasurers and CFOs to focus on their core business growth and other operational processes rather than spending time calling multiple banks for FX quotes and having to adopt other strategies to aggregate or accumulate FX in the hope of obtaining differential pricing for large value trades.

A banking product that enables customisation and automation of all FX related flows can also ensure greater efficiency and transparency while simultaneously reducing costs and increasing profitability. 

A bank’s transactional FX solutions can allow easy access to most freely traded currencies and prices transactions at real-time competitive rates, regardless of the amount in question. This gives corporate customers an easy and convenient overview of their working capital, as there is no need for dedicated currency accounts with low value transactions which can often result in higher costs, cumbersome reconciliation and, most importantly, multi-currency credit exposure. Once the margin is negotiated with the customer, that margin will always be applicable regardless of amount transacted by the client. Furthermore, no trading infrastructure needs to be set up at the clients’ end. There is also no value date loss.

Bespoke client pricing, with straight-through processing (STP) capabilities in non-regulated countries in Asia, has positive implications for corporate customers in today’s world. A simple overview of the company’s working capital can reduce operational and settlement risk. This overview can also have a huge impact on the overall profitability of the corporate by helping to mitigate FX risk. The customer can also be offered bespoke pricing in regulated countries, although STP and the associated benefits will not be possible. 

Today’s market environment is multifaceted and affected by numerous global forces and events, which force clients to change their business strategies all too frequently. Added to this complexity is the movement of FX markets. It is no surprise, therefore, that treasurers and CFOs look to partnerships with banks that help them manage complex businesses with innovative solutions.

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