As exporters in Virginia focus on growing – or at least sustaining – foreign sales while overcoming the effects of the coronavirus, Foreign Exchange (FX) may not appear to be a priority. However, implementing or modifying your FX program can yield positive, immediate results. In this article, GPS Capital Markets discusses three topics: (1) Increase Sales, Boost Competitiveness by Selling in Foreign Currencies (2) Earn More from Foreign Sales Through an Easy, Quick Improvement in FX Rates and (3) The Coronavirus, Market Volatility, and Hedging FX Risk.
Increase Sales, Boost Competitiveness by Selling in Foreign Currencies
Pricing your exports in U.S. Dollars (USD) may seem logical, but does that put your company at a disadvantage? That is, if your competitors agree to accept the currency of the customer but you will not – all else being equal – will you potentially lose the sale? Out of necessity, most exporters in other countries have almost always had to manage FX transactions and have therefore become well versed in the topic. If you can price in USD and win the deal, all the better; some foreign buyers might be willing to pay in U.S. Dollars. However, the willingness to accept foreign currency, or at least the knowledge about this component of cross-border transactions, will empower your firm to compete more nimbly on the international field.
How do you evaluate and implement pricing in non-USD, if it is in fact appropriate for your business? First, arrange a consultation with a FX provider on the benefits, challenges and general concepts of selling in the currency of the client, which should cost nothing. If it is a beneficial strategy, learn the specifics and methods of managing present and future conversions of foreign currencies into USD. A professional FX provider should be able to educate you and your team in little time, and be available for continual consultation as your exports grow.
The next question: does the current economic environment make it more or less likely that foreign buyers will want to pay me in their currencies? While each export opportunity is unique, a stronger USD or the recent volatility in FX markets may render buyers reluctant to agree to contracts in a monetary unit other than their own. Rest assured that there are methods for mitigating currency risk, should you choose to accept it. More on this later….
Lastly, if your company needs to buy foreign currencies in order to facilitate exports, you should avoid unnecessary conversions. For example, if you win a sale of EUR 1,000,000 and need to pay EUR 200,000 to foreign vendors, employees or contractors, you should convert EUR 800,000 only. Converting the full EUR 1,000,000 to USD and subsequently trading dollars back to EUR 200,000 wastes significant, valuable funds. How can you prevent this? A Foreign Currency Account (FCA). Simply direct the funds to be deposited into your FCA, convert EUR 800,000 to USD, and disburse the EUR 200,000 to the foreign recipient(s). Not all banks or FX providers offer FCAs, and their cost is often high – be sure to explore a few alternatives.
Earn More from Foreign Sales Through an Easy, Quick Improvement in FX Rates
Whether you already conduct business in foreign currencies or will soon begin to do so, utilization of more than one FX provider can help to ensure that you receive the most USD from your exports. An easy, quick improvement in rates could generate immediate, all-important increases in the net proceeds of foreign-currency-denominated sales.
A brief case study: on two separate occasions within the last 12 months, a client and exporter in Virginia opted to convert large amounts of foreign currency through their bank, whose rate was worse than ours. Had they traded with us instead, they would have approximately $40,000 more in their bank account as a result of the conversions to US Dollars. While rate is not the only factor to consider and no provider always offers the best one – we do not always – this is a real, recent example of how a decision on FX can negatively affect a company’s profitability and cash position. If the exporter had chosen the better rate, how could they utilize the extra $40,000? Alleviate the effects of a challenging economic environment? Hire, or keep, an employee who helps the business grow? Invest in software or equipment that improves efficiency, reduces costs, or enables an increase in production? Reduce debt?
FX is like other financial components of business operations that are separate and independent, such as insurance, retirement plans, and equipment financing. Governmental regulations prohibit lenders from “tying”, or requiring, that a borrower transact FX with them because of a loan, whether it is communicated directly or suggested indirectly. Companies with developed, formalized FX programs typically maintain at least two providers in order to create competition for rates, service, systems, and strategies. Adding an alternative FX provider is quite easy to do, even for smaller companies, but does not obligate you to trade with them; they are simply available when and as you see fit. Additionally, for those that hedge currency risk, access to another line of credit for hedging (to be covered later) could be beneficial, in case an existing capital provider chooses to limit or not increase exposure. As with other functions of a business, one should evaluate alternatives before adding them, and the existing FX program and provider(s) at least annually.
The Coronavirus, Market Volatility, and Hedging FX Risk
If you accept payment in foreign currencies and therefore have FX risk, how can you protect your company against the corresponding financial hazard? Fortunately, there are many strategies and instruments at your disposal to hedge risk. Defined simply, “to hedge” is to mitigate risk by creating certainty for future transactions, which in this case means to secure a rate for conversion of currencies at a later date. A hedging contract specifies the exchange rate, the two currencies and respective amounts, and the date/dates on which the conversion will occur. Through consultation and collaboration with an FX provider you can customize an approach to managing currency risk. Some considerations and parameters that help determine how to hedge and how much will be: risk tolerance, probability of transaction, budget FX rate, gross margin of sale, credit for hedging, and conditions of the market …
While the outbreak of the coronavirus has caused significant volatility in the stock markets, what has it meant for the FX? After a long period of calm in most currencies, the spreading of the virus has disrupted the currency markets in similar fashion. As an example, following is a chart of the Euro vs. the U.S. Dollar spot exchange rate year-to-date; charts of other currencies would show large fluctuations as well.
* source: Bloomberg
Interestingly enough, some currency pairs are more or less back where they began in late February and early March but have fluctuated significantly in the meantime. Even so, the risks still exist in the interim and should be taken seriously. As is often the case with FX, such movements can present disadvantages or advantages, depending on your position.
“I don’t want to hedge because I don’t like to bet” is a refrain that is sometimes uttered by those with currency risk. While understandable, the purpose of a hedge is to remove or at least reduce risks. If misused, hedging instruments can in fact cause trouble, but planning with your FX provider will help to prevent such scenarios. The word “derivative” has often been maligned in recent history, even though thousands of companies and organizations use them daily to mitigate risk and therewith operate their business. In other words, hedging enables a company to remove or reduce currency risks so that it can focus on its core business or primary purpose.
You want to hedge, but can you? An FX hedge creates credit exposure between the two counterparties, the client and FX provider. While not a loan, the securing of a rate creates some risk of future, albeit hypothetical, loss. Said another way, if a client does not fulfill its obligation under the contract, the FX provider may have to “unwind” its part of the trade in the market at a potentially worse rate, thus creating a loss. The credit risk is usually not the full amount of the contract (ex. EUR 1,000,000 = USD 1,100,000), but usually a fraction of that figure (1% to 20%), depending on the length of time and market volatility. If you wish to hedge, assess early on whether your FX provider can offer a Hedging Line of Credit, which is sometimes known as a Guidance Line/Facility. If a company borrows under an Asset-Based Lending facility, a bank will likely reduce the available credit in order to cover the FX risk, which would reduce all-important operating capital. Some FX providers can offer unsecured credit to companies that want to hedge. Again, please know that alternatives may be available.
The purpose of this is not to cause reluctance, but rather to provide awareness while emphasizing that you are empowered to manage what might appear to be unmanageable. While no perfect formula or method for managing FX exists – even the biggest and most sophisticated companies fall short of flawless execution – following are some considerations and recommendations on how to administer the foreign-currency component of your business:
- Consult with an FX provider early to learn about the currency component of cross-border trade, to assess whether offering exports in foreign currencies is the appropriate strategy for your company, and if so, to design and to implement the relevant functions
- After a long period of calm in FX markets, unforeseen events can radically and quickly change the landscape, a foreign buyer’s willingness to trade in US Dollars, and a company’s risk profile
- Optimize the FX component of your business by establishing more than one provider of services, systems and strategies
- Prepare in advance by formalizing an approach to hedging, even if with a simple, one-paragraph policy
- The concepts in this forum apply also to purchases of foreign currencies, which may be required to facilitate exports
- You can customize your approach to hedging FX; both simple and more flexible strategies are available to you
About the Author
Jason Roof represents GPS Capital Markets from the firm’s Charlotte office and advises companies on Foreign Exchange. He has over fifteen years of experience in Foreign Exchange, Global Treasury, International Banking, and Interest Rate Derivatives. Mr. Roof holds an MBA in International Business & German, and a B.S. in Engineering.