6 TIPS WHEN SETTLING IN FOREIGN CURRENCIES
Rohit Arora, CEO of Biz2Credit in New York City, had to take currency fluctuations into account when striking a deal with an Australian firm to license the rights to bring his online matchmaking platform for borrowers and lenders to its own country. Arora had negotiated an agreement to invoice the company, Australian Finance Group (AFG), in Australian dollars for the licensing fees.
Arora, who works closely with banks through his platform, checked out the fees changed for helping hedge against currency fluctuations. They told him it would not be cost effective for the Australian transaction, which is in the $5 million to $7 million range, as the fees would range from 3 percent to 8 percent of the total invoice amount.
“For smaller transactions, it doesn’t make sense to hedge,” says Arora. “The hedging process is too expensive.”
Arora and his financially savvy team opted to take a DIY approach. They did an analysis of currency fluctuations for the Australian dollar over the previous two years, looking at the daily moving average, and negotiated an amount they would invoice AFG in Australian dollars that was somewhere in the middle of the highs and lows.
“We came up with a number we think is pretty comfortable,” says Arora, though he acknowledges he could lose money if there is an unforeseen event during the ongoing arrangement.
As many exporters find, settling a transaction in a foreign currency can be complicated. Given the nature of Arora’s business, he is more financially sophisticated than most and was able to come up with his own approach, but many exporters need to seek expert help from a banker or other advisor.
“There is no easy solution,” says Robert Bolle, key accounts currency trader for AFEX, a global payments and risk management solutions specialist in the Greater Los Angeles area that assists businesses with Forex (FX) currency market and risk management needs. “The currency markets are always moving.”
Nonetheless, it is very possible to shield your company from currency risks when settling transactions in a foreign currency. Here are some tips from experts on how to decide if it makes sense to settle a transaction in a foreign currency and to determine how best to protect from currency risks.
EVALUATE THE IMPORTANCE OF THE CUSTOMER
It is always easiest to invoice in U.S. dollars but that may not be convenient for some clients. Offering to invoice in your foreign partner’s currency, if that is what they prefer, may strengthen your relationship.
“Most U.S. companies invoice their international clients in U.S. dollars,” says Bolle. “U.S. companies really ought to be open to invoicing their clients in their local currencies.”
Currently, products from the U.S. have become very costly for importers in the UK because the pound dropped dramatically after Brexit, Bolle notes.
“Now is a great time for a U.S. company to offer a UK client the opportunity to pay in pounds,” says Bolle. “It would give them a competitive advantage and make them more attractive to the UK customer.” However, he adds, this would require some planning and re-adjusting of prices. “If the U.S. company were to do this, then they should seriously consider hedging their exposure.”
LOOK AT THE COSTS
Generally speaking, if a foreign currency is rising against the dollar, you should profit by invoicing in that currency, says Magda Szabo, a tax partner in the New York City office of the accounting firm Grassi & Co.
If a foreign country’s currency is falling against the dollar and you are a U.S. business with an investment there, you are going to be losing by doing the transaction that way, Szabo says. “At the end of the day, you are going to be impacted by which way the currency is swinging.”
However, the costs of opening a currency account and hedging a transaction can be substantial, so you need to weigh those factors when figuring out if a deal will work for you financially. Both banks and currency brokers offer currency accounts, and shopping around to find an arrangement that brings down the cost of the transaction is often worthwhile. “You have to weigh the cost and anticipated results,” says Szabo.
To achieve cost efficiencies, it is best to develop a strategy with your advisors for settling foreign transactions, rather than dealing with transactions on a one-by-one basis, says Bolle. “I’d never recommend that clients receive currency on a contract-by-contract basis,” he says. “With the levels of volatility we’ve seen recently, clients would leave themselves extremely exposed to adverse market moves without hedging at least part of their exposure.”
If you trade in multiple countries, it may make sense to offer settlements in foreign currencies only in the major markets where you do business. When you arrange contracts to lock in rates for a set period of time, you have to have individual contracts for each country, says Bolle. For instance, if you trade in both Singapore and the UK, you’d have to have separate contracts for each.
BUILD A HEDGE
When you invoice in a foreign currency, says Szabo, “the largest hazard is currency fluctuation and the risk of the currency moving up or down against the dollar.” Currently, the picture for U.S. companies exporting to Canada is fairly healthy, according to Bolle, but he notes that Europe is seeing some uncertainty related to Brexit. “The markets are extremely volatile right now,” he says.
Your bank or currency broker can advise you on whether it makes sense to hedge against a potential currency fluctuation and what type of transaction is best. “There are transactions you can engage in to offset and mitigate your risk,” Szabo says. Some transactions will protect you from a potential upswing or downswing in the currency you are using. “If you are worried about it going up or down and want to protect yourself in both directions, there is a different kind of hedging transaction,” she says.
Typically, the contracts exporters use to hedge are called currency forwards or FX forwards. If you sign a 90-day forward to buy the euro, for instance, it will lock in the euro at today’s exchange rates, says Bolle.
No matter what hedge you use, it can’t protect you from every potential risk, so make sure you have the cash reserves to insulate your firm if something goes wrong. “Any time you are dealing with variability in pricing, there is an element of gambling—an element of Lady Luck,” says Peter Bible, chief risk officer at New York City accounting firm EisnerAmper and former chief accounting officer of General Motors. The best solutions will narrow the effect of that variability in pricing, he says.
CONSIDER YOUR EXPOSURE
One rule of thumb when you are exporting manufactured goods is that the longer the period from initial contract and manufacture to shipment and delivery, the more exposure you have to fluctuations between the two currencies, says Bible. For instance, he explains, if you are making a vessel in Florida that is being sold to a shipping company in Greece, the time period between the start of the project and payment would be fairly long, bringing a lot of exposure. “The longer it is, the less likely that either the importer or exporter is willing to absorb that risk,” says Bible. “That’s when you need to bring in a third-party professional like a banker to provide a financial solution to lock in a price for both parties.”
However, if you’re shipping an order of shirts for which you know the client always pays in 30 days, the solution may be simpler, he says. Both parties may be willing to agree up front on an exchange rate that will apply when the delivery occurs, he says.
Be realistic about the potential for delays on your end of the transaction or in the shipping process, Bible advises. “What I’ve seen is companies not hedging their entire exposure,” he says. “They didn’t increase their position in the local currency, and the currency moved away from the dollar more quickly than anyone anticipated.” This scenario often comes up when companies are building a specialized piece of machinery that takes substantial time to build, ship and install, he says. Making sure your financial team stays on top of the project’s timeline and adjusts your hedging arrangements accordingly can help you avoid those risks, he says.
KNOW YOUR MARKET
Generally speaking, the highest risks of currency fluctuations are in developing countries with economies that are volatile. “If their currency is not pegged to the dollar, it can change dramatically overnight,” says Bible. If you do business in these markets, you may want to use a more comprehensive hedging strategy.
Some companies ultimately find that manufacturing locally is the best way to prevent currency risks in a particular market. “To have an operation in the country you are exporting to, you remove currency fluctuation from the equation,” says Bible. Of course, he adds, “For middle market companies, that’s not always feasible. That’s where financial instruments come into play.”
CONSIDER THE TAX IMPLICATIONS
If you play your cards right in hedging transactions, you may collect a capital gain—one on which you have to pay taxes. Ask your accountant to review the tax implications of any potential transaction with you before you move ahead with it. “Depending on the specifics of the transaction, it will impact you,” says Szabo.
If you can predict that impact ahead of time, you can plan ahead with your tax advisor. After taking the time to set up a hedging strategy that works, you’ll want to reap the rewards of the profits you earned—not pay a hefty tax bill.
MyBucks Piloting FinTech in New Markets With Novel AI Credit Scoring