Forward rating and how to avoid losing out to currency fluctuations

This article comes from our interview on Pricing and Getting Paid with Kevin Shakespeare from the Institute of Export & International Trade.

Why is it important that companies keep an eye on currency fluctuations?

Firstly they should be managing the business effectively and simply by virtue of this they should be aware that currencies they pay and receive in fluctuate.

If, for example, a business is quoting for a potential export sale and they’re quoting $1k today, if the buyer company looks to take that up in a month’s time, the exchange rate has probably moved in that period.  Conversion of the $1k a month ago compared to today could mean that the UK exporter receives less now than they would have a month ago.

There’s definitely a need to stay aware of currency fluctuations. What some exporters might do is state on the pro forma invoice for their quotation that the price is only valid for 5 days or a week from the issuing of the invoice, to take account of currency fluctuations beyond that time.

Clearly business should look to manage their currency risk but in circumstances where they don’t have confirmed orders, that is harder to do. If however you have a well-established exporting business with regular sales and customers you should be able to take a view based on past history and past trends. If a business wins an export contract for the first time, if they have a confirmed order, they are in a better place to protect their exchange rates, especially through things like forward foreign exchange rate contracts.

If a business has payables in particular currencies – i.e. imports as well as exports – then they can open up an overseas currency account – i.e a Euro or dollar account – with their UK bank.

What are the mechanisms that allow companies to stay on top of and plan for fluctuations in currency?

If a company has payables and receivables they can net them over a currency account, effectively having a credit for the receivable and debit for the payable. That obviously assumes that there is some similarity in amounts and timings. It’s no good having to pay out US dollars and then not receive US dollars for 90 days  – this could leave you overdrawn. There has to be some correlation between the ins and outs and as businesses get bigger and factor in imports more as part of their supply chain and raw materials, as well as their exports, it’s more likely that currency accounts will come into play. For first-time exporters that’s obviously harder.

The other main method is the forward foreign exchange rate contract. If a business goes to the bank and says they have a confirmed order to receive $1k dollars in 90 days time, what a bank can do provide is a rate for that maturity in 90 days time.

You’ve got two types of forward exchange rate contract. You’ve got a fixed one where you fix the rate for in 90 days time. You may however say that as an exporter you don’t know if you’re going to receive it in 90 days – it might be 100 days or 110 days. What you can do then is take out an option forward foreign exchange contract. That is an option in terms of the maturity date. You can get an option for between 90 and 110 days and that option effectively can mature at any point in that period.

A lot of people will say how does the bank know what the exchange rate will be in 110 days time? Basically the exchange rate is worked out through the interest rate differential between the two currencies.

For euro against the pound both interest rates are at virtually minimal levels so the actual differential is therefore minimal. The exchange rate in 90 days is therefore quoted as similar to what it is today in this scenario. That’s how the banks do it – not on speculation, but on forward rates linked to interest rate differentials.

Companies can get forward rates from companies such as Reuters, Bloomberg, the Financial Times, and the rates you get at the banks might be slightly different as they might take into account the value of the transaction.

Companies might say can I take out a currency option or derivative? Generally the answer is no because banks are highly regulated on these matters. Banks often have a floor limit of around £250k and they may want evidence of the transaction. For a lot of companies this will not be a viable transaction.

For example where it can apply is if I’m tendering on a one-year contract and I won’t hear if I’ve got the tender for 3 months. If I don’t protect myself against the exchange rate, and the rate moves against me, I could lose out substantially. I’d therefore go to the bank with the evidence of the tender and if it’s a substantial amount they may give me an option to sell the currency.

For all currency transactions  we would say to the exporter in these cases is make sure that the Financial Conduct Authority (FCA) regulates this organization that provides the currency.


Bank or forex? 

If I’m an exporter I’m interested in the best customer service and the best rate. I don’t treat this too dissimilar to going on holiday – you want to get the best rate for your money whether that’s online, your bank or through a specialist provider. We don’t mind who gives the best rate, we just want the best rate.

Clearly exporters will have bank accounts so the theory is that the money goes into your main bank account in any case so that it’s easier to control.

Clearly specialist currency brokers and providers will argue that their rates will be more competitive and their customer service more specific. The exporter must consider the convenience factor in using a currency provider and the exchange rate they provide. They may try to benchmark the rate they receive from their main currency provider against that which they could receive from their main bank.

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Topics: Credit Facilities, Currency Exchange, Direct Selling, E-commerce, Export Planning, Finance, Getting Started, Market Research, Marketing Agents, Payments, and Sales & Marketing
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