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How to hedge your forex payments

How to hedge your forex payments article image

If you think a hedge is something that shelters you from the prying eyes, then you need to consider how much you may be losing on your foreign exchange payments. A hedge is any strategy that allows you to minimalise or remove financial risk. For foreign currency, this mean a strategy employed by businesses to reduce their exposure to foreign currency market movements and to provide more certainty and cash flow, defines Barry Fletcher, director of Business Development for Australia and New Zealand at American Express Foreign Exchange International Payments. For exporters who deal only in Australian dollars, that is, who buy and sell wholly in Australian currency, you can stop reading here. But for everyone else buying and/or selling in currencies other than AUD, hedging is an essential part of maintaining your margins. Why hedge? As an exporter you will almost certainly price your goods in a foreign currency to compete globally. The price at which your buyers purchase your goods or services will therefore be subject to currency movements until the time they pay their invoices-this could be 90 days down the track and the rate could have changed 20 percent since the sale. Hedging minimises the impact of those currency movements to allow you to retain your margins.

Hedging strategies

The first step is to understand how exchange rates affect your pricing. "The question has to be what FX rate an exporter has built into their pricing. They need to hedge at that point or better, then they can forget what the market does because they'll have that price risk covered," Fletcher says. "If you don't have much fat built in, you can't really afford to stay at the whim of the market because there is going to be a time when the market will work against you and that will erode all your profitability." One of the easiest ways to avoid exposure to currency fluctuation is by holding a foreign currency account, which gives you a 'natural' hedge. If a lot of your costs and earnings are in US dollars, for example, it makes sense to have an account in that denomination because you don't have to convert anything until you need the money in Australia. Then, "if your cash flow is strong enough, you can leave those US dollars in the account until the rate is beneficial to you," says Fletcher.

He advises exporters to conduct a cost-benefit analysis to ensure the volume of payments and outgoings to that account makes the fees and charges for holding the account worthwhile as this solution may not be ideal for exporters who only have ad hoc transactions in that currency. Another popular strategy is the use of forward exchange contracts, where the exporter books a rate for the future based on the spot rate today and the difference between the interest rates of the two countries' currencies. This means the exporter is assured a particular rate at a specified time and can therefore calculate their margin with greater accuracy. Like any financial contract, however, you need to understand the terms and conditions; exporters must use the rate by the maturity date for the amount booked. "If you haven't used that forward contract, that contract needs to be bought back at whatever the prevailing rate is on the day. That will almost certainly not be the rate at which the contract was locked in. If it's worse and there's a financial loss, that can have a significant impact on your cash flow," warns Fletcher. Taking out an option is also another strategy, though this more sophisticated product is not recommended for exporters struggling to understand foreign exchange. "In essence, you pay a premium up front for a rate that you may or may not use in the future. If you choose not to use the rate or the rate doesn't trigger, you've basically forfeited that," explains Fletcher. "You have to be clear on the premium, what you're getting for that, and whether you can afford it because it will affect your cash flow."

Common mistakes

Once you've devised a plan, stick to it, says Fletcher. "The one error we see people making regularly is they don't stick to their plan. They start to feel they can predict what the market is going to do. You may get it right a couple of times, but the one time you get it wrong it may destroy your business," he says. "Exporters shouldn't look to derive profits from trading in FX; focus instead on whatever it is your business does to make money." Speculation is not a good business practice, agrees Kerry Agiasotis, regional managing director for Asia-Pacific and Japan at Travelex. He says businesses often see favourable movements and regret they can't take advantage of them, but "the minute you start thinking that way, you're going against the philosophy of having a strategy". Exporters must also be mindful of how much to hedge. "Sometimes organisations will overhedge; they may hedge all of their receivables too far out. That might not be a great thing in a period of uncertainty. A smaller business in a more dynamic industry may only need to put in hedges to match more near-term cash flows," says Agiasotis. "Being underhedged can also be a problem, and that's where a proactive service provider is important."

Finally, remember to review your strategy regularly so that it remains relevant to your business as you change and grow, says Fletcher. "Make sure you understand the product, your liability and ultimately make sure it's the right fit for your business, for the FX requirements that you have. Choose an FX partner who will know enough about your business to give you the support you require, to build a strategy." And don't think about hedging as a product, think of it as a risk mitigation strategy, says Agiasotis. "It's a business practice to preserve an organisation's profits. The minute you start participating in gain, you seek the upside rather than focusing on the risk mitigation."

Growing a bigger hedge

Government credit agency Export Finance and Insurance Corporation (EFIC) and foreign exchange service Travelex have introduced a new facility to enable businesses to extend their trading ability when dealing with foreign currency. A small business on Travelex's default facility would ordinarily be allowed to trade to $500,000, for example. "If they were trade above $500,000, they would need to offer up security," says Kerry Agiasotis, Travelex regional managing director for Asia-Pacific and Japan. "What EFIC provides is the ability of that organisation to hedge double that amount without offering up any additional security." The guarantee means that growing businesses needn't use working capital to provide security, instead relying on the due diligence conducted by Travelex and EFIC to secure a higher trading limit, up to $1 million on the default facility, or larger depending on the business. EFIC's executive director for SMEs Andrea Govaert says the guarantee broadens the ways in which EFIC helps exporters manage the risks of international trade. "The guarantee is designed to assist small and medium-sized businesses, in line with EFIC's focus on helping SME exporters overcome financial barriers and move into global markets." 1. You have, or have approval for, a Travelex foreign exchange facility. 2. You request an EFIC foreign exchange facility guarantee to increase the trading limit on your facility. 3. If EFIC approves the application, it provides a foreign exchange facility guarantee to Travelex. 4. Travelex increases your trading limit, enabling you to hedge more of your export contracts.

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