The Evolution of FX Payment Institutions
When managing international transactions, it used to be the case that most companies had one bank managing the foreign exchange (FX) and international payments. Some employed multiple banks to work on their behalf, but the majority still relied on just the one. In the past decade or so, a new group of FX payment institutions (PIs) has arrived to provide a valuable alternative to the banks.
While the largest FTSE100 companies were generally already receiving good rates, service and advice, small and mid-sized enterprises (SMEs) were not afforded the same time and attention. When it came to FX transfers, it was the norm for a bank to only offer executional support to everyone outside the top echelons of business and not much else. While big business was taking a strategic approach to currency planning, most SMEs were just using simple spot contracts.
Furthermore, larger companies with multiple banks usually found their rates improving due to the competition factor, but not all companies merited or wanted more than one bank. Brokers stepped in to offer price competition and the kind of customer care that was previously reserved for a select few. It is a growth industry – we estimate that brokers have grown from making up about 1% of the corporate market in 2000 to around 20% in 2011. The five biggest brokers in the UK are Travelex, Moneycorp, World First, HiFX and Currencies Direct.
The volatile nature of the currency markets means that all companies will feel the pain of exchange rate fluctuations at some point. A difficult year often prompts companies to revaluate. In the 1990s, many large companies were actively speculating, sometimes taking positions in currencies where they had no exposure, while others were passively speculating by not hedging positions.
Then there was a big move among the larger companies towards fixed hedging mandates, where a fixed percentage of all known exposures are covered. This would often diminish the further away the exposure. For example, all known transactions in the next six months might be hedged 100%, whereas transactions two years away might only be hedged 25%.
This policy-driven hedging strategy helped some avoid blame if exchange rates moved against them. Many corporate treasurers have complained to me that they get no praise if the rate improves, but they always get blamed if it gets worse. This trend is starting to filter down into smaller companies. However, there are still many businesses out there with significant foreign currency exposure who do not adequately hedge their risk. This could have a significant impact on their profits.
Some companies take the view that they will lose out some years and benefit in others. However, most – particularly publicly listed companies – are keen to protect themselves against risk. Shareholders simply don’t want the volatility of earnings, and resultant volatility of share price, and there are cases in highly unpredictable times where companies have failed altogether because they had neglected to adequately hedge their exposure.
This has led many companies to move on from just using spot transactions to using forward transactions instead. This was a prudent move, allowing the company to fix their profit margin. However, the corporate treasurer was still sometimes blamed when the rate improved and the rigidity of the forward contracts meant they had missed out on favourable moves that would have led to increased profits.
This prompted the arrival, in the late 1990s, of structured hedging solutions involving options and derivatives. The word ‘option’ led some to cover their ears, following some high profile failures from speculative options (such as Orange County in 1994). In reality, the options being offered to corporates were all risk mitigating, with known worst-case rates capping any potential downside.
The simple premise of most of these structures is that you can protect yourself from the rate worsening, but you are also able to see the benefit if the rate subsequently moves in your favour.
The same trend followed whereby these options were initially only offered to the largest global corporates, but during the past 10 years the banks have started to offer these to smaller companies.
Lots of businesses liked these products, and the banks also preferred them because they usually had a higher ‘spread’. This, coupled with their popularity, led a few top FX brokers to enter the fray – offering the market broader product ranges and better pricing.
When FX brokers started, they tended to think of themselves as ‘FX companies’, but soon most also realised that the payment element of the transaction was as important to their clients as the actual rate itself. As a result, some of these FX companies have developed sophisticated and efficient systems, enabling them to offer payment services to the high volume corporate.
Most banks and some FX companies have developed the ability to upload files, which often accept the standard file format from treasury or accounting systems. However, automation and straight-through processing (STP) is the real ‘Holy Grail’ for treasurers, particularly those with subsidiaries or high volumes of payments.
The internet, and the introduction of ‘standards’ between systems, is enabling new solutions whereby a company’s system talks to a bank or broker’s systems usually via an application programming interface (API). This can enable total automation of a company’s payments without having to switch back and forth between systems. RBS developed FX Micropay to target this market and World First has also developed an API called World First Autopay.
If a company has 50 payments in its system, for example, the system can pass these straight through to World First Autopay, where they will be priced, a compliance check run, and the payments will be sent straight out through SWIFT in just a few minutes.
There are obvious advantages to this. Many look at the time saving element, but there’s also a significant cost savings associated with removing the need for staff to spend time performing manual processes. Automation also leads to a reduction in errors, which (as anyone who has ever tried to recall an incorrect payment from a country without a robust rule of law will know) can be a significant advantage.
Because the payments can be automated, the cost can fall significantly, potentially down to just a few pounds for a same-day SWIFT payment.
You should also be able to get a better rate by dealing with a foreign currency specialist or broker than going to a bank. The exact rate you receive relative to the interbank rate will depend on the amount you’re transacting, the frequency of your transactions and whether you are booking an immediate transfer or forward contract. However, unless your transactions are small (under £1,000) you should normally expect to save something between 0.25% and 1% of the amount you’re transacting.
There are many brokers out there to choose from, but for additional peace of mind it helps to use a broker that is authorised by the Financial Services Authority (FSA). A major stipulation of this regulation is to safeguard client funds by segregating client money.
There are ways of managing your risk and planning ahead efficiently and with confidence, making sure that your bottom line doesn’t fall victim to the perils of the currency markets. It is important that you are aware of the options that are out there, and that you go to a company that is properly authorised and big enough to ensure your financial security too.