Mastering FX Risk Management: A Guide For Small Businesses Operating Internationally

Small businesses are increasingly tied into the international economy. Whether it’s shipping in supplies from cheaper nations or selling products to larger overseas markets, managing multiple currencies is playing a bigger role in small business operations.

Despite selling abroad, many small firms still neglect the importance of currencies. From either relying on intermediaries for exchange or not acknowledging the market fluctuations, thousands of dollars each year might be lost due to currency handling.

With the help of resources from MTC, below is a guide for small businesses who want to master their business foreign exchange and subsequent costs. This goes far beyond ensuring finding the cheapest currency transaction, as ensuring you choose the right broker and strategy play a vital role too.

Knowing Your Partner

Selecting a reliable FX broker is a critical first step. The risks of not conducting proper due diligence could result in being subject to hidden fees, poor service, compliance risks, financial loss, or outright scams.

It’s best to steer clear of any FX broker that is promising profits or claims of certainty around returns. This would not only indicate suspicion, but a company that doesn’t care about adhering to regulations. You can also check the CFTC red list of unregulated brokers acting as if they are.

It’s not just about avoiding poor or risky FX brokers, but finding the best one for you. You will develop a relationship with your FX broker, as most offer a dedicated dealer who will provide ongoing support. There are some universal things to look out for, such as client reviews, customer support, security measures, transparent fee structures, and transaction speeds. MTC’s business section can help provide a quick snapshot of such aggregated data.

However, the exact pricing and services offered is down to what you prioritize most as a business. So, whilst we should focus on knowing your partners and eliminating disreputable entities from the start, you can wait until last to finally decide on the specific broker once you have more information.

Timing Your Transactions

Currency risk is a serious threat to companies that operate internationally. An American company with a Japanese supplier, for example, went from paying ~150 JPY per dollar to around 128 JPY in the space of a couple of months at the end of last year. This 15% increase in costs could mean thousands of extra dollars in supplies.

With central banks around the world being aggressive with their monetary policy changes, along with volatile geopolitical situations and high inflation, fluctuating exchange rates are expected to continue.

This currency risk can make it difficult to forecast cash flow, make steady debt repayments, and even cause liquidity issues. Providing that your business isn’t a financial firm, it’s advised to steer clear of the temptation to time your transactions in search of a preferential rate. Today’s rate is always the best rate, because tomorrow’s could be worse.

This is why forward contracts are an integral part of a responsible currency strategy. Currency forwards, which are commonly offered by corporate FX brokers, helps lock in a currency exchange rate which is close to day’s spot rate, and agree on a transfer amount at that rate on a given date. Such foreign exchange hedging technique protects you from fluctuating currency risk, making it effective in hedging future cash flows.

Some business money transfer providers will offer option contracts too, which means you can bail out of the contract when the date finally arrives (i.e. if you decide to change supplier, or change the amount of supplies you want to purchase). It is a risk in and of itself to lock in a forward contract that you may not want to (or cannot) fulfill.

However, the luxury of currency options will usually result in a slightly higher fee than a forward. This highlights the positive relationship between bearing a small cost today to avoid a potential bigger cost down the line – a little bit like the nature of insurance.

Understanding The Deal

Details to watch for in a currency transaction, including currency exchange rate, due date, bank fees, and other specifics.

It’s important to know the terms of any deal you complete. This is the biggest limitation of using traditional banks, that they are not transparent with fees and exchange rates. So, assuming you have made a good decision with your choice of broker, here are some details to keep an eye on when completing a deal or currency transaction.

• Exchange rate — Always verify the currency exchange rate before initiating a transaction. Have up-to-date knowledge of the mid-market rate (a simple Google will do) and ensure it’s close to this.
• Transaction fees — Make sure the fees add up and are correct. This may include a percentage fee, commission, flat fee, or a combination.
• Hidden fees — Make sure to read the small print and understand any hidden charges, as well as reconciling the amount charged after the transfer has completed.
• Bank fees — You may also be charged bank fees for international transfers. It’s important to clarify these beforehand, and potentially separately with your bank.
• Payment method — Check any associated fees with debit and credit cards, or if you’re using bank transfer
• Transaction speed — Read the estimated time estimation for the transfer
• Due date — If you’re entering a currency forward contract, make sure to take a note of the due date
• Recipient information — Double-check the recipient information (i.e. bank account details) are correct
• Contract details — If you’re entering a contract of any sort, make sure to read the terms, such as your rights, obligations, and any possible penalties
• Security measures — Complete your transfer using a VPN when on a public network, ensure the website has a padlock SSL symbol, and take any other security precautions when handling money

Mitigating Risks And Reducing Costs

When handling currency, mitigating risk is your primary goal. To do this, it’s important to understand the different costs and risks associated with FX. For example, there are the more visible and immediate tangible costs, such as withdrawal fees, early termination penalties, transaction fees, and bank account fees. These costs can add up and impact your bottom line.

However, there are some intangible costs too, that are harder to measure. For example, time is a valuable resource that is hard to put a price on, but a poor FX provider can eat up a lot of it (i.e. with poor, unresponsive customer service). There are opportunity costs here too, such as the time that could have been spent on income-generating activity, along with the money from fees that could have been reinvested back into operations.

It’s also possible to have reputation risks from partnering with disreputable brokers, or a general lack of trust in your business when you’re working with unreliable entities. Other intangible costs might include data breaches caused by the broker, and additional time spent getting to grips with a convoluted, user-unfriendly platform. Again, this further emphasizes the importance of due diligence.

Comparing Rates

Once you have your due diligence out of the way and you’re left with a choice of reliable, reputable brokers, we can focus back on what was once the primary objective: cutting currency costs. The previous section may be important for the majority of costs, but it’s also very important to consider a poor exchange rate as another form of cost. And, it can often be the primary one.

The difficulty here is that many brokers have varying and fluctuating exchange rate margins – meaning they don’t have a fixed amount they take as “commission”. A good start is to focus on transparent companies, that way it’s easier to measure the exchange rates early on.

It’s also important to avoid being swayed by the rate offered on a given day. If you take a practical approach to testing out a pseudo transfer at a few brokers, you want to experiment with a variety of currencies and on a variety of days.

Some companies may provide the mid-market rate with fees on top of that, whilst others may offer zero fees but have an exchange rate margin. Try and consolidate these together in your assessment to provide a standardized comparison.

You can also use blog and user reviews to aggregate information. Whilst this can help get a gist for companies perceived to be cheap or expensive, it’s not conclusive data because, again, exchange rate margins are often not rigid and consistent, and are therefore difficult to report on.

Banks vs Third-Party Providers

Pretty much every business will have a primary business bank account. Even if you’re a sole-trader with no business account, you will still have a personal bank account. This makes it the default choice for many people, because there’s a high amount of familiarity, trust, and even convenience when it comes to centralizing your transactions and accounting.

However, there’s more chance of having costs associated with deposits, withdrawals, and transfers when using banks. With a third-party provider, there’s often more flexibility and choice, which can lead to more opportunities to reduce fees. Just be sure to stick with reputable third-parties and not make the process too complex or fragmented.

Hedging Strategies

As mentioned earlier, foreign exchange hedging can be a way to mitigate potential losses due to volatility. However, there are a wide range of FX risk management tools.

Forward Transactions

Forward transactions, as mentioned earlier, help secure an exchange rate for a transaction that will occur on a future date. Pre-agreeing on an exchange rate like this may leave you worse off, or better, but one guarantee is that you will limit your risk from an unfavorable fluctuation.

Limit Orders

A limit order allows you to specify a desired exchange rate for your transaction. Once the market reaches this specified rate, your transaction will be executed. Of course, you run the risk of this order never coming to fruition, but it’s also a way to automate your transaction by specifying preferred rates.

Stop Loss Order

A stop loss order helps limit potential losses by establishing a minimal acceptable rate. This means that if the market drops to a given rate, your stop loss order will act as a way to bail out of holding the currency for any longer. It is an automated way of selling any holdings that are crashing.

Currency Swaps

Currency swaps are a way to have two parties agree to swap the principal and interest payments of a loan in one currency for another loan (of equal value) in another currency. This is a way to hedge against exchange rate risk, but it may also lead to preferable interest rates in a foreign currency.

Currency Futures And Etfs

Currency ETFs are a very accessible and liquid way of gaining currency exposure. This can be used to hedge a currency. To leverage this more so, a future can be used to increase your exposure to a currency even more given a limited amount of capital. These incur their own form of risk and costs, which is why they’re not a common way for businesses to mitigate currency risk.

Choosing The Right FX Provider

Discuss the merits and demerits of choosing large or boutique service providers, depending on the size and needs of the business.

Once you have established the FX providers to avoid and do your due diligence, as well as reflect on your own needs, it’s time to take a positive approach to seeking out the right broker for you. Of course, there is no single best broker, because they have their own advantages and disadvantages. Here are some factors to consider.

Size Of The Broker

Let’s categorize brokers into 2 simple lanes: Large corporations and smaller boutique providers. A large broker will likely have international operations, meaning they’re more likely to offer stability, broad currency coverage, extensive resources, and experience in a variety of markets. You may want to look for these when dealing with less common currencies, then, or perhaps a straightforward online onboarding process.

A smaller boutique provider, though, can usually offer a more personalized service. You’re more likely to know your dedicated dealer a little better, and they may spend more time assisting you with specific strategies. For bespoke needs, this may be the way to go.

When it comes to competitive rates and fees, there isn’t a reliable rule of thumb to divide the two.

Needs Of The Business – Extra Services Or Simple Spot Rates Conversions?

Ask yourself what your currency needs are and the nature of your business operations. If you want a straightforward process, such as a spot transfer, then it’s a matter of finding a cheap reliable broker.

If you’re unsure on your exact needs, perhaps there are bespoke strategies that could help you but you don’t know what they are yet, then seek out personalized boutique agencies that focus on corporate FX, and perhaps even other areas like treasury services, FX risk management consultation, payment and collection services, multi-currency accounts, and supply chain finance solutions. Payment automation with overseas sellers is a common service to explore.

App, Website, Or Phone

The above will play a role in how you interact with the broker, but also consider how you want to communicate. If you dislike lengthy phone calls and prefer using a 24/7 app, then there are brokers that excel at this. But, bear in mind that the more bespoke the service, the more likely a phone is needed. So, app-based brokers are more geared toward convenient and speedy spot-rate conversions.

Fees And Competitiveness

Again, a large factor in what determines the price of a service is what you get in return. But, most companies offer a free dedicated dealer, which implies an indirect cost of using a platform that has extensive bespoke services. In other words, if you’re looking for simple solutions, using a highly bespoke boutique service may mean you’re getting a bad deal in other ways (i.e. pay a high exchange rate margin) simply because you’re not getting the most out of the free dedicated dealer (that needs to be paid a salary from some form of revenue).

So, try and outline your exact needs (feel free to use free consultations to map these out too) and compare companies that focus on these needs. Then, straight comparisons between fees and business currency rates may make more sense.

Conclusion

Running an international business can be complex, even deciding on which currency to use when selling abroad can be challenging. International business payments can range from simple one-off cross-border transfers to ongoing, pre-agreed deals. The biggest risk – the one we cannot control – is the broader currency market, which is affected by economics, politics, and speculation.

What we can control, however, is the broker we choose and the strategies we employ. Most business owners are not FX specialists, which further emphasizes the need for a reliable, trustworthy broker to offer suggestions and execute proper currency risk management.

The more passive we are, the more we are exposed to fluctuations and currency risk. Whether it’s overseas buyers or sellers, handling other currencies requires a proactive approach to minimize risk and keep costs down.

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