Shining a light on FX rates


Currency muddle: Rates and spreads in cross-currency payments are often obscured, making FX risk a scourge of treasury departments

In this respect, foreign exchange risk can be the scourge of treasury departments, because the rates and spreads used during cross-currency payments are often hidden, keeping treasurers in the dark.

There is an increasing pressure on treasurers to mitigate FX transaction costs – and on banks to accommodate their clients’ concerns regarding FX transparency. Yet progress in this area has been slow. Techniques that address FX transparency, such as transaction cost analysis, have not been sufficient, while calls for an independent regulator on FX transaction costs have, so far, fallen on deaf ears.

Can sophisticated FX tools, that tackle transparency at source, work where regulatory efforts have failed? Certainly, treasurers can regain visibility of FX rates by rationalising their banking setup, helping them to reduce costs and improve trades. But first, let’s examine the problem. The opportunity to scrutinise the true transaction costs of cross-currency payments is not afforded to treasurers in the same way as other processes.

This transparency gap is two-pronged: firstly, some treasurers are not given full disclosure of the rates and spreads applied throughout the transaction lifecycle. In fact, treasurers are often authorising payments without an accurate understanding of the true costs – including both the FX rate used and the hidden or indirect costs applied by the bank for processing a transaction. Transparency gaps are not limited to when the payment is made – the rates applied during a payment might not even appear on a financial statement.

Secondly, such transparency gaps mean the treasurer will be unaware of the intraday spread used by the corporate’s bank. Wide margins are used by banks when clearing FX payments because the rates are updated perhaps only twice every working day to protect against sudden intraday volatility. As a result, these buffered exchange rates can deviate significantly from currency values in the real-time market.

Reducing risk

Naturally, counter-strategies have attempted to mitigate such gaping holes in the corporate’s ability to manage FX risk, though with limited success.

For instance, TCA tools can provide proof to clients that FX trades have been cost-efficient. But although TCA has provided some welcome credibility to equity markets, it remains only a partial solution for FX transactions. As there is no central exchange to offer benchmark FX values, TCA technologies evaluating FX transactions do not have full access to the market’s activity. Therefore, they are unable to instil confidence among adopters as to whether the judgment on the competitiveness of rates ought to be trusted.

What’s more, this has given leverage to those calling for an independent regulatory body tasked with governing the FX trading sphere. But this too poses operational challenges. Undoubtedly, banks holding a comparative advantage in global forex markets would welcome an independent seal of approval. But in reality this comes with wider concerns. The trade-off between encouraging FX transparency and ensuring the confidentiality of client data may prove too difficult to reconcile.

In practice, establishing an effective regulatory body would require vast streams of market-sensitive data to be shared. Although stripped of confidential information, such data-sharing arrangements on an unprecedented scale represent a major shift for the bank-client relationship. Therefore, with both TCA and any move for independent regulation discounted, where can FX transparency be addressed adequately? In our view, richer data reporting and real-time FX rates seems a more viable alternative.

Certainly, if FX risk is perceived to carry unavoidable costs, transparency blind spots will endure. Yet there does seem to be a tangible solution: cross-currency payments using real-time FX rates that offer rich data reporting throughout a transaction’s lifecycle.

By converting flows using real-time FX rates during a cross-currency payment – rather than fixed rates – treasurers can be more assured of cost-effective FX strategies.

Banks are already integrating forex trading floor platforms with corporate cross-currency payments, enabling corporates to access competitive currency rates that accurately reflect the market’s current liquidity rather than buffered rates.

Above all, however, the power of advanced FX solutions is their ability to provide additional and far-reaching practical advantages unavailable to TCA: advantages that can provide leverage to negotiate price points and currency account consolidation, which will – ultimately – reduce operation costs.

Corporate accounts with real-time FX rate capabilities can be used to pay in many foreign currencies, making local-currency accounts unnecessary. A treasurer may once have set up a web of infrequently-used currency accounts in order to pay particular invoices. This cumbersome practice traps cash across the balance sheet, in numerous accounts, and also exposes the corporate’s cashflow to intraday currency volatility – usually by holding particularly sensitive currencies.

Real-time rates

Instead, by operating from one consolidated account from which all payments – both domestic and cross-currency – can be processed, corporates are able to achieve a greater operational overview of corporate cash while also rationalising their processes.

What’s more, the treasurer can use this certainty regarding costs to negotiate favourable prices with their suppliers. As the corporate can now pay in a range of currencies, the treasurer can engage the procurement department to re-negotiate contract terms to pay directly using the supplier’s base currency – a clear advantage. This means the supplier is no longer subject to a currency risk on its side, which was previously a source of uncertainty and friction in the supply chain.

Of course, the choice between using corporate accounts that offer cross-currency payments or TCA is not an either-or decision. That said, treasurers seeking to mitigate the costs of cross-currency payments may benefit, in the first instance, from tackling the common causes of FX transparency gaps at source: by adapting the corporate’s banking setup.

My colleagues and I have found that corporates are operating in silos when it comes to FX and domestic payments – a mindset causing operational idiosyncrasies to appear. Given this, the transparency gaps are best addressed by treating FX transparency at the beginning of the transaction cycle as a necessity, not a luxury.

Dieter Stynen works in global transaction banking FX at Deutsche Bank

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