Foreign Exchange for business explained
No matter how many businesses we talk to there is a lot of confusion around the topic of foreign exchange (FX). And by talking to businesses we mean talking to people in those businesses. Often those who profess to know the most can be the least informed about what is going on. They fail to understand the basic concepts. They often repeat all the myths and misinformation they think they understand. The reality is that true understanding impacts the benefits that are available. You just need to know…
Not that it is easy to understand by any means. Like most aspects of the financial industry, it delights in low transparency. Of course with a good pinch of secrecy thrown in. The industry gears itself towards benefiting the high volume / wealthy. With low accountability, it often uses smoke and mirrors to maximise profits. This is not an industry that has generally focused on the customer, which is you.
We did not envisage that FX was a category that we would deliver large benefits to many of our members. Over the last few years, we have helped members save millions of dollars in FX costs. Not that every discussion was simple. There were some members who failed to capitalise on the opportunity to save.
One that sticks out for us was a company who had the opportunity to save over $400,000 pa. We delivered an audit and benefit analysis of their past trades. They stalled and stalled. Why? They bought into the ‘pitch’ that their financial institution (in this case a ‘big four’ bank) fed them. They took the matched rates that the bank had offered.
Pain it turns out, is a great teacher. Over time they asked us to take another look at the rates provided by their bank provider over time. Their bank provider had crept up the margin over time. It was back at the same as they had paid in the beginning. That decision over two years cost our member $900,000 in real cash.
Finally, they are now saving the money we proposed through our supplier. They get the same transparent rate, every time. We provide them with a tracking report that shows the benefit since changing. The finance team can view at all times on-line the cost of all trades for previous periods. And, it makes finance look like a star to the board.
So why is there confusion? Why is it so hard to understand? What are the myths around FX that everyone is falling for? And, what could the benefits be for you and your company?
Why there is confusion in FX?
The most dangerous words we hear are … ‘we get a good rate from our bank’. Very few can tell us what that ‘good rate’ is. Even less actually verify the ‘good rate’ that they believe they are receiving.
Because FX providers (none that we are aware of) do not provide a method of verifying the FX rates. Nor the margin charged. Only the FX deal sheet is provided showing the date, time and rate charged. No comparison to the wholesale rate. No transparency to the margin charged… nothing really.
So the reality is most do not know what their true FX costs are.
That is, how their FX costs compare to the market rates (known as the wholesale or inter-bank rates). Due to a lack of transparency it has never been easy to do the comparison.
Why is it difficult to get a clear picture?
Once you understand the basics, then you can try to work out what the cost of foreign exchange is. Right? You look at your trade summary, it is easy to work out the rate you paid – then…
Why can you still not work out the cost of the trade?
The reason is that currency pair rates (e.g. AUD vs USD) change all the time. The rates can move by as much as several percent in a day if the market is volatile. To work out what the real cost was, you would need to know what the currency rate and the inter-bank rate was at the specific time the trade happened.
But that level of transparency is not required in the banking system in Australia. So it’s no surprise that most FX providers don’t even go close to providing that information in their reporting. This simple lack of transparency gives FX providers the ability to increase revenue. And of course profit. And, the reality is that many FX traders receive bonuses based on profit or revenue. The royal commission may change this… we will leave that speculation up to you.
Editors Note: We did a Google search for a course on transparency or ethics in banking as part of our research. Google brought up zero results…we moved on.
To measure and report, you need access to a proper FX feed and the time the trade happened. Or you need a provider who will provide you with this information. You can then determine the true cost.
But isn’t dealing with my bank easier and safer? The 2 common myths of foreign exchange
Myth # 1: Banks are easier to deal with
It depends on what you mean by easier to deal with.
Do you mean that you can transact your Foreign Exchange trades in the same internet banking site? Yes, that’s easy.
Do you have access to a dealer who can provide information on upcoming risk events (e.g. US trade figures)? Market movements? Other factors that may affect your risk analysis and decision making? Especially if you are not a large business? Definitely not.
Ease of use means many things to most people. And, we are all different. When it comes to ensuring that you are getting the best rates and lowest cost on your Foreign Exchange. Specialist FX providers usually offer a better level of service. This is because that is the only business they do.
The reality in Australia right now is this. None of the ‘big four’ or other banking institutions (that we are aware of) provide any level of transparent reporting. So how can this make dealing with them easy?
Myth #2: Banks are safer to deal with
As a result of the GFC the Australian government has guaranteed the ‘big four’ banks in the event of a crisis (such as the GFC).
So if you trade FX through your bank your funds are safe.
But this does not mean that a non-bank provider is any less safe.
If your non-bank provider uses a ‘big four’ bank to maintain custody of your funds at all times then, by definition, your funds are safe. They are held in custody by a guaranteed bank provider.
Said another way trading with your bank is not necessarily any safer than trading with a non-bank provider. That is if they use a guaranteed Australian bank to hold your funds in trust. If the non-bank provider were to fail your funds would still be safe as they are held in custody by the bank.
All you need to do is answer the following questions:
1/ Are your funds held in as a secured creditor in an Australian bank account?
2/ Is the account you pay into separate to any operational account the provider holds?
3/ Are the funds you transfer held until your supplier is paid in full?
4/ Does your provider hold an appropriate Australian Financial Services license?
What could the benefits be?
The benefits for yourself and your organisation depend on what your goal is. In the example earlier, $900,000 is a very positive cash flow saving. The money could be re-invested into other areas. Not all businesses are going to be saving an amount that large. It depends of course on the total volume you trade and the rates you are currently paying.
We have seen results as high as 1.5% savings as a percentage of the total trade value. And, those sort of results as a reduction in the cost of goods or expenses can make a big difference. The difference between achieving profit or not.
What should you do next to minimise foreign exchange cost?
Next time you are looking at foreign exchange ask the following questions.
1/ Are your advisers, dealers or staff compensated by commission?
2/ Are you able to offer me transparent reporting on the margin I am offered for every trade?
3/ Do you provide value-added advice on when I should be trading to help me manage my risk?
If they cannot answer yes to these two questions, find a supplier that can say yes. Without these conditions, you will most likely end up paying more than you should.
After all that, it is your choice
Our role is to tell our members what they should be considering. We are not here to make the decisions for them. We do have the data and war stories to prove that this is one area that most businesses should look at. If you have never looked at it. If you looked at it over 3 months ago. Or want to check your options – FX could be a big opportunity to save.