Whether you run a small family company or a large multinational corporation, if your business is directly impacted by foreign currency and exchange rates, it is important to understand not only how currency volatility can impact your bottom line but also who you conduct your transactions with can have an impact on your business. Traditionally, large financial institutions were the only place to exchange money and send international payments. These institutions offered the service as an add-on and often charged clients a significant amount to conduct these transactions with very little customer support. These transactions were simply accept instructions from the client and execute. The amount of money exchanged globally daily led to the rise of a new competitor, the private broker, in the foreign exchange space. Many early brokers were former bankers that realized that there was an opportunity to provide a service to clients that was lacking at the big banks, provide it at a reduced cost and still have a healthy profit. These private brokers built business on price and service, but because they were private entities, they could not provide the same level of security that financial institutions could. In fact, over the years several private brokers filed for bankruptcy leaving their clients in difficult positions.
Over the years, because of the rise in private brokers and many clients moving their foreign exchange business away from financial institutions, the banks have become more competitive and engaged in the foreign exchange space. This, combined with the rise in technology and the ability to access interbank rates, has been very good for those needing foreign exchange. That said, there are still pitfalls that a business owner must understand if they are to make the best decision about where they send their foreign exchange business.
The first thing to know is if the organization you are dealing with provides security on the transaction. Questions to ask your foreign exchange partner is how are they funded and how clients funds “flow” through the organization. Are client funds used for the organization’s general operating accounts or do they reconcile only the profit generated from a transaction and add that to their general coffers. If they run one general operating account for all business and transaction management, the risk increases for the customer in the event of insolvency as any transaction in process could be at risk of a total loss of funds.
Because of this point, understanding how your foreign exchange partner manages margin requirements on forward contracts and options is essential. It is crucial to understand how they protect themselves and their clients. Large financial institutions may not require margin deposits on contracts but that is because they have security in the form of other assets held at the bank. If you are dealing with a bank, ensure you understand how margin and subsequent margin calls have an impact on the rest of your banking as items such as credit and availability to cash could be restricted. If you are dealing with a private broker, typical margin requirements are 5% of the total value of the contract, with additional margin calls once 4%of the margin has been utilized. This practice ensures that the broker is covered against volatility and that one or two clients in bad positions do not negatively impact other clients. Business owners need to understand how a broker manages their risk. If a broker is offering no margin contracts or credit, it is important to ask more questions. While it may seem like an advantage to not have to place a margin of 5% to a client, the reality is it is likely that they are carrying significant market risk. This risk compounds when you have major global events such as a pandemic or war and currency markets suddenly react. Without margins, many positions can quickly move to a place where the broker can no longer cover their positions leaving them in tough positions with their counterparties, potentially leading to massive delays in payments or insolvency. For large brokers with international operations, this means that the risk taken on one side of the globe could adversely impact clients in other offices. As such, knowing how a broker covers their risk is essential.
As every business owner is different, it is important to find a partner that suits you and your needs. With the rise in self-servicing, many clients enjoy the ability to log onto a platform or portal and conduct their own trades and initiate their own payments. Ensure the partner you choose has the functionality you need and know what support they offer behind the scenes. How does their support team respond to inquiries or troubleshoot technical issues? How do they support you in ensuring if you are maximizing the capability of the platform? Even if you are a savvy computer user that is very intuitive, it is always good to ensure that quality support is available and not provided through a self-help automated system.
Platforms and technology are not for everyone and for those that still want to conduct business in person, it is important to find a partner that approaches you and your business in the unique nature it requires. Finding a partner that understands you, your business, your objectives, and things such as cash flow and risk appetite are critical. It is crucial that they focus on the entity of your business and do not just manage the transaction, meaning they only manage the current transaction as a point A to B and do not look at it within the context of your total business operation. Find a partner that helps you determine the best strategy for your business.
Over the years, the foreign exchange landscape has changed due to the increase in competition, the natural evolution of business in the space and competing has made the experience much better for all clients regardless of whether you conduct your foreign exchange business with a financial institution or a private broker. The rise of technology has also created more transparency and access for clients which is also positive for business owners. You need to understand you have options, understand the pros and cons of each and decide not just on price, as cheapest is not always best. In the end, as a business owner you want a foreign exchange partner that provide value for the fees you pay and meets your businesses needs.