FX and International Payments

31st July 2023

Solving the Conundrum

With more and more businesses operating internationally, FX risk management continues to be one of the most vital treasury tasks. After all, failure to correctly monitor and mitigate potential currency-related pitfalls may cause significant headaches for treasurers, senior management, and shareholders. Despite these challenges, there are proactive steps that treasurers could take today to get a better handle on their currency exposures – from automating FX workflows around cross-border payments to building a flexible hedging policy.

A sizeable percentage of companies’ FX exposures arise from the fact that they’re paying and receiving funds to or from overseas, a trend that is only set to grow. The Bank of England, for example, estimates that the value of cross-border payments will rise to $250tr. by 2027[1] – driven in no small part by the boom in e-commerce (see box 1). Under the surface of this growth, however, multinational corporates are contending with currency volatility that is drastically affecting the bottom line, with one report finding the global impact of recent FX fluctuations to be more than $64bn in Q3 2022[2].

BOX 1:  E-Commerce Catalyses the Focus on Transactional FX

One critical development as a result of the Covid-19 pandemic was the importance of firms being able to shift their business to utilise online as a sales channel. Companies that previously did not have the scale to be international or have a global supply chain now can, thanks to digitalisation. While this is fantastic for business, it brings an element of FX risk that may not have been considered before.

“E-commerce definitely impacts the likelihood of increased cross-border transactions and needing to pay out and receive monies in different currencies that a company has not dealt with before,” highlights Amanda Lovewell, Head of Transaction Services Account Management, NatWest. “As a company grows its online channel, the transactional FX in the business will grow with it. Treasurers must understand what that is and how they’re hedging or optimising it.”

With even well-established, traditional non-e-commerce industries taking an aggressive approach towards the channel, either for consumers or as a platform for their B2B customers, the pressure is on treasurers to support new payment measures and currencies and understand the associated FX exposures.

“Corporates need to be able to quickly understand how they are going to accept different e-commerce payments and handle pricing in far more currencies than they are used to,” comments Nick Pedersen, Global Head of Digital, NatWest. “For treasurers, being on top of that and leading that dialogue is really important.”

Lovewell agrees that treasury can be a hub for the commercial discussions that happen in an organisation, particularly when exploiting a new sales channel such as e-commerce. “It’s about how businesses are contracting for supply, how they are going to be selling the product, in which currencies and which currency pairs, what the cost is linked to, and whether there is any currency element to the costings that need to be factored into the contract,” Lovewell notes. “Ensuring the treasury team is party to all those discussions is vital to knowing where operational FX is hidden in those contracts. That broader piece of the business is not necessarily in front of treasury on day one.”

Lucy Grimstead, Head of UK Corporate and Private Funds FX Sales, NatWest, comments: “Visible FX exposures – relating to the core underlying business – are often well understood and actively managed. However, less visible exposures, such as international payment-related flows and indirect FX, typically attract less focus while often amounting to potentially significant levels of unmanaged risk.”

This issue of inattention to FX associated with cross-border payments can arise if companies don’t look at their payments in domestic and international terms but rather see them purely as AR/AP and which of their customers and suppliers they need to be paying in more general terms. This kind of approach can be fairly common where legacy, highly manual processes are in place around FX payments.

Another scenario which may see FX left out of the workflow, says Amanda Lovewell, Head of Transaction Services Account Management, NatWest, comes when corporate treasurers are looking to automate payments and connect to their systems to achieve straight-through processing (STP). “In this instance, rather than coming to the bank first, corporates are making those payments from their in-house systems and getting those to come straight through to the banks via an API. Efficiency and reduced fees are potential upsides of doing this, but it could mean they’re not always considering the FX elements of where those payments are debiting or where they’re coming in from.”

Managing hidden exposures

Yet tracking the FX element of a payment is crucial, particularly in today’s market environment of increased volatility. One area this has particularly impacted treasurers has been forecasting.

“Recent years have challenged the predictability in underlying business performance and the reliability of supply chains to the limit, and so forecasting with confidence has become harder,” reflects Grimstead. “As a result, we’ve seen that influence not only the interest in better transactional FX solutions but also hedging behaviours and treasury policy around FX risk management more broadly.”

The importance of being nimble became evident last year, as did having a flexible policy that is able to adapt where necessary, says Grimstead. “This could be regarding hedge tenors or ratios, or even product selection, but treasurers need a policy that provides control discretion. A corporate might wait for those volatile moments to warrant reviewing and enhancing policy, but that’s exactly the time they should invest their energy elsewhere. It’s essential to invest that time early on in the process of building the policy.”

The current market climate is also forcing corporates to shine a light on some of their less visible FX exposures as they strive to improve operating efficiency and reduce costs. “Technology and data advances have simplified our ability to assess and manage these more hidden exposures,” adds Grimstead. “That is absolutely something treasurers should be embracing.”

Treasury leading the dialogue

Naturally, these advances in technology and the expanding digital toolkit available to treasurers will play an increasing role in assessing and managing FX risk. Through the introduction of technology – including automation, APIs and AI-driven tools – corporates can interrogate and actively deal with unmanaged or under-managed exposures and could benefit from those streamlined processes and improved efficiencies elsewhere.

‘By better managing exposures through technology, treasurers can create the capacity and confidence to focus on more strategic risk management, such as policy revisions, the inclusion of optionality, and the ability to monitor and manage currency risks and exposures continually,” notes Grimstead. “I would encourage every treasurer to invest in understanding the advancements and applications to their business and be open to that evolution, whether it is products in the more classical sense or technology as a whole.”

Of course, it is not just the treasury department generating FX exposures. These can come from across the organisation, including procurement and sales. So, to truly get to grips with all FX exposures, treasurers need to drive the agenda with all other relevant stakeholders in the business.

Nick Pedersen, Global Head of Digital, NatWest, explains: “When we implement one of our automated services with a corporate, it’s rare that we operate only with treasury. More often than not, treasury is the introducer or the ‘go to’ for different parts of an organisation – product management, enterprise sales teams, accounts payable, logistics, supply chain – a diverse group of people. An effective treasury team educates and leads internal teams through the technology change but then operates as something of a go-between to all of the providers, ensuring everyone is onboard and singing from the same hymn sheet.”

Increasing transparency

One area where technology is making a significant and positive difference is the transparency of FX flows. As already noted, the increased efficiency of embedding AR/AP processes into banking can sometimes obscure sources of transactional FX and the rates that treasurers might have to pay for. Determining how those rates are calculated and how they impact an organisation’s inbound and outbound flows in terms of value is vital, but can be tough. This is where technology comes into its own.

“In its most basic form, treasurers have to understand all the FX flows relating to the business and, as a result, the currency accounts that may be needed,” says Lovewell. “In theory, having accounts for each currency enables treasurers to receive and pay in the currencies they’re trading in across their business directly and takes out that FX risk altogether. But in practice, this can create its own issues, notably in relation to increased complexity and a greater administrative burden. Treasurers often want as few bank accounts as possible, particularly physical accounts to have governance around.”

Virtual accounts are an increasingly popular solution in this regard, providing cross-currency capabilities without needing a physical account. What’s more, FX APIs – delivering rates direct from the bank straight into treasury systems and embedding them in workflows (see box 2) – can combine with virtual accounts to offer the ability to split a payment and its associated FX relatively simply. Treasurers considering this approach should be able to implement the process in a nimble and cost-efficient manner, as Grimstead explains.

BOX 2: Unlocking efficiencies with APIs

While FX APIs have been around for a number of years, the proliferation of other API services driven by open banking – such as payments as an API or bank accounts as an API – is enabling plugging FX into those services to be relatively simple.

“API integration needn’t take months of development resources because the specifications of the APIs are now so standardised and, in many respects, already embedded into other processes,” comments Pedersen. “It’s a very light-touch implementation in many cases.”

Moreover, treasury systems such as TMS and ERPs now actively consume services as APIs to embed FX into those places. “There’s definitely a scenario where corporates could devise their dream treasury management set-up and buy it off the shelf with a couple of customised tweaks,” Pedersen continues. “That was certainly not the case five to 10 years ago, where the corporate would have to produce a detailed plan of what they were after and the provider would go away and build it bespoke, charging quite a lot of money.”

“Working with a client last year, I found it fascinating that investment in technology used to mean a high cost of entry and time spent for both parties involved. This client was fully up and running on virtual accounts and bisecting their payments and FX risks within around 48 hours.”

Elaborating on the trend for treasurers to embed the rate they can get on FX from their bank into the payment journey across all the relevant partners in the business, Pedersen notes: “This is where payments and FX collide.” He continues: “It does vary depending on the payment type. For cross-border wires and bank transfers, it would be pretty rare for the provider not to be able to identify and split out the FX rate associated with that payment and offer it on volumetric or commercial terms that make sense for the customer. Card payments, or receipt of card payments, is a different scenario altogether, however.”

The FX spreads charged on card payments traditionally are not particularly transparent, which is also sometimes the case with alternative payment methods or non-card consumer-based payment accepted methods. But the technology exists to help treasurers gain better transparency.

“It’s up to us as an industry and to treasurers to keep pressing for greater transparency,” adds Pedersen. “SWIFT gpi as an industry implementation was a great tool to help that along because, if we cycle back five or 10 years, cross-border bank transfer payments didn’t have the same associated transparency and competitiveness in FX as they do today. It’s a journey. The newer or more niche the payment type, the more important it is to get under the hood and look at where the FX is actually happening. And I would encourage treasurers to be part of this dialogue with their banks and industry bodies.”

A little curiosity goes a long way

Grimstead takes this message of participation one step further and encourages treasurers to be curious and invest time in understanding how all of the technologies could make a difference in their business. “Understand how tech innovations could help streamline processes, support cost reductions, and enable the wider treasury team to get their arms around even more of the FX risk. In doing so, corporates will free up more capacity to think strategically about how they can be tactical around FX risk management.”

Lovewell echoes the advice to be curious, particularly regarding what different business areas are doing. It is important to understand from where the transactional FX scenarios are emerging as a result of a company’s contracting with customers and suppliers.

“Are there other activities going on in the broader business that are not being brought to treasury but could create FX within their payment journeys?” she questions. “Also, when treasurers are thinking about automating and optimising how they manage payments and collections with their bank, they should consider the FX element of that automation and that channel connection they have with their providers – aiming to integrate all elements.”

Finally, when considering the technologies that can support the management of FX in cross-border payments, it is essential to understand what is available in the market today and which are more theoretical or in development, says Pedersen.

“Use the 80/20 rule – 80% of the focus on technology should be on ones that are being used today,” he concludes. “APIs are a great example of that, versus blockchain and CBDCs, which are much further out for treasury to use in real-life scenarios. Be aware of these developments, but spend 80% on the technologies that are actionable today. And FX, especially in relation to payments, is one area where these developments are extremely tangible.”

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