Companies can lock in rates in volatile times with products like Bank of America Merrill Lynch’s CashPro.
Foreign exchange (FX) volatility has wreaked havoc on multinationals’ budget planning over the last year, with the US dollar (USD) strengthening significantly compared to most currencies, and especially the euro, and the Chinese government unexpectedly devaluing the renminbi (RMB). What if a corporate could guarantee the FX rate it uses to pay suppliers or receive payments from customers?
In fact, that’s already possible through several global banks, but the rate is typically guaranteed for only a few days or in some cases a few weeks. Bank of America Merrill Lynch has been somewhat of a laggard on this front, but it is currently in the process of onboarding a handful of clients to a product guaranteeing rates as far out as six months. Called CashPro, it enables companies to lock in FX rates so they can pay and price or invoice goods and services in local currency, without taking on FX risk.
The role of corporate treasury has become less transactional and more strategic in recent years and includes mitigating an increasingly wider range of risks. A guaranteed rate mitigates FX volatility and also provides more certainty in terms of receivables and payables, improving a corporates’ ability to predict cash flow. That’s particularly relevant to companies expanding into new markets.
“When a company expands internationally into a new market, it will need to think about how to manage receivables from local customers and payables to local suppliers, and as a result of the day-to-day cash flow, how to manage the FX exposure to the local currency,” said Kefei Chang, regional head for transaction FX trading, Americas, at Bank of America Merrill Lynch. She added that the extended guarantee period provides additional flexibility to address the changing needs of corporates, whether involving online retail shopping, monthly subscription for digital content, or 180-day net-term invoices for import and export of goods and services.
“It more than covers the common distribution cycle. Companies typically try to execute in six months or less,” said Paul LaRock, principal at Treasury Strategies
Corporates paying suppliers in their local currencies typically go to their local banks to wire the payment to the supplier’s bank, which in turn does the conversion. During that process, rates can move significantly in favor of one party or the other—the Swiss franc, for example, soared 13 percent in a day. In addition, the supplier’s bank receiving the wire rarely discloses the upfront the spread and processing fees it charges, and that can result in payments falling short. Funds may take one or more days to appear in the supplier’s account, potentially arriving late.
Guarantying the FX rate should prevent such hiccups from arising, and vendors will be less tempted to overinflate invoices to mitigate such uncertainties. Another boon to the corporate’s customers is that they should be able to use their local payments systems to facilitate the transaction, lowering costs.
“By offering corporates guaranteed rates for a period of time, whatever the tenor of the invoice, we can enable that company to pay the invoice in the local currency, fostering a better relationship with suppliers,” said Ms. Chang.
Similar benefits can be accrued by companies invoicing corporate customers.
Several large banks guarantee rates for 24 hours or perhaps a few days, and RBS and HSBC offer guarantees going out further. In the case of RBS’ FXMicropay, for example, the bank notes that it takes on the FX risk.
“And with no minimum transaction size it’s a platform ideally geared at companies with large volumes of low value payments or receivables,” the bank says.
RBS did not respond to inquiries about its FXMicropay service. Once a high flyer in global markets and one of the largest banks in the world before the financial crisis, the bank is now majority government-owned and it has retreated from much of its global footprint.
HSBC has offered FlexRate for three years, and it is aimed at allowing merchants to price and sell their goods in buyers’ local currencies.
“We work with online merchants to design the optimal time period for the guaranteed rate, so it best matches their end buyer’s shopping needs,” said Betsy Waters, head of transactional FX at HSBC.
Ms. Waters noted that a merchant selling physical goods may need a guarantee period of many days to accommodate packing and shipping, where as a merchant selling a digital product may only require a few hours. A corporate customer collecting via invoices may need a hold time of several months, she added.
“Our HSBC FX E-Risk team manages the specific risk associated with pricing and managing the FlexRate pricing and trades,” Ms. Waters said, adding, “The pricing is a function of three factors: market liquidity, volatility and the duration of the price required.”
In the case of CashPro Flow, Bank of America Merrill Lynch is taking on the FX risk. Such convenience typically carries a cost, noted Jeff Wallace, managing partner at Greenwich Treasury Advisors. He added that an arbitrage approach will give some idea of the cost of this convenience.
For example, when a company is buying a foreign currency for subsequent payment to vendors, treasury can hypothetically calculate the all-in cost of buying spot the full amount of the currency and investing it overnight. Then it can use the cash to pay vendors when they are due, and compare the all-in effective rate against Bank of America Merrill Lynch’s guaranteed rate. A similar comparison can be done when a company is receiving a foreign currency.
Bank of America Merrill Lynch’s Ms. Chang said pricing information is proprietary, but the “bank has developed a risk management framework that is specific to transactional FX flows and enables us to offer much longer periods of rate guarantee at a competitive price.”
The bank is compensated for taking on that risk by charging a “risk management spread” that is agreed upon with the customer for each currency pair. Corporates can request guaranteed rates, which are time-stamped and can be audited to confirm an accurate spread was applied. By turning over the FX risk to Bank of America and essentially receiving the FX rates upfront, companies are also reducing their operational risk.
“They are essentially outsourcing their risk through a guaranteed rate, and as a result they achieve a lot of efficiencies in their reconciliation process,” said Hilani Kerr, head of global currency products in global transaction services at Bank of America Merrill Lynch.
Ms. Chang noted that a large technology company that pays app developers around the world on a monthly basis could benefit from CashPro Flow by providing those developers with a pre-established rate for which they’ll be aid when their apps are downloaded by customers during the month.
Treasury Strategies’ Mr. LaRock said the savings accrued for eliminating the need to engage in forward and other financial contracts, as well as the accompanying account requirements, would be especially helpful to midsize and smaller companies distributing goods purchases overseas. He added that large distributors could benefit as well, assuming the risk-management spread is indeed competitive.