Companies merge cash management and foreign exchange to tackle risk

For corporates, the post-crisis era has been a period of adaptation to new challenges, such as increased currency volatility and lower availability of credit from banks. It has also been about exploiting new opportunities, such as the growing importance of emerging markets to the global economy. These trends have accelerated the integration of cash management and foreign exchange, which until just a few years ago were clearly distinct for many companies.

The tighter credit environment – initially a direct result of the financial crisis and more recently a reaction to regulatory efforts to raise banks' capital adequacy – has prompted companies to focus ever more forensically on cash management. By improving efficiency and lowering costs related to payments and collections, internally generated cash can be used instead of scarce borrowed capital.

Meanwhile, the rollercoaster economic ride of the past five years has resulted in higher forex volatility, which has shone a spotlight on the need to manage forex-related risk. The increasing volumes of business done in emerging markets – by multinationals and rapidly growing emerging markets firms – has further emphasised the need for forex risk management, given the greater volatility of emerging market currencies.

"Many companies are growing fastest in emerging markets and, as a consequence, have greater forex exposure than in the past and can find themselves with multiple currency accounts that are difficult to manage, can have expensive overheads, and create risk management challenges," says Steve Everett, global head of cash management at Royal Bank of Scotland in London. "By thinking about cash management and foreign exchange in an integrated way, those challenges can be overcome."

When a company makes a payment or receives a collection in a currency other than its home currency it necessarily faces forex risk. How that forex risk is addressed should be determined by circumstances and the needs of the company, says Eric Mueller, head of global network banking and cash management, corporates, global transaction banking at Deutsche Bank in Frankfurt. "Corporates' most important choice is whether to open a local currency account or to convert currencies as necessary," he adds.

Many companies are growing fastest in emerging markets and, as a consequence, have greater forex exposure than in the past

Having a local currency account only makes sense if there is sufficient transaction volume to justify it, notes Mueller. "Multinationals may receive collections in as many as 80 currencies, but the vast majority of those will have low values and volumes," he adds. "The costs of operating such accounts – and the risk management challenges they create – mean they are unlikely to be advantageous for a company."

As a result, the majority of corporates instead choose to trade forex when a payment is required or a collection received. "Usually, companies will have a standing instruction with their banking partner to trade when balances reach a preset level," says Mueller. "However, the trade itself is usually completed manually, either via the telephone or online. As a consequence, it can be cumbersome and may lack transparency."

Lee Swee Siong, global head of global corporate products at Standard Chartered in Singapore, agrees that such manual management of forex is highly inefficient – particularly for companies dealing with bulk payments. He says that in response, larger corporates have moved towards embedded forex with pre-negotiated rates based on a set spread over a reference price or fix (which can be tiered to reward transaction volume) in recent years.

While automating forex conversion into payments and collections can be advantageous in terms of margin savings, Lee says most companies are primarily motivated by the overall processing and cost efficiency that can be gained as well as the rate transparency benefits of such a solution. "In any forex transaction, transparency in relation to forex rates is critical," adds Everett at RBS.

Forex factor

With payment and collections increasingly integrated with automated forex conversion at many corporates, larger multinationals have looked for additional ways to improve forex risk management related to cash management processes. "As companies build up their shared service centres and payment factories, there is more they can do on the forex front, such as multilateral inter-company netting and multi-currency notional pooling – forex efficiency has become a more important issue as a result," says Lee at Standard Chartered.

The use of a netting centre can reduce the need for multiple cross-border payments between multiple entities, which can produce huge transaction and forex cost savings, according to Lee. "The use of multi-currency notional pools allows companies to make use of their funds in a single currency without performing any forex trades," he explains. "It's a very powerful tool, according the treasurer much greater flexibility in utilising their multiple currency positions optimally."

Everett at RBS agrees that the most sophisticated multinationals now have treasuries that manage both cash balances and forex risk in an integrated way on a day-to-day basis. "Most frequently, they net between all their global subsidiaries to arrive at a single position in each currency at the end of the day," he says. "They are then in a position to make an informed decision about whether to hedge those positions or run them based on an assessment of their forthcoming needs. For example, they may choose to open renminbi accounts because they expect their suppliers to increasingly want to be paid in renminbi."