The rise of international trade and floated currencies has entailed a growth in the foreign exchange market to be the world’s most heavily traded financial commodity, with global volumes of $US4 trillion traded every day.
While large trading and investment banks engage in this trade for hedging and speculation, thousands of Australian businesses have to negotiate the foreign exchange markets as a practical necessity.
The entry of business owners into a world controlled by traders and speculators creates pitfalls, says
As well as the pitfalls to trading in different currencies, there are drawbacks to mitigating the risks, Ord says.
The classic pitfall occurs when a business that imports materials for manufacture or resale suffers from a falling domestic exchange rate against the currency through which it is purchasing its imports. This scenario can increase costs for the importer, usually reducing their profitability and eventually the market value of the business.
When the Australian currency gains against foreign currencies, our exporters lose profitability and the cost of foreign inputs usually decreases, giving importers an advantage over domestic producers.
Businesses that attempt to hedge currency risk also face pitfalls. “There are two main ways of dealing with foreign exchange risk: the forward exchange contract and the foreign currency option," Ord says.
But business owners should not think that because they buy either a contract or an option that they have no risk. “An option means you can buy a stipulated foreign currency at a date in the future, at a certain price, if you want to buy at that price. If it’s advantageous to your business, you buy the currency at that rate, but you don’t have to. It’s relatively expensive."
The forward contract is locked in at a certain price in the future, so you can create certainty in your costs at a low price. But if the exchange rate moves against you between taking the contract and having to pay the vendor, you are committed to paying that exchange rate. “You have to treat foreign exchange risk as a cost, just as the cost of other inputs are risks to be managed," Ord says.
Some currencies, such as the US dollar, have frequent small movements against the Aussie dollar, but others – such as the rouble – are volatile.
Ord suggests business owners should measure foreign exchange risk by keeping a register of foreign currency exposures and by creating a table of foreign currency cash flows.
There are more technical approaches such as “value at risk", but, according to Ord, conducting a “sensitivity analysis" on foreign exchange transactions gives a business owner a sense of which transactions are sensitive to exchange rate movements and should be hedged with risk products.
When a business is comfortable with the currency volatility with a specific currency, they can avoid risk products and use a foreign currency bank account with a loan facility, Ord says.
“Many businesses have a bank account in the currency they usually trade in," Ord says. “Because most of the risk and cost happens when the foreign currency exchange occurs, you can make payments and accept payments in the chosen currency and convert it back to Aussie dollars as and when it suits you."
He says some Australian businesses with foreign currency bank accounts also borrow foreign currency to pay for foreign currency purchases, and then use the foreign currency to repay the loan.
Bryan Clark, head of trade and international affairs at the Australian Chamber of Commerce and Industry, says some smaller traders are urged into taking forex risk products when they don’t need them.
“You have to assess your own business and establish where the risk lies, and how much it could cost you.
“There are many mid-sized Australian companies that make frequent orders from overseas and so long as they’re trading in a currency such as the US [dollar], they may not hedge because over a year the losses are made up by the gains."
Other importers may bring in large orders infrequently and they have to hedge with contracts because they cannot afford to be left with a warehouse filled with goods that cannot be sold at a competitive price. “Some of the hedging products are expensive compared to size of the deal, but businesses are talked into them because they don’t want to lose money."
Clark says many small and mid-sized Australian businesses avoid foreign exchange risk altogether by writing their contracts in Aussie dollars. “Asian businesses probably prefer the US because it’s a recognised trading currency," he says. “But the Aussie is recognised and trusted too – more business owners should insist on dealing in Aussie dollars."
One of the pitfalls of using foreign currency exchange to pay offshore suppliers or be paid by foreign customers is that innocent businesses can be caught in money-laundering channels used by organised crime. Specialist foreign exchange remitters who “wire" payments to offshore recipients in a chosen currency are targeted by organised crime gangs who use legitimate forex transactions to hide their own money-laundering trails.
Australia’s foreign transaction regulator and intelligence gatherer – AUSTRAC – monitors transactions where the client believes funds are being exchanged into a foreign currency and remitted in another country, but in fact the money given to the foreign exchange agency is handed to the crime gang, and the criminal associates in the other country make the payment to the ultimate recipient.
AUSTRAC requires all independent remitters to register for the Remittance Sector Register and advises business owners and individuals to search the register before wiring funds internationally through an independent remitter.
The Australian Financial Review