Minimising Risk in FX International Payments: 2024 Strategies

In addition to the challenges of setting up operations in multiple countries, paying suppliers in different currencies, and receiving funds in different currencies, international businesses also face foreign currency risk when making foreign exchange payments - also known as exchange rate risk.

In this article, we will examine the risks associated with international FX payments and present several strategies that businesses can adopt to minimise those risks and ensure efficient, cost-effective payments.

Foreign currency exchange risk occurs when the value of assets or funds may change as a result of the relative fluctuations of the currencies involved, which are influenced by a number of external factors such as regulations and social, economic, and political conditions.

For example, businesses are affected in the short term by FX risk when they receive less payments than expected or when foreign transfers cost more than originally anticipated. The larger the international payment, the higher the costs, and in the long run, negatively impacting the trust of suppliers, investors and the bottom line, as well as the cash flow.

Having a clear understanding of the forces at play that influence the exchange rates and the risks associated with international payments are one of the cornerstones of cross-border business. Therefore, developing strategies to mitigate risks will ensure the business can navigate cross-border trade smoothly and expand without significant damage to its trust, reputation, or bottom line.

When a supplier and a customer agree on a price for goods or services, along with payment and delivery dates internationally, changes in exchange rates can cause issues. For example, if the supplier wants payment in USD, but the client pays in EUR, any changes in the exchange rate between the agreement and the payment can lead to a loss for either party.

A variety of risks arise from forex payments - some are related to external factors, others to internal processes. Despite having more control over internal processes, you can still mitigate external risks from FX exposure with appropriate strategies and preparation. Please keep in mind that we are merely addressing the FX risks involved in international payments - this is not considering forex exposure risk that may also erode your assets, equities, liabilities or income over time through, for example, translation risk - how international currency transactions impact reporting and balance sheets.

Foreign exchange rates can vary greatly day to day based on a variety of external factors, including politics, social media, climate, and economy. When operating cross-border, you need to keep track of exchange rates when sending and receiving funds in different currencies. When you receive a product or service in the currency of the supplier, transaction risk is the biggest risk to watch out for. In a situation where their currency is stronger than yours you'll be at a loss. Receiving businesses usually do not carry the same risks as businesses completing the transaction unless the transaction includes additional fees. In addition, the greater the transaction volume or value, the greater the risk of losses.

Consider this scenario: A US based (Company A) imports machinery from a French manufacturer (Company B). The purchase agreement is set at €1 million, with payment due in 30 days. At the time of the contract, the foreign exchange rate is 1 EUR = 1.10 USD and the cost for the company A would be $1.1 million.

If USD weakens between the contract and the execution of the payment and the exchange rate changes to 1 EUR = 1.20 USD the new cost is now $1.2 million, which means an additional cost of $100,000 due to the unfavorable dollar exchange rate movement.

It is possible though for the exchange rate to be favourable, though. If in the meantime the markets move, USD strengthens - and the exchange rate is down to 1 EUR = 1.05 USD, meaning the cost is now $1.05 million, Company A would save $50,000.

The term operational risk refers to any risk resulting from inefficient processes, accounting systems, human errors, or external events.

Here are a few examples of operational risks associated with international currency conversion and payments:

Technology Failures: This occurs when a payment cannot be executed as planned because of bank closures, platform maintenance, data feed disruptions, or any other errors. Because the payment cannot be executed and cleared in a timely manner and will need to be processed at a later date, the business may be exposed to further, unexpected currency fluctuations.

Human error: Many international businesses still use human intervention to execute and process international payments - although human oversight is essential, it can also lead to errors and miscommunication. If an incorrect amount is sent via an incorrect payment rail, bank or at the wrong date, the business or the recipient can be exposed to additional FX risk at the time of the transaction and will have to revisit the transaction at a later date, which means additional forex exposure.

Process Failures: Inefficient payables or receivables processes can lead to delays in receiving, sending, clearing and reconciling payments which once again, results in losses if trading in two different currencies, as the currency exchange will fluctuate between the agreement being made and the payment execution and completion.

Forex transactions have jurisdiction risks due to the legal and political environment in the countries in which they take place. It is not uncommon for the regulatory environment to change, which can make it difficult to expedite or receive transactions from a given jurisdiction if a country decides to impose new foreign exchange regulations or restrict capital flows. If a company is unaware or incompliant with the new or amended regulations on how forex transactions are conducted, reported, and taxed, it may be subject to fines or legal repercussions, as well as reputational damage. For example, a country might introduce new AML regulations or new tax laws on international FX payments - if the business is unaware and is not caught by internal compliance processes, which may be difficult when operating in several countries, fines or sanctions may be incurred.

Diversification Strategies

If you want to protect your business from the forex risk associated with international payments, you should diversify your currency portfolio. By paying your suppliers in their preferred currency, also known as matching, you eliminate net exposure, and by keeping multiple currencies, preferably with different providers, you minimise operational risks.

Integrated payment solutions play a crucial role in facilitating growth and supporting businesses with their financial operations. These solutions streamline FX payments for international transactions and manage complexities associated with currency exchange, ensuring sustainability for fast-growing companies.

Hedging as a Risk Management Tool or foreign exchange trading

In order to protect your assets and minimise the risks in contracts that may take longer from the agreement to payment you may use hedging tools such as forward contracts. In the forward contract you'd agree with the supplier to pay at a specific exchange rate at a specific date in the future. This eliminates unexpected changes coming from currency volatility and you will know exactly how much the transaction will cost.

Internal Controls and Audit Practices

On top of the actual FX practices it's paramount to keep regular stock of the processes and controls your business has in place for foreign transactions and regularly evaluate how these can be improved for speed, efficiency and cost-effectiveness. Additionally, the finance team needs to work closely with the compliance team to ensure that new regulations don't slow down the transfer process. If you complete a lot of cross-border payments, you may want to hire a specialised forex compliance manager.

Exchange Rate Monitoring

While all those things are in place, it's still important to keep an eye on the currency market. You can set up alerts for your preferred currency pairs to receive real-time updates when exchange rates reach a certain level. Additionally, it may be worth keeping an eye on additional economic trends such as GDP growth, inflation rates, employment data, and interest rates, as well as Central Bank announcements, as they significantly impact currency movements.

Working with the right FX Payment provider

Manual currency management can be challenging, but various FX payment solutions can streamline international transactions, making it easier for businesses dealing with overseas suppliers. By working with a technology provider who can assist you with managing your FX payments and multiple currencies from one place, you will have real-time visibility into all of your cash in one place and be able to minimise operational risks. Additionally, relying on technology instead of spreadsheets eliminates the human error factor and streamlines international payments. Choosing a reliable FX provider will provide you with access to treasury, multiple currency payments, and hedging and forward contracts.

It's ideal if you use one FX payment provider for all your international payments, as doing so will consolidate your processes and minimise operational risk. Here are a few things to consider when choosing your FX payment provider:

Transparency of fees and exchange rates - All transaction and exchange fees need to be transparent and you should consider whether the provider uses at least the mid-market exchange rate for your main currency pairings.

Access to currencies - How many currencies can you send, receive and exchange funds in? Consider your long term plans as well - at the moment you may only need a few but as your business grows and expands you may want access to more currencies and sourcing additional providers will only increase operational risk. Partner with a provider that gives you easy access to multiple currencies.

Availability of advanced tools such as hedging - Does the provider offer you access to forward contracts to protect your assets in case of delayed payments after contract?

Speed of transfers - How are the payments executed? It is common for international payments to be executed using a lot of intermediary banks that each take the cut. This not only increases the cost of the transaction but also slows it down. Consider partnering with a provider that gives you access to domestic payment rails such as SEPA, ACH, Faster Payments and others as those payments will reach the beneficiary account nearly instantly.

Over 300 international businesses use Fyorin for cross-border transfers, offering them easy access to nearly 220+ currencies to send, receive, hold, and exchange funds quickly and efficiently. Using one platform, your business can expedite payments in multiple currencies through local and domestic payment routes with confidence that you are getting the best exchange rates and that the funds will reach the beneficiary's account almost instantly.

Interested in seeing how we can help you minimise the forex risk in international payments? Book a free demo or send us an email to [email protected].