Managing cross-currency volatility has become increasingly complex. The sudden economic uncertainty caused by COVID-19, disproportionate levels of recovery throughout countries and regions, political unpredictability, and market speculation and shifting investor sentiment are among the key driving forces in today’s rising levels of foreign exchange (FX) fluctuations. As the world continues to undergo significant economic, regulatory, and political changes, it is becoming more challenging to anticipate future currency movements.
In order to contend with rising cross-currency volatility, businesses must identify beneficial tools and enact financial strategies that focus on mitigating FX risk and maximizing financial certainty. Although currency volatility poses a greater risk to some industries than others, any business that overlooks FX management faces potential danger, while those that adopt it stand to gain greater stability and solid revenues.
In this interview, Grain Co-founder Aharon Navon outlines three major risks that businesses may encounter if they do not employ cross-currency solutions, as well as the benefits of building an effective FX hedging strategy.
Q: What exactly is a cross-currency solution, and how can it help businesses manage risks associated with foreign exchange rate fluctuations?
Cross-currency solution refers to a set of financial strategies and tools that businesses use to manage or mitigate the risks associated with fluctuations in foreign exchange rates. These solutions can include a range of financial instruments such as forward contracts, options, swaps, futures, and embedded FX solutions that are designed to protect against currency risks that could arise from fluctuations in exchange rates.
The objective of FX hedging is to minimize potential financial losses caused by currency movements, and to provide more stability and certainty in cross-border transactions and financial planning. By using FX hedging solutions, businesses can reduce the uncertainty and financial risk associated with currency fluctuations and help ensure more predictable financial outcomes.
Q: Which specific industries are most vulnerable to the financial risk caused by currency volatility?
Every industry faces a certain level of risk from cross-currency volatility, but some businesses have unique circumstances that make them more vulnerable than others. Industries that rely heavily on international trade, such as the automotive, technology, and manufacturing industries, are particularly vulnerable to the financial risk caused by currency volatility. Additionally, industries that operate in countries with unstable currencies, such as emerging markets, are also at higher risk. When a company’s profit margin is low, the fluctuation in FX rates can have a major influence on both revenue and expenses. Some low-profit margin industries that are most often affected by FX volatility include:
Supply Chain
Retail
Companies in these industries are more vulnerable to profit losses and unplanned expenses due to fluctuations in FX rates. The changing rates can lead to overpayment or underpayment for goods when converting payments into their functional currency, impacting not only the company but also its supply chain partners, ultimately resulting in unexpected costs. For example:
Importers: Companies that import raw materials or finished goods are impacted by exchange rate fluctuations when paying in a foreign currency
Exporters: Companies that export goods to foreign countries feel the strain of exchange rate volatility when converting payments into their functional currency
While these industries are especially impacted by cross-currency fluctuation, every business operating in multiple currencies still feels the effects of FX volatility — and reaps the rewards of effective FX hedging.
Q: What are the consequences for businesses that choose to ignore cross-currency management in today's global marketplace?
In today’s markets, fluctuations in currencies are so prevalent that ignoring cross-currency management can be considered gambling on the health of your business. Naturally, ignoring critical steps of cross-currency management can increase a company’s FX exposure. FX volatility can have a significant impact on the profitability of a business, particularly if it operates in multiple currencies or relies on imports or exports. As geopolitical and economic concerns continue to rise worldwide, so too do concerns about increases in FX volatility. In fact, 70% of CFOs indicate their companies suffered reduced earnings between 2016 and 2018 due to unhedged FX risk. However, there are other consequences that businesses should be aware of, as well.
1. Surprises result in profit loss
Businesses that do not yet employ an effective hedging strategy may be caught unaware and unprepared and, in turn, experience varying levels of profit loss in cross-currency transactions. Market surprises punish companies that have not planned ahead to hedge foreign currency risk. As mentioned above, there are financial instruments that companies can utilize to manage their foreign exchange exposures and get ahead of risks, including commodity price and interest rates. By executing these instruments, such as forward contracts, options, and swaps, involved parties can create agreements that stipulate that exchanges can be conducted at a later point in time, but with a locked-in rate. Embedded FX solutions come as an added advantage that companies can integrate into their platforms to not only lock their own FX rates but also enable their users to lock currency rates, allowing users to pay in local currencies and companies to receive the payments in their functional currency.
The losses companies experience when not hedging can also build up over time; while a few unfavorable dips or changes in exchange rates may not seem like an issue at first, these can quickly add up to significant unplanned losses if they reoccur over time. The ability to not only adapt to fluctuations in currency rates, but also analyze past transactions to gain a clearer picture of FX exposure and risk over long periods of time, is crucial to maximizing efficiency and visibility into long-term profit margins.
2. Missed opportunities for new clients
In addition to not realizing the risk of financial losses, those businesses not utilizing an FX hedging solution may also miss out on opportunities for new or increased revenue streams. Effective cross-currency solutions can help companies guarantee better prices for their customers, gain a competitive edge in their market, and retain stability despite unpredictable financial factors. The more competitive you remain amid unstable markets — retaining business and easily navigating geopolitical change — the more attractive your business is to prospective clients.
Once your cross-currency hedging solution is integrated throughout your business, you can explore new markets of clients and vendors. For example, you may be wary of starting business in new markets known for being more volatile, but with a powerful cross-currency solution, you can offer certainty and better prices to your customers, break into new markets, and get paid or pay in your functional currency.
3. Taking time & resources away from industry activities
When your team is dedicating valuable time and resources to managing currency exchanges, their primary work for your company may suffer. By having certainty in financial planning, businesses get more competitive in other aspects as well.
Ignoring FX hedging can lead to operational risks for your business, such as supply chain disruptions. Remember, your primary currency is not the only one to consider; your supply chain partners are equally impacted by FX fluctuations when they are forced to convert currency with unfavorable rates. By utilizing a cross-currency solution — especially one with automation capabilities — you can focus your resources on what you do best and leave the stressful details and nuances of supply chain issues and other operational risks to the tool of your choice.
4. Other repercussions of unmanaged FX volatility
Aside from these three primary risks that companies may be exposed to when they ignore cross-currency management, there are several additional consequences that can arise and must be mitigated. These include:
Reduced predictability: When working with multiple currencies, predictability is paramount. Without the insights needed to properly forecast expenses and earnings, businesses are left in the dark and unable to plan for the future.
Supply chain disruptions: Profits aren’t the only aspects of business that can be significantly impacted by currency fluctuations; your supply chain can be vulnerable too. Without the certainty created by cross-currency management, third-party partners and vendors can be impacted by changes in prices and payment dates, thus creating potential for delays in the delivery of goods and services.
Loss of customer confidence: Repeatedly failing to address and mitigate the risks of operating in multiple fluctuating currencies can affect not only your business operations, but also the perspective of your customers. When customers lose confidence in your company's ability to navigate financial challenges and prioritize their best interests, they’ll likely move on to engage with another entity with a track record of success.
We’ll discuss how properly managing cross-currency payments can change these outcomes into positive business actions in more detail below.
Q: When trying to get ahead of these risks associated with FX volatility, what recommendations do you have for businesses to begin building a strategic and effective hedging strategy that promotes stability?
As we discussed, when a company ignores FX hedging, it puts itself in a position of vulnerability, where rising and dropping currency values can greatly affect financial performance. Conversely, engaging in effective cross-currency management not only mitigates exposure risks, but also unlocks several benefits that promote stability and better positions a company to begin building a strategy that will support future hedging activities. Businesses can focus on several key areas that can easily be improved by the implementation of an effective hedging strategy. With each of these outcomes in mind, businesses can prioritize what would benefit them most, and use these insights to build out their own hedging strategies.
1. Expansion into new markets
Hedging against currency risk allows businesses to scale their operations effectively by creating better opportunities for market expansion and customer acquisition. International expansion, as well as new partnerships with vendors or suppliers in different regions, can be better facilitated with a dedicated solution in place thanks to the ability to better predict expenses and revenue, which allows growing companies to adjust their budgets accordingly.
2. Competitive prices
Hedging promotes greater visibility into expenses and can help companies predict the cost of goods and services throughout different regions. Having insight into product costs allows for strategic price optimization that can increase profitability in a company's target markets. By understanding fluctuations in product expenses across time, companies can utilize data from currency values to set a price point that remains profitable, despite rises and drops in different currencies. Additionally, locking currency rates eliminates the need to add markups to cover potential future FX losses.
3. Business advantage
With an effective FX hedging solution, businesses can gain a competitive advantage over their rivals by locking in favorable rates and guaranteeing better prices for their customers. Without the need for steep markups to accommodate currency volatility, businesses can keep their prices lower than market competitors. Favorable locked-in prices can not only help attract new customers, but also aid in current customer retention efforts.
4. Cash management
Currency management and cash management should not be viewed as two separate entities; in fact, strategic and effective cross-currency management is essential for achieving optimized cash management. Essentially, FX hedging can help businesses better manage their cash flow by reducing the impact of currency fluctuations on their revenues and expenses and freeing up cash flow for transactions in other currencies.
5. Diversification
Hedging also empowers businesses to diversify their revenue streams by having exposure to multiple currencies. Operating in multiple currencies helps to mitigate the numerous risks associated with relying on a single currency.
Provide additional value to your customers with embedded integration
Embedded cross-currency hedging solutions integrate risk-elimination and retention-boosting processes throughout the entirety of your operation, ensuring your customers are always protected from currency volatility. Grain Finance:
Eliminate risk: Our solution eliminates risk from cross-currency transactions. In just a few clicks, businesses can input their currencies and due dates, then view and lock in current rates to remove the hassle and uncertainty from their transactions.
Share revenue with platforms on hedging fees: This partnership allows businesses to access a comprehensive hedging solution at an affordable price, all while optimizing their overall profitability on every transaction.
Increase retention: Keeping your prices low, adding stability, and integrating business insights help increase retention among your existing customers.
Boost revenue: Add new markets to your portfolio and share revenue coming from hedging fees with Grain.
Expand your client base: Integrate a fully automated cross-currency solution into your own software, retain low prices that best competitors, and provide stability to buyers in an unstable environment to win new business.
Transfer global payments: Make payments happen, no matter the country or currency. Regardless of where customers are in the world, Grain can help ensure they will receive their payment on time and in their local currency.
Ready to regain profits while buffering against losses? Get in touch with us today to learn more about how Grain can help you mitigate the risks of FX volatility and manage cross-currency transactions with confidence.
Ready to regain profits while buffering against losses? Book a demo today to learn more about how Grain can help you mitigate the risks of FX volatility and manage cross-currency transactions with confidence.