The hidden FX risks in holding currency balances

Written by: Nigel Verdon
Published on: September 06, 2013

The hidden FX risks in holding currency balances

Treasurers in payment firms understand payables and receivables, and indeed the associated FX risk and how to hedge this risk. However, the FX risk in holding of currency balances is very different to the FX risk in payables and receivables; and it is  the FX risk in the holding of currency balances  that many treasurers are less familiar with.

For example, ‘it’s just euros in, euros out’. The expectation with holding currency balances is that the euros coming in are used to pay the euros that are going out. So where is the FX risk?

The FX risk is there if firms analyse the transactions underlying the currency balances, as there will have been FX transactions to create the initial euro balance, replenish the euro balance and pay in/out of the balance. It is likely that all of these transactions will have been at different prices. The risk sits within the variance of those prices; henceforth this can be a powerful force in negating margins if not monitored closely and managed.

So, how can payment firms ensure that they are managing their currency balance FX risk efficiently?

Start by really understanding the risk, recognise that it can work against margins and then consciously decide whether to manage the risk or not. Some firms intentionally decide not to but, more often than not, shareholders generally prefer revenue or margin certainty rather than having FX risk embedded in the firm’s P&L.

If you do actively decide to manage currency balance FX risk, make sure you collect all data at the point of transaction. This is absolutely vital otherwise the risk is un-manageable. If you do not have the data to hand (e.g. timestamp, market price and client price), you cannot calculate the price difference for each transaction and most importantly, the embedded profits and losses.

You might also take on a hedging strategy and hedge out the FX risk in your currency balances using the forward market (forward contracts are means of hedging against the risk of adverse market movements). This way you can ensure that you maintain your margins if the market moves against you.

Let’s be clear, at Currency Cloud we’re not risk advisors but we do understand the risk in not managing both our currency balance and our transactional FX risk. Here are two little anecdotes to end on…

There are companies that do not have the technical know-how of banks or trading specialists to understand the benefit from sophisticated hedging strategies. These companies tackle this ‘ailment’ by passing the risk onto the customer by pricing up the cost of their FX at 10% or more. It does beg the questions; should the customer be funding the firm’s risk management? Or if the firm managed their risk, how much would the customer benefit?

A treasurer of a well-known Stock Exchange listed firm once ignored the FX risk in his firm’s currency balances. After reporting some x million profits, he was exposed after his profits for that year were adjusted by some clever auditor to zero, as his profits were the result of the FX market movement. So with no actual product related profit, one would assume that this company did in fact have a serious sales issue.