What are currency controls?

In order for a currency company to both ‘buy’ and ‘sell’ a currency we require three things:

The first is a bank account to receive the currency we are converting from, the second is a bank account for the currency we are 'sending' or converting to, and the third is an institution who is prepared to act as market maker to facilitate the transaction. In some cases a currency broker doesn't have to expressly hold an account in a currency to be able to transmit it. We can simply buy the currency from the market making institution in exchange for the currency we do hold (the currency you're 'selling'); however, if you do not hold an account in the currency you wish to convert from then you cannot reasonably hope to execute the intended transaction.

Having a bank account in any currency requires a bank to provide you with it. As it stands there are only a few UK banks prepared to provide client accounts, of the segregated kind, to foreign exchange firms, aka ‘Money Service Businesses’. The reasons as to why this is the case belong in another post.

In some cases it is simply not possible for a client account to be opened in a particular currency. This is usually in instances where the currency you want to convert to (or buy) isn’t actually available outside of the country in which it is used. Your UK bank doesnt want to receive rare currencies or buy them from you because they have no one to whom they can then sell it on. We refer to this scenario as there 'being no market' for it. Furthermore, typically, if a central bank or government has imposed Currency Controls to limit the movement/dissemination of their local currency, it would not be possible for an FX firm or bank to actually receive in that local currency because said central bank would invariably convert the local tender into a more readily available, openly traded currency - South African Rand (ZAR) is a good example of this.

Foreign exchange controls come in various forms.

Their effects are felt in relation to both the purchase/sale of foreign currencies by residents and the purchase/sale of local currency by nonresidents. In many instances currency controls can create a false market. In some countries the local residents may use the local currency when transacting between themselves, but they will only be prepared to accept currencies like the US dollar from not residents. This creates an artificial economy which can have a number of tiers to it.

Often foreign exchange controls can result in the creation of black markets to exchange the weaker currency for stronger ones. This leads to a situation where the exchange rate for the foreign currency is much higher than the rate set by the government, and therefore creates a shadow currency exchange market.

Following the financial crises of the early 1930’s, the application of exchange control became widespread internationally. Among the techniques used by governments were the requisitioning of foreign exchange earnings and bans on exports of capital; also of importance were various compensatory and clearing agreements, of which Germany was the chief exponent.

In the early part of the 20th Century, as in many emerging markets and developing economies today, the main object of exchange control was to conserve and increase tangible assets such as gold and to stockpile foreign currency reserves.

When wearing my layman’s hat and trying to explain the concept of exchange controls (which it must be firmly noted come in different forms) I think of it thussly:

US dollars is the global reserve currency. Countries who want to protect themselves and not limit whom they can deal with will stock pile US dollar. For young economies which still have a somewhat subsistence existence at a grass roots level, the amount of hard currency in circulation can fluctuate wildly and is truly difficult to accurately determine because much of the population won’t have bank accounts. By imposing a currency control you can ensure that, effectively or ineffectively, there is a modicum of stability within the domestic/local currency supply.

If one were a government that wants to grow one's country’s economy, one wants to deal in a currency that can be spent anywhere, globally. A bank in France is only going to want to use one's Botswanan Pula if they are planning to invest in Botswana or they have a customer who is. As there are so few entities in need of Botwanan Pula it is sensible for me to deal in something else. One can get one's hands on that ‘something else’ (namely US dollar) by making sure than anyone who wants to do business in my country has to pay me in US dollar.

Consider this – there are about 37 countries out there that employ currency controls. This leaves a huge number of countries who do not. It would make little sense for an FX broker to have accounts in every global currency because it is tremendously unlikely they will ever actually need to make a payment in that currency. It would cost the broker just to hold and service those accounts.

What most brokers tend to do is hold accounts in the major FX currencies. That way they can be confident that they have an account denominated in the currency their client wishes to ‘sell’. They would only need to hold accounts in the rare and more obscure currencies if their clients wished to convert from those rare or obscure ones. This is unlikely anyway and, even if the client did want to convert something like Botswana Pula into GBP, it is more than likely that the customer’s UK bank would give a rate similar to that which the FX firm (who might only deal in Botseanan Pula for that one conversion) could get. The economies of scale which underpin the business model of the deliverable FX world wouldn’t benefit the client here because their FX deal in so little that they couldnt offer an improvement to the margin.

Interestingly…a number of FX firms celebrate the wide range of currencies they ‘deal in’. ‘'Special FX' deals in 173 global currencies!’. In actual fact though, Special FX probably holds accounts in a fraction of those 173 currencies. If there customers are in the UK and are only selling/converting GBP, then Special FX dont need to actually hold any of the other currency accounts themselves, because they’re not receiving any of those currencies.

Countries like South Africa can be tricky to deal with when it comes to moving money internationally. This is surprising particularly when you consider that the IMF and World Bank have recently labelled them as a developed economy (I am sure that is not the correct term, but it is something like that). The residency status of the client, the amount they are moving, where they are domiciled and the purpose of the transaction are all taken into account when trying to move funds from SA. Fundamentally these criterion determine whether the institution holding the clients Rand (ZAR) are at liberty to electronically transmit ZAR, or whether they arbitrarily convert them into a different currency and then send them to the beneficiary.

This post consists of a number of little segments because, for the most part, our understanding of currency controls and the information we can pass on to you is mainly determined by anecdotal evidence. The fact that one doesn’t have much in the way of technical information to pass on is probably indicative of the fact that it is uncommon to deal in currencies that have these types of controls.

Sending money to a country like India can be terribly terribly tricky. Whilst it may be useful for me to say it is ‘terribly tricky’ because it could prompt you to look into it further, it probably isn’t at all useful for us to be so vague…however, we have no choice. We are told by peers and contacts in payment despatch and compliance that funds can take up to two weeks to clear in an Indian bank if they arrive at all. It may be two weeks before the recipient bank acknowledges that you’re trying to pay a customer of theirs and they ask you to supporting information. It is a long a drawn out process.

So inconsistent are the rules for sending payments from countries like India, Kenya and Malaysia, that savvy 'internationalistas' have found a number of ways to circumvent regulation.

We are not advocating this and, frankly, we don’t actually know how it is done, but if it became apparent that one were dealing with a Malaysian resident, one would not be surprised to receive funds for a conversion denominated in Singapore Dollars. Likewise, I know of businesses in the UK that do their own sort of Transferwise set up….if they’re working with a supplier with activities in India the UK firm pays the UK company and the Indian side of the suppliers business makes good on the settlement of the pay in country.

The general rule of thumb when it comes to currency controls and sending money internationally is that you need to be realistic about what using a foreign exchange specialist will actually achieve for you. You may very well find that your headache is only made greater by trying to incorporate a third party, like an FX broker, into the process.

Bear in mind also that the mere fact that a broker does not deal regularly in a rarer or ‘exotic’ currency means that their ability to undercut a banking institution is in fact undermined before the get go. You might even be charged extra by your broker because they know how few other options you have.

Most emerging market and developing economies will be just as ready to receive US dollars, euros or even sterling so be prepared to ask them whether this is the case. They will either use a set or ‘pegged’ rate to tell you how many Vietnamese Dong or Myanmar Kyatt you need to send, or they will simply invoice directly in USD as the Chinese do. In fact, China is exactly the example one should use to explain about currency controls. They want to be dollar rich. Now, the buoyancy of their own local/domestic currency has been a source of much discussion of late…as has their ability to floor the market with the USD they hold…but, fundamentally and for all these reasons, currency controls are not the policy of a developed or free market economy.

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