You may have seen that a number of our recent social media posts have referenced the Rugby World Cup to be held in Japan, September 2019 and some other sporting events.

So taken were we with the foresight of one of our clients - Joro Experiences - that we thought we must share the strategy we have discussed with them.

For one thing, thinking about payments they have to make some 18 months before deadline is commendable, but also, penning a bit about the reason for the payments they need to make is a good way to show the diversity of the payments and transactions we are instructed on and can cater for in a corporate context.

So, a luxury travel brand (introductions on request) is in discussions about a booking from an individual keen on going to the Rugby World Cup in Japan.

The individual in question would like to pay for this booking in US Dollars.

Our client is a UK based company, but, sensibly they have a USD account - they use one of our 'named accounts'. This serves more than one purpose.

On the one hand it means they can invoice their clients in USD - yay! Their client base is a global one - truly representative of the reach of contemporary travel businesses!

Also it means that they can carry a USD 'float' which enables them to happily and comfortably pay away USD expenses. So, rather than exchanging USD into GBP Sterling (the primary currency of operation) and then exchanging currency back into USD when they need to pay a supplier, they keep the USD revenue as US dollars; and just make a. same currency payment when invoiced so to do.

Their customer paying them in USD can choose which currency to pay them in. In terms of convenience it is unlikely to be a deal breaker, but it is a nice touch.

We, rather tongue in cheek, congratulated them on unearthing the most important thing about dealing in foreign currencies - if you're a business and you can avoid making a foreign currency exchange...do!

This matter (booking well before time) presents our client with more than one issue.

They're quoting their customer for a package/trip that is scheduled for 18 months from now and, as we all know, exchanges rates will move.

So, what are the key concerns here...and how does our client make sure they don't lose out on margin and ensure they're not carrying undue risk?

Between now and September 2019 the rate of exchange between USD (US dollar) and JPY (Japanese Yen) will go both up and down from the current point.

When calculating what USD/JPY rate to use to provide their customer with their quote, our client, like many, looked at the Prime Cap Data Centre and took the prevailing 'market rate' of exchange for their numbers.

The first thing to stress is that unless you actually lock in the rate you use for your calculations at the precise time you calculate your figures, you're going to find that the rate is either higher or lower within in moments of your tapping the '=' on your calculator.

Rates of exchange do not stay where they are...so, the only way for our client to ensure that their costings are accurate is to fix the rate the moment the quote is produced.

The trouble is that this is sometimes not realistic or practical to do so, especially if cash flow plays a part in what contract you can use for your currency booking.

They're quoting on a trip. Their customer might or might not accept their quote...in which case, had they fixed the rate, they might well find themselves locked in to an exchange that is no longer going to happen. Every business wants to avoid this.

So, therein lies one of the first issues for businesses with such long dated sales pipelines.

What happens if the customer changes their mind?

What happens if the rate moves between when you provide a quote to the client and the client gives you the 'green light' for the trip?

If the rate goes up then you're making more margin, but, you're client is getting less value.

If the rate goes down you're eating in to your own margin...should the client pick up that cost with a requote?

These are just some of the perils that businesses face when a) they're buying well ahead of time and b) they're being paid by an individual for a specific project/matter.

So, how does our client approach these issues?

We suggest they incorporate a buffer or 'extended margin' in to the USD price they quote their customer.

It is always favourable to revise down costs rather than have to justify a price increase.

Our client is providing their customer with a convenient way of settling a transaction.

Therefore, provided that the buffer is not too wildly uncompetitive - and, because we can afford them a comfortable improvement on the FX margin, they could simply price the transaction at 'retail' - their customer should be happy to acknowledge this as a welcome alternative to exchanging their USD into GBP.

So, our client has applied a buffer to the USD amount they intend on invoicing their customer for, so as to ensure that their base margin is intact between quoting and formal booking.

We can advise our client on what buffer to include. They do not need to call us necessarily and they can use the same 'mid-market' rates as published on the Prime Cap Data Centre to simply calculate how to quote their customer, but, our brokers are always and ever on hand.

But, this is just one element of the equation.

We've still not addressed how to ensure that the unit cost in JPY can be bought with the USD paid by the customer. One has to equate to the other.

How does our client protect themselves against a drop in the value of the USD between now and September 2019?

Well, typically we would recommend the use of a forward contract.

This is an instrument which means that we say to our wholesalers "we agree to buy 'x' JPY but we would like them available for us to release 3, 6, 12, 18 months from now."

This product is a means by which businesses and individuals can lock in today's cost and lock out their exposure to the rate moving over the term of the contract.

"It is tremendously clever, rarely applied and wholly underrated."

The use of this type of contract, particularly in this instance where our client relies on payment from an individual customer, is not risk free.

Our client and we still have to take into account the chance that in 18 month's time, when the contract matures and the World Cup payment is due, his customer may not want to pay.

The customer might back out for any number of reasons:

The USD has strengthened against JPY and he can now pay less.

He no longer wishes to go on the trip.

He gets hit by a bus.

So, our client needs to protect themselves from the risk of their customer not paying. The contract struck, the forward contract, is between our market principle(s) and our client.

So, now the question becomes 'how do we ensure our client's costs/margin are fixed, whilst ensuring they are not unduly exposed to the chance their client might not pay for the booking?

Well, because our client is a direct 'B 2 C' (Business to consumer) company, they quite rightly ask their customer for a deposit to insure their booking.

So, what part could that deposit, collected by our client, play in ensuring our client is protected from the risk of the client defaulting on a forward contract taken out to cement the cost of their trip some 18 months from now?

To answer this we need to explain how a forward contract works and what happens if someone does not wish to pay for it. How does one 'unwind' this instrument?

When buying 'forward' one is simply saying to an institution "please can we agree a rate today for the provision of the agreed amount of currency on a date some time in the future." We are agreeing to pay the base currency amount on the agreed date, and the institution we are dealing with agrees to make the foreign currency amount on the same day.

If on the day of maturity we do not have the base currency then we can either ask our counter-party to be lenient and wait for our client to settle, or we ask that institution to unwind the position.

This basically means that, say we're holding €10,000 having sold £7500...we sell those EUR back in to GBP.

We have to hope that at the point of sale that €10,000 can purchase back the £7500 we cannot deliver to our counter party.

If the foreign currency has strengthened in value then €10,000 possibly buys more than the initial £7500 sold.

However, if GBP has strengthened then €10,000 will no longer buy the same amount of sterling...€10,000 buys fewer GBP than is owed to our counter-party.

In this case there is a shortfall, and it is this shortfall which our client (the entity with whom the transaction has been agreed) who is liable to pay that shortfall.

This is why some currency brokers ask their clients to lodge some money with them. It is that lodged money which is used to pay any shortfall should one arise.

It is worth noting that in over 10 yrs of buying and selling currency, we can count on less than three fingers how many times these types of products have been unwound at our instruction. This is because we are very very careful to make sure that our client knows the risks (of their client not paying, for instance) and very careful to ensure we are not entering in to a contract that we worry might not be settled at the point of maturity.

So, back to our client the travel company - having bought all the JPY they know will be owing come September 2019, forward - what confidence can we give them that they won't be on the hook should their underlying customer back out?

Our client took a deposit from their customer.

This deposit is non-refundable.

No doubt there would be other penalties to our client if they backed out of such a booking with the JPY supplier...but, provided they have asked for a sufficiently large deposit from their customer they should be able to cover any shortfall and pay the penalties that might or might not be levied by their suppliers.

Therefore, built in to their own operating model, is the failsafe that ensures our client is not unduly exposed to the risk of settlement default.

As this post no doubt illustrates, the particulars of these types of strategies and the contracts appropriate for getting rid of exposure to moving rates and consolidation of margin, are entirely specific to the matter at hand.

You cannot expect this type of bespoke solution from an online transfer service like the one's animating personal foreign exchange activities across the global payments space.

Give us a ring on 0203 172 8193 if you would like to talk about this or any of our services.

We remain at you service.

#IRD #IRB #Japan #Rugby #Forwardcontract #Currencyexchange