- Establish a Competitive Advantage. Doing business in the local currency can save you and your cross-border partners and customers time and money through smoother, more transparent and efficient transactions.
- Advantages also include increasing your negotiating power with in-country businesses, and protecting bottom-lines with effective currency hedging tools.
- Manage Currency Volatility Risk. Doing nothing is just as speculative, if not more, than doing something. Hedging does not always result in a gain, but it does provide financial certainty to transactions and currency balances.
Today, innovation companies understand that expanding across borders can deliver a competitive advantage and catalyze growth. You might correctly be concerned about currency fluctuations that affect profits, budgets and planning. But when done right, you can save time and money while accessing new global markets and creating operational efficiencies.
Like any sound financial planning, expanding your ability to transact in foreign currencies requires strategies that optimize opportunities while reducing risk.
Benefits of Doing Business in Local Currency
You can benefit from transacting in local currency rather than U.S. dollars whether you are funding an international office, paying vendors and employees for products and services, or invoicing across borders.
Expansion to new markets often requires working with new partners and vendors with whom you want to build long-term relationships. At the same time, you need to reduce the risk of currency fluctuations and have a clear vision of the market potential, including a strong negotiating position when it comes to signing contracts and service agreements. One of the most efficient ways to meet all these goals is to do business in the local currency.
Negotiating in the local currency often gives you more leverage to get a better price or service, since the other party does not have to account for foreign currency conversion risk or costs. U.S. exporters gain a competitive advantage by invoicing products in foreign buyers' local currency.
A Case Study in How Hedging Works
Hundreds of billions of dollars a day changes hands in currency trades. It can be extremely difficult to guess where the market will be for a given currency a day, a week or a month later, when the transaction is completed.
For iRise, a California-based visualization software company, currency hedging strategies have become essential tools as the firm expands in U.K. and Europe. Like many companies, iRise at first didn't give much thought to currency risk. That was until a couple of years ago, when the company made what was then its largest sale in company history – to a British customer. The deal represented 30 percent of the company's annual licensing revenue that year.
At the time, the pound was losing value against the dollar, recalled iRise Corporate Controller Peter Felesina. He went to the company's board to get approval for a hedging strategy. During the 60-day period before the deal closed, the value of the pound declined about 5 percent, meaning the value of the contract for iRise would have dropped by that much. But because iRise had locked in the earlier, more favorable exchange rate for his company, Peter said his company realized the full value of the contract when it was negotiated. Without the hedging, iRise would have lost several hundred thousand dollars.
"Now we implement hedging on any significant overseas contract. By locking in the current rate, we manage to take away that risk and potential loss pretty much completely," he said. Even in today's environment of a strengthening dollar, hedging makes sense. "We aren't in the business of currency trading, even on an upside," he said.
As the iRise example shows, when structured properly, the risks for both buyer and seller can be controlled, no matter what your position in the transaction. U.S. companies with unhedged foreign currency payables and receivables otherwise risk earnings volatility that can hurt their bottom line, fog forecasts, and materially impact earnings per share for a public company.
Some companies have a misconception that trading in U.S. dollars makes them immune from foreign currency dynamics. In fact, pricing and reporting in U.S. dollars does not mitigate currency risk and can hamper relationships with your global partners and customers on whom you depend.
If the U.S. dollar strengthens, you may conclude that is a good event. However, on the other side of the equation, that means your customers will be paying more in their local currency. It also means your partners or employees will be earning less. In these cases, the local customer or service provider may default or cancel the agreement, and instead go to a competitor that prices in local currency.
Here are some tools and best use cases you may want to consider when managing foreign currency risk:
|Currency Risk Hedging Strategies ||How It Works |
|Forwards: A foreign exchange forward is an agreement to buy or sell a currency at a specified exchange rate on a future date or during a specified period of time. || |
- This tool enables you to lock in your profit margin at the time of the contract negotiations to obtain more predictable cash flows.
- It also buys your customer protection. If the dollar strengthens, it will cost your customer more and could hinder the existing or future contracts.
- You avoid premiums. Foreign sellers may charge a premium to invoice in dollars, but hedging foreign payables through forward contracts involves no fee.
|Options: A foreign exchange option or a combination of options involves essentially purchasing protection against future unfavorable currency swings. || |
- These tools typically involve a company either purchasing downside protection or setting a range in which their effective currency exchange rate will move.
|Rolling Hedge Execution || |
- A company maintains a constant percentage of its cash flow exposures hedged for a predetermined period of time. As one hedge comes to maturity, the next period is hedged.
|Layered Hedge Execution || |
- A company hedges a percentage of its future exposures and then adds to future period hedges over time to increase the percentage of coverage in those future periods.
- Some companies prefer to do opportunistic hedging, in which hedges are executed when market conditions appear optimal. Historically, layered hedging provides the most stable currency exchange rates over time.
Have questions on how to set up accounts for your overseas business? We are here to help. Contact your Silicon Valley Bank Relationship Manager or Global Treasury and Payments Advisor to start a conversation. Visit SVB.com for additional information and best practices for global expansion.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.