In a recent webinar, representatives from PNC Capital Markets’ Foreign Exchange Group offered insight into strategies businesses can adopt to mitigate risk and gain efficiencies when dealing with international payments. 

Highlights

  • Foreign currency accounts, paying foreign companies in local currency, and hedging strategies may be useful options for managing FX risk in international payments.
  • Multilateral netting platforms can provide valuable benefits to companies processing intercompany payments.
  • Technology, communication, and forecasting are three essential components of effective international payment management. 
  • Click here to sign in and view a recording of the Managing International Payments: Mitigate Risk and Gain Efficiencies. 

Unrelated Entity Payments

PNC FX Specialist Brian Fitzpatrick began the discussion with an overview of the various types of payment methods used for remitting unrelated entity foreign exchange (FX) payments, noting that wire is the most common form, although checks are still used in some instances, and ACH and real-time payments (RTP) are growing in popularity as payment technology evolves. Fitzpatrick emphasized that, regardless of the currency in which a payment is denominated, there are FX risks to consider any time a payment is sent internationally. 

Managing Spot Market Risk 

Given that most FX payments are made in the spot market, it is important for businesses to consider the potential advantages and disadvantages of these trades. In spot market transactions, two counterparties agree to exchange currency at a defined rate for settlement generally within two business days. There is upside potential in the sense that the exchange rate can move in a participant’s favor before the actual execution of the payment. Additionally, these transactions offer flexibility in regard to payment timing, and this can be important if cash forecasts change. However, there is also uncertainty associated with spot market transactions, as on the trade date participants may be subject to an exchange rate that is not in their favor, which might have been avoided by locking in a rate ahead of time with a hedge.

Foreign Currency Accounts as a Cash Management Tool

For businesses that have two-way cash flows, such as those with payables and receivables in the same foreign currency, a foreign currency account may be an effective method for cash management. However, Fitzpatrick highlighted that this may not be the best solution for every company and that businesses should consider whether their foreign currency volumes are sufficiently significant to warrant a foreign currency account, emphasizing that what classifies as a significant volume will vary from company to company. Other considerations include evaluating what costs are incurred by not having the account, such as FX transaction costs, and what costs are involved with opening the account, including maintenance fees and the administrative aspect of maintaining a separate account.

Paying Foreign Companies in Local Currency

Fitzpatrick noted that, although companies that conduct business entirely in U.S. dollars may not think they are affected by foreign currency moves, payments to foreign companies are in fact subject to FX risk. Foreign vendors are likely to build in a premium to the prices they charge to help protect themselves from FX rate risk on their end. By paying a foreign vendor in their local currency, a U.S.-based business may assume the FX rate risk, but this may result in a better payment rate and overall cost savings. 

Managing Risk through Hedging Strategies

Hedging tools may appeal to businesses looking to protect against FX risk, but, as with other international payment risk strategies, there are several considerations to keep in mind. Not only should businesses evaluate whether the volume of payments is significant enough to take steps toward hedging, but also if there are margins or budget rates they need to protect. The certainty of cash flow forecasts can also be important, as this factors in when structuring hedges.

For businesses who opt to use hedges, two of the most common strategies are forward contracts, which allow the buyer to fix the exchange rate today of a payment that will occur at a predetermined date in the future, and options, which offer the buyer the right but not the obligation to buy or sell a currency at an agreed upon rate at a predetermined time in the future. Fitzpatrick noted that there are many different option rate structures available, including combining different “vanilla options structures,” which are the simplest and most flexible option strategies, to create a zero-premium hedging structure, such as a collar. 

Technology as a Solution for Intercompany Payments

PNC FX Specialist Augie Barkow led the discussion on intercompany payments, which are any payments between affiliates or subsidiaries of the same parent company that settle in U.S. dollars or foreign currency. For many businesses, managing these payments is often a manual process, which can be slow, costly, and error-prone, and does not afford visibility into cash forecasting and managing FX risk exposure.

Multilateral netting platforms can be a solution to improve the intercompany settlement process, as they automate the process of collecting and verifying payment data, trading the FX risk, remitting payments, and reconciling and reporting the data through ERP (Enterprise Resource Planning) or TMS (Treasury Management System) software. These platforms offer multiple benefits aside from saving on time and cost, including providing reporting for valuable insight into managing FX exposure and predicting cash flows.

Barkow noted that there are several multilateral netting technology options available to businesses, ranging from fully automated solutions that PNC supports, to fintech platforms that offer limited automation but more user interaction. Companies can choose the best alternative that fits their needs.  

The Key Takeaways

Whether dealing with unrelated entity or intercompany payments, PNC’s FX specialists concur that there are three important areas companies should focus on when it comes to managing international payments and FX risk:

  • Technology: The use of technology platforms can streamline and add efficiencies to the payment process.
  • Communication: Effective communication internally across the organization and externally with customers or financial institutions is crucial for efficient management of payment risk.
  • Forecasting: Accurate cash flow forecasts are essential to a sound FX payment process, particularly when considering hedging.

Ready to Help 

PNC can work with you to help manage FX risk and improve your international payment processes. For more information, click here or reach out to your PNC Relationship Manager.