“CFOs now look at their hedging strategy with a lot more sensitivity”
Here is this week’s new #CFOBrain interview with Pranav Parekh, Director, FX Product Management, GTS, Bank of America Merrill Lynch. Pranav explores the evolution of Transactional FX components and shares his views on the future of the payment landscape. Check out other pieces from Kantox’ interview series here.
Arturo: How would you define transactional FX?
Pranav: The term Transactional FX refers to cross-border payments based on the periodic exchange of goods and services (integrated into the day-to-day running of the business) that have an FX component. In other words, payments that companies make to vendors and suppliers, as well as, for instance, the payment of royalties, made in a different currency. Companies also refer to it as cross-currency and FX payments.
There are three main components to an FX payment. There is the user interface (UI) for connectivity, the payment itself, and the FX booking. Additionally, there is the impact of data analysis and the new focus on receivables.
Will Transactional FX, as a subset of cross-border payments, keep growing?
Definitely. According to WTO numbers in 2013, the total value of cross-border merchant payments was more than USD20 trillion. And this figure has kept increasing due to the growth of global trade, the rise of borderless e-commerce, and the evolution of C2B and B2C payments structure.
The increased demand has made not only banks but also some Payment Service Providers (PSPs) and fintech companies increase their focus on the provision of a best-in-class solution for customers in this space.
How have those three Transactional FX main components evolved?
UI for connectivity has developed dramatically in the last 10 years. It has gradually progressed from paper to electronic – either via e-banking or host-to-host – connectivity. Then, it moved to the client’s ERP system sending in payment messages. And now, we see the evolution towards APIs connection, which is going to lead to a major shift in connectivity and the way we conduct business.
We can break payments down to two layers: messaging and settlement. Settlement methods have experienced a dramatic change in recent years. In addition to cross-currency wires, we see the introduction of cross-currency ACH and now, we are witnessing new payments methods through digital wallets, push-to-card options and e-payment options.
And the last component is FX booking. Previously, FX booking was considered a byproduct of the international payment as this type of FX payment used to be smaller amounts. But given the FX volatility and its impact on the bottom line, CFOs and treasurers now look at their hedging strategy with a lot more sensitivity.
The digitalization of payments (from origination to execution) allows data analytics to play a more important role in how clients approach and manage FX payments. There are benefits to be gained with regards to automation, efficiency, and progressive FX risk management.
The rise of e-commerce has also meant that transactional FX goes beyond payments and includes receivables solutions.
Could you develop this last point?
Until recently, e-commerce websites were mainly B2C and domestic in nature, meaning customers were making same-currency payments by credit or debit card. But now that e-commerce has gone cross-border, credit cards charging two to three percent for FX payments is not a sufficient solution anymore.
And on top of that, we are also seeing a shift from B2C to B2B e-commerce websites, where companies make purchases involving a large sum of money. And collecting large payments through credit cards is extremely inefficient. So, corporates are looking for a better solution. As such, receivables solutions have been coming into focus as it’s been lagging behind in terms of innovation relative to the payments space.
What is the attitude of CFOs and treasurers towards the new FX solutions offered by banks and fintech companies?
Using simple conventional methods for managing and hedging smaller payments that are typically less than USD500,000 equivalent (handled by the Procurement or Accounts Payable teams) is simply too inefficient for it to be standard practice – both in terms of premiums payable and internal workflow.
And although there has been considerable progress in the payment component as treasurers started utilizing ERP and online tools, enhancing working capital cycles and reducing cost, the cross-currency component was still treated as a byproduct.
But, with all the FX volatility over the past few years along with the growth in the cross-border trade, CFOs and treasurers are looking increasingly at the effects of transactional FX. And this is not just on large-value cross-border capital flows, but also on small-value payments. They want solutions to hedge these flows and ensure that there is no impact on the organization’s bottom line.
And why don’t treasurers hedge more of their cross-border accounts payable risk?
In many cases, it was difficult to integrate FX risk management techniques into their A/P work stream, because all these payments tend to go through ERP and other online channels. So, if you were to match them with advisory FX booking or hedging, it would essentially break their entire automation process, which would translate into significant costs and delayed payments. Such delayed payments could, in turn, affect the supply relationship and ultimately, have an adverse impact on the bottom line.
The second difficulty revolves around the premium since it would be too high for managing smaller payments through the advisory process. Banks and new fintech players are trying to provide innovative solutions to integrate the payments process along with FX Hedging.
Could you elaborate on these new solutions?
I would distinguish two solutions provided by the industry that reveals a paradigm shift in FX risk management. The first consists of the integration of FX risk management instruments along with payments without having any conflicting issue. Banks and fintech are offering an FX advisory experience, via phone or online booking, or through a more specialized portal. These new interfaces enable the procurement or payables team to use this existing FX trade within the payment process without disrupting the payment execution process.
The second solution consists of banks providing a competitive lock-in guarantee rate for anytime between 24 hours to a few months, so instead of the companies, banks own the FX risk. This solution can be integrated within the client’s treasury platform so that the automation gained in payables and receivables process is not impacted.
What does “to integrate FX risk management instruments along with payments” mean?
Let me give you an example. Imagine you are phone manufacturer in the U.S, your suppliers are in Korea, and your order-to-pay cycle is 90 days. The client’s Account Payable team will send the payments file at the end of this 90-day period. Although the FX spread applied can be pre-agreed and at very competitive margins, the problem is that the market could move considerably and the client can be on the other side of the volatility.
Instead, the treasurer or a specialist could book an appropriate FX instrument at the right time and the right rate within that 90-day cycle, and lock-in the FX rate for those currencies. Given the integration enhancement completed by the bank, this particular contract would get recorded and automatically reflected on the client’s online payment system. Then, the operations team would go on to the online banking portal, upload the file, and during the last stage, use the FX booking which was executed by the specialist, match it up and execute the transaction.
The result would be that they minimize their exposure to FX volatility. At the same time, their payables team will still have an automated process without losing any efficiency nor adding any additional cost by embracing that process.
We live in a high-volume economy (think e-commerce, online travel, digital advertising) where firms often sell hundreds of thousands or millions of products globally. What difficulties arise for companies trying to develop a hedging strategy in that context?
At the moment, one of the challenges faced by clients relate to the need of a receivable solution, i.e. where money is coming in, but you need to match it off and ensure that you are paying your suppliers without risking your margin. If you take an e-commerce website, they will have a supplier wanting to sell the goods and somebody who is a buyer. It is possible that the site receives payment in the buyer’s currency and in turn needs to pay the supplier in a different one.
In the past, many e-commerce firms used to apply an extra spread (between two and three percent) to cover the FX risk, but this is not an option anymore if they want to stay competitive – especially in industries with very low margins. Additionally, applying the advisory hedging process to a constantly fluctuating receivables flow can be cumbersome, expensive and inefficient.
The FX guarantee rate explained earlier would be a good solution for e-commerce clients. The client can concentrate on their business expansion whilst the FX risk management is passed on to the banks.
Real-time Payments versus Blockchain: Which of these could have a higher impact in the payments space? Are there other technologies impacting payments?
The evolution of Blockchain in the payments arena is still difficult to predict, and its adoption depends on the success of the projects, partnerships and collaborations by banks and other institutions. However, we think that it could potentially have a huge impact in other banking areas like KYC, trade finance, or mortgage processing. Furthermore, there are broader implications for banking services including payments from technologies that utilize machine-learning and predictive data-driven analysis.
But coming back to payments, real-time payments schemes are becoming a reality today, since they are already being introduced in several countries.
And what will be the impact of Real-time payments schemes on the corporates?
At the moment, the fastest impact would be in the B2B payment space since corporates would be able to have more certainty and transparency on their payments. And this would directly affect their business model as well as how they manage their liquidity and cash flow.
For instance, imagine the last layer of the existing settlement of funds is real-time instead of using the current batch or SWIFT mechanism. This could reduce the whole process down to a few minutes. The supplier would be certain that the payments have been received, so it makes it possible to release the goods instantly. All this would have a significant impact on how corporates handle cash flow management.