Exposing underlying FX risk
8 February 2023 · 3 min read
Embrace currencies to protect your capital, maintain your cash flow, secure your earnings and access better financing! Let’s find out how to mitigate the consequences of an underlying yet dangerous type of FX risk, credit risk.
When working with foreign currencies, CFOs and treasurers have the mission to reduce FX risk as much as possible. But they could be overlooking an underlying type of risk: credit risk.
In this week’s episode of CurrencyCast, we shared the secret to mitigating credit risk. Now, we will explain in detail the key actions you need to take to eliminate this risk.
Understanding credit risk in currency management
Credit risk or, more precisely, the risk in account receivables is when customers need to settle their bills in a different currency than their own.
This underlying currency risk can easily be eliminated by following a simple rule in your currency management strategy, embracing currencies.
But, what do we mean by embracing currencies? Embracing currencies —that is, adding more currencies to your business operations— is like speaking in the languages of your customers and suppliers. It makes business a lot easier and helps you to avoid your client’s FX risk from turning into your own credit risk.
Uncovering the underlying credit risk
If you are selling in Emerging Markets like Brazil or Turkey but using only one currency like EUR or USD, you might be tempted to think that you have solved the currency risk problem.
But that’s an illusion: the underlying currency risk is still very much there. By urging customers to use a currency that is foreign to them, you are, in effect, transferring that risk onto their shoulders.
In the event of a sharp devaluation of the local currency, they might feel inclined to wait for a better exchange before settling their bills. In other words, your customers would speculate in FX markets with your firm’s money.
We’ve seen that phenomenon at play after the pandemic, both in Latin America and Eastern Europe. As a treasurer or CFO, you don’t want to be in that position.
Taking ownership of credit risk
In order to avoid your client’s FX risk from turning into your own credit risk, the solution is to sell in the currency of your customers while taking care of the underlying FX risk. Needless to say, this presupposes a strong, automated currency cash flow hedging program.
Such programs include: hedging firm sales/purchase orders as they materialise, hedging forecasted exposures for one or more campaign/budget periods, or a combination of these, with tools that provide visibility over the exposure throughout.
Advantages of owning the currency risk
Now that you see the importance of credit risk. It is time to consider the advantages that would flow from taking full ownership of it:
- Capital protection. You are protecting your firm’s capital against catastrophic loss while managing reputational risk simultaneously.
- Cost of capital. You are reducing the cost of trade credit insurance if you use it, slashing lousy debt reserves and freeing up capital.
- Performance. You are securing company earnings while maintaining cash flow.
- Commercial expansion. You are in a position to expand sales with confidence, gaining market share and/or targeting new customers.
Finding a solution to mitigate the risk efficiently
After uncovering credit risk, you need a solution to mitigate it.
A currency management automation solution could be the answer for companies that want to embrace currencies. This type of tool can streamline your currency management strategy and automate your entire FX workflow to reduce FX risk, including the ‘hidden’ credit risk.
As we mentioned before in a previous episode of CurrencyCast, we live in a multi-currency world where businesses can take advantage of the profit margin-enhancing benefits of selling in many currencies, like monetising existing FX markups or driving high-margin sales to company websites.
Thanks to automation, these advantages far outweigh the perceived inconveniences and costs of managing the underlying FX risk. And, in the current scenario of uncertainty, you get an additional and very attractive bonus: less credit risk in your commercial operations. That’s quite a lot!