Guest blog by James Boorman, Project and Corporate Finance Advisor and Founder of New African Projects and Business Ltd.
In the first of a series of guest blogs that look at issues around financial management issues for women entrepreneurs, this week we get a better understanding of how Foreign Exchange works, particularly for those businesses that import and export - and importantly, how to get the best rates!
Foreign Exchange (FX) is not just about paying your bills offshore or receiving payment when you export, used well it is an essential tool to allow you to continue doing what you do best (be it manufacturing ‘widgets’ or supplying a service globally) and most importantly, it will allow you to sleep well at night.
But how do you know you are getting the best rate when you trade with your Bank ?
This is a question with which all Importers and Exporters struggle.
Sadly there is no magic formula. Banks trade huge size every second of the day and in doing so will always trade at ‘better price’ than you, usually at or very close to the midprice. They will then take this ‘better price’, add on their large profit and pass it onto you.
Instead of discussing a ‘better price’, let us talk of a ‘tighter price’. Why ? This is because whether you are an importer (buying US$ to pay your overseas manufacturer) or an exporter (selling your US$ earned offshore to buy local currency to pay your staff etc), what matters to the bank and ultimately to you is the ‘spread’ between the Bid (what you sell at to the bank) and the Offer (what you buy at from the bank) and how ‘tight’ this spread is…. The tighter this spread, the better for you.
Let us say that the mid price of the USD to the ZAR (South African Rand) is 13.00, the Bank could easily make you a spread of 12.80/13.20. Trade US$100,000 and that’s US$1,500.00 you’ve just donated to your Bank (how kind !). Just think what you could do with the extra US$1,000 if you were given a tighter spread of say 12.93/13.07.
Here are a few simple rules to follow:
- Never, ever fax or email your FX orders in. Never (you will get the very worst price imaginable).
- Never give your orders to your friendly business Banker, he will have no idea where the market is. He will ring his business sales team who will ring their FX sales team who will call over to the traders and ask them to do the trade… for the traders this is a license to print money at your expense.
- If you are offered an electronic trading system from your Bank - they will add their profit onto the price you see on the screen so you will think that you are getting a good deal, this is not necessarily so. Keep an eye on where you are trading and where the mid price of the market is....
- Do get a direct dealing FX account and a phone number for their actual trading room. You will not be allowed to trade direct with the traders, but you will have access to their sales team, the less people you have to go through for your quote, the less hands in the foodchain each taking fees.
- When you call, ask for the Bid/Offer Spread - Why ? If you say you are a buyer of US$ there may be a temptation in the bank to move the price in their favour - they do know you are a buyer after all !
- If all else fails bring in the professionals, hire a Treasury Team of your own or sign up a transparent fee based group who will negotiate very tight rates on your behalf. We know exactly where you should be trading and the good ones will ensure you still keep trading through your own bank, but at a much tighter spread (this is very important for credit purposes - especially if you wish to trade Forwards).
- Spend the next 3 weeks listening to your Bank asking you to deal with them direct again and promising that this time it will be better !
Next time - All you need to know about Forwards and sleeping well at night !
James Boorman, 22 years in the Financial Markets in London trading many different products from FX to Interest Rates to Commodities to Futures and Options, before being relocated by Credit Agricole in 2007 to Johannesburg as an Investment Banker, Head of their Financial Institutions Department, sub-Saharan Africa. He now spends his time with his family in South Africa whilst advising on Project and Corporate Finance deals. He adds significant value in the foreign exchange value chain to those companies who do not have the necessity or resources to justify a full time Treasury professional or department, but still need to ensure that their market risks are managed (and their sleep patterns undisturbed). Seen here planting Bamboo in Mozambique.