To thrive in today’s internationally volatile markets, financial institutions and other organizations must attend more closely to the cross-border payments process.
Fortunately, significant advances in facilitating efficient, secure payments in local market currency have substantially mitigated the risks associated with accessing local markets. Organizations are afforded the opportunity to be involved directly in the payments process, which allows them to secure favorable rates and ensures transparency.
Advances in technology, as well as the services offered by payments providers and local market experts, have opened up a plethora of options for organizations seeking to make local currency transfers. By utilizing these services, financial institutions can insulate themselves from risk and gain unprecedented access to developing markets.
These advancements are coming in a more challenging market. With large discrepancies between global currencies, institutions have been forced to reevaluate their traditional methods for transferring funds in local currencies, particularly to developing world countries. This shift in mentality has begun to manifest itself in a number of ways.
The proliferation of electronic trading platforms, which has resulted in institutions have greater access than ever before to developing world markets, has caused a dramatic improvement in the capability to transact and settle in local currencies. Traditionally, institutions would simply send hard currency to emerging markets countries to be converted onshore, which exposed them to a multitude of risks because they were not involved in the procurement of local currency.
Organizations now have the ability to participate directly in the currency conversion process, which affords them transparency into the rate at which funds are converted, ultimately allowing them to control pricing. Firms can now utilize hard currency as an asset in negotiating conversion costs in advance, and can secure competitive exchange rates from a range of global payments providers rather than relying on a single source.
Another conventional approach that has been upended is lump sum funding. Historically, accounts were predominantly funded on a lump sum basis to cover projected operational expenses, anticipated invoice payments, etc. In the case of relatively stable currencies specifically, any marginal depreciation of local currency balances in these accounts was counteracted by the cost efficiency of an organization sending an individual cross-border payment.
Given the recent and severe volatility in the markets, however, mitigating the risks of depreciation on balance exposures has become increasingly difficult. Lump sum payments also represent an unnecessary risk today, as the ability for institutions to quickly make local currency payments in developing world countries has improved dramatically.
Currency depreciation suffered on balance exposures could result in inaccurate projections and insufficient funding for cross-border payments when expenses are required more quickly than expected. With the multitude of options to make multiple payments in local currency at a more rapid pace, lump sum payments have proven largely uneconomical, and have given way to “just-in-time” funding, whereby institutions expend capital for cross-border payments immediately before the transactions are made.
As mentioned above, organizations throughout the markets have begun to adopt a risk-based approach. Global compliance standards are stricter now than ever before, and new laws and regulations with regard to international currency transfers have been adopted in many countries worldwide.
Institutions have the ability, as well as the responsibility, to monitor the currency exchange process more closely, in order to ensure compliance with local law. Additionally, ensuring that transactions are conducted with approved counterparties is crucial in order to prevent financial loss, and just as importantly to avoid funding terrorist regimes, money launderers, and other criminal groups.
Finally, analyzing performance risk of the local banking sector can and should be outsourced to professionals who monitor these markets on a daily basis, and thereby have deep knowledge of credit conditions. Institutions can insulate themselves from credit and liquidity risk in developing world countries by relying on outside parties for market intelligence.
Carsten Hils is global head of INTL FCStone Ltd.’s Global Payments Division
