RISK MANAGEMENT | 12 OCTOBER 2021

FX Risk Mitigation
for SMEs

Absa-CIB-Author

Paul Fenwick / Trevonica Naidoo

CFA: Digital Markets
COO: International Banking South Africa

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Small businesses face big risks when they make international payments. Here’s how to mitigate those risks – and prevent possible financial disaster.

The biggest difference between a small business and a big business is their size. And while that may sound obvious, it’s at the heart of the many challenges small or medium-sized enterprises (SMEs) face when it comes to international payments.

“Global corporates trade in millions of dollars at a time, whereas SMEs come in at $10 000 or $15 000 per transaction,” says Paul Fenwick, CFA: Digital Markets at Absa CIB. “So from a foreign exchange (FX) point of view, there’s less need to be as sophisticated and diverse in the products SMEs use. And honestly, if you’re a small manufacturer or a farmer working in the agri sector, FX is often not your biggest pain point. Just being able to settle a transaction is usually where you would focus your attention.”

Yet small businesses face big risks when they do business across borders. SMEs across industries – from agriculture to retail, manufacturing and more – need to know what those international payment risks are, and how to mitigate them.

Spots vs forwards

In Fenwick’s view, the biggest risk SMEs face is currency volatility. Yet, as he explains, that’s also where some of their biggest missed opportunities lie. “It’s no secret that the rand is one of the most volatile currencies globally against the US dollar, and we sometimes see massive exchange rate swings,” he says. “The question for SMEs is: How are you hedging yourself against that volatility risk? If you’re just coming in and booking a transaction whenever you need to make the payment, you would be using a very basic spot product.”

The “spot” exchange rate, Fenwick says, is the exchange rate you’ll be offered right now, today. “When you expose yourself to spot products you expose yourself to all types of associated risks,” he says. “Everything that happens in the world – from political news to economic news – impacts that spot price. That’s why it’s the most volatile FX product.”

Fenwick suggests taking a forward, but warns that there are pros and cons to that choice, too. “Some clients say they don’t want to take a view on the rand, and they just book when they need to,” he says. “What they don’t realise is that by taking that stance, they are actually taking a view – and they are exposing themselves to whatever might happen between now and when they need to make that booking. There is a lot of risk associated with that. With a forward, you know what you’re going to get.”

A customer foreign currency account provides another natural hedge. “If you’re both importing and exporting, it’s a good solution to help you hedge the exchange rate risk without necessarily taking out forward cover,” says Fenwick.

Who’s on the other side?

The underlying payment is another potential risk. Trevonica Naidoo, COO: International Banking South Africa at Absa CIB, offers a real-world, worst-case example. “One of our customers had a supplier in the Far East who sold them some goods,” she says. “The supplier asked for 30% in advance, with the balance to be paid once the goods were on the ship. The South African SME was, in essence, paying in advance; it was just that the payment was split. They waited for the shipment to arrive, and when the ship docked in Durban... Long story short, they were duped. There were no goods. The documentation was all fraudulent. They lost R100 000. To a bigger corporate that might not mean much, but to an SME it could have been everything they had.”

That sort of thing could happen to any business, large or small. “From a risk perspective, you need to ask: Who is the supplier on the other side? And what banking instrument can you use to get some assurance that you will get what you’ve asked for, while also giving your supplier the assurance that they will get paid for what they’re sending across? That’s where letters of credit or some type of foreign guarantee could come into play,” says Naidoo.

Know your options

Fenwick warns that the world of international transactions has become more complicated – and riskier – than ever owing to COVID-19 travel restrictions. “As an importer or exporter you can’t travel easily, so you can’t always validate the people you’re working with – especially when you enter into new supplier relationships,” he says. “Without the traditional verification steps you would have taken to validate your partners, you need to have extra layers of protection.”

Naidoo agrees, adding that small businesses in particular need to do their homework around international banking and FX risk mitigation. “One thing I’ve learnt over the past couple of years is that many SMEs don’t know what is available to them from an FX risk mitigation point of view,” she says. “I’d encourage them to speak to their bank to find out what their options are.”

Absa-CIB-Author
Paul Fenwick / Trevonica Naidoo

CFA: Digital Markets/ COO: International Banking South Africa

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