The ongoing rand manipulation saga has thrust the role of banking institutions in currency markets into the spotlight, while sparking increasing concerns and complaints regarding opaque and exorbitant forex fees, complicated transaction processes, and a general lack of service.
However, this could prove to be valuable, as these events have finally compelled consumers and businesses to question their foreign exchange service providers, and shop around.
“We’ve heard of instances of banks and forex providers charging up to 3% on transactions, which is frankly exorbitant. Business owners and managers need to feel empowered to take a harder look at the prices and service they’re being offered, and, if they’re not satisfied, change their provider,” notes Peregrine Treasury Solutions Executive Director Bianca Botes.
The 2019 Deloitte Global Corporate Treasury Survey indicates that a key focus for treasurers is to actively contribute to the bottom line by optimising any financial transactions. A large part of this involves seeking out potential price-efficiencies or cost-cutting measures for businesses – especially with an economy under significant pressure. For many businesses, the cost of forex transactions is a particularly significant expense that is often overlooked.
“Many export and import businesses in particular are not aware of the margins and fees being charged by their forex providers for transactions,” she says. “For importers, high margins on forex transactions means inflated costs on imports, leading to reduced profit margins for the underlying business. Likewise for exporters – many of whom receive significantly less than they had forecasted or budgeted for when researching currency exchange rates on the internet.
“The digital age has done wonders for driving increased transparency from financial services providers. Unfortunately, however, there is still a significant lack of understanding regarding foreign exchange markets, where the costs of forex transactions lie, and what the most appropriate options or avenues are for various business needs. This stems from a general lack of access to information and consumer education regarding forex markets, which in the past were primarily the playground of large institutions.”
Questions to ask your forex provider
With this in mind, Botes outlines three crucial questions consumers and businesses should be asking their forex service providers:
1.What is the margin paid per unit of foreign currency?
Margins are usually quoted as a percentage of the full transaction amount. For example, if you are importing goods from the US and the current exchange rate is R18.00/$, and your forex provider charges a 3% margin, you would actually pay R18.54 per dollar. If you were to buy $100,000 worth of goods, this essentially means that you would pay your forex provider R54,000 for the transaction.
2. What other commissions and fees are applicable?
In addition to the margin levied upon the cost of the exchange, forex providers may also charge a set fee or commission for executing trades, transaction fees such as SWIFT fees, which can add up to R1250 per foreign payment, processing fees for administrative duties, and, in times of low liquidity, a liquidity premium.
3. Is the margin fixed, or does it depend on market conditions and volumes?
Rather than set a fixed margin rate, some forex providers may set a relative margin, with a higher price or margin for relatively small transactions, and a lower price or margin for larger transaction amounts where clients may be more cost-sensitive.
Using a similar example as above, assume the rand is trading at R18.00/$, and you wish to make a payment for $100,000. If your forex provider, Company A, is charging a 0.7% margin for the transaction, this means that you would actually pay R18.126 per dollar, or R12,600 for the transaction.
However, if another provider, Company B, will only charge 0.5% for the same transaction, this means that you would pay R18.09 per dollar, or a total of R9,000 instead. While the percentage difference appears almost negligible, this means that you would save more than R3,500 on the single transaction.
4. Do you require any initial margin?
Some forex providers require up to 20% initial margin, and often encumber your balance sheet to cover their risk. Forex transactions are frequently undertaken on credit and a financing institution will require a margin for protection in case of a negative cash flow when rates move against you. For example, on a $5 million transaction, you might be required to put up R5 million to protect the forex provider. This ties up your balance sheet until the transaction has been completed. Worse, these providers can, at the same time, continue to charge high fees even though their risk has been significantly reduced.
However, there are other providers who will use their balance sheet to provide the facility for their clients who are then not required to pledge an initial margin.
5. Are you compelled to use a particular service provider because of their finance agreements?
Clients are often forced to execute their forex through a particular bank as part of their finance agreements.
When lending institutions provide working capital for international trade transactions, they are performing their primary function. However, when they tie this function to effecting forex deals for the trade, there is no certainty that you will be able to secure an optimal rate. Once you are compelled to use a particular forex provider, you no longer have any pricing power which could significantly impact on the profitability of your trade.
6. Is the quoted margin the one you actually receive?
There are forex providers which are willing to adjust their margin when a client questions and objects to it. However, they can revert back to the higher margin as they are not obligated to uphold a certain percentage.
For example, let’s assume the charges be a set margin of 2% on your forex transactions, and you complain to your relationship manager, they will often adjust the margin downwards to, say, 1.5%. However, as they are under no contractual obligation to maintain the margin at 1.5%, one often finds that it is back at 2% a few weeks later.
In an age of digital trading platforms, it is also harder to question the margin charged, as you no longer have physical interaction with a dealer.
“It’s therefore crucial to ensure that the fees and margins being charged by your forex provider are commensurate with your volumes or transaction sizes, as well as the service that you are receiving,” says Botes.
“Additionally, by having a forex specialist in your corner with real time access to details such as market liquidity and volatility, you can ensure that your forex prices are not being inflated unnecessarily, and structure your transactions to avoid additional costs such as liquidity premiums.”