FX clients turn to non-banks

CFO - April 2006

Foreign-exchange providers are giving the big banks a run for their money in the quest to help smaller businesses manage their offshore currency risks. Ed Charles reports.

The volatility of the Australian dollar is a constant threat to the profits of small and medium enterprises who fail to hedge their foreign-exchange risk. The dollar, which has fluctuated wildly since 2001, "was at 48¢ against the US dollar 30 months ago", says Mark Whelan, ANZ joint managing director of markets sales. "It's peaked at 80¢ and is now back down at 73."

Yet only 5 to 6 per cent of small to medium enterprises actively use any sort of hedging product for foreign-exchange risk, compared with 70 to 80 per cent of larger companies, says Martin Crawford, managing director of leading non-bank foreign exchange dealer Travelex.

"It's very hard running a small business and the last thing you want is foreign exchange to tinker around with your margins," Crawford says. "You price something, you think you've covered your costs, then all of a sudden the currency moves 5 per cent against you and you've lost 5 per cent of your margins."

Companies also need to be aware of the changing foreign exchange markets of their trading partners. China has become Australia's second-biggest export market and has just overtaken the US as the third-biggest trading partner. While most businesses use the US dollar to trade with China, the yuan is on the road to full deregulation.

Last July, pegging of the yuan was changed from the US dollar to a weighted index of currencies (see "Renminbi pegged", page 47). In November, the central bank, the People's Bank of China, executed its first domestic currency swap. In January, over-the-counter trading was introduced.

ANZ reckons these changes herald the greater volatility of China's currency. Yet many SMEs - companies, turning over from $5 million to $20 million - are ignorant of the implications of the changes.

Part of the problem is that smaller companies do not know where to go for sophisticated hedging and foreign-exchange services. The major banks are focused on the foreign-exchange needs of larger companies. Smaller companies, even in the internet age, have literally been forced to transact at branch level.

Matt Gilmour, joint managing director of non-bank OzForex, says: "In the 1990s when there wasn't so much activity in the non-bank sector, the banks were pretty choosy who they'd do forward contracts with and options with. One of the things about the non-banks coming into the market is that we offer a much greater breadth of product to smaller customers, from forward contracts to options."

Paul Dowling, principal analyst at specialist banking research firm East & Partners, says there is a long-term trend for SMEs to use more foreign-exchange products. Historically, they have used spot FX and the banks are aggressively pushing FX contracts and swaps.

In the SME sector, however, many companies are not relationship-managed. "These smaller customers have no idea within the bank where to go for foreign-exchange advice," Dowling says, "Most of them resort to visiting the bank branch."

The non-banks have been successful in building market share because "they seem to be much simpler to deal with".

Travelex is the world leader in the non-bank market, created by merging its corporate exchange trading business with that of Thomas Rook in 2001. Locally, Travelex is No1 in the micro business (under $5 million), has a 16 per cent share of the SME market ($5 million to $20 million) and 6 per cent of the commercial mid-cap market, covering companies with turn-overs of $20 to $240 million.

The non-banks, which also include Customs House and American Express, offer different levels of services. OzForex grew out of a portal founded in 1998 to offer comprehensive data and information on foreign exchange rates (it still does) at a time when small companies couldn't justify the thousands of dollars it costs to subscribe to prices from a service such as Reuters.

At the time, Gilmour and his partner, Gary Lord, saw the banks' big corporate clients receiving high levels of service, including entertainment at the rugby sevens in Hong Kong and at other prestigious events. "The other end of the market wasn't getting any service and the banks were treating them poorly," Gilmour says.

In 2002, the company started dealing, with the aim of offering the best prices. To this end, it quotes the rates offered by the major banks to its customers online. The company offers spot foreign exchange deals and forward contracts but will not deal with speculative dealers.

Whelan admits that on occasion the non-banks can sometimes offer better prices. However, he says that with the transparency in price in the market, locally and globally, margins are being shaved by competition, so there is little difference between players. Travelex does negotiate on bigger trads and with bigger customers, which are offered a better spread in their buy and sell rates.

In March, the company announced a significant revamp of its internet-based foreign exchange management system.

The aim is to de-mystify the "black arts" of foreign exchange transactions and introduce customers to new futures products.

Importantly, the online product consolidates the purchase of currency and the payment to a third party in one system. It handles both spot deals and forwards contracts as well as incorporating company's individual checks and balances such as multiple sign-offs on transfers and deals.

There is no cost to clients to use the system. Crawford says part of the idea is that it cutes the costs of transacting.

Typically, the non-banks concentrate on the smaller end of the market. For example, OzForex's transactions range from $5 million down to $10,000. Transactions under $10,000 cost $15 to execute. Travelex will trade upwards of $5000.

Cut-throat competition between the big four banks means they are responding to the demands of smaller companies. Still, trading foreign exchange with most of the large banks means they are responding to the demands of smaller companies. Still, trading foreign exchange with most of the large banks requires the loading of proprietary software.

ANZ has proprietary systems for foreign exchange, capital markets and trade. Each requires a separate software installation on a computer, although the bank is working towards integration.

In contrast, non-banks, while executing smaller deals, do it all on the web or via the phone. For smaller business, they offer 24-hour access to foreign exchange markets, a luxury reserved by the banks only for their biggest customers.

Among these customers, one recent influence has been the introduction of International Financial Reporting Standards. Whelan says confusion around IFRS over what constitutes effective hedging, and the volatility this may bring to the profit and loss account, has simplified the products used by many listed companies.

"I think in general in the market place, because of accounting standard changes and because of the sheer complexity of some of the products, there has been a movement by the corporate market back to more simple product, at the spot and the forward and basic options," Whelan says. "And I think that's been a positive in a lot of respects for the risk management on FX."

He says part of the story is a new conservatism post-Enron. "A lot of corporate boards decided they would simplify their hedging policies and that's a good thing."

Gilmour, who worked for Westpac, Bankers Trust and UBS, says that banks often sell foreign-exchange products that are more complex than they need be.

He says that the reality is that most trade with Asia is done in US dollars. Trading partners use the greenback to buy their raw materials imports and a few trade in Chinese currency.

For most SMEs, the simple solution is best, he says. Hedging with forward contracts is the simplest, most transparent and efficient way to go. "If you are looking at option products, the more complex they get, the more fat and margins are built in by the provider."

The banks are busy bundling their products, ANZ is working on bringing together its foreign exchange, capitals markets and trade services into one product. "If you combine the payments transaction with the foreign exchange, you're bundling together what the customer is trying to do more and more," Whelan says.

Generally speaking, the bigger banks and non-banks offer more advice. Travelex visits its clients and works through with them their hedge plans.

It offers seminars and training through its subsidiary, Risk Solutions.

ANZ has a subsidiary, Consultative Risk Management, which will help manage all risks. Whelan says that the company will analyse cash flows, trade flows and currency risks to help provide hedging for various interest rate and exchange rate scenarios.

Such services are free for the larger end of town and companies that trade more than $20 million in foreign exchange annually. Whelan says that the level at which it can offer this advice will fall over time.

Meanwhile, China faces pressure to further deregulate currency trading from the US and other major trading partners. As Whelan says: "I think you will find that there will be continued pressure for the Chinese to deregulate but they will do it at a pace that suits them."

~ Renminbi Pegged: The Chinese currency is the reminbi, which is divided into units of yuan, that translate as "round object", or coin, literally a translation of dollar. Until last July, the currency was pegged at 8.28 to the US dollar. It was revalued at 7pm on July 21 to 8.11 renminbi to the US dollar and pegged to a basket of currencies. The renminbi trades within a 0.3 per cent range of the currency basket of currencies, which is dominated by the US dollar, Japanese yen, South Korean won and, to a lesser extent, the British pound, Thai baht, Russian rouble and the Australian, Canadian and Singapore dollars. ~

Back to Media Centre

Go to top