How to reduce FX risk in global supply chains

Whether you’re starting up, scaling up or already running a global organization, minimizing currency risk in your supply chain is crucial. In fact, in a 2021 survey from HSBC¹, managing FX risk was seen as one of the most important tasks of over 50% of US company treasury professionals as they seek business growth in a volatile environment. Here’s how.

FX risk isn’t new. But in a highly interconnected world facing unprecedented pressures, it’s a make-or-break factor for more businesses.

FX risk is inherently multi-faceted - influenced by everything from political shifts, inflation, global demand, commodity costs and more. And as businesses increasingly work through integrated and expansive supply chains - often spanning the entire world - the ways in which FX risk filters through to company profitability have multiplied.

Take for example the back to back impact of Covid-19 followed immediately by geo-political instability from the Russo-Ukraine war. Businesses around the world have faced unprecedented pressure as surging demand, rising costs and currency volatility have shed light on the vulnerability of global supply chains.

In this climate, mitigating against currency fluctuations is key to the profitability and stability of global businesses. Let’s dive into some solutions.

1. Build a diverse supply base through multiple sourcing

Being able to rely on fast moving global supply chains has led to great opportunities for building agile businesses. However, the global pandemic showed vulnerabilities in availability and connectivity of supply chains, which have carried forward into economic volatility around the world. And while just in time sourcing and managing with limited buffers of supplies may be good for cash flow it also needs to be controlled in line with currency risks.

If your business is dependent on a limited number of suppliers, from a single country or geographic region, you’re at risk in the event of significant swings in exchange rates, or failures in the localized supply chain. By relying on suppliers who accept payment in a single foreign currency your business is particularly exposed if their local currency rallies, at the expense of your own.

Solution: A key strategy against this is to increase flexibility and build defensibility by sourcing products from multiple locations. If it’s feasible to use multiple suppliers for your business, this can be part of a long term approach to build trusting relationships with a range of suppliers which can create a broad base to rely on when currencies fluctuate. Even if using multiple suppliers is not a realistic option based on your business model, having alternative backup suppliers, including domestic options if possible, can be used as part of a contingency plan to be rolled out when the situation demands.

2. Currency hedging

Currency hedging involving risk management instruments like forward contracts and target rate orders can help businesses of all types and sizes to manage FX risk in global purchasing.

Forward contracts as an example, can help businesses making contractually agreed purchases on a regular basis to plan their cash flow and expenditure. While instruments like these aren’t entirely without risk - currency fluctuations move both ways, after all - they do remove ambiguity and ensure you’ll know, up to 12 months in advance, exactly what a foreign currency payment will cost you. And if your business is more risk tolerant, you don’t need to ignore forward contacts entirely. One alternative, for example, is to take a forward contract to the value of half the future foreign currency payment, and rely on a spot rate for the rest - allowing you to monitor exchange rates and potentially benefit from both the certainty of a forward contract and any subsequent improval in the spot rate.

Solution: Arguably, businesses could do more with currency hedging. In the HSBC survey mentioned earlier, over 60% of US CFOs described losses to their business as a result of unhedged foreign exchange risk. However, with the increase in easy to use tech support for businesses looking to understand and manage currency risk, this may be set to change. In the same report, HSBC found that over 50% of company treasury managers executing hedges were doing so through technology platforms, offering an easy to use, reliable way to access these more specialist currency instruments.

3. Identify the risk and keep an open line of communication with your suppliers

No business operates in a vacuum. And all the challenges your business is experiencing are being felt just as acutely throughout other companies within the supply chain. However, unless you have an open dialogue with your suppliers to help you understand the type of currency exposure they’re subject to, it’s hard to prepare for cost fluctuations and changes suppliers are forced to pass on along the chain.

Building a collaborative relationship with suppliers is essential to help both sides understand how constantly evolving FX rates impact costs. And of course, stronger relationships with your suppliers can also lead to more robust and future proof supply chains over all. An enviable situation for any business, particularly in volatile times.

Solution: Build a dialogue with your suppliers - they don’t want to lose key customers any more than you do. From this starting point you can look to negotiate contractual agreements which minimize and manage risk for both parties - by reducing payment times to reflect live exchange rates as closely as reasonably possible, or agreeing refunds or risk sharing in the case of excessive short term currency fluctuations.

4. Leverage cross-border payment APIs

As external forces have changed, company finance and treasury professionals have had to pivot somewhat to focus on analyzing, predicting and minimizing risk across currencies. Here, technology has become a differentiating factor as off the shelf tools offering access to instant cross border payments and currency conversion have allowed forward thinking businesses to get the best help available, without the risk, cost or time needed to build out solutions from scratch.

As an example, as a business buying from a foreign supplier, currency fluctuations can push up invoice costs from the original point of purchase to when the goods or services need to be paid for. Cross-border payment APIs can reduce this transaction risk by providing instant payments in the required currency, ultimately saving time and money. Choose a provider offering modern payment infrastructures and you may also get access to local payment rails that lock in more favorable rates and reduced overall fees compared to a traditional bank wire.

Payment APIs like those available from the Wise platform also empower businesses to hold money in local currencies and convert at the optimal moment, creating the opportunity to build a natural hedge and lock in rates where the situation allows.

Solution: Cross-border payment APIs offer an endless range of configuration options to help businesses across a range of industries step up to the particular challenges they face. They also cut costs, risk and time to market, allowing you to deploy your resource where it’s really needed while still benefiting from leading edge solutions from partner providers. Learn more about how cross-border APIs could help your business, here.

Wise Platform - Give your users access to world class FX products today

With Wise Platform, your business can become an API Connected Payments Partner, giving your customers access to Wise’s competitive products and rates on the world’s largest instant payments network.

• Connect to the Wise payment infrastructure for payments to 50 currencies
• Offer solutions for all international transaction types including send, spend, treasury and payment collection for your global customers
• Access some of the lowest, most competitive FX market rates available - no hidden commission at point of conversion
• Get clear and up front fees every time, plus delivery estimates and real-time payments tracking

Sources

1. HSBC 2021 Rethinking Treasury Survey