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Cutting the cost of cross-border currency flows

WORLDWIDE: Understanding the true cost of foreign exchange is important for finance directors within the wind sector as there is a foreign exchange fee every time a currency border is crossed.

Once you know what you are paying, you can take action to reduce your costs, explains Nigel Verdon.

The cross-currency financial flows that take place within the wind industry typically involve one or all of the following: investment (equity capital), capital expenditure (equity and loan capital), interest payments, maintenance costs and general operating costs. Before you can reduce your currency costs, the first step is to understand fully what those costs are, how to identify "hidden" costs and how to move beyond foreign exchange myths.

I expect every finance director whose company operates internationally has been offered "better-than-bank" pricing by a currency broker or "choice pricing" by their bank. What these pitches mean is that the broker or bank wants you to believe that it can provide better foreign exchange rates.

Both offers are highly appealing, but before finance directors agree new terms with a currency partner, they should understand what they are currently paying — in other words, what is known as the true cost of currency.

Another frequently used concept is "commission-free" foreign exchange and/or "no payment fees". Both terms are fundamentally inaccurate as every currency transaction involves commission and payment fees, but in some cases these are hidden.

To understand the true cost of currency your company pays, the following questions need to be answered. Do you know how much commission you currency supplier is earning? How do you know that the rate you are quoted is in line with the current market? Will pricing remain consistent over a specific period for all your trades? Can you audit past and present trades to validate that you have been provided with consistent pricing?

There is a simple methodology for answering these questions. Using the example of selling €1 million and buying sterling, the first step is to use a free online market-data checker to identify the current mid-market "spot" price, bearing in mind that spot prices change by the second. In this example, the mid-market spot price for GBP-EUR is 1.1324. Based on this, €1 million would buy £883,080. While the mid-market rate is not used commercially, it serves to establish your currency rates. Next, ask your currency supplier to tell you its price. If the currency broker price is 1.1424 this would buy £875,350. In this example, the difference between the mid-market spot and the currency supplier's price is 0.0100, which is termed 100 pips.

This information allows you to work out how much commission your currency supplier earns: £7,730 in this case. This is your true cost of currency.

Once you have calculated currency cost, you can judge whether it is reasonable. The cost discussed above is unreasonable, although I have seen customers charged £20,000 or more despite being told they had a commission-free deal. A reasonable price for euros and pound sterling would be based on a mark-up of 0.0040 on the mid-market price - meaning the currency supplier would earn £3,100 - although typical prices vary by currency.

Another sales ploy used by brokers and banks is to quote cheap in order to win a new customer and then increase the price gradually, hoping the customer does not notice. To check whether this is the case take note of the mid-market price each time you transact and check the mark-up over a series of transactions is consistent.

In conclusion, next time a cross-currency investment or payment occurs within your business consider the following in order to reduce your currency costs: the mid-market rate at the time you buy currency; what represents a fair commission for the transaction; and whether the mark-up applied over time is consistent.

Nigel Verdon is chief executive and founder of FX Capital Group. He can be contacted on nigel@fxcapitalgroup.co.uk. For more details see www.fxcapitalgroup.co.uk/takeacloserlook.

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