Companies who are active players in international trade inevitably face the question of whether or not they should transact with foreign counterparties in their home currency — or if it is better to do so in their counterparties’ local currencies.
At first glance, it may seem more attractive to conduct trade in your company’s home currency — however, this is usually an expensive myth. Many companies believe they can eliminate foreign exchange (FX) risk by conducting international transactions in their home currency. Unfortunately, the truth is that FX volatility risk between two currencies is always present. By transacting in their home currency, companies end up passing on the FX risk to their suppliers — many of whom will charge an extra premium for assuming the risk, or may fail to manage the risk appropriately.
If we focus on the supply chain for importers, there are many benefits to be gained from having your trading partners price goods or services in their local currency. For the exporter, it may be easier to understand their profit margins when clearly seeing direct revenues against actual cost of goods when both are priced in same currency. Also, the supplier can focus on their core business, and not need to worry about FX volatility, risk management, exchange rates etc.
For the importer who is driving the business relationship, purchasing international goods priced in their home currency may cost far more than needed, due to mark-ups applied by the seller. For example, suppliers in China often incorporate CNY/USD fluctuations into the pricing of their products, increasing the price of goods as the exchange rate becomes less favorable, sometimes by as much as 5 to 10% above market rate. Purchasing goods in local currency allows companies to negotiate competitive local pricing and avoid overpaying for imported goods, while the importer manages any FX risk exposure and determines a competitive FX rate to use when settling the invoice.
Another important reason to pay in local currency is control. If an importer pays its overseas supplier in USD, the supplier’s bank has no incentive to give the payer a preferential rate when it converts the currency since it has no relationship with the payer. However, if the payer converts the USD with its own bank before making the payment, it will likely get a better client rate. Additionally, if the payee’s bank does not have foreign currency conversion capabilities, it will rely on a correspondent bank to provide this service on its behalf, further increasing fees.
Overcoming the Obstacles
One of the biggest hurdles companies must overcome when converting to local currency is the fear of foreign exchange risk. Companies who choose to move to local currency must learn how to manage this risk effectively. In China, for example, companies have the opportunity to take advantage of the new CNH (offshore renminbi) market for certain types of payments, such as invoice or trade-related settlements. This means that the risk associated with pricing in Chinese currency can be hedged more effectively than ever before. By working with a knowledgeable and supportive banking partner, companies gain access to the most advanced tools and expertise needed to manage foreign exchange risk.
To combat foreign exchange risk that the importer will start to assume, your accounts payable team and/or sourcing team should work with your finance and treasury partners to agree on a strategy to manage FX volatility in-house (e.g. pay at spot FX rate, hedge exposure with forwards, use guaranteed FX rates, etc.)
Another common obstacle companies must address when moving to local currency occurs when the exporter’s ledger system only accepts denomination in a specific currency. Issues such as these can be overcome, by enhancing your enterprise resource planning system (ERP) or treasury workstation (TWS).
To combat technological issues that may arise, consult your technology provider to ensure invoicing and accounting systems have the ability to support multiple currencies, and update internal procedures and provide training to staff on managing a multicurrency vendor process.
Contractual terms of invoicing can also raise issues for companies transacting in local currency. If contract terms with local suppliers specify that invoicing must take place in a certain currency, the terms of the contract may need to be adjusted so that the supplier can bill for items in local currency. The importer, or buyer, may also decide to review payment terms to ensure the company is receiving the best price from the foreign supplier by comparing the price of similar goods offered by local suppliers. The exporter will often welcome a move to local currency invoicing terms, because this provides added convenience while avoiding the need to manage the foreign exchange risk associated with the contract.
To combat terms-of-invoice issues, work with your sourcing or vendor management team to change contract stipulations to allow both invoicing and payment in local currency.
If updating vendor contracts is too big of a task, some companies choose a simpler approach – opting to continue receiving invoices in local currency, and then converting the payment from the company’s home currency into the supplier’s local currency. While missing out on a few key benefits, international suppliers will still profit from the locked-in exchange rate, as well as the ability to easily reconcile the payment. We should point out that there are cases where local currency transactions are not the best option. In certain industries, it is common for all parties to invoice expenses in a common currency like USD, or, a supplier may hold offshore accounts in primary currencies like USD or EUR, or perhaps uses FX forwards for expected large payments. Suppliers with such arrangements should be left out of your conversion plans.
Any company that is expanding their supplier network globally should take this strategy into serious consideration, as they can gain numerous benefits from adopting a sell global, price local approach to their imports and exports.
For those ready to make the move to local currency, here are some steps to get you started:
- Quantify the benefits to you and your payees. Ask your transaction banker for help.
- Educate internal stakeholders and supply chain partners on the simplicity and benefits of FX payments.
- Take the time to understand the risk management implications of the move.
- Make sure an appropriate FX policy is in place, which details what can and cannot be done in terms of hedging against risk.
- Begin the transition with a few large suppliers/customers rather than trying to move every contract to local currency terms at the same time.
- Expect the transition to take time — a minimum of three to six months if you have a high number of global payees.
- Conducting trade in your company’s home currency may be convenient, but not always cost-effective
- Globally ambitious companies can improve efficiency and profitability by converting to local currency transactions
- A series of tactical steps can help you mitigate common local-currency hurdles, such as FX and contract-term risks, and launch your local-currency strategy