Tired of calling broker after broker trying to find the best rate today, only to find the rate's already gone by the time you go back to the lowest one? The competitive nature of the foreign exchange market means you could be wasting your time chasing the carrot at the end of the stick.
In fact, what makes the “lowest rate psychology” truly frustrating is how it catches out even the savviest of customers.
In this webinar we discuss why chasing the ‘best price’ isn't the ideal way to get the best rate, and what you should be looking for instead.
Read the full transcript here, or alternatively, watch the full webinar here.
Race to the Bottom
So as you know, the reason we’re here is to discuss why using multiple brokers can have a negative effect on your fx.
First things first, just before we dive in, let me just quickly explain why using multiple brokers can actually be beneficial for your business. At a given point in time, driving the price down by, for example, comparing rates with multiple brokers, can, in fact, generate a cheaper price; it is a simple concept because you are trying to simulate a pricing battle between banks and brokers to generate the cheapest price.
We can't stand here and actually tell you this is wrong; there are some positives and we do understand that there is some value in using multiple brokers. For a one-off deal, you can drive the price down, however, let's think a little bit longer term - is this actually the best thing for your business? Have you thought about the future? Or the next quarter? The next year? The next two years?
I quite like to use analogies to try and explain concepts that seem quite complex. The one that I am going to use is laser eye surgery.
Let's say your eyesight is worsening over time and you need to have laser eye surgery. So you do your research and go to different clinics and have multiple discussions with different surgeons with the intention of gaining an insight into how it works, what it costs, the timeframe, what can go wrong, etc. Imagine your surgeon is an account manager and your clinic is your broker, you want to be assured that your account manager has a complete understanding of what your fx exposure is, what payments have been made, and the risks behind these payments. Just to be clear, this analogy relates to the volatility of the market and to your company’s short term and long term foreign exchange exposure.
You don't want a quick fix job on your eye when further down the line it is going to create more problems than before; you do want, however, a very clear structure to make sure the process runs smoothly and efficiently. We are here to provide the knowledge, experience, and the tools to execute this process; you would not accept a surgeon who gives you a great price but in return gives you a poor quality service, it’s the same with fx brokers and your international payments. So there are certain situations where price is not the focus, most importantly you'd need to trust the clinic and broker and you need to trust the abilities of the surgeon or the account manager.
Continuing with that analogy, going to multiple surgeons, they may handle it brilliantly in the short term, but actually, in the long run, you could have very easily been blinded. If you're going to all these different surgeons you may not know what they’re like and how well they do their job. Also, they may not know you, that you don't like needles, for instance, they won't know your eyes and they won't know what's been done to your eyes before.
We think that this works exactly the same way with fx and brokers. We want to understand your business in the same way that you would want the surgeon to understand your eyes. We want to know your business and your exposures because that's how we can help - when you use multiple brokers, it's not that easy. So, it's potentially great in the short term but actually, how beneficial is it in the long term?
So there we were talking short term and long term; bringing it back to foreign exchange, let’s change it up a bit and get a different perspective. Let’s look at a client on the phone, as if you are talking with different brokers. There are two points here: the first point is that the currency market is constantly on the move. For example, you go to your first bank or broker and you get a rate - this is your benchmark rate. You then go to a second bank or broker and get another rate so you can compare them, thus creating that pricing battle. But how can you use that first rate as a benchmark when the rate is constantly on the move? It's a variable, so you lose that comparison and can no longer use that first rate as a benchmark. This is seen often with our clients and we’re part of the pricing bartering wars.
The second point, in terms of staying on the phone, is the broad costs. I went on the website PayScale to give you a complete estimation of what salaries are. For a finance director, the average came to £71,000 per year, so it works out to roughly around £270 per day and let's just say, as a completely rough estimation in our working day, comes out to about £32 per hour. Let's imagine you spend 30 minutes of this time on the phone going between different brokers, that's about £16 every time you do a comparison of the rates, which is an unneeded cost. The way I like to think about it is the more time you spend on the phone to a bank or broker, the more you are reducing your profit margin. Ask yourself this: is it worth the time and the potential savings?
Following on from that, we wanna hit the point home a little bit more, with this more numerical example. Consider the example and pretend you're a client coming to your broker and you want to buy GBP10,000 worth of dollars so you get an initial benchmark. The first broker or bank you go to gives you a rate of 1.2501 and in return that’s $12,501. You then call your second bank or broker and they might give you a rate of 1.2511, maybe more, maybe less, maybe 1.2522 or 1.2530 etc, and finally you get your final quote that you're happy with: 1.2537. you made 36 pips, you feel like a hero. You've done so well, but actually, let’s look at the real savings. You’ve saved yourself $36, that's about £28 at the exchange rate right now. Is that worth it? You spend half an hour of your time on the phone, which is about £16 as we’ve said already, so you save £28. Do you think, realistically, that's worth your time?
I want to take a look from a different perspective. What if the rate goes up by 1% an hour later? Let's just use an example that Donald Trump is talking, and we saw a lot of this when he was first President; every time he’d go on Bloomberg say something he maybe shouldn't and the rates would move all over the place. Let's just say that that happened an hour after you got that final quote. The rates then just moved up 1%, so the initial quote that you got, if you called them an hour later, would’ve been 1.2637 - which is almost 1% better than what you got. Surely you can understand that your calling multiple brokers was a complete waste of time. Not that you can necessarily know that's going to happen, but clearly when you're calling around any one time, there’s a risk that the market could very easily move; rates can go up and rates can go down. Therefore, it could be very easily seen as a waste of time.
We’d like you now to put yourselves in our shoes for a second. We're here to save our clients money and reduce their risk. We understand that you guys, as financial leaders, don't sit at your desks and stare at an FX screen all day. Unfortunately, we have to. We can, therefore, be your eyes and ears in the market. Essentially, we aim to deliver a good service and good prices, and work to save our clients money; that's how we make our money. We also retain speculation because, as you know, FX is a gamble, but you’ll want to know your bottom line figure. You don’t want to leave that up to the market, and that's where the trusting relationship with your broker allows for the risk reduction that you're looking for.
I’m going to use another analogy here - let's just create a scenario where you're told of your foreign exchange exposure and so you’ll go to three or four different brokers. You'd essentially create a competitive scenario where each broker is trying to get on your foreign exchange exposure and telling you what they’re going to do to beat the other brokers. So they'll say ‘you need to buy your currency now, the market is there and you need to do it now’. This might not necessarily be the correct intel. Bear in mind the long-term view of your business; you may have the best rate or service now, but have you given thought to the long-term? How do you know the right time to buy and sell that currency? We want to provide that long-term view of the business and we don't want to be in a pricing battle that should not be taking place.
That service is what we pride ourselves on here at Currency UK. It’s actually something that we do with every client regardless of their size. The SMEs and the larger companies, we deal with everyone the same.
Another quick point; say you're a company that has a manufacturing station in Europe and you’re buying euros every month. The point here is when you were looking around at manufacturers in Europe, you looked at many different locations and had long discussions to sort out the timing and the payments etc. Are you going to be constantly chopping and changing manufacturing suppliers? No! You want that relationship - it’s the same principle as foreign exchange, just a different commodity.
There are the three things we're interested in doing: (1) saving up our clients time and saving them money, (2) ensuring the beneficial timing of payments and, of course, (3) mitigating their risk to exposures.
So, why would you want to leave your hard-earned profit in the hands of an extremely volatile market? I pose that question to try and hit the point home. We have heard stories of businesses that have folded within our market. This has happened to a lot of businesses before, but one business especially stands out for me. The point I’m trying to make is FX can pose huge risks to any business’s bottom line, whether they think so or not.
The case I am going to use is the recent Swiss bank sell-off. In 2011, when exports to Switzerland were almost at 70% of its GDP, in order to keep exports cheap, the Swiss National Bank made an unprecedented announcement. They fixed the Swiss franc against the euro at 1.2EURCHF and vowed to safeguard this peg with unlimited intervention in the open market. Suddenly, and very unexpectedly, the Swiss National Bank removed the price peg, triggering a flash crash and the price of the EURCHF pair dropped by almost 20%. It was a nose dive; in less than a minute the price went from 1.2 to less than parity (1). So, this flash crash obviously left hundreds of thousands of traders and businesses with negative positions. The event caused heavy losses to foreign exchange brokers as well. What I am trying to say here is that we are affected by this, as well as all of our clients. Some of these more speculative foreign exchange brokers had to announce bankruptcy. Another leading fx broker reported losses of 225 million dollars, and its stock price in funds fell by 90%. With this company I’m talking about, business X, let’s say, they often bought a lot of Swiss francs with their euros. I believe they bought around 10 million euros worth of Swiss franc every single quarter. They were a bit delayed, they were looking to buy their currency around the 26th January; this flash crash happened on the 15th. So they were willing to purchase around 10 million euros with of Swiss franc. After the flash crash, their costs rose by approximately 20% which was around 2 million euros. Of course, they had to put their prices up, but ultimately they couldn't cope, and that’s what I’m trying to explain. It’s often very difficult. You cannot necessarily see what's going to happen; a lot of people didn’t expect it. But the point we always try and push to our clients is that you should always be risk averse. We don't expect and we don’t know for sure what's going to happen, we can only infer from the market. Of course, this doesn’t happen often, but we have seen it before. Brexit, for example, or the flash crash in 2008. It’s those sorts of events that we ensure our clients are risk-averse to because we don’t want them to be on the wrong side.
I'm now going to take you through an example of a more regular event, which is the non farm payroll employment report. This report is released every third Friday of the month; it is compiled of mainly goods, construction, and manufacturing companies in the U.S. It does not include farm workers, private household employees, or non-profit organization employees. This report has the potential to cause large swings in the market because it’s an economic indicator and a comprehensive report on the labour market. It can cause rates to move against you and we try to avoid this and be risk-averse. Even for a broker, it’s difficult to predict where the market’s going to go. A recent example of how this report had an effect is from March of this year. The overall prediction for the report was at 180,000, but the actual reading came out to 98,000. This is a significant drop in the payroll, and if you can look at the example on the EURUSD currency pair, that pair started out in the morning at 1.0504 but ended out at 1.0601, roughly a 1% change with the euro strengthening and the dollar weakening.
Admittedly, the euro did show signs of growth and the same day inflation came out to 2% after predictions of 1.8%, so this led to expectations Mario Draghi would comment on policy change and consider normalizing it. This led to the euro strengthening.
Of course, we’re talking currency pairs here; there are two currencies in each currency pair to fuel the fire of uncertainty - you don’t know what’s going to happen with either. Both currencies have an effect on the currency pair.
I think that's important to note it’s often the case with regular events that they can affect the price, in this instance, drive the dollar price lower. But at the same time we have other information out in Europe and that drives the euro stronger, so it’s actually both sides of the coin pulling against each other. But we can infer from that, and that’s sort of information we want to give to our clients.
A more recent case study is the UK general election.
I’m sure many of you already know a lot about the general election that's just happened; Theresa May was fighting for her majority in parliament. What did we do as a brokerage, what did our sales team do? What we do all the time, and especially with macro events like an election, we give our clients all the possible outcomes, specific to the currency pairs they trade, and essentially allow them to make a decision based on all the possible scenarios. What this entails is a proper conversation. We are talking about actual companies and their exposures, what they wanted, and what they needed in terms of their foreign exchange in the coming months and what effect the election could have. For some of them, we mitigated their risks, especially those who were dollar buyers, because we thought there was a lot more downside risk than upside risk. Hence, some of them mitigated and, because of the drop of 1.5% when the exit polls came out, they were actually better off. The point we’d like to emphasise here is that we told all our clients about this and they made the decision. A lot of them benefitted because of that. Some of them actually, despite being euro and dollar sellers, still mitigated the risk because there was some upside risk. If Theresa May did get the majority that she was after then we would have probably seen the pound strengthen, but obviously, it didn’t, and hence, our euro buyers and dollar buyers that made the decision to be risk averse were 1.5% better-off.
To summarize these case studies, you just have a look at the risk, because the costs can really affect you. The currency market is always doing unpredictable things, and we can only infer what is going to happen. I’m going to use one last analogy (I promise this is my last one) - it’s a cake analogy: we provide the ingredients, you bake the cake. It’s your decision; don't let the ingredients go off, lock in your profit, take back some control. So what does this really mean overall? There is potential for large swings in the market. Is this a gamble you or your company can take? Mitigate your risk and lock in your profit - it’s a piece of cake!
I think it's very important to look at the bigger picture at this stage. We understand that it can be very easy to get distracted when paying invoices as and when they land at your desk. You've got a lot of other stuff to do. As we all know, business is judged through accounting. We don't want your hard-working sales team’s best quarter to date to be subdued when you look at the fx market and realise that you're in the negatives. As a result, you’ll look at your bottom line and see it’s not where it should be considering your sales team put in the work. Why would you want to take that risk?
So, we’ve talked about this risk and, hopefully, laid it out quite clearly, but being consultants, what I would suggest? We suggest having a proper relationship with one broker; allow them to understand your business and the ways in which you work, just like you’d want one surgeon to work on your eye when having laser eye surgery (to go back to the real world analogy).
I really do suggest going with one broker, but also maybe having other brokers to compare prices with and check that they’re not messing you about, because we know that happens with many other brokerages. The next thing I would suggest is to agree your margin if you can. A lot of companies verbally agree their margins, but what we do here is actually legally agree on the margin and therefore have to stick by it. That’s what we call a rate agreement. It works for both spot and forward agreements, we’re not insinuating that people should move from buying at spot to buying forwards and mitigate their risk completely, but we're here to talk about that. In this rate agreement, you get that transparency; that's what I love as an account manager. I like that my clients know what I'm taking because we’re a business, we have to make a bit of money on top, but we want to give people a good price and we want to stick by that, be transparent, and work on the relationship. This allows us to look into your exposures and not even have to have a conversation about the price because you know what you’re going to get every single time you trade.
To be clear, we’re talking about locking in the margin, not the rate, but the margin that is imposed on top of the rate. The legally binding document allows trust - we open our books to you when it comes to the end of the year financial auditing. Imagine, come the end of the year, we've made a little from the open market, we give that back to you as added money that you didn’t know was there. Let’s say we, as a broker, were to lose from the open market - we take the hit. It’s not passed onto you, that’s part of our customer service. We take the hit or we give that money right back to you if it's in your favour. So this leads to an open, honest chat about the consistent pricing and allows a structure or plan to be imposed; you’re then able to manage that risk accordingly. Our focus is on service and risk management.
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Posted in Business Resources on Jun 7 2017