How to Accept Payment in Foreign Currency for Exports
Foreign exchange (FX) risk exposure is often overlooked by small and medium-sized enterprises (SMEs) that wish to enter, grow, and succeed in global markets. Although most U.S. SME exporters prefer to trade in U.S. dollars, creditworthy foreign buyers today are increasingly requesting that payment be accepted in their local currency. To a U.S. exporter who chooses to trade in foreign currency, FX risk exposure is the potential financial losses due to foreign currency depreciation against the U.S. dollar when payment is due. Obviously, this exposure can be avoided by insisting on trading only in U.S. dollars.
However, such an approach may result in losing export opportunities to competitors who are more flexible in the choice of payment currency by their foreign buyers. Trading only in U.S. dollars could also result in non-payment when foreign buyers find their U.S. dollar-denominated obligations magnified due to local currency depreciation.
While the risk of non-payment can be mitigated by export credit insurance, such “what-if” protection is meaningless if export opportunities are lost due to a “payment in U.S. dollars only” policy. To remain competitive in global markets, U.S. exporters should consider being flexible in accepting payment in foreign currency while exploring ways to proactively manage FX risk exposure.
|Characteristics of Foreign Currency-Denominated Export Sales
||Recommended for use (a) in competitive global markets, and (b) when foreign buyers insist on paying in their local currency.
||Exporters are exposed to the risk of currency exchange losses unless FX risk management techniques are used.
||Competitive payment terms to win more sales. Reduced non-payment risk resulting from local currency depreciation.
||Cost and burden of managing FX risk. No potential profit from favorable FX movements except when using FX Options hedge.
- Most foreign buyers prefer to pay in their local currency to avoid FX risk exposure.
- Exporters who choose to trade in foreign currency could boost their competitiveness and win more sales.
- The volatile nature of the FX market poses a risk to exporters, as unfavorable FX rate movements may cause significant financial losses from otherwise profitable export sales.
- When export sales are denominated in foreign currency, exporters could minimize FX risk exposure by using one or more of the FX risk management techniques.
- The primary objective of FX risk management is not to aim to make a profit, but to minimize potential financial losses resulting from unpredictable and unfavorable FX movements.
FX Risk Management Techniques
Several techniques are available for reducing short-term FX risk exposure, which are suitable for new-to-export SMEs or exporters who are exploring accepting payment in foreign currency. The FX instruments outlined below are available in all major currencies and are offered by numerous commercial banks and FX service providers. However, some techniques may be impractical or cost prohibitive for certain SME exporters.
Cash-in-Advance in Foreign Currency
One way exporters could avoid FX exposure is to demand cash-in-advance payment for foreign currency-denominated sales. The exporters can then immediately calculate the expected net proceeds in home currency using the spot exchange rate, which is the current exchange rate of two currencies.
Another way to minimize FX risk exposure is to find natural hedges, that is, matching foreign currency receipts with foreign currency expenditures. For example, an American exporter who receives payment in pesos from a Mexican buyer may use pesos for other purposes such as paying agents’ commissions or paying another Mexican trading partner for supplies.
If the pesos receipts and payments are comparable in value, FX risk is minimized as the exporter will rarely need to convert pesos into U.S. dollars. The risk is further reduced if those peso-denominated transactions are conducted on a regular basis.
FX Forward Hedge
The most popular way of hedging FX risk is using a forward contract, which enables the exporter to sell a set amount of foreign currency at a pre-determined exchange rate at a pre-specified time in the future with a delivery date from three days to one year into the future. For example, a U.S. exporter agrees to accept payment in euro for 1 million euros worth of goods sold to a German company on a 60-day term.
In fear of euro depreciating in the next 60 days, the U.S. exporter engages in a forward contract today at the forward exchange rate of one euro to 1.25 U.S. dollars. This forward contract helps the U.S. exporter minimize FX risk exposure by ensuring the conversion of 1 million euros to 1.25 million U.S. dollars, regardless of what happens to the dollar-euro exchange rate in 60 days.
However, if the German buyer fails to pay on time, the U.S. exporter will still be obligated to deliver 1 million euros in 60 days. Hence, when using forward contracts to hedge FX risk, exporters are advised to pick forward delivery dates conservatively or engage in a “window forward contract” which allows for delivery between two dates instead of a specific settlement date.
If the foreign currency is collected sooner, the exporter could hold on to it until the delivery date or could “swap” the old FX contract for one with a new delivery date at a minimal cost. Note that fees or charges for forward contracts are very minimal as the FX trader makes a “spread” by buying at one price and selling to someone else at a higher price.
FX Options Hedge
If an exporter has a large transaction quoted in foreign currency and/or there exists a significant time period between quote and acceptance of the offer, an FX option may be worth considering. For an exporter, using FX option to hedge currency risk is like buying insurance against foreign currency depreciation.
Under an FX option, the exporter acquires the right, but not the obligation, to exchange the foreign currency into home currency at a specified rate on or before the expiration date of the option.
As opposed to a forward contract, the exporter who purchases an FX option has to pay a premium, which is similar to an insurance premium. If the value of the foreign currency goes down, the exporter is protected from the loss.
On the other hand, if the value of the foreign currency goes up, the exporter simply walks away from the option contract and sells the foreign currency at a more favorable rate in the spot market. While FX options provide flexibility, they are more costly than FX forward contracts.