Forex Services and Risk
Forex services and risk are two closely related topics. Currency fluctuations affect the value of assets and can have a direct impact on companies’ financial performance. For example, a US company that pays suppliers and customers in USD faces the risk of currency depreciation. The EUR/USD exchange rate may have a significant impact on the future value of the company. Similarly, the USD exchange rate can negatively affect a company’s short-term, medium-term, and long-term competitiveness.
FX service providers must implement a sound AML/CFT program to minimize the risks and detect money laundering and other criminal activities. The company must perform customer due diligence checks to verify customers’ identity and establish beneficial ownership when dealing with another FX company. Financial institutions that provide FX services must follow the AML regulations of each member state. Money laundering and other criminal activities can be detected by checking customer identification and financial background information. The underlying risk factors for FX services and risk are outlined in the following sections.
The global foreign exchange market is extraordinarily volatile. Events such as the COVID-19 pandemic are just some of the factors that can drive FX volatility. Throughout the past five years, the market has been battered by a toxic mix of circumstances. Brexit, the U.S.-China trade war, and the breakdown of NAFTA negotiations have all been catalysts for volatility and uncertainty. The COVID-19 pandemic, meanwhile, has only added to the risk sundamic. Despite the volatility, developed market currencies remained relatively strong. In more tranquil times, these currencies were relatively stable and relatively safe.
Companies exposed to FX risk should implement hedging strategies to protect themselves from unwanted foreign exchange moves. These strategies typically involve forward contracts, options, and exotic financial products. Forex services and risk management can help protect a company from unwanted movements of its currency. However, currency fluctuations are only one source of FX risk. Those interested in foreign trade should consult with a knowledgeable treasury management professional or a foreign exchange banking professional to determine the best strategy for their business.
Hedging strategies are critical for a firm’s international operations. Hedging strategies reduce a company’s exposure to FX market volatility by hedging its assets and cash flows in reporting currency. In addition, companies can reduce their exposure to market volatility through various operational techniques, such as currency invoicing and leading and lagging of payments and receipts. A third type of risk management strategy is to manage the exposure to currency fluctuations through risk management models such as cash flow at risk and earnings at stake.
While hedging can reduce the company’s FX rate risk, the process can be expensive and time-consuming. To minimize FX exposure, companies should determine the currency in which they are most exposed. By identifying the major exposures to FX risk, businesses can implement tactics that reduce the overall exposure. One example is pricing their products in their local currency, which helps pass on the FX risk to customers. While hedging does incur a small loss, it can protect the company from a major rate swing.