For Importers: Our complete guide to hedging FX.

We explain the what, how and why of hedging foreign exchange risk, in a way that specifically addresses the needs of importers.

I am an importer. How and why should I start hedging?

As an importer, potentially your largest business risk is a drastic drop in the value of the domestic currency. If properly managed, this risk can turn into a source of strategic advantage for your firm.

This article will cover:
  1. An Introduction to Hedging for Importers
  2. Hedging strategies for Importers
An Introduction to Hedging for Importers

Hedging is the protection of your business cashflow against foreign currency risks. For importers, these risks can constitute a significant portion of the total financial risk your business faces. Most importers can relate to waking up in the morning to a negative headline, and panicking as they watch the Australian Dollar to US Dollar price drop like a stone.

To protect against this specific risk, we are looking for protection against Upward movements of a foreign currency (e.g. US Dollars - USD) against our local currency (e.g. Australian Dollars - AUD).

The normal process for importers:
  1. Our customers pay in a local currency (AUD) and we anticipate future contracts that must be paid in a foreign currency (USD)
  2. The foreign currency (USD) increases in price against our local currency (AUD)
  3. These future contracts will cost more in our local currency (AUD) when it is time to pay
  4. Our profit and cashflow is negatively affected by an unpredictable amount

Hedging stops this specific case from impacting our business costs.

With hedging, an importer's process instead becomes:
  1. Our customers pay in a local currency (AUD) and we anticipate future contracts that must be paid in a foreign currency (USD)
  2. We place a hedge with HedgeCheap, protecting our contract value in local currency (AUD) against Upward movement in the foreign currency (USD)
  3. The foreign currency (USD) increases in price against our local currency (AUD)
  4. These future contracts will cost more in our local currency (AUD) when it is time to pay
  5. HedgeCheap pays out any difference between the hedged exchange rate (the rate on the day the hedge was placed), and the exchange rate on the day that the hedge ends
  6. Our business profit and cashflow is unchanged, as although our contract costs more in local currency, HedgeCheap pays out this difference.

In this way, hedging creates predictability around your foreign currency costs.

For further details, see our full article: What Is Hedging?

Hedging strategies for Importers

Forcing your customer to pay in the foreign currency

This approach mitigates your currency risk by forcing your customers to pay in the same currency that your goods are purchased in. Generally, this isn't an acceptable outcome in many B2C sales situations, as consumers generally prefer to pay for goods in the currency that their earnings (salary) is paid in.

For some B2B sales transactions, this approach may be acceptable - banks and large financial institutions, or wholesalers that export to the country you're importing from are generally the most amenable to this approach. However, companies that will pay in foreign currencies usually attach a 'risk premium' to the price paid in an overseas currency, and will offer a discount if you are able to offer your product in AUD.

  • Advantages: Covers the risk to the full value of the contract.
  • Disadvantages: Generally not acceptable to the customer, except if the customer is a large company. Your costs additionally may be a blend of local and foreign currency, and you will be generally unable to split your invoice across both currencies.
  • Recommendation: Offer an alternative price in your local currency, with our upfront hedge cost built-in. This may also allow for a slight increase in your prices.

Paying your contracts upfront

This approach reduces your currency risk by paying your contracts in advance of their due date. This approach creates absolute certainty regarding the price paid in domestic currency for overseas goods, however this may be the most expensive of all approaches listed, due to some potential drawbacks:

  1. Risk of default by wholesaler - If your wholesaler defaults in the time between being paid and shipping your goods, you are likely able to reclaim only a small fraction of the amount payable. For a retailer operating on thin margins or with a business loan, this can be catastrophic. Using an escrow service to avoid this risk of default brings an additional set of risks and costs.
  2. Cashflow impact - For all but the most liquid companies, cashflow must be carefully managed. Unnecessarily locking your funds up for the period between contract signing and receiving the goods will ultimately reduce the net volume of stock that you are able to re-sell.
  3. Interest not received - Generally, funds left with a supplier will not accrue interest if paid in advance. A competitive interest rate on your funds for the period between signing and payment due date may in fact be sufficient to cover the upfront hedge cost with HedgeCheap.
  • Advantages: Covers the risk to the full value of the contract. No uncertainty.
  • Disadvantages: Increased risk of supplier default due to time between payment and goods received. Significant cashflow impact, especially for contracts with long lead times.  Hidden cost of interest not received on transferred cash.
  • Recommendation: This strategy generally has the greatest potential cost of any hedging approach, due to the risks described. We recommend that you change your approach - contact us and we can discuss your options.

Requiring supplier quotes in your domestic currency

This approach reduces your currency risk by requiring that your suppliers accept payment in your domestic currency. While this appears to be a secure approach, we generally find that:

  1. You will inevitably be charged more - Your supplier will have one price in the currency that their inputs are paid in, and another, higher, price for your contract, reflecting an additional cost that they may have to incur. We generally find that the additional cost can be in the realm of 5%, but is not separately identified.
  2. It limits your selection of suppliers - Only larger and more sophisticated suppliers are generally able to hedge their currency risks (HedgeCheap is working to change this).
  • Advantages: Covers the risk to the full value of the contract. No uncertainty. No visible cost impact.
  • Disadvantages: Currency risk is transferred to the supplier. The supplier is likely to demand a hidden risk premium for accepting payment in a currency foreign to them.
  • Recommendation: This strategy generally results in a hidden risk premium being added to your invoices. For importers who currently use this approach, ask your supplier for a seperate quote for the same goods in their domestic currency (or ask an alternative supplier, to create competitive pressure). Add this to the upfront hedging cost from HedgeCheap to determine the lowest cost option.

Locking in your rate with your bank or Forex provider

This approach reduces your currency risk by negotiating a contract with your bank or Forex provider. This can be a reasonable option in some cases, but it isn't without downsides:

  1. You need to be hedging millions - Generally the minimum sized transaction that a bank will hedge long-term is in the million dollar plus range. If any banks are prepared to hedge less than $1M AUD in a variable-period upfront hedge without taking an additional fee, let us know and we will retract this statement.
  2. Pricing is non-transparent - Give a couple of banks a call and ask them for a price sheet for foreign currency; it will inevitably be out of date by the time it's printed. When you do get a price, check it against ours - our margins are wafer thin, and we would love to know if you ever get a better deal.
  3. You are locked in to the one provider - Currency lock-in services are mostly provided as a compliment to a full-service forex transaction, and cannot be done in isolation. Generally, full-service means full-fee, including high spreads on foreign exchange. Check your costs and let us know.
  • Advantages: Covers the risk to the full value of the contract. No uncertainty.
  • Disadvantages: Higher fees. No transparency on price or forex rate. Usually unavailable for smaller companies. May require securitisation.
  • Recommendation: This strategy may be a good fit in some circumstances, however our fees are likely to be much cheaper, and you can use any foreign exchange provider to perform the money transfer when using our hedging service.

Purchasing a CFD (Contract for Difference) from a share broker

This approach negates your currency risk through the purchase of a Contract-For-Difference (CFD) with a share broker. CFDs on currency are used widely in banking to hedge risk at low cost, but are highly complex instruments, and come with some important caveats:

  1. You can experience significant losses - A CFD offers an extreme level of leverage when the position creates a return. But, when a CFD creates a loss for the user, the downside is significant. In hedging for importers, this is often acceptable, as CFD losses are offset with an appreciation of the domestic currency, reducing the future cost to import goods. However, if a contract should fall through, the importer may be liable for CFD losses without being able to realise the upside.
  2. You need to fund leverage - CFDs can function well, provided that the account holder is ready to fund the account with additional leverage at any time. If the CFD experiences rapid losses, a CFD broker may 'margin call' the account holder, and demand immediate funding to keep the position open. For small businesses, funding on demand is occasionally unavailable, and may result in the CFD being sold. Which leads us to:
  3. Position can be closed for any reason - Generally, a CFD provider has the right to close (sell) a user's position at any time, under any circumstances. This can occur during market volatility, after a risk assessment, or if the provider is experiencing a shortage of supply of the underlying commodity. The sale event may then result in:
  4. Spreads that are hidden and variable - CFD markets are not open markets, and are instead run by, and at the discretion of, the broker. This means that a broker is entitled to offer you ANY price it deems reasonable for your existing CFD contracts, meaning that the global price of currency can increase, but the sale price of the same currency on the particular CFD platform may not reflect the increase.
  5. Hidden fees - Despite the fact that a CFD is a digital product without any marginal cost, we have seen a multitude of fees charged by CFD providers, including: Currency conversion charges, overnight finance fees, credit card fees, stop loss charges, funding fees, platform fees, exchange fees, inactivity fees, and monthly charges to see pricing in real time.
  6. Complex to buy and manage - For the reasons listed above, trading CFDs require professional expertise and attention that is costly to hire.
  • Advantages: Covers the risk to the full value of the contract. Requires a smaller fee relative to upfront hedging in order to place the CFD.
  • Disadvantages: Potential for significant losses. Requirement to fund leverage quickly during a margin call. Position can be foreclosed for any reason. Variable spreads. Hidden fees. Highly complex.
  • Recommendation: If you have an expert team of finance professionals, unlimited liquidity, a high tolerance for financial loss, large purchase volumes that mitigate hidden fees, and can guarantee the completion of your wholesale purchase contracts, a CFD may result in lower long-term fees than hedging upfront with HedgeCheap.
  • However, if you are in this situation, do give us a call - we may be able to set you up with a bespoke hedging solution that results in total costs lower than the comparable set of CFDs.

Hedging upfront with HedgeCheap

Here at HedgeCheap, we believe that upfront hedging is genuinely the most straightforward and cost-efficient means by which a business can protect itself against currency risk. We have designed our service to directly address the dissatisfactions we, and our customers, have had with the above approaches. Our advantages include:

  1. Costs known in advance - The hedge cost displayed is the hedge cost. There are no other costs.
  2. No potential for losses - Once you have paid the hedge cost, the only possible outcomes are that you will be paid out $0, or an amount greater. There is no risk of loss.
  3. No hidden fees - We really do need to say it again. There are no hidden fees, costs, or charges.
  4. Hedging returns paid out within 1 week - The primary reason for this delay is ensuring that our compliance requirements (Anti-Money Laundering - AML, Know Your Customer - KYC) are met. For return customers, we can pay out our hedging returns faster, and we will soon be able to guarantee a shorter window.

Recommendation: Try hedging with us today!

Disclaimer: This article is meant to be general guidance only, and should not be taken as financial advice. Seek specific guidance from a qualified professional for your particular situation.

Dimitri Vasdekis

Founder - HedgeCheap
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