Businesses in the fresh produce industry are under increasing pressures to improve their international competitiveness, raise profits and keep costs under control. Traditionally most of the cost-saving efforts have been directed at production, transport and distribution.
However, many UK-based companies are now operating internationally and therefore are exposed to foreign exchange (FX) markets. Recent swings in the currency markets suggest an increasing need to manage cashflows wisely, as well as keeping costs associated with FX risk under control. (See Figure 1)
Foreign currency management may not be the most obvious area of business to focus on when looking to improve company performance, but it certainly is one that can result in significant cost-savings when controlling cashflows for any business. With FX on-line trading tools now available to businesses, it is sensible to manage FX exposure and secure future payments against unfavourable movements in exchange rates.
The principle of FX risk management is to minimise adverse affects of market swings and to control financial consequences before they occur. In the case of a UK grower selling produce into the domestic market, there is no FX risk since both costs and revenue are transacted in sterling.
However, a UK-based importer buying overseas-grown produce in a foreign currency, and then selling into the local economy, is exposed to the risk of currency fluctuations. To demonstrate this, let’s look at a hypothetical scenario. In July 2003, a UK-based importer agrees to buy 1,000 tonnes of produce, at $40 a tonne from a South American grower, for delivery and payment in January 2004. The cost of this transaction to the importer is $40,000. (Assume in July 2003 the spot rate for GBP/USD is $1.50 and the forward rate is $2.00).
As there are seven months between the order and delivery date, the importer is exposed to movement in the GBP/USD rate, despite the fixed-price agreement. This is known as transaction exposure and is the risk a company incurs due to constantly changing exchange rates. The importer is obliged to pay the grower in USD and can employ several strategies to manage the currency and timing mismatch.
One option is to convert GBP into USD at the time the order is placed in July 2003. This involves buying spot USD - at the exchange rate quoted on that day. In this example, the spot transaction would be $40,000/1.50 = £26,500. The $40,000 is deposited into a USD-denominated account, earning seven months of interest at US interest rates. However, there is an opportunity cost involved if UK interest rates are higher than US rates, and £26,500 is not earning UK interest for seven months. Interest rate differentials between the economies should also be taken into consideration.
Since the exchange rate in this example favours the UK importer, this FX strategy may not be financially the best solution. Alternatively, the importer can enter into a forward FX contract, converting the $40,000 using a seven-month forward GBP/USD rate. A forward contract locks-in the price at which a company buys or sells a currency at a future date, for a specified quantity. It is based on the forward rate, which is the current market expectation of the FX rate in seven months time.
In this example, using the forward rate, the transaction would be$40,000/2.00=£20,000. The payment to the grower is secure and the importer has hedged the FX risk over the next seven months. At physical delivery in January 2004, the GBP/USD spot rate was approximately $1.90. If the importer transacted in the Jan04 spot market, the cost of the overseas shipment would be $40,000/1.90 =£21,000. In today’s currency climate, FX rates have moved favourably for the importer. However, if the January 2004 GBP/USD spot rate had been $1.70, then transacting in the spot market would have resulted in the shipment costing $40,000/1.70=£23,530 and they would have been £3,530 worse off.
When dealing with multiple currencies and transactions during a season, a company’s FX portfolio needs to be constantly administered, and exchange rate movements monitored. It is estimated that a high proportion of fresh produce businesses are executing FX trades over the phone, and the use of this traditional method is neither time-efficient nor cost-saving. But the sector is now adopting internet-based solutions that offer competitive buy/sell rates and allow fresh produce companies to save time and money.
UK importer Griffin & Brand (G&B) is a specialist supplier of grapes, stone and soft fruit, importing mainly from North and South America. The company has recently begun using the internet for FX dealing. Company secretary, Jesus Insua-Naya, says: “We’ve been using ANZ bank’s FXOnline portal for over six months. Previously, we dealt with one bank for our currency trades, and dealing with different employees often meant rates having to wait to be called back with. With the online system, transacting in FX is quicker, simpler and has given us greater flexibility. The online portal not only provides us with valuable market information but allows us to deal 24/7 at the time and price we want.”
The majority of shipment payments for G&B’s physical business are quoted in $ and e, while their sales are in sterling. Depending on the season, the company my be dealing in the FX markets on a weekly or fortnightly basis, netting off their currency positions and hedging their exposure. Given the weak USD, G&B is currently transacting in the spot market but normally pre-empts future currency movements. “Typically our payment window is 14-21 days for most buyers and sellers, but in some cases it can be longer. We are never exposed for any length of time.”
Prior to using FXOnline, the company dealt with its main bank for exchange rate quotes. “This was time consuming as we didn’t have one point of contact, it meant us waiting to execute the trade and also for the deal confirmation,” he explains. “Today, we continue to do our daily banking with our original bank but now also transact FX through the ANZ online system. It’s an advantage having access to real-time FX data that’s not delayed, and it’s counter-productive to ring around for several quotes.”
The main system users are the commercial directors who find having daily access to market information has improved their levels of communication. “Previously, our FX management tended to be reactive to changes in the markets. Now we are proactive and the commercial directors execute the FX transactions online. We still compare the online rates with other banks but we find the ANZ prices to be competitive.”
The online system was easy to integrate into G&B’s existing network and was customised to suit the company’s needs. The commercial team regularly speaks to their ANZ FX specialist, Andrew Freedman about the currency markets. Insua-Naya says: “Andrew is pro-active by flagging news and issues regarding the dollar and euro. He provides us with professional market commentary and it is great to have one contact at the bank who knows their business.”
ANZ Investment Bank is an established market participant in global foreign exchange. It is one of the four largest Australian banks and has had a presence in London’s financial markets for 40 years. Freedman believes that many UK-based fresh produce companies may not be getting value if they are using the telephone to make foreign exchange transactions, since these traditional dealing relationships can be costly to maintain.
“This ‘old fashioned’ way of dealing can take up an unnecessary amount of time and businesses may be incurring significant transaction costs that can be reflected in the price,” explains Freedman.
Smaller businesses can often pay substantial margins when only telephone-trading and may be limited to carrying out FX transactions during normal banking hours, despite FX being a 24-hour market. Using an online FX dealing portal, commercial managers can execute the same transactions quicker and at competitive prices. Deal confirmations are also received instantly, unlike traditional phone trading, where there is a delay before printed confirmation of the FX transaction is received by fax or post.
The ANZ portal also incorporates training material which is ideal for educational purposes, though Freedman advises that the platform “does not offer financial advice, but rather provides sound market information and live pricing that assists commercial managers with hedging their FX risk”.
In addition, online trading does not exclude treasury managers from speaking to an FX trader if required. As an ANZ customer, G&B has access to the currency traders in the London dealing rooms as back up, if the system was to fail. Looking to the future, the take up of internet-based foreign exchange will grow as more companies see the benefits and begin to transact in spot and forward markets across 27 currencies and even adopting more sophisticated financial products, such as swaps or options, as part of their treasury management.
All industries that trade across borders need to guard against fluctuating exchange rates and many don’t even realise they are exposed to foreign exchange risk. Furthermore, international price competition threatening the UK fresh produce sector reinforces the need for importers and growers alike to be smart about managing daily operations and overall cashflows, including foreign currency risk. The currency market is the last of the major asset classes to move to electronic-based trading and the introduction of online FX vehicles will facilitate fresh produce companies to hedge their foreign currency positions.
COPEFRUIT WELL-INFORMED
How does an international exporter manage its foreign currency?
The Cooperativa Agrícola y Frutícola de Curicó Ltda., Copefrut S.A., is a major Chilean fruit producer and exporter. It specialises in exporting apples, pears, kiwis, stone fruits, cherries and grapes to Europe, the US, Latin and Central America, the Middle and Far East. Europe accounts for 50 per cent of its exports and during the season all euro and sterling received is held in either a euro or pound-denominated account with their European bankers, Rabobank in the Netherlands. With dollar-based transactions, funds received are held in an account with the Bank of Chile, New York, which represents Copefrut’s business needs for exports into non-European markets.
A third of the group’s total revenues for a season are received in euro or pounds, while all financial reporting is quoted in Chilean peso as the company is listed on the Santiago Exchange. Copefrut’s treasury managers normally exchange its foreign payments when peso-based obligations need to be met. Occasionally, euro, dollars or pounds are converted if the exchange rates are favourable and the funds are invested in the short-term money-market instruments with the Central Bank of Chile. These money-market positions are reviewed on a weekly basis to match its weekly cash-balance needs.
When looking to transact in the currency markets, the commercial team will telephone or email various local and foreign banks for the best rates. Ximena Munizaga, finance and external affairs director, explains: “To ensure we are well informed for our decision making, we subscribe to a currency market website, which supplies us with relevant FX market information. If the rate parity is very different between the local and foreign banks, we do have a local euro account in case we need liquidity immediately. We perform end-of-day checks of all our current accounts and banking transfers. Not all the foreign exchange balances are sold or invested, as a considerable part are used to pay the group’s dollar and euro commitments.”
KHAS ISSUES ADVICE
Ali Khas, director of AK Fresh Limited, has been advising companies in the fresh produce sector for over two decades. His view on currency management is that companies exposed to FX risk, importers and exporters, should adopt different foreign currency strategies depending on market conditions. Khas explains: “Companies in this sector tend to protect the customer and this is why contract buying is popular - customers want a stable price for the season so importers and growers are committed to that currency.
“Several months ago foreign exporters were selling with a stronger USD, but now the pound has strengthened. Two years ago it was the reverse. For the coming year, I advise suppliers to not lock-in 100 per cent of their production/sales into fixed-price contracts but to diversify; have 50 per cent contracted and 50 per cent trade from week to week in order to gain from favourable currency movements. Half of my corporate clients manage their FX exposures weekly and this way can profit from the weakening USD.”
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