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How Mitigating Trade & Currency Risk
Can Foster Success in the Global
Economy Kathy Jiang
SVP-Int’l Trade Specialist
Oscar Arriaza
SVP-Int’l Foreign Exchange Specialist
April 23, 2014
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Agenda
Overview of Global Trade and Trends in Finance
Structure Favorable and Acceptable Payment Terms With Vendors
Expedite Export Payments While Mitigating Risks
Trade Finance Case Study Summary
Mitigate Currency Risk by Developing a Workable Foreign Exchange
Policy
Address the Hidden Risk of Transacting International Payables and
Receivables in US Dollars
Texas Exports Set New Record in 2013
Texas merchandise exports reached $279.7 billion, 5.7% increase, a record
high level for the state
U.S. goods and services reached $2.3 trillion, an all-time record, supporting
nearly 10 million American jobs
Texas top export markets: Mexico ($101 b); Canada ($25.9 b), Brazil ($10.8 b),
China ($10.7b), Netherlands ($9.6 b)
Texas key merchandise export categories:
Petroleum, computers, electronic products, chemicals, machinery and
transportation equipment
Overview of Global Trade and Trends in Finance
Free Trade Agreement
The US has free trade agreements with 20 countries, which account for $168.9
billion (60%) of Texas’ exports
During the past 10 years, exports from Texas to these markets grew by 130%,
with NAFTA, Colombia, CAFTA-DR, Chile and Korea showing the largest dollar
growth during this period
Overview of Global Trade and Trends in Finance
Total U.S. Imports via Texas in 2013
Texas merchandise imports reached $311.6 billion, down by 5.7%, representing
13.7% of share of the total US imports
U.S. goods and services reached $2.7 trillion, down by 0.1%
Texas top import markets: Mexico ($94.9 b); China ($42.8 b), Saudi Arabia
($22.6 b), Venezuela ($16.2 b), Canada($14.5 b), South Korea ($9.3 b)
Texas top dollar commodity & merchandize imports include:
Crude oil, cell phones, TV, digital processing units, wireless & data products,
parts & accessories for machines, etc.
Overview of Global Trade and Trends in Finance
Global & Regional Trends in Trade Finance
Trade Finance empowers the engine of global economic growth
Trade Finance deals mainly in short-term maturities; the security is held in the
underlying goods moved in the transaction
The center of gravity of world trade is shifting to Asia from Europe and ASEAN
Markets are the primary region for financing trade
The outlook for Africa’s trade is positive with a persistent demand for many of
the commodities Africa produces, coupled with rising imports of food, fuel and
consumer goods
The global trading system will be re-arranged in coming years
Source: ICC survey 2013
Overview of Global Trade and Trends in Finance
Global & Regional Trends in Trade Finance
The ICC Banking Commission’s 2013 survey reviews:
- Trade finance is more available, but the increase is marginal
- The alarming rise in fees for trade risk after the 2009 trade collapse has
abated
- A large gap remains in the market for trade finance and risk coverage
even while trade finance pricing is lower or unchanged
- KYC principles are seen as hampering the smooth flow of trade finance
- Basel III regulations affect the cost of funds and liquidity
Overview of Global Trade and Trends in Finance
Export Trade Finance Mix Import Trade finance Mix
Overview of Global Trade and Trends in Finance
AN ICC PRIVATE SECTOR DEVELOPMENT PERSPECTIVE
43%
5% 14%
17%
19%
2%
Figure 12: Export Trade Finance Mix
Commercial Letters of Credit
Standby Letters of Credit
Guarantees
Collections
Open Account
Other
39%
8% 16%
15%
18%
4% Commercial Letters of Credit
Standby Letters of Credit
Guarantees
Collections
Open Account
Other
Figure 13: Import Trade Finance Mix
Standby Letter of Credit
Standby
– Most often used as a default mechanism - other payment type used as primary payment method
– Uses:
o Financial (for payment default)
o Advance Payment Bonds
o Bid and Performance Bonds
o Insurance
o Real Estate
ICC Uniform Customs and Practices Publication - UCP 600
ISP 98
Commercial Letter of Credit
Commercial (Documentary) used as a
payment mechanism
Sight – Time/Usance – Deferred
---Uses:
– Primary mechanism for payment
– Import
– Export
– Domestic shipments
ICC Uniform Customs and Practices
Publication -UCP 600
Overview of Global Trade and Trends in Finance
Receivables
Lower borrowing
costs, shorten
Dales Sales
Outstanding
(DSO)
Improve “quality of
A/R earnings
Reduce payment
and FX risk
Broaden sales
market (revenue
growth)
Global Trade Cycle
Inventory
Improve asset turnover
and ROA
Maintain/expand
supplier base
Risk management
Supply chain strategy
Payables
Extend Days Payables
Outstanding (DPO)
Lower Cost of Goods
Sold (COGS), access
supplier’s discounts
Links with payment
technology & card
solutions
Working Capital Optimization
Overview of Global Trade and Trends in Finance
Structure Favorable & Acceptable Payment Terms with
Vendors
As the global recession continues to impact most markets, exporters and sellers
are aggressively competing for sales and market share placing buyers or
importers in a stronger negotiating position over trade and payment terms.
Dual quotes in USD vs. Foreign Currency
Advance Payment vs. Open Account
Down payment & progress payment
Commercial Letter of Credit vs. Standby Letter of Credit
Sight Draft vs. Time Draft
Delay the payment to minimize your risk and maximize your working capital.
Expedite Export Payments While Mitigating Risks
Letters of credit (LC) can discipline buyers and sellers to make a payment and
ship goods in a timely fashion
Confirming export letters of credit to shift a foreign bank risk to a US bank risk
Discounting drafts under letters of credit to expedite payments and liquidity while
reducing risk
Use of guarantees and standby letters of credit to save cash and protect against
default
Purchasing export credit insurance to cover foreign AR under open account
Depending on the size of the transaction and numbers of POs, one should apply
different payment methods. Trade financing cost is relatively higher in emergent
markets . US exporters can take advantage of low cost trade finance market
here to help foreign buyers and promote sales
14
How do I make payments to
my suppliers?
How can I manage my
working capital needs?
How do I manage my
currency risk?
How do I manage trade
disruption?
How do I streamline the
payment process?
How can I better track my
currency positions?
Access / Move Capital Manage Risk Improve Efficiency
Client: Import Co is a mid-size company that is planning to source its inventory from
China Situation:
Payments are made to Chinese suppliers
50% down and 50% upon BL
Orders are placed regularly
Trade cycle requires significant working capital
Goals:
Keep cost of goods as low as possible
Minimize risks
Streamline payments
Key Considerations
Trade Case Summary
Client: Import Co imports from multiple suppliers in China
Challenges: With the rising cost of labor and material, suppliers constantly
change the prices and the 50% down payment absorb too much working
capital
Concerns: Reliability of the new vendors . Receipt of damaged merchandise
Non receipt of required documents
1) Ask for a quotation in both USD or CNY
2) Issue a commercial LC for a large transaction or
for a new customer to mitigate risk
3) Extend payment term from sight to time draft
4) The bank will finance the time draft
Challenge
Solution
Benefits
Extend payment
term
Better negotiated
price
Help vendor obtain
low cost financing
2. LC or CNY Trade Payment
Beneficiary
Account.
3. Advising LC or
crediting CNY
Credit to Bene
Acct
Import
Co
U.S. China
1. USD Funding or LC request under the line of credit
Beneficiary
Bank
15
GOODS
Trade Case Summary
.
16
How do I receive payments
from my buyer?
How can I manage my
working capital needs?
How do I manage the
foreign risk?
How do I manage trade
disruption?
How do I streamline the
payment process?
How can I shorten DSO?
How can I accelerate
payments?
Access / Move Capital Manage Risk Improve Efficiency
Client: Export Co is a mid-size company that is planning to sell machines to India
Situation:
First time to sell to India
Progress payments per milestones
India buyer wants a 270 day payment term
Trade cycle requires significant working capital
Goals:
Secure the sales
Minimize risks
Streamline payments
Key Considerations
Trade Case Summary
Solutions & Benefits
The Export Co obtained working capital from its bank under Ex-Im Bank Working Capital
Program
The Export Co negotiated payment terms allowing a performance & warranty bond instead
of cash holdback by the buyer (releasing the working capital constrains)
The India buyer agrees to issue a commercial LC in favor of the seller allowing multiple
drawings and shipments (LC allows flexibility and disciplines all the parties for the
obligation)
The Export Co's bank confirms the LC and discount the time draft (mitigating the risk and
accelerated the payments)
The Export Co is able to sell to its Indian customer without worrying about their credit
worthiness, receive payments per schedule without delays, increase visibility of their cash
flow and accelerate the payments while shortening DSO
Trade Finance Case Study Summary
Mitigate Currency Risk by Developing a Workable
Foreign Exchange Policy
Consider for a moment the following statements:
International sales are down 10% and it’s not because of the abilities of
our A-Sales Team, or the demand and quality of our product
Foreign currency receivables have deteriorated by 12% and it’s not
because of bad debt expense
Our baseline US dollar payables to foreign vendors have increased by
2.63% Year-Over-Year!
-19-
3
Define
Corporate
Philosophy
4
Define Policies
and
Procedures
2
Identify
Strategies to
Manage
Risks
5
Monitor
Exposures
and
Execute Hedges
6
Review
and
Measure
Performance
Mitigate Currency Risk by Developing a
Workable Foreign Exchange Policy
1
Identify and
Quantify
Exposure
Time
Horizon
Risk
Type
“Ease” of
Risk
Management
Shorter
Longer
Easier
Difficult
Mitigate Currency Risk by Developing a
Workable Foreign Exchange Policy
20
Transaction Risk - Exposure arising from conversion of known and
expected foreign currency cash flows from international transactions (e.g.,
receivables, payables, loans, etc.)
- Does your company produce revenue in one currency and expense in
another currency, and will it do so in the future?
Translation Risk - Exposure arising from periodic revaluation of a
subsidiary’s net foreign revenues and expenses or assets and liabilities
into USD to create consolidated financial statements
- Although sales from a self-sustaining foreign operation are steady, the
parent company may be exposed to the translation of net income back
to USD
Strategic/Economic Risk - Changes in a company’s competitive position
arising from movements in exchange rates
- Can your company absorb a substantial move in exchange rates over
the long run such as those that take place when bidding on a foreign
project or acquisition?
21
Un-hedged - Spot
Speculative
Full flexibility to change notional amounts
100% participation in favorable moves
100% risk of unfavorable moves
Zero cost
Forward
Provides certainty but at the expense of opportunity
Full commitment to settle original notional
0% participation in favorable moves
0% risk of unfavorable moves
Vanilla Options
Maximum risk is
premium paid
upfront
No commitment to
settle at all
100% participation
in favorable moves
0% risk of
unfavorable moves
Cash outlay is
required
Option Structures
Potentially locked
into forward contract
Potential
commitment to
deliver
Restricted
participation in
favorable moves
0% risk of
unfavorable moves
Zero or little cash
premium required
Mitigate Currency Risk by Developing a
Workable Foreign Exchange Policy
The goal of a hedge program should not be to try to “beat the market”, but to provide a known outcome
Establish benchmark rates to guide you in applying a reasonable and manageable hedge program
There is no “right way” to manage FX risk; However, it should coincide with corporate philosophy
22
Corporate Philosophy Hedge Strategy Execution
“Our goal is to know exactly the USD value of our
foreign currency receivables. We are less concerned
about sacrificing upside potential if we can determine
the future USD equivalent today”
"There may be some uncertainty regarding the amount
and timing of our currency cash flow. We also would like
to retain upside potential and don't mind paying for it”
"We can tolerate some variance due to FX movements,
but we definitely want to protect against large adverse
movements. In addition, we would like to participate in
market upside, but are not willing to pay any premium
for hedge protection”
Lock in future rate with Forward Contract
Purchase the right to lock in a future rate with an Option Contract
Combine a Forward
with an Option
Contract
Mitigate Currency Risk by Developing a
Workable Foreign Exchange Policy
23
“Our baseline US dollar payables to foreign vendors have increased by
2.63% Year-Over-Year!”
“We don’t have any foreign exchange risk because we deal exclusively in
US dollars”
If you transact business outside the boundaries of the U.S. and deal in
U.S. dollars only, you are participating in the foreign exchange market
In any international transaction, foreign exchange risk exists
What business opportunities are lost by dealing exclusively in US dollars?
Address the Hidden Risk of Transacting International
Payables and Receivables in US Dollars
Address the Hidden Risk of Transacting International
Payables and Receivables in US Dollars
24
Situation Analysis:
US golf club manufacturer imports components from China for final product
assembly in Texas. A Chinese vendor provides a price list in US dollars good
for 90 days; terms are net 45 days
Prices have increased 2.63% Year-Over-Year directly impacting profit
margins
Tough competition in the US market makes it difficult to pass along price
increase to consumers
With a newly minted Foreign Exchange Policy in place, the US company can
inquire about obtaining component prices in both US dollars and Chinese
Renminbi
25
Address the Hidden Risk of Transacting International
Payables and Receivables in US Dollars Chinese Vendor- 2013 Sales Budget
13-Jan ¥ 28,000,000.00 6.2800 $ 4,458,598.73
Price Increase Progression
Quarter Receivables FX Rate USD Equivalent Actual FX Rate Short Fall in USD New USD Pricing
13-Mar ¥ 7,000,000.00 6.2800 $ 1,114,649.68 6.20680 $ (13,145.64) $ 1,127,795.32
13-Jun ¥ 7,000,000.00 6.2068 $ 1,127,795.32 6.13560 $ (13,087.40) $ 1,140,882.72
13-Sep ¥ 7,000,000.00 6.1356 $ 1,140,882.72 6.08650 $ (9,203.54) $ 1,150,086.26
13-Dec ¥ 7,000,000.00 6.0865 $ 1,150,086.26 6.05000 $ (6,938.54) $ 1,157,024.79
Total $ 28,000,000.00 $ 4,533,413.98 6.17636 $ (42,375.11) $ 4,575,789.09 2.63%
US Importer- 2013 Inventory Budget
13-Jan ¥ 28,000,000.00 6.2800 $ 4,458,598.73
Quarter Payables Forward USD Equivalent Actual FX Rate Savings from Hedging US dollar Pricing
13-Mar ¥ 7,000,000.00 6.2755 $ 1,115,448.97 6.20680 $ (12,346.35) $ 1,127,795.32
13-Jun ¥ 7,000,000.00 6.2805 $ 1,114,560.94 6.13560 $ (26,321.77) $ 1,140,882.72
13-Sep ¥ 7,000,000.00 6.2860 $ 1,113,585.75 6.08650 $ (36,500.51) $ 1,150,086.26
13-Dec ¥ 7,000,000.00 6.2900 $ 1,112,877.58 6.05000 $ (44,147.21) $ 1,157,024.79
Total $ 28,000,000.00 $ 4,456,473.24 $ (119,315.85) $ 4,575,789.09 2.63%
26
International Team
Guy Lamb SVP -
Manager, International
Services
Tulsa, OK
Kathy Jiang SVP
International Trade &
Treasury Specialist
Dallas
214-346-3938
Oscar Arriaza SVP
Foreign Exchange
Specialist
Dallas
214-346-3993
Mark Way SVP
Foreign Exchange
Specialist
Dallas
214-346-3999
27
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