Managing FX Risk with the Provision of Credit: Case Study

Managing FX risk effectively can have wider implications for cash flow and working capital. This case study explores how Marex supported a growing business in protecting margins while preserving liquidity through the provision of a tailored credit facility.

 

Overview

This was less a study of how to solve the FX market, but instead, how effectively managing the FX market might have wider implications for a business and how we worked with the client to solve them.

Our client imported finished products from Europe, the US and Israel. As all of their product cost base was in foreign currency, they were particularly sensitive to market moves and these moves risked impacting their profit margin.

They wanted to protect their margins by using forward contracts but, as a high growth business, were concerned about how their cashflow might be impacted by having to place initial margin and variation margin to support these contracts.

 

FX strategy and proposed solution

Forward contracts on a per-invoice basis

Our client had order lead times of eight to sixteen weeks and payment terms that ranged from pro-forma to 60-days after receipt. This meant that they had a requirement to pay their invoices between one and 180 days from placing their order.

As they had specific invoices and therefore known costs, we suggested they enter a forward contract on a ‘per invoice’ basis, meaning taking out a contract to lock in the exchange rate.

This meant that they knew their exact cost in pounds for each invoice they received, which meant as long as they sold their goods at the price they expected, their margin was protected.

When the invoice was due, the forward contract matured. Our client then sent us the pounds and we paid their supplier directly, in foreign currency.

Understanding margin requirements

Usually, when you book a forward contract, you pay a deposit of between three and ten percent of the total value of the contract. 

Every contract that we entered into with a client, we take an equal and opposite position with one of our counterparties. We take the deposit so that if for any reason you are unable to settle the contract, we were able to close it and settle any loss that occurred.

This is known as placing initial margin – and the money deposited is used towards the final balance payable when the contract settles. 

If there are material market moves and the forward contract moves ‘out of the money’ then we might request a top up of the margin, because if you are unable, or decided not to settle, the loss on closing the contract with our counterparty might be more than the money you have placed with us.

This is known as variation margin and is also used towards the final balance payable.

Credit facility to remove margin requirements

To eliminate the need for initial margin and reduce the likelihood of calling for variation margin, in this example, we gave the client a credit facility.

This meant they didn’t pay any initial margin when they took out a contract and would only have paid variation margin if the market moved considerably.

 

Implementation and delivery

Before we offered the credit line, we conducted due diligence with credit checks and a review of their latest financial statements.

 

Results and outcomes

Having the bulk of your costs in foreign currency gives a greater degree of sensitivity to the FX market than businesses where only a couple of components are sourced in countries and currencies different to your own.

Getting a handle on this risk is important and making sure that any solution proposed doesn’t have any unintended consequences, such as tying up valuable working capital, is a must.

By offering a credit facility to our client we achieved both. They had no risk of the markets moving adversely and a greatly reduced risk of tying up working capital in achieving this.