Managing FX Risk in The Commodities Sector: Case Study

Companies in the commodities sector face constant FX exposure due to USD‑denominated trade flows and narrow operating margins. This case study explores how Marex supported a Toronto‑based commodities business with a tailored FX risk‑management strategy that protected margins while enabling upside participation.

Overview

Why FX matters in the commodities sector

With standardised product specifications and quantities, price becomes one of the primary drivers to be competitive for commodities businesses. 

Our client wanted to ensure they could manage all the variables in their organization to keep their margins razor sharp. 

Fine margins can bring heightened sensitivity to risk. So, it was our job to ensure their currency risk was nailed down. 

Client challenges and FX exposure

Preserving banking relationships

We didn’t disrupt their trading with the banks to do our job effectively. Instead, we sat alongside the banks but made sure the solution could be applied through all their counterparties – taking the opportunity to keep costs low across the board. 

Currency exposure profile

Like much of the commodity trading market, most of the business they did was in US dollars, which meant they bought and sold in USD, while their profits needed to be repatriated into Canadian dollars.  

There was some trading where they were buying in a currency other than dollars and selling in either US or Canadian dollars. This business attracted a slightly better margin, but with that better margin came FX market risk causing uncertainty.

Payment terms and timing risk 

Like most businesses, the contracts they wrote came with payment terms, both from the purchase of the commodity and the sale. This meant that they had an ‘end to end’ transaction time of anything from two weeks to six months, with this often being caused by delays like cargo being held up for a number of reasons. 

FX Strategy and proposed solution

Forward contracts for USD-denominated trades

With the USD to USD business, protecting their expected profit in their functional currency was pretty straight forward. 

They knew what their ‘profit per lot’ or ‘profit per ton’ was going to be and when they were likely to have settled the transaction. 

This meant that we could simply book a forward contract on a per transaction basis for them. 

We’d build in a one-week settlement window, which gave settlement flexibility at a negligible cost. But if the timelines shifted more dramatically, we could move the contract further for them, with no cashflow implications and minimal impact on their profitability. 

The higher margin business brought with it more risk, but also a little more opportunity. 

Structured FX for higher-margin cross-currency trades

By using a portion of this margin towards a structured FX solution they were able to lock in a known worst-case exchange rate but take advantage of favorable market movements in the time between agreeing the deal and settling the cashflows. 

By being fully protected to the downside, but participating in the upside, they were able to accrue incremental gains to their margins. This meant fewer sleepless nights worrying about where the FX market was going.

Hybrid execution with existing banks 

Keeping the banks in the mix was a key requirement for our client and they did this through a combination of giving them the hedges from the ‘same currency business’ as well as in certain instances where there was a cross currency deal, but the market conditions weren’t right for a structured solution. 

Implementation and delivery

With a small finance team based in one location, getting going was easy. We started by benchmarking the trades with their banks, to get their pricing standardised. This gave them transparency and peace of mind that their panel of providers, including ourselves, were on a level playing field. 

Once this was taken care of, we were able to show our strategic expertise and we began trading some simple outperformance structured solutions. 

We benchmarked their outcomes versus an equivalent forward, being clear that it wasn’t about beating the forward every time, but by realising a cumulative gain over time. 

Now the team knew who they were speaking to for what type of transaction and took comfort in us being able to step in if things got complex. 

Results and outcomes

The goal was to optimise on part of a transaction process, and we succeeded. We also delivered incremental gains to our client’s bottom line along the way. 

‘One size’ wasn’t going to fit all in this case, but by breaking their business down into the various transaction shapes we were able to provide a tailored solution for each one. 

With fine margins being robustly protected, along with opportunities for enhanced margins with favorable market movements, the business continued to increase its transaction volumes and maintain its profit margin in functional currency.