Leveraging Forward Contracts to Boost Commercial Services
As the highest rated overall for banking services, and with an expanding list of offerings in wealth management, mortgages and insurance, the appeal of credit unions is growing at a stronger pace than ever.
While the momentum is great, I have observed one gap in the business services of my credit union partners when it comes to foreign exchange transactions, and that's in their failure to leverage a tool that is more sophisticated than your average international wire transaction; I’m talking about forward contracts.
It might seem like a trivial place to look for opportunities in growing your business, but by educating your members on forwards, your advisers may be better perceived as risk management experts who can then support your members to achieve greater success in their budgeting and forecasting.
Most of the credit unions that I work with are simply more accustomed to providing their commercial members with the typical day-to-day services; that's their comfort zone. This ad hoc approach is what credit unions turn to for their FX dealings, opting to recommend only the most standardized solution–the international wire in foreign currency–as their main offering, often due purely to a lack of knowledge about other instruments.
Spot trades are useful for carrying out an “on the spot” trade, which locks in the live market rate. If your member is a product dealer making a quick shipment to a new customer across the border in Canada, this would be their best choice. Whichever exposure that member might warrant in their conversion from USD to CAD will be removed from the equation.
However, what if you know that same member has a queue of shipments to their regular customers in the same region for the next two quarters? They may want to lock in their costs now versus taking a risk that the exchange rate may move out of their favor. An example is the extreme drop by the Canadian dollar we’ve seen in recent months which could slice a chunk from that company's revenue. This is where utilizing forward contracts becomes a valuable strategy.
There is a stigma attached to forwards as being a complex instrument used for the most part by large multinationals, but they’re actually quite simple to execute and play a very practical role in cash flow management for the average business, big or small. Their simplicity remains in the fact that, much like a spot, they have only one settlement date.
The difference is that the settlement date is based on a time within the future, and the rate, which is negotiated once the contract is booked, remains locked in. If it's purely a closed forward contract, the member must take delivery of funds at the time of the expiry date, which is typically six months down the road from the time the contract is made.
As your member, the business owner, prepares to fulfill a mass of orders north of the border for Q4, that member will know exactly how much they’re paying against the exchange rate, not later on when market conditions may have shifted unfavorably. Despite how they are perceived, forwards are also quite flexible, with various options for settlement based on the payment schedule of a company.
For example, depending on the type of contract, a user may choose to pay prior to the settlement date through pre-delivery, or within a delivery window period, such as in the case of open forwards, the window of time usually falling within a range of dates over three months. This ensures that the company can pay when it has cash available.
The budgeting process becomes even more complex when you consider other parts of a company's operations that might spread across multiple borders and deal in an assortment of currencies, requiring more advanced tools, and even perhaps, a risk management policy.
At the basic level, the beauty of forwards is that while they are more advanced than their counterparts, they are straightforward to execute and help you achieve greater potential for future revenue by securing the long-term activity of your member. This may lead to further opportunities as you become a trusted resource to your member's operations.
Mike Rockouski is SVP for financial institutions at Cambridge Mercantile Group in Denver. He can be reached at (303) 471-1161 or firstname.lastname@example.org.