Mitigating currency risk in International Trade

The average daily trading volume of global foreign exchange has surged to approximately $7trillion and is by far the biggest market in the world.


If you are involved in any aspect of international business, be it freight, international trade, insurance, warehousing and/or Customs clearance, you are exposed to currency fluctuation.


Many people in the supply chain feel that currency and exchange rates are a topic only for bankers and their finance department to give consideration to, and many businesses are exposed to currency risk without evening realizing it.  With recent wild swings in global currencies, exchange rate risk is very real and many companies should give serious consideration to mitigating their foreign exchange losses.


So how big is the problem managing currency risk?  Managing currency risk can bring benefits to your business by protecting your cash flow and profit margins.  South African exporters benefited during the Covid-19 pandemic through the depreciation of the South African Rand against other major currencies.  When converting global currencies such as the US Dollar into ZAR, these companies made unexpected additional profits as a result.


The South African Reserve Bank allows South African exporters to hold foreign currency accounts in South Africa. This provides benefits such as paying for imports and/or freight from a Corporate Cash Management (CCM) account or Client Foreign Currency (CFC) account which eliminates hedging of ZAR to USD. However, this benefit is only extended to exporters and often due to cash flow issues, many South African exporters have to convert their foreign exchange earnings immediately upon receipt.


Steps to managing your business’s currency risk.

Understanding where and how currency fluctuations affect a company’s cash flow is not as straightforward as it may seem.  Many different factors influence exchange rates - from the political aspect of the US’s elections to the economic issues relating to BREXIT, and macroeconomic trends, are only some of the factors that influence currency rates.


Understand your operating cycle

Understanding your business operating cycle is essential to understand where the Forex risk exists. Freight payments, imports, export earnings and possibly the payment of taxes in foreign countries should all be taken into account.  Additionally, the payment terms offered to international clients and the cost of banking should also be considered.


Managing your exposure to currency risk

This should include the risk exposure before a deal, purchase or transactions are agreed upon and the actual risk that exists after the deal is completed.  Therefore, you would need to have an understanding of pre- and post-shipment transaction risk and the level of risk to which you are exposing your company.  Transaction risk is the simplest currency risk to measure and manage.  These occur because of timing difference between contractual commitment and actual receipt of funds.  Transaction risk can be hedged with financial instruments including currency futures, swaps contracts and/or options. 


Hedging means that you use financial instruments, such as currency or FX forward cover, to lock in the currency rate so that it remains the same over a specified period of time. 

Spot Cover refers to foreign exchange transactions where one currency is bought or sold against payment in another currency, as a specified rate, with settlement taking place two business days later.  The two-day settlement process, commonly referred to as “spot”, is an international practice and due to differences in time zones and the time required by banks to ensure that settlement occurs correctly.


Same-day and next-day value deals, where urgent currency payments or receipts need to be processed, one-day value or even same-day value exchange rates may be provided, depending on the currency cut-off times (typically 11am for same day transactions).


FECs (Foreign Exchange Contracts) are used to hedge exposures to exchange rate fluctuations by “locking in”, future foreign exchange rates.  FECs are contractual agreements between the bank and its clients to exchange a specified amount of one foreign currency for another at a predetermined exchange rate on a specified future date.  There are various types of FECs that can be used depending on the client’s requirements.

  • A fixed FEC can be used only on a specified maturity date
  • A partly optional FEC can be used within a prespecified period between two future dates
  • A fully optional FEC can be used at any time between the date of establishing the FEC and the specified maturity date.


Swaps – A swap is the simultaneous purchase and sale of identical amounts of one foreign currency for another, but on two different value dates, either spot against a forward date, or one forward date against another forward date.

Early receipt (or pre-take up) - swaps are used to bring forward the maturity date of an existing FEC.

Extension (or rollover) swaps are used to extend the maturity date of an existing FEC to a later date.

Long-dated forwards, these are FECs with a maturity date longer than 12 months forward.


Currency derivatives, these can also be used to hedge exposure to exchange rate fluctuations but are fundamentally different from FECs.  Whereas the parties to a FEC are locked into a future transaction in a forward contract, the buyer of an option contract has the right, but not the obligation to buyer or sell a fixed amount of currency as a fixed exchange rate on a predetermined date in the future.


The option holder (buyer) can therefore choose the better exchange rate – either the prevailing rate in the market at the time, or the price specified in the option contract.  There are two main types of option contracts, namely call options and put options, and these can be used in various combinations to provide structured solutions to meet a client’s hedging requirements.  While currency derivatives provide greater flexibility as a hedging instrument, they also have a cost in the form of a premium that is payable at the time of purchasing the option contract.

With a call option the buyer has the right, but not the obligation to buy the underlying currency at a fixed exchange rate on a predetermined future date.


Currency futures, or a CFs contract is an agreement that gives the buyer the right to buy and sell an underlying currency at a fixed exchange rate at a specified date in the future.  One party to the agreement agrees to buy the CF contract at a specified exchange rate and the other agrees to sell it at the expiry date.  The underlying instrument of a CFs contract is the rate of exchange between one unit of foreign currency and the South African rand.  Contracts are cash settled in ZAR and no physical delivery of the foreign currency takes place. CF contracts are traded on the South African JSE and have margin requirements that the client must provide.



The impact of foreign exchange risk will influence the preferred sources of funding for a South African company trading in Global markets. When the performance of the company is negatively affected by consumer behaviour and the ability of the organisation to reprice its goods in a volatile forex market, it is worthwhile to determine whether the company has economic foreign exchange risk which is embedded in its service and goods.


Contributed by Linda Bird-Duxbury, Director at Leading Edge - a specialist company assisting in mitigating foreign exchange rate risk –