In this episode of Good Money Guide TV we talk to Mark Phipps from Linear International Payments and discuss:
- What is a currency broker and why should you use one compared to a bank?
- What is the best way to compare exchange rates?
- What are currency forwards and how can they be used?
- Why is it so important for businesses to manage currency exposure?
- Top three tips for preparing for a large currency conversion?
- What to look for in a currency broker?
- What are the biggest mistakes people make when dealing in large currency conversions and international transfers?
Below is the transcription of the interview in the video where we discuss the benefits and risks of using a currency broker instead of your bank.
Tell us a little bit about what a currency broker is, and why either a business customer or a private individual should use a currency broker instead of just using the high street bank?
So just to keep it as simple as possible, a currency broker offers an alternative to what a bank would do in terms of the actual foreign currency conversion process. Companies like Linear International Payments came around because banks give notoriously poor rates of exchange, particularly to private clients and sort of mid-size UK corporates.
So what we enable those clients to do is to achieve a much more competitive rate of exchange, but also really offer them a much more personalised service to help them throughout the whole currency purchase process, not only with the exchange rate but also to help them out with timings of execution and strategies when they’re buying, which can really add sort of a significant amount to their bottom line come year-end, if we help them with that process.
The high street banks tend to have quite high margins when it comes to foreign exchange, but there’s a new breed of online-only FinTech money transfer firms that have very tight pricing. How would you say a currency broker is more appropriate for some customers over the new online-only platforms?
There’s pros and cons. If you’re an individual who might be doing a small one-off payment of 10,000 or spending a couple of thousand on a monthly basis, the online platform, which is just online, is good for that kind of stuff because you don’t really need to talk to someone to talk you through the process or talk to you about the pricing.
So it works in that sense. But if you’re doing a larger trade or if you’re selling a property in the UK and moving overseas, you might want that personal interaction of someone to talk to you and to talk you through the process, where the prices have been and what we might have coming up over the next couple of weeks that might affect the price.
So in terms of order types and transaction execution, obviously a currency broker’s more flexible. You offer obviously market raise limits, stop limits, and stop entries. Can you just talk us through what those specific order types are?
So a limit order can be very good in terms of a client looking to achieve a better rate of exchange. What a client can do is, if you look at say, to keep it simple, sterling-euro rate of exchange, over the course of a day, it can move between two prices, and it tends to bounce between those two levels.
So what’s always good is to try and catch it at one of the highest prices of that day. So what a limit order can actually do is you can place an order in the market towards the top end of that range, and it’s what we call a GTC order, so it’s good till cancelled; it stays in the market for 24 hours, seven days a week, so it covers the overnight market as well. And as soon as that level’s actually achieved, it automatically buys for you.
So it’s actually a firm order placed in the market at that pre-stipulated level. If the price hits it for more than a second, it automatically buys it for you. So that’s on the top side.
You’ve touched on there is a stop loss order, which is the reciprocal of that, which you can place on the bottom side of the market. So essentially what you can do is if you’re an individual who’s sold a property in the UK, looking to purchase overseas, then you can place a limit order in the market, above where the market’s at, and if there was some concern about sterling depreciating and the price collapsing, then what you can actually do is place an order above the market and below, and what that basically does is it ring fences the market for you, so if sterling was to depreciate aggressively further, you’ve got the stop loss there, safety net, but if the price does go higher, then it automatically fills it for you. So essentially, what you’re doing is preventing too much downside risk, giving you a chance of some upside potential as well.
Moving onto exchange rates. As with any comparison site, we compare brokers, and one of the things we do compare is price. So for an individual or a business shopping around for the best exchange rate, how would you say a customer should compare exchange rates from various currency brokers? Should you just go around and get a load of quotes from someone or are there any specific questions you should ask?
Well I mean first of all, to go right back to basics, just to understand sort of how foreign exchange brokers actually make their money out of conversion. So what we have is we have an interbank market where the exchange rates trade at freely, and then what you have is you have a buy and a sell price on either side of that. If you’re buying euros, you’d be quoting off the buy side. If you’re selling euros, you’d be quoting off the sell side. And then essentially, from that price, the bank or broker will then put a spread, so to speak, on top of that to actually execute the trade on their behalf. Notoriously, banks these days can quote anything up to three or four per cent. Brokers these days and essentially people like ourselves as well are bringing those prices right in and trying to quote it as transparently as possible from where the interbank market’s trading at.
Can you just talk us briefly through what a currency forward is and how they can be used for businesses to manage their foreign exchange exposure, and also, say for an individual who’s got a large foreign purchase, maybe a villa coming up in, you know, six months to a year; how can business and private clients use currency forwards to help hedge that exposure?
Yeah, quite straightforward. I mean we use currency forwards all the time, and particularly with your second example there, on the property purchase side of it, and on the business side as well. So what the client would basically do is they were perhaps selling a property in the UK to purchase that property overseas and they were quite late in the property sale process, and the exchange rate was at a good level, or perhaps they were concerned about sterling depreciating any further and the price getting worse and the property sale that they were buying essentially getting higher, what they can actually do is they can lock in the exchange rate today, so to speak, by placing a five per cent notional amount against the forward contract. That price is then secured for them for the duration of the contract. The contract could be anything up to a year, so basically, what we’d do is we’d lock the price today, just say for instance if the property sale was going through and they think they would have the money within, say, two months’ time, we lock the exchange rate in for them, we essentially pre-buy those euros on their behalf, and then they would pay use the five per cent deposit, and they would pay use the remaining 95 per cent on the maturity date, so when they actually got the funds through. So even though they might not have all the funds in place, those kind of tools will enable them to take advantage of the exchange rates, without actually having the funds in place.
So they’re protected, so that foreign currency’s not going to them cost them any more.
Exactly. So for that duration of the contract, irrelative of what happens to the exchange rate, if it drops by five per cent, it doesn’t matter because we’ve already pre-bought it and it’s secured and locked in for them.
And what about businesses; why is it so important for businesses to effectively manage their foreign exchange exposure?
I mean these businesses will be working on profit margins. You know, we deal with a lot of fruit importers, travel companies. Travel companies specifically, you know, very tight margins, as well as the fruit sector as well. So when they’re pricing up their products, they will have a profit margin locked in. What they don’t want to do is the exchange rates to move over the duration of the year and their profit margin to depreciate, or worse than that, when the prices move aggressively and they haven’t locked in, they might have to reprice to their customers, which is not a scenario they want to be in. So by doing a forward contract, what they can do is, if the exchange rate’s at a good level, they’ve got a good profit margin locked in, then they can actually keep that profit margin for the duration of the year by booking out a forward contract and just making it secure and making the profits of the company solid and guaranteed.
Are there any downsides to using currency forwards and hedging tools?
The downside with the forward or hedging tool is if obviously the market doesn’t go your way. If you did a forward contract for a period of time and then the market didn’t move the way you thought it would move. So if you bought euros forward and then the price carried on moving higher over the duration of the contract, obviously that wouldn’t work out well, which is why one of the best strategies we tend to use with a client is if they do a 50 per cent hedge, just for an example, if they did a 50 per cent hedge out one year, when they come to actually making the payment on a monthly basis, if the spot market was higher than where their forward price was at, you simply buy spot to increase your average, but if the price was lower, then you can actually draw down off your forward contract. So what you’ve got is you’ve got the cover in place, but come the end of the year, you should end up with a much better blended level, but still enabling you to increase your average.
For someone who has some upcoming large currency exposure, what advice would you give them, even before they’re considering executing the transaction? What’s your top three tips that someone should do, whilst doing their research and due diligence for an upcoming large transaction?
I get so many private individuals that come onto me kind of last minute, when the property purchase has been completed, funds are in their account, price is at a good level, and they want to get everything set up within a couple of hours. Which is doable but it’s quite stressful for them and for us at the same time. So one of the key ones would be to get everything in place ready, to make sure that you’ve got your foreign exchange account open with a provider, to make sure that you’ve got all the necessary documentation in place. Because of anti-money-laundering regulations in the UK, we have to source the funds on anything over 10,000, so I’d make sure you’ve got all that documentation in place. If you’re selling a property in the UK, it would quite often be that you need to show the property sale contract, normally with a signature on it. So I’d just make sure that all that paperwork’s in place, the account’s set up and ready to go, just to avoid any panic. And then if the price is at a good level, you’re in a position to take advantage of it.
I would also make sure… one of the things that quite often clients do is, if they sell a property and they’re buying overseas, they might be abroad, and when they actually come to do the conversion, they can’t move the large amount of funds suddenly. So they could be in Australia, they could be in the States or anywhere in Europe, and suddenly they need to move the money to complete the transfer, but their bank won’t let them do it. So I’d say just to try and speak to your bank before you go, perhaps notify them you might be making those currency transfers, and quite often, the maximise amount you can do on an online payment is sometimes 10K, but you can get those limits upped, but it’s something that’s always a little bit more difficult to do when you’re abroad.
So I’d say, you know, planning is key, making sure that you’ve got all the necessary paperwork in place, and making sure you’ve got a broker essentially that you can rely on, you know, by getting an understanding of where your kind of spread will be at before you execute it, and just, as I say, getting all the paperwork in line because it’s crucial.
What should they look for in terms of regulation, capital, stability, protection of funds and so on, what are those sort of key things, because nowadays, you know, there’s currency brokers setting up every day. What are the sort of top three things people should look for?
Yeah, you want the company should be be FCA regulated. You want to look at where your funds will be being sent into. Essentially, you want to make sure that they are financially stable. Obviously, if you’re sending in large amounts from property sales and stuff, you want to make sure that the funds are going into a good home, where the funds are going to be safe.
Because one of the things is that currency brokers, you know, you aren’t covered by the FSCS compensation scheme.
No, that’s correct. So it’s about that peace of mind. I mean most times now, when funds are coming into a broker, they’ll be held in a ring-fenced client trust account. It’s segregated essentially, so it doesn’t form part of the balance sheet, but you know, you want to make sure it’s going into a good, reputable company.
Still something to be mindful of.
It’s all good having a good exchange rate, but security’s obviously the most important thing as well.
Very quickly, top three mistakes people always make that you’ve come across when dealing in foreign exchange?
Focusing on the spread rather than the time they’re executing is always a big one. Going with a provider that they perhaps may have offered them a very good price when they set up the account, but when they actually come through to executing it, that’s changed. So it’s that kind of trust thing. Another one would be working with brokers that don’t offer currency hedging or different kind of strategies, or actually helping them throughout the process really is quite key.
Richard founded the Good Money Guide (previously Good Broker Guide) in 2015 and has been a broker for 20 years most recently at Investors Intelligence and previously a multi-asset derivatives broker at MF Global (Man Financial). Richard started his career working as a private client stockbroker at Walker Crips and Phillip Securities (now King and Shaxson) after interning on the NYMEX oil trading floor in New York and London IPE in 2001 & 2000.