By Harry Scherzer
When it comes to forex in a South African context, how can South African businesses and high-net-worth individuals (HNWI) ensure that they are receiving the best service possible and secure the best rates?
It is estimated that the local daily forex trading volume in South Africa is more than $19.1 billion and, according to the results of an upcoming research report by Future Forex, more than three-quarters of businesses contracting forex service providers in South Africa were not sure how their providers were charging them.
In addition, more than half of the participants would consider changing their provider.
Mastering forex might seem daunting, but in reality it all starts with getting the basics right.
Choosing the right forex service provider based on your business needs begins with understanding South Africa’s forex landscape.
The South African Reserve Bank (SARB) has implemented mandatory exchange controls that apply to these transactions, stipulating that they must go through an Authorised Dealer, who is required to report back to the Reserve Bank.
Local businesses and HNWI may contract the services of banks for their forex requirements, but they aren’t required to deal directly with them. They can also go through a Treasury Outsourcing Company (TOC), a registered Financial Services Provider that will act as an intermediary between the business or HNWI and the Authorised Dealer.
A good TOC will help the business complete forex transactions at a lower cost and will also simplify the onboarding and documentation processes. This is important because those processes can be complex with a traditional Authorised Dealer.
Most of us are aware of the fact that forex service providers charge for the transactions they facilitate. They are businesses, after all, and they need to make money. But what you might not know is how those fees are structured.
There are two main fees you need to know about.
Forex service providers, whether Authorised Dealers or TOCs, will charge a set of fees for each transaction processed. The best-known is the transaction fee, which can be charged as a set fee or as a percentage of the total transaction. A commission fee (usually based on a percentage of the transaction amount) may also be charged, as well as account maintenance fees.
Many are familiar with processing fees since they are transparently stated during transactions. However, it’s crucial to note that this fee often represents only a fraction of the total charge – the lion’s share is often hidden in the less transparent exchange rate margins.
Exchange Rate Margin (“the spread”)
The spread, meanwhile, is simply the difference between the rate at which a forex service provider buys a currency and the rate at which it sells it.
The spread can be expressed as a percentage relative to the exchange rate, which fluctuates over time because of its responsiveness to market sentiment. Because there is no standardised practice or rule about how big the spread is allowed to be, it’s a lot easier for forex service providers to charge inconsistent and occasionally exorbitant margins, and so this is the primary fee to watch out for – 66% of participants in the Future Forex survey did not know about the exchange rate margin.
So, for example, if a South African business had hypothetically to import goods from the US today at $10 000, a deal could be booked with an AD or TOC. If the exchange rate is currently 18.70, that business would expect to pay around R187 000.
However, because of the spread, that business could get quoted a rate of 19.1 (~2% more), which equates to a fee of R3 740. We can also assume that in this example the business will pay between R500 and R1 000 in transaction fees, bringing their total spend for $10 000 (R187 000) to around R191 000 (a total cost of over R4 000).
The spread frequently overshadows processing fees, often accounting for a significant proportion of them, sometimes even multiple times more.
As a result, businesses and HNWI may unknowingly incur higher costs through the spread, all the while believing they are only paying a nominal processing fee. This lack of transparency can lead many to underestimate the true cost of forex transactions.
If that business was initiating transactions for over R1 million multiple times in a year, spread fees could end up costing them hundreds of thousands of rand. The good news is that there are local providers that charge a fair spread and are completely transparent about the fees they charge. Understanding how these fees are charged is part and parcel of forex mastery.
We now have a good starting point when it comes to making cost-effective forex transactions. From here, more complex concepts enter the picture, such as Forward Exchange Contracts (FEC), Customer Foreign Currency (CFC) accounts, and Trade Finance.
Forward Exchange Contract
An FEC simply locks in a rate today for a near-future payment. It is especially useful for protection against risks associated with fluctuations in foreign currency exchange rates. It’s hard to believe that in the same study conducted by Future Forex, 61% of the participants did not make use of an FEC.
CFC accounts, meanwhile, allow businesses to hold foreign currency, so that it doesn’t have to be converted back to rand. This allows them to send and receive currency without being affected by the exchange rate.
Trade finance is a loan used for funding import trades where the imported goods are used as collateral. This can help reduce risk by reconciling the needs of an importer or exporter.
Understanding these concepts paves the way for forex success, and of course, identifies the ideal forex service provider.
* Scherzer is CEO of Future Forex