FX Averaging helps remove the risk of picking the wrong timing for your FX transactions. Instead of risking the uncertainty of selecting the wrong day or time for your currency purchase, where you may encounter an unfavourable exchange rate, FX averaging breaks down the transaction into smaller increments, spreading them evenly over a designated period. Businesses commonly opt for monthly averaging, although the timeframe can be adjusted to suit individual business requirements. This approach ultimately results in more consistent exchange rates, steering clear of the short-term highs and lows of currency fluctuations:
Using FX averaging in practice
Utilizing an averaging strategy proves beneficial for businesses experiencing consistent FX exposures over time. Take, for instance, a retail e-commerce enterprise where daily foreign currency sales flow steadily and predictably. Rather than incurring substantial (2%+) FX conversion fees through payment processors like PayPal or Stripe, businesses have the option to accumulate funds in foreign currencies and employ FX averaging with a provider such as HedgeFlows. This approach not only saves on FX conversions but also eliminates the FX risks associated with holding foreign currency balances. By leveraging cloud-based technology and API integrations, averaging contracts can align seamlessly with the frequency and settlement timing of payouts from e-commerce platforms, ensuring currency proceeds are converted at stable and foreseeable rates.
What’s wrong with FX averaging for medium- and long-term currency risks
While averaging proves effective in managing short-term timing risks, its effectiveness diminishes over longer periods, spanning months or quarters. Despite this, some businesses still rely on averaging for their extended currency management needs, often overlooking the real FX risks they face. Consequently, these businesses remain vulnerable to currency fluctuations over prolonged durations.
For example, raising capital in foreign currencies often creates the financial risk that the foreign currency depreciates, making the raised funding worth less in the home currency. Thus, this leads to a reduced runway. As explained in this post, these risks are greatest for longer periods, where currencies may have more time to move unfavourably.
In this scenario, the averaging strategy would delay fixing exchange rates until future periods, focusing on spreading out transactions over a set timeframe, such as one month before the settlement date. Consequently, this leaves the business vulnerable to long-term FX fluctuations - a predominant risk in such situations.
For more effective currency management in these cases, a static FX forward strategy or a more sophisticated, layering approach proves to be significantly more robust and beneficial.