A company that regularly conducts business in multiple countries must spend a considerable amount of time settling foreign exchange transactions. A common scenario is that the company may be both buying and selling the same currencies many times over as it processes individual payables. Also, since these individual transactions may be small, foreign exchange fees can be high.
There are two ways to reduce the volume of these transactions, depending on the number of parties involved:
- Bilateral spreadsheet netting. If two companies located in different countries transact a great deal of business with each other, then they can track the payables owed to each other, net out the balances at the end of each month, and one party pays the other the net remaining balance. This is a good way to try out the netting concept, though most companies have considerably more than one key trading partner, and will want to progress to the following method in short order.
- Multilateral centralized netting. When there are multiple parties wishing to net transactions, it becomes much too complex to manage with a spreadsheet. Instead, the common approach is to net transactions through a centralized exchange, such as Arizona-based EuroNetting (www.euronetting.com). Under a centralized netting system, each participant enters its payables into a centralized database through an Internet browser or some other file upload system, after which the netting service converts each participant’s net cash flows to an equivalent amount in each participant’s base currency, and then uses actual traded exchange rates to determine the final net position of each participant. The exchange operator then pays or receives each participant’s net position, and uses the proceeds to offset the required foreign exchange trades.
Either type of netting arrangement can involve a broad array of payment types, covering such areas as products, services, royalties, dividends, interest, loans, and hedging contracts.
When bilateral or multilateral netting is used, the parties usually sign a master agreement which itemizes the types of netting to be performed, as well as which contracts or purchase orders are to be included in the arrangement.
Though netting can be a highly effective way to reduce foreign exchange transaction costs, some governments do not recognize the enforceability of netting arrangements, because they can undermine the payment rights of third-party creditors. Consequently, consult a qualified attorney prior to entering into a netting arrangement.