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Supply Chain Disruption: Managing International Risk

Companies have been adversely impacted by breakdowns in the global supply chain, both logistically and financially.

Supply Chain Disruption

Companies have been adversely impacted by breakdowns in the global supply chain, both logistically and financially. The complex landscape is influenced by a range of factors, such as inflation, labor shortages, continued COVID-19 disruptions and geopolitical events like the invasion of Ukraine. These pressures impact the supply chain and broader global markets — particularly, the foreign exchange (FX) market — and may further exacerbate existing issues.

Ongoing delays and uncertainty are presenting many businesses with cash flow and customer service challenges directly related to delivery and fulfillment. To insulate against these challenges, businesses need to effectively manage risk attendant to supply chain disruption to stabilize, protect and enhance profit margins.

FX Hedging

As the Global Supply Chain Pressure Index — a measure of supply chain disruptions launched in January 2022 — remains elevated, businesses may struggle to accurately predict timelines for production, fulfillment and, as a result, payment. Factor in volatility, inflation, interest rates, geopolitical risks and their impact on the U.S. dollar, and companies must now contend with added risk through prolonged exposure to an unpredictable FX market. With the forward hedging strategies described here, businesses can protect against this volatility.

For example, a business may consider an Outright Forward hedge, which predetermines the exchange rate that will be used on the scheduled transaction date.

For a seller that receives payment when products ship — but is uncertain of when that may be due to delays — a Window Forward hedge will lock in an exchange rate for a set period. Payment at the determined rate can be completed at any time during the window, with an option to roll the hedge forward if delays continue beyond the rate’s maturation date. Any company looking to protect its downside risk and benefit from favorable exchange rates may consider a Participating Forward. Here, a company sets a protected rate for a percentage of the transaction. On the date the transaction is executed, if the exchange rate has improved, the business can complete payment at the favorable rate. If the market is unfavorable, the entire transaction is completed at the rate protected by the hedge.

When a company has a big wait to complete a cross-border transaction (for example, during due diligence or waiting for regulatory approval), it may safeguard against unfavorable rate fluctuations with a Foreign Currency Hedging Option that guarantees an exchange rate. However, a business can walk away from the hedge to secure a more favorable rate to close its deal, time permitting.

Supply Chain Financing

While less frequently discussed than its logistical counterpart, disruptions to the financial supply chain — which includes the processes to make and receive payments — can have a significant impact. A business may employ multiple methods to protect or enhance their margins and manage payment risk. For example, with a supply chain financing agreement, or reverse factoring, a buyer’s bank may deliver immediate payment to a supplier while providing extended repayment terms to the buyer. This allows both buyer and supplier to maximize working capital while they navigate production and sales, providing a buffer against delays.

Financing strategies can also enhance profitability by reducing the cost of the transaction for the buyer and seller.

Supply Chain Management

Companies relying on a concentrated network of international suppliers may consider regionalizing or reshoring. In a regional model, raw materials sourcing, processing and manufacturing all occur within one area of the world or country. In reshoring, a business will bring offshored supply chain links back to the U.S. While these changes may require a significant investment of both time and money, they could offer long-term protection in a scenario like the pandemic when entire nations were forced offline.

Letters of Credit

Another international financing strategy is the use of Letters of Credit (LCs), which can transfer the risk from a buyer to its bank and safeguard against nonpayment. Additionally, LCs serve as contract insurance, prohibiting one side from walking away from a transaction without the required consent.

LC strategies can provide benefits to both the buyer and the seller, while also allowing businesses to take advantage of more favorable interest rates between the participating countries.

Here is an example of how a commercial LC works:

  • Company ABC in the U.S. imports raw materials from Company XYZ in another country to manufacture widgets.
  • On average, it takes four months for ABC to manufacture, sell and receive payment for the widgets. However, XYZ requires payment within 30 days.
  • A Commercial LC is issued by ABC’s bank to provide payment for the raw materials while manufacturing/sales are completed. XYZ can use the LC as collateral to borrow from ABC’s bank and take advantage of their interest rates, rather than a bank in XYZ’s own country, where interest rates may be considerably higher.
  • ABC gets a longer payment term while XYZ gets access to working capital and lowers its borrowing cost. Transaction cost is thereby reduced, and the profit margin is improved for both buyer and supplier.

Contact FNB at 1-866-362-4603 to learn more about how our solutions can protect your business in a challenging supply chain environment.

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