During supply chain disruptions, such as the prolonged period during the COVID-19 pandemic, predicting production, fulfillment and payment timelines becomes difficult. Combined with volatility, inflation, interest rates and geopolitical risk, along with their collective impact on the U.S. dollar, companies may face prolonged exposure to an unpredictable FX market. Forward hedging strategies, in which parties agree to prices or rates for a future transaction, mitigate volatility and protect budgets as part of financial risk controls within supply chain risk management.
For example, an outright forward predetermines the exchange rate applied on the scheduled transaction date. On the other hand, for a seller that receives payment when products ship but is uncertain when that may occur because of delays, a window forward locks in an exchange rate for a defined period. Payment at the agreed rate may be completed at any time during the window, with the option to roll the hedge if delays extend beyond the maturity date. Consider whether shipment dates are fixed or variable. This distinction often guides whether an outright or window forward is the better fit.
Companies seeking to protect downside risk while maintaining the opportunity to benefit from favorable exchange rate movements may consider a participating forward. With this structure, a protected rate is set for a percentage of the transaction. On the transaction date, if the exchange rate has improved, payment may be completed at the more favorable rate. If the market moves unfavorably, the entire transaction is completed at the protected rate.
When a company anticipates a longer timeline to complete a cross-border transaction, such as during due diligence or while awaiting regulatory approval, it may hedge against adverse rate fluctuations with a foreign currency option. This approach provides a guaranteed exchange rate while preserving the flexibility to walk away from the hedge or the transaction itself if the deal were to fall apart. If decision milestones are uncertain, options provide additional flexibility with rate certainty while mitigating the downside.
Regionalizing or reshoring the supply chain
Companies that rely on a concentrated network of international suppliers may consider regionalizing or reshoring their supply chains. In a regional model, raw material sourcing, processing and manufacturing occur within a single geographic region or country closer to your manufacturing facility. Reshoring involves bringing previously offshored supply chain operations back to the United States.
While these changes often require a significant investment of time and capital, they may offer long-term protection during large-scale disruptions and improve visibility, lead times and service levels. These foundational strategies reduce risk and improve an organization's ability to identify and evaluate supplier-related vulnerabilities throughout the supply chain.
Supply chain financing
Financial supply chain breakdowns, such as delays in sending and receiving payments, may significantly impact operations even when logistics remain stable. Businesses may use multiple financing strategies to protect or enhance margins while managing payment risk. These approaches may also strengthen working capital and lower transaction costs for both buyers and sellers.
One example is a supply chain financing arrangement, also known as reverse factoring. In this structure, a buyer's bank provides immediate payment to the supplier while offering extended repayment terms to the buyer. This approach enables both parties to optimize working capital as they navigate production and sales cycles, offsetting delays and reducing strain on cash flow. It also reduces cost of capital if financing is moved to lower interest rate environment.
Letters of credit
Another international financing strategy is the use of letters of credit for international trade, which transfer payment risk from the buyer to its bank and safeguard against nonpayment. Letters of credit also function as contractual protection, preventing either party from exiting a transaction without the required documentation and consent. Combined with supply chain risk management strategies, they mitigate financial and external risks associated with cross-border commerce. For counterparties in new or higher-risk markets, letters of credit may serve as the first step toward building trust and standardizing documentation.
These structures may benefit both buyers and sellers while enabling businesses to take advantage of more favorable interest rate environments in participating countries.
Example of a commercial letter of credit
- Company ABC, based in the United States, 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.
- ABC's bank issues a commercial letter of credit to facilitate payment for the raw materials while manufacturing and sales are completed. XYZ may use the letter of credit as collateral to borrow from ABC's bank, often at lower interest rates than those available in XYZ's home country.
- ABC receives extended payment terms while XYZ gains access to working capital at a reduced borrowing cost. Transaction costs are lowered and profit margins improve for both the buyer and supplier.
To learn more about how FNB solutions support your business in a challenging supply chain environment, explore the International Banking team’s capabilities.
