Transaction cost analysis: How is it helping INGOs reduce FX costs
Transaction cost analysis: How is it helping INGOs reduce FX costs
As some international charities find it increasingly difficult to fundraise during the COVID-19 period, reducing foreign exchange (FX) costs is becoming even more pertinent.
What is transaction cost analysis?
Transaction cost analysis (TCA) can be described as “the auditing of historic transactions to reveal the overall remittance cost being charged”. There is a common saying among auditors “it is difficult to control costs unless you know what the true costs are in the first place.” Hence this analysis is important when trying to increase donation value.
Before we delve into the depths of TCA, it is important to understand what makes up foreign exchange costs and why it is essential to measure them. FX costs can be divided into two:
- Explicit cost: A visible charge applied by a currency provider and acts as a dealing charge.
- Implicit cost: Sometimes referred to as ‘margin’ or ‘spread’ taken by a currency provider and is defined as the difference between the interbank rate and the exchange rate the charity is given when making a transfer.
The explicit cost is often not applied by non-bank providers despite it being much easier for charities to understand and control due to its transparent nature. Unlike the explicit cost, where the fee paid is clearly visible, implicit costs are more difficult to measure. Banks and brokers are not required by law to provide transaction cost transparency, making it very difficult for charities to have full visibility on costs, thus making it challenging to manage. TCA reporting offer charities the utility to control and reduce the spread/margin taken by providers.
Although charities may be promised tight margins and competitive pricing at the beginning of a relationship, there is a risk that margins will be increased over time, creating a lack of consistency in pricing, ultimately resulting in greater revenue for currency providers. The only way for an INGO to prevent this from happening is to ensure that it measures the margin charged against an accurate and reliable source. By measuring the margin, the charity is put into a position of strength, increasing its financial governance and accountability.
In our experience, many charities try to measure their FX pricing by using one of two methods:
- By having more than one provider with the idea of picking the most competitive on the day.
- Cross-checking pricing against sites such as Oanda or XE.com, sometimes even Google.
Method 1) and 2) are not wrong, as they are both good practices to consider; however, there are inconsistencies that need to be considered. Firstly, could the charity be selecting the best rate out of a bad bunch? This should be considered more so if only a couple of providers are being used. Secondly, free, online FX data feeds are not FCA regulated and sometimes only show limited data (e.g., average daily rate). Therefore, this can provide an unreliable source and untrustworthy results, holding no validity when negotiating improved margins with existing providers.
So how can charities accurately measure transaction costs?
The exchange rate received by a charity should be compared to an independent benchmark rate, representing the true position of where the interbank/ market rate was at the time of execution. It is important to benchmark against an accredited and reliable mid reference rate from which margin calculations are made.
At Charitytransfers.org, we have partnered with New Change FX (NCFX), the only ESMA registered, and FCA authorised administrator of live spot FX benchmarks. NCFX’s systems produce an official rate every 50 milliseconds in 70 commonly traded currency pairs. For less liquid pairs, rates are produced periodically, usually once a minute or so. Therefore, providing an indisputable benchmark when comparing exchange rates.
The benefits of TCA can be best described through a real-life example. Mark Shadrack from Hope and Homes for Children will explain how TCA has benefitted his charity.
Case study – Hope and Homes for Children
Hope and Homes for Children aims to be the catalyst for the global eradication of institutional care of children. Our teams of skilled, local, child-protection professionals are working worldwide to shut down these institutions, finding a safe, sustainable, and loving family-based solution for each individual child and working with governments to tackle the root causes of family breakdown. Each year, we remit over £5m to our overseas operations and partners in around 15 countries. Therefore, it was imperative that we improved our efficiency in this area and received the best execution on the FX market.
Historically, we processed our partner payments through our bank and often sent hard currency to emerging markets. By remitting payments in this way, our charity funding was exposed to poor in-country bank exchange rates and poor payment accuracy. We did not have an independent transaction cost analysis (TCA) process, which meant we could not report back to donors or Trustees on the true cost of sending funds overseas nor implement best practice on currency execution.
Running a transaction cost analysis report allowed us to gain complete remittance transparency and negotiate improved terms, generating consistent savings and preventing overcharges.
Twelve months’ worth of historical transaction data was collected from our UK head office and audited. Our current operating processes and payment software was also reviewed. A visual, interactive TCA report was produced within one week which, provided complete remittance cost transparency per transaction. The report had several sections which reviewed the costs by currency pair, volumes transacted, bank/broker relations, and office locations.
Monetarily, the transaction cost analysis report identified that we were being overcharged by 50% and gave us the ability to reduce our remittance costs by a conservative forecast of £25,000 to £34,000 per annum. These annual savings will enable Hope and Homes for Children to help more children to grow up in the care of a loving family.
The negotiation process enabled Hope and Homes for Children to access a provider which offers fixed margin agreements on all future payments that are c.50% more advantageous than our previous facilities. Further operational benefits were gained from the ability to send more exotic currencies, access to an online platform, and automatic settlement. To ensure the improved terms are upheld and adhered to, we plan to repeat the TCA reports regularly.
For further details, please visit www.charitytransfers.org
For details about Hope and Homes for Children, please visit https://www.hopeandhomes.org/