We came up with a little infographic that is supposed to help you understand a little better, where your foreign exchange provider makes money off you, ignoring for now any (international) transfer charges, commissions or any other out-right fee that will be added on top. We will focus on the so-called Spread, also known as the “FX margin”. Continue reading
Following our previous post on how expensive some currency brokers really are, we thought we’d put what we found into a worked example. Object of aspiration: Gucci Bamboo Shopper Leather Tote (…in our humble opinion an astute accessory) Retail price: GBP … Continue reading
“There ain’t no such thing as a free lunch”, is a popular adage communicating the idea that it is impossible to get something for nothing, and foreign currency exchange is no different – Accept that as fact!
In our last post, we researched how competitive different currency brokers are, analyzing a set of roughly 20 companies.
These providers pitch themselves as a means of minimizing costs, not altogether avoid them. So, one needs be realistic about the fact that currency conversion NEVER comes for FREE, despite what you see online, at airports or anywhere else. It is in the nature of running a business, that it cannot be.
For those keen to understand how much you pay whom for what, you need to bear two things in mind:
1) The stated fee (visible)
2) The implicit fee: The margin over and above the actual midpoint rate at which the market exchanges the currency you would like to purchase (often not visible and priced into the rate they quote you)
To expose any fees that are potentially implicit in the quote they give you, do the following:
1) Check interbank rates here.
2) Choose your currency pair. Living in the UK with upcoming holidays in Oz? Pick GBPAUD.
3) Calculate the mid-point rate between Bid and Ask. (1.80439 + 1.80452) / 2 = 1.804455.
4) Choose your provider and get a quote. To make our point, we chose this one. Currently quotes, 1.786455.
5) Divide 3) by 4) and subtract 1. You just calculated an implicit fee of 1.00% (they do not tell you this).
6) Add stated fee: Mentioned provider quotes £10 for a £1,000 transfer. Another 1.00% (they tell you this).
7) Sum 5) and 6) and you get to your total fee (the sum of what they tell you and what they do not tell you).
This transfer will cost you 2%, not 1% as they may make you believe.
A little experiment: Who charges what? We have had a look at prominent providers of money transfer services and compared their rates, by using their online currency conversion tools or manually adding their rates (where we could find them without registering). The focus of our analysis … Continue reading
Size and major participants of the global FX market
According to statistics maintained by the Bank of International Settlement (BIS), the global FX market produced an average daily turnover of $5.3 trillion during the month of April 2013, up from $4 trillion in 2010. On a net-net basis (meaning any double-counting of local and cross-border inter-dealer transactions were eliminated), the total value of spot transactions globally (the exchange of currencies at the prevailing market rate) amounted to $2.046 trillion per day in the same period. The remainder of transactions ($3.3 trillion) is made up of currency transactions involving financial instruments. The UK continues to comprise the largest slice of this market.
Looking at who the main counterparties of spot transactions were, we see that:
• 39% of spot transactions were affected by reporting dealers
• 53% by other financial institutions (non-reporting banks (24%), institutional investors (11%), hedge funds and prop trading desks (11%), official sector (1%) and others (6%)), and
• 9% by non-financial customers (mainly corporations).
As retail customers (we / you) we buy and sell our currencies through one of the market participants listed above.
So where is the “we and you” in this equation?
As retail customers (we / you) we participate in this market through the intermediaries listed above. They take the form of your …
- your commercial bank when transferring funds to a foreign bank account or paying an international supplier, it may be …
- your stock broker when buying foreign stock, …
- your private bank when buying that house in the South of France, …
- your Western Union transfer, …
- your PayPal or Moneygram transfer, …
- your exchange at the PostOffice, …
- prepaid cards, …
- your high-street currency broker (“0% commissions”, right? Wrong!), …
- your credit card provider, while on vacation, when paying for those Gucci loafers you absolutely didn’t need to have, …
- … and so on.
This intermediation comes at a cost, which varies by type of intermediary for various reasons; reasons which we dedicate this blog to.
Surely, these intermediaries will make a small profit off you which is included in the bid/ask spread they quote you. Spreads allow market-makers to turn a small profit, but also protect them from the risk of holding currencies. “What’s the risk?”, you might ask; Consider the following: The demand for converting Indian rupees, say, into British pounds (i.e. sell INR, buy GBP) may be less than the demand the other way (i.e. buy INR, sell GBP). A banking institution standing in the middle of that transaction, will be able to fill the resulting funding gap or “liquidity gap” by effectively taking a position in Indian rupees (i.e. buying Indian rupees). In all cases, a transaction takes place between two bank accounts of differing currencies. The spread will therefore also include transfer charges to effect the payment to an overseas institution.
This is where the P2P concept comes into play and the likes of Midpoint, TransferWise, CurrencyFair make their fee. Converting currencies peer-to-peer is the closest you can get to actually exchanging hard currency with another individual / small company, i.e. between two market participants (we / you) of opposing currency needs. P2P would naturally also count as an intermediary in the list above, with the important difference that they…
- Do not take a position in a counter-currency (this means lower risk, and for you, lower fees)
- Match demand and supply of a currency, i.e. a transaction only happens if there is someone wanting the currency you want to sell
- Avoid international money transfers and related charges, by maintaining local, segregated trust accounts in several currencies that the two participants of the transaction either transfer money into and get money transferred from. The point is: your money stays local and you save by avoiding international transfer charges.
Which part of this market is P2P FX competing in?
Let’s try and establish a rough size of the market for peer-to-peer foreign exchange (“P2P FX”). We shall focus on:
- Total volume of spot transactions globally
- Focus on SME and retails client transactions (in the understanding that larger / institutional clients have the means of getting lower rates through better level of market access and experience, meaning that they have little to no use for the P2P solutions we are focusing on)
We established that the average daily volume of spot transactions is around the $2.046 trillion mark, 9% of which, or $184 billion, were accounted for by small to medium size corporations. A further $78 billion were retail-driven transactions (we and you). This suggests that P2P FX has a minimum daily market of some $262 billion in terms of currency volumes traded. Taking the 80-90% cost reduction the likes of CurrencyFair are suggesting with regards to the 2% of typical banking fees charged on exchange of foreign currency (which suggests a fee of 0.2% or 20 basis points), annual revenues in this industry over 251 trading days per year (365 minus bank holidays and weekends), should amount to some $132 billion of revenues per year.
Considering that CurrencyFair and TransferWise have merely just crossed the mark of $1 billion of currency volume converted, tells us that this exciting new sub-sector of the financial services industry will produce some interesting developments to look forward to.
The sharing economy in recent years has harnessed the “value of idleness of expensive objects”, enabling owners of such items to monetize the idle state of their dire investments. Airbnb created an online marketplace for vacation rentals that connects users with property to rent with users looking to rent the space. The likes of Zipcar did so for cars. A group of enthusiastic, new, disruptive and by all means innovative companies are attempting to apply this peer-to-peer concept to humanity’s prime medium of exchange itself: money.
The idea is to offer users that are looking to exchange money a cost-effective way of doing so. The idea behind the idea is to avoid international flows of funds by matching demand and supply of a particular currency at the local / national level – i.e. using each others money to settle trades, making faster and cheaper local transfers rather than international ones – and hence offering cost efficiencies of up to 90% to charges banks typically apply for overseas transactions. While we have not been able to independently verify these figures, it has been suggested that typical fees for transferring $1,000 into a foreign currency can amount to USD50 dollars for the international transfer in addition to 3% to 6% for the exchange of currency.
We have collected a number of videos by companies in this thriving industry, that explain the concept of peer-to-peer currency exchanges well:
1) Business Television report on Midpoint Holdings interviewing John Booth, CEO & Chairman:
2) Brett Meyers, CEO & Co-Founder of CurrencyFair, explains how fin-tech start-up CurrencyFair disrupts international banking with peer-to-peer currency exchange:
3) Kantox FX infomercial:
4) TransferWise shows the inner workings of its platform in this short snippet:
Thanks for dropping by our site. We wanted to post a few words on…
- what we aim to achieve with our blog,
- who it is aimed at, and
- what you might expect to find here going forward.
Let’s get right to it then …
Our site is geared towards educating individuals and smaller companies on the nature and typical size of banking charges when transferring funds overseas, and towards developing a better understanding of effective ways to minimize these charges (we would like to write “avoid” here, but found “minimize” to be a more truthful reflection of reality). We will do so with particular focus on peer-to-peer foreign currency exchange services which have gained popularity in recent years.
Anyone that has lived and aggregated wealth abroad, smaller institutions that maintain bank accounts in different jurisdictions or that generate and repatriate revenues (or costs) from currencies other than their home currency, may or may not be aware of the fees these transactions entail. While astute retail investors and arguably most institutional investors benefit from knowledge, access and experience to mitigate these charges, uninformed individuals with irregular or spontaneous need to convert currencies are most likely to experience (and never notice) hidden fees in the process of converting from one currency to another.
Amongst other factors, this is often a matter of opportunity cost and lack of process transparency:
1.) opportunity cost, i.e. in case of individuals, saving $20 on a $1,000 cash withdrawal might not be worth one’s time to establish the effective exchange rate at time of withdrawal and nature /size of the applicable transaction fee and as a result, the most cost effective option to convert said funds, or indeed,
2.) lack of process transparency or traceability, i.e. ability to find out
- the exact change rate used (consider a quote with two decimals (i.e. “EUR 1 = USD 0.73″) to be a quote worth challenging)
- the date and time-of-day the conversion was made (time of withdrawal or fixed by bank once a day)
- the breakdown by nature of charges (may include transaction fees, withdrawal fees, bid/ask spreads and others)
Our blog anticipates to educate interested individuals and small corporates on the means of managing banking fees by explaining the options that are available to them, the providers of such options and the process of using such options. We will do so with particular focus on peer-to-peer currency exchange solutions. As we are not professional participants of this new industry ourselves, this blog is to be seen as a writing-while-learning account of our analysis of this upcoming sector.
We hope you enjoy reading our blog and welcome any comments you might have.
WATCH THIS SPACE!
… and most people as well as most smaller institutions without the benefit of an internal treasury function, do not either!
Banking charges arising during foreign exchange transactions are typically made up of several components, these being the spread between the bid and ask prices of a reference currency as well as a transaction fee a bank will charge you to affect your trade.
The bid represents the price at which the foreign exchange market maker is willing to buy a base currency in exchange for the counter currency. Conversely, the ask price is the price at which the foreign exchange market maker is willing to sell the base currency in exchange for the counter currency.
While these charges typically and collectively amount to up to 2% of the amount you would like to exchange, they can easily be more if you are not careful. You might not feel the bite quite so much when withdrawing a few quid for your next pint, which is why it is all the more important to have done your homework before departing on your next vacation of the debaucherous kind.
What companies such as AFEX, Travelex, Midpoint, TransferWise, CurrencyFair or Kantox are offering is the possibility for individuals/institutions to enter into a transaction directly, without the need for a bank or similar intermediary to match demand and supply of a particular currency. The benefit being that the exchange of currencies occurs at true midpoint rates, for a small and visible fee, that can be up to 90% lower than what a bank would charge.
The following video describes it quite well…
If I want a taxi, Uber is faster, safer and easier than most cabs certainly the case in Melbourne. If I want accommodation anywhere in the world I turn to AirBnb. It offers simple, easy and affordable accommodation. And if I want to exchange AUD for GBP then I can do so with CurrencyFair. It’s cheaper, faster and easier than any of the Aussie banks.