Negotiating Foreign Currency Exchange Agreements (Part 2)
Every international negotiator needs to know how to factor currencies into agreements with foreign business partners. This continues on from Part 1: International Forex Currency Risk Agreements.
The other foreign currency challenge that can cause us to scratch our heads while our faces screw up in a perplexed frown is how to manage situations when the foreign currency is not easily convertible. The reason could be a result of the unsteady political climate of the country, or the foreign trading partner has taut policies that deliberately limit the ability of its citizens to use the foreign exchange market. The value of currencies could also be deliberately regulated by a series of regulations called ‘exchange controls’ to regulate the flow of both local and foreign currencies in and out of the country. Other nations may allow their currencies to be only ‘partially convertible’, so they can only be converted for specified transactions. There are some countries where even the mere possession of a foreign currency is considered a criminal act. While the only way in which we cover forex aspects of negotiation contracts during our negotiation training seminars is via our more complex role play exercises, we are glad to share advice in this two part article series.
Examples of Currency Problems
Example 1: A company that has set up a plant in a foreign country, and has just been paid for the sale of its products in foreign currency, may be legally required to convert these funds into the local currency after depositing it into a local bank. However, if the company wants to convert the local currency into a foreign currency to purchase materials from outside the country, the company will have to make a request to do so through the foreign country’s central bank. The central bank will review the submission. The bank may or may not allow the company to exchange funds. The result is that the foreign based subsidiary would have to seek alternate financing elsewhere to purchase the materials.
Example 2: Similarly, a company located in a foreign country may initially harvest decent profits which they are legally bound to bank in local currency. This negotiation problem occurs when the local currency fluctuates downward causing their profits to shrink. The company may be forced to stand helplessly by because they are prohibited from converting local currency into a more stable foreign currency to offset the losses.
How to Address and Negotiate Foreign Exchange Restrictions
How can we move restricted money in a foreign country?
- The first step is to learn the money regulations before we begin our negotiations. Contact others who have had prior dealings with the country in question. We must also be cautious and recognise that a foreign government can change the rules at any time.
- Negotiate the transaction that enables us to acquire foreign exchange. For example, the foreign central bank may prioritise agreements that generate profits based on technology rather than those derived from a joint venture. This might allow us to create our agreement on a transfer of technology rather than an equity joint venture. This would allow us to access foreign exchange. Some companies inflate their prices when selling technological or manufacturing equipment, or basic raw materials to their foreign subsidiary. They do this to get around the regulations that might have restrictions on dividend payments for example.
- Go direct to the government regulators and negotiate privileges or obtain a special exemption. We might be able to arrange an exemption for our project to obtain the required currency, especially if the project has particular relevance to the government. We may be able to negotiate holding specific profits in an offshore account as an alternate means that doesn’t contradict their laws.
- Secure an assurance or guarantee from an outside financial institution. We could seek to obtain political risk insurance, or a letter for a line of credit, from one of several lending or financial institutions outside the foreign country. This form of arrangement will offer us protection against foreign restrictions that restrict money conversion.
Negotiate a Countertrade Agreement
One age old effective technique when negotiating with organisations that have limited cash flow is to “take it out in trade”. This occurs with countries that have limited foreign exchange at their disposal and seek to barter for the goods or services through a countertrade agreement. There are four types of arrangements:
- Barter – A venerable system that is as old as human history. This is a simple exchange of one type of goods for another type of goods. Due to the complexity of financial practices, it is employed less in our modern world because it is difficult to match goods with needs. When a barter system is employed, the situation might warrant the use of a trading company to facilitate the sale of the exchanged goods.
- Counterpurchase – Also known as “parallel barter”. Counterpurchase is the most commonly employed barter system. Here, we would arrange not one but two separate and linked foreign exchange agreement contracts. A company might negotiate to sell technology to a foreign partner for cash, but also agrees in a separate negotiated agreement to buy for cash, products or services that are produced by the foreign partner.
- Offset – Similar to a counter-purchase agreement. Rather than pay for the trade in cash, the manufacturing company agrees to buy a negotiated percentage of goods or services from the foreign partner that are relevant to the product being manufactured. This could be in the form of components or specialised knowledge used in the development and manufacture of the product being sold.
- Compensation – Also known as a “buyback”. Compensation occurs when we purchase a foreign manufacturing plant. We agree to immediately pay for the purchase of the plant with a defined number of goods that the plant manufactures back to the seller over a defined period of time.
Pros and Cons of Countertrade Agreements
Countertrade agreements tend to be costly and may also be inefficient. Negotiating the agreement can involve considerable time and the goods involved may be difficult to sell except at a considerable discount. A company normally engages in these agreements with a foreign partner to secure an agreement that might otherwise not materialise.
Some foreign countries require that companies wishing to do business with them must specifically enter into countertrade agreements. However, the upside is that a company may be able to negotiate long term access to materials or components relevant to the products being manufactured either within the foreign country, or for products being manufactured by their plants in other countries.
Countertrade Negotiation Issues
We must be cautious when negotiating with a foreign country as one common tactic they use is to indicate that the negotiated agreement is for cash, but at the last stages of the negotiation they advise that we will have to enter into a countertrade agreement to seal the deal. A crucial negotiation issue to raise at the outset, is to clarify that they will not want a countertrade as part of the negotiated arrangement. Put the issue on the table immediately.
If a countertrade agreement is required, the agreement will normally entail what is called a “compensation ratio”. This ratio is the percentage that they will expect us to counter-purchase. A foreign government will keep their ratio secret but it will likely be negotiable to a certain extent. Our counterparty will likely initially ask for a high ratio, and here, the negotiations begin. The issues that affect the ratio may be connected to the foreign exchange available to the foreign trading partner. Another key issue is the relative importance of the goods or services we are selling to the country’s development. Other negotiation issues will centre on the price of the countertrade goods and the quality of these goods. It is not uncommon for the foreign country to try and flog countertrade goods that they cannot sell because they are of inferior quality.
Issues to Consider before Entering into Negotiations
In considering your negotiation strategy, we have to establish how far we are prepared to go in making countertrade agreements, and what goods we are prepared to agree to.
Goods can be categorised as:
- Goods that can be utilised in our own operations.
- Basic materials and especially if they can be marketed according to market prices.
- Products that are relevant and sellable by the exporting company.
- Products that have no relevance to our operations and are the least desirable as they may be unprofitable.
Good preparation and intelligence gathering is absolutely essential before we begin our negotiations. A prepared negotiation strategy must be established beforehand to ensure what we are prepared to accept in making an agreement with a foreign partner. We don’t want it to blow up in our face later. There are many options to consider so each must be examined in relation to the situation.
Jeswald W. Salacuse, ‘The Global Negotiator’ Palgrave MacMillan, (2003).