How are Price and Exchange Rate Risk managed in an international business contract?

Pricing terms (i.e., amount, discounts, invoicing currency) for Deliverables (i.e., goods, services, or licensed materials) are often contained in Schedules to an Agreement. The Agreement usually has clauses describing the structure of the Agreement itself. Within these clauses the parties can identify how schedules can be made and by whom, how they are to be interpreted in case of conflict with the Agreement, how long they will be in effect and outline any country specific terms.

A country specific term in the Agreement may reference Pricing whenever Deliverables are purchased or sold in a foreign currency. If the Deliverables are intended for a Purchaser’s foreign entities, it is often stipulated that the Supplier’s foreign entity will provide the Deliverables in that country and invoice the Purchaser in the local currency. 

Under this model, exchange rate risk should only arise when Deliverables are invoiced in a currency that is foreign to the recipient, like when a Canadian company purchases goods from an American company and is invoiced in USD. In that case, using USD as the invoicing currency creates risk because of exchange rate volatility. It is important to both address this issue and state how long the chosen Pricing terms will remain in place before renegotiation takes place. 

To address exchange rate risk within the contract itself, the parties could agree to split the difference in price caused by exchange rate fluctuations. Or they could agree to maintain the Pricing terms if the fluctuations fall within a certain range and agree on a delayed payment schedule to take advantage of exchange rate fluctuations. They could create a sliding scale whereby price changes as exchange rates change. Finally, they could agree to renegotiate Pricing terms if the exchange rate fluctuates so much that the price falls outside of an acceptable range. Stating the exchange rate indices against which the exchange rate is measured is an important part of this clause. 

Outside of the contract, a business can use hedging strategies offered by third party banks. The most commonly used are Forward Contracts, but Futures Contracts, Swap Contracts, and Option Contracts are also available. A Forward Contract allows an importer to buy and an exporter to sell a foreign currency at a set rate on a particular date. The bank charges a fee for this agreement and the lifespan is usually limited to 12 months but could be longer for certain currency pairs. The lifespan of the Pricing terms within the parties’ contract often mirrors that same timeframe. 

The takeaway is that currency transaction risk can impact a company’s projected value and competitiveness. If a company is regularly invoiced in or is invoicing in foreign currencies, it may be prudent to create risk management guidelines for these scenarios that outline both contract-specific and external hedging strategies in different scenarios.