FX 101 – what clients and IP professionals need to know about Foreign Exchange

I’m going to explain what you really need to know about foreign exchange (‘FX’). What is in truth very straightforward, is made complicated by those in whose interests it is to do so. Read this and you won’t be FX’d by anyone ever again.

‘SPOT’ FX – “I WANT FOREIGN CURRENCY TODAY PLEASE”

For a legal professional, perhaps the most common situation involves payment of charges from a foreign firm in local currency; the bill comes in and you want to pay it today. The circumstances are no different to one that we all know well and that I will use to explain the principles involved.

You turn up at the airport and need some cash for when you arrive at your holiday destination.  You have US Dollars and want UK Pounds. The exchange rate offered is to buy £1 will cost you US$ 1.4400 (FX rates are quoted to 4 decimal places).

You say “Hey, I thought the rate was 1.3400 – I looked it up on the internet this morning”.

The cashier replies “Sorry sir, the rate you are referring to was probably an interbank rate and would only have been available to you if you had exchanged a million dollars or more, and we don’t handle transactions of that size here.”

“Oh” you say, feeling a little foolish, “I only need £100” and to which the cashier replies, “the cost to you, sir, will be US$ 144.”

In the professional situation, where you are paying an invoice in foreign currency, your objective should be to get the best rate for your client. This may mean negotiating with your bank for better rates or working with some of the challenger currency providers such as CurrencyFair and Transferwise.

Profit Margin

In the example, the key difference is between 1.3400 (the interbank rate) and 1.4400 – i.e. 10 cents (or 100 basis points if you want to speak like an FX trader). The provider makes US$ 10 on the deal and the profit is built into the rate so if you change your mind and want £500 then the provider makes US$ 50.

FORWARD CONTRACT – “I WANT A SPECIFIC AMOUNT OF FOREIGN CURRENCY ON A SPECIFIC FUTURE DATE”

Example: You have to send a payment of US$ 10,000 to pay an agreed fee to a US patent agent six weeks from now and want to be sure that you collect the right amount from your client in advance. You ring your bank.

You say “I need US$ 10,000 in six weeks’ time. How much is that going to cost me in addition to the spot price?”

The bank’s FX person replies, “at this time interest rates are the same for US Dollars and Sterling for the six-week period, so the spot and forward rates are the same – I can give you a rate of 1.3100”.

“What if the interest rates had been different?” you might ask.

The answer is quite simple:

  • You always start with the spot rate on the day you negotiate the forward contract.
  • If the interest rate earned by the currency you have is higher than the currency you want then the forward contract will have a cost (a ‘hedging’ cost) and will be reflected in the rate – essentially you will get a worse rate than the spot rate.
  • If the interest rate earned by the currency you have is lower than the currency you want then the forward contract will have a gain (a ‘hedging’ gain) and will be reflected in the rate – essentially you will get a better rate than the spot rate.

WHY DO INTEREST RATES MATTER?

If you enter into a forward contract that matures in six weeks then it is assumed that you and the bank will each place the money on deposit for six weeks earning the relevant interest rate.  So, if there is a difference then that difference is applied for the period (six weeks) and added as a cost, or as a gain, depending which currency earns more.

FX BUYING POWER

If you are regularly handling large foreign exchange transactions then the spot rates you get should be nearer to the interbank rate.  Buying power does not influence the hedging cost (or gain) in a forward contract as that is determined by interest rate differentials alone.

CONCLUSION – LET THERE BE NO UNCERTAINTY!

Legal service firms do not need to take risks with FX. There is no need for uncertainty.  Charging for FX risk that does not, and need not, arise must be wrong. Charging for organising FX transactions may well be a service that firms wish to charge for, in which case those charges are professional fees that should be made clear to clients in advance.

This post was originally published on pacipr.com.

Payments in foreign currency: disbursement or profit costs? What are the FX charges for, exactly?

Foreign Exchange (FX) is for many shrouded in mystery created by tales of currency speculation with millions won and lost in seconds by international speculators. For ordinary mortals, including legal professional firms, there are limited options with known costs offered by regulated intermediaries. FX need not, and arguably should never be, a matter of uncertainty or speculation for legal professionals.

Intellectual property – inherently international

Patent and trademark firms commonly make payments overseas on behalf of clients. These include paying fees of other professional firms; another example would be official fees charged by national patent offices where, for example, a patent renewal fee is paid direct.

Converting Sterling to pay an invoice in another currency inevitably incurs an FX charge from the intermediary, usually a firm’s bank, making the payment. Fortunately, many firms are in a position to secure favourable FX rates from their banks based on volume and pass on the benefits to their clients. The FX cost incurred is reflected in the Sterling amount required to cover each payment; an amount that can be invoiced to the client in the usual way.

Disbursement or profit costs – importantly different

A disbursement is generally understood to be a cost that a firm incurs and pays on behalf of a client. Profit costs, on the other hand, are charges made by a firm for its services. Each involves different obligations in relation to information to be provided to clients, and in relation to VAT.

Arranging payment of foreign agent fees could be considered a service that involves a firm’s time and resources and for which a firm might seek fees. If it does, in the UK at least, professional conduct regulations impose obligations to make clear to the client how those charges will be formulated and what actual charges are likely to be.

If a foreign agent invoice is paid on a given date, the FX transaction also takes place on that date. If a firm invoices a client in advance of payment, seeking money on account of expected costs, then the FX rate applied will be the applicable rate on the date of invoice. Once the costs in question have been paid, any shortfall can be recovered by issuing a further invoice; equally, if there has been an overpayment it can be returned to the client by way of a credit note.

Terms and conditions – how some leading firms deal with FX

I was able to search for and download examples of Terms and Conditions from three leading IP firms in the UK that include specific provisions with regard to FX allowing the relevant firm to charge over and above actual FX costs.

Firm A

In paragraph 6.2 of this firm’s Terms and Conditions is stated:

“(d)Where we incur charges in foreign currencies (i.e. not Sterling) or where we agree to bill you in a foreign currency, we will apply an exchange conversion rate which is based on the spot rate at the time of billing but which includes a margin to cover our conversion costs and currency risk.”

This language appears to refer to a situation where the firm has to bill before a cost is incurred. The reference to ‘spot rate’ is simply to the FX rate that the bank would have charged for the required amount of currency on the relevant date. What is not clear, to me at least, is what currency risk arises and why the firm needs to charge a margin. As already mentioned, all the firm need do is submit a further invoice for any shortfall or a credit note for any overpayment.

Firm B

In paragraph 6 of this firm’s Terms and Conditions, under the heading ‘Expenses’, is stated:

“Where disbursements are incurred in a currency other than sterling, we will apply an additional amount to reflect the cost of dealing in the foreign currency.”

If the cost of ‘dealing in the foreign currency’ is the actual cost incurred by the firm and no more, it forms part of the disbursement. If, however, the firm were to apply ‘an additional amount’ that goes beyond the actual cost incurred then such charges would be profit costs.

Firm C

In paragraph 6.5 of this firm’s Terms and Conditions is stated:

“Expenses and disbursements such as postage and packaging, courier costs, telephone call charges, faxes, photocopying and the charges (if any) paid or to be paid by us to third parties on your or the Client’s behalf (such as registration or renewal fees to be paid to the trade mark or patent offices, or the charges of overseas patent or trade mark attorneys) will be invoiced in addition to the fees and will be subject to a handling charge.”

Again, this provision clearly deals with disbursements and yet there is reference to ‘a handling charge’ (that would be profit costs) but with no specifics as to what the amount will be or how it will be calculated.

In a later paragraph 7.2 is stated:

“All sums payable hereunder will be invoiced and paid in pounds sterling unless alternative arrangements have been agreed. Invoices levied in any other currency will be converted at a premium to the prevailing exchange rate. All invoices shall be paid on receipt.”

Under this provision, the firm is entitled to charge ‘a premium’ on the FX rate. This presumably arises because the firm does not know when its invoice will be paid and so includes a margin to cover the risk that the FX rate moves against the firm so that when payment is converted to Sterling the amount received is less than expected. In such a situation, it is always open to the firm to invoice for any shortfall or credit any overpayment. If, however, some or all of the ‘premium’ is retained by the firm, those charges would constitute profit costs.

Don’t forget the VAT!

If FX-related charges are not disbursements, then they are profit costs and therefore must be subject to VAT. What is not allowed, as I understand it, is to add a premium or ‘handling charge’ or other FX-related overhead or service cost to a disbursement. There is no VAT charged on disbursements; anything else, including recovering overheads, is subject to VAT and must be accounted for as such. This subject is covered in detail in a very helpful article published by the Lawyers Defence Group which includes the following:

“For the purposes of VAT, charges which are not proper disbursements must of necessity be profit costs and as such subject to a charge to VAT. Thus, even if you choose to list them separately, then you should, if you are registered for VAT, be charging VAT on them.

You may, therefore, from a VAT perspective, need to separate out those charges which you make which are recovering overheads from those which are genuinely disbursements.”

HMRC guidance in relation to invoicing in foreign currencies and VAT can be found here.

Telegraphic transfers – SDT ruling

In a practice note produced by the Law Society as a result of a Solicitors Disciplinary Tribunal (SDT) ruling in a case* involving a firm charging more than the actual cost to them of telegraphic transfers (the respondents were fined), is stated:

“A TT fee is an expense but some practices charge more than the cost of the transfer under the heading disbursement, thereby concealing profit costs from clients.

The SDT has found that this clearly breaches rule 1 of the code of conduct, particularly in relation to the solicitor’s duty to act with integrity and in the best interests of the client.

This conduct is also likely to be in breach of rule 2, client care, if any amount over the cost of the transfer is not explicitly declared to the client as profit costs.”

*The SRA Code of Conduct was revised after this decision and the new version can now be found on the SRA website.

There are arguably parallels between telegraphic transfer and FX charges and this may therefore be a matter to which IPReg, and the SRA where firms are also offering services as solicitors, will have to turn their attention.

Conclusion

Firms that routinely apply mark ups to FX transactions that have no bearing on any actual or justifiable risk are charging fees and so must draw attention to and explain those fees to their clients (and charge VAT on them) or explain themselves to their clients and, potentially, to the Regulator.

Further information

IPReg – what does the Code of Conduct say?

The starting point in the Intellectual Property Regulation Board’s Code of Conduct must surely be Rule 5, which states:

“Rule 5 – Integrity

Regulated persons shall at all times act with integrity putting their clients’ interests foremost subject to the law and any overriding duty to any Court or Tribunal.

The guidance notes elaborate as follows:

“Guidance

5.1 A regulated person should in all professional activities:

a) practise competently, promptly, conscientiously, courteously, honestly and objectively, avoiding unnecessary expense to the client;”

The words ‘avoiding unnecessary expense to the client’ would appear to place the burden on the individual professional and firm to ensure, in relation to FX, that the best rate is achieved.

The other rule that has a bearing on the matter is Rule 6:

“Rule 6 – Client Care and Service

Regulated persons shall carry out their professional work in a timely manner and with proper regard for standards of professional service and client care.”

The guidance notes (para 6.1) refer to providing the client with written terms of business “at the outset of a relationship and as often as necessary thereafter”.

Firms are required to inform clients of how they are to be charged for professional services and what future costs are likely to be. If charges are made for ‘handling’, ‘converting’ or otherwise dealing with foreign exchange then the client is surely entitled to know the details.

 

 

This post was originally published on pacipr.com.