Which exchange rates to use for corporate finance, tax, and accounting.
In recent years, Central Banks around the world have made the news in an unprecedented way, and with more frequency than ever before. From the Swiss National Bank event at the beginning of 2015 - and subsequent “flash-crash”- to the Chinese Yuan devaluation in 2016, central banks are undoubtedly playing much more aggressively on the global chessboard.
On top of this, macroeconomic and geopolitical events such as the fall of oil prices or the numerous chapters of the Brexit saga, are also having a deep impact on the foreign exchange market, resulting in increased volatility and currency rate fluctuations.
It is safe to say that the new normal in the foreign exchange industry is dominated by high volatility, and that all actors involved are looking more closely at the economic calendar, especially when Central Banks meetings are on the schedule.
Another area where Central Banks play a more active role than they used to, is in the publication of currency exchange rates, in some cases mandating that companies operating in their territories of jurisdiction comply to the currency data they provide.
Market rates vs. Central Bank Rates
At this point, it is important to make a distinction between a market rate and a Central Bank exchange rate. Foreign exchange market rates are determined by supply and demand of market participants. Factors that affect the supply and demand are: geopolitical stability, employment outlook, trade balances and Central Bank actions. Since the foreign exchange market is an ‘over the counter’ market or OTC, different currency rates from different sources might all be valid at any point in time, as long as buyer and seller agree on it. Due to the nature of the currency market, providing an accurate rate becomes an art and a science; that’s why at OANDA, world leader in the forex industry, we are able to provide what is widely considered the gold standard in exchange rates since we are in the unique position to:
Access the main players in the foreign exchange market in real-time
Rely on a broad range of redundant (and reputable) data sources
Aggregate all the data points from one trading day
Calculate a time-weighted-average-price (or TWAP)
Deliver foreign exchange data automatically via API, as well as through our cloud-based Historical Currency Converter
A Central Bank exchange rate is also based on demand and supply, as well as other factors and guidelines. The European Central Bank (ECB) for example, published their reference rates taking into account the recommendations of the Financial Stability Board on foreign exchange benchmarks, as well as the principles for benchmark-setting processes in the EU drawn up by the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) and the principles for financial benchmarks drawn up globally by the International Organisation of Securities Commissions (IOSCO). The issue here is that unlike the ECB, other Central Banks will follow only some of these guidelines, or others altogether. Ultimately, inconsistency will emerge between the same currency pair between two CB rates.
What does this mean for accounting, tax and CPA professionals?
Small and large organizations operating in countries where the local tax authorities only accept Central Banks as the source of FX data for financial reporting, sometimes struggle to find alternative FX data sources for specific countries, especially when it comes to leveraging exchange rates for automated processing and reporting. Most companies tend to implement a dedicated manual process for specific countries, while relying on their preferred automated source of currency data to retrieve market rates for all other financial operations.
Three main challenges with Central Bank rates
Technology and consistency. Central Banks can be unpredictable in how their data is published; they might make changes to the time of the day at which they release their data. For example, the Bank of Canada just announced they will update the delivery time of 26 currencies, which will be daily at 16:30 starting on May 1st, 2017. Also, the format, delivery method, and calculation method differs between Central Banks eliminating the option of “scraping” rates from their websites.
Coverage. The BoC example also shows us that not all currencies are being covered by Central Banks. For global businesses leveraging a single source of foreign exchange data, a Central Bank might not be the solution when the currencies they’re exposed to are not being covered by the bank.
Reference-only rates. In most cases, and certainly for the larger Central Banks, they are explicit in that the data being published is for reference only. In other words, not intended for use in evaluating transactions or risk. This leaves companies with a gap if they are using Central Bank rates to understand their market risk.
So, which exchange rate should companies use?
The business and finance context determines which rate should be used. Where compliance with local regulation or accounting standards requires it, clearly Central Bank rates should be used in financial reporting. To understand a firm’s risk, price actual cross-border transactions, or to set products and services foreign jurisdictions, a true market price is required. And even in these cases, due to the OTC nature of the foreign exchange market discussed above there is no single source of truth for currency rates.
While there is no silver bullet, there are best practices that should be followed. Leading audit and accounting firms, tend to support companies’ decisions to streamline their FX data retrieval for accounting, tax and financial reporting when the process is fully automated, or in a suboptimal case when the data can be retrieved manually directly from its source (i.e. with a daily, weekly, monthly data download). Aside from the delivery method, the data is only as good as its source. The reasons listed below, in our experience, make a reliable foreign exchange data provider:
Deep knowledge in the complexities of the forex market
Access and visibility into the interbank forex market
Technology to produce an accurate TWAP
Reliable and automated data delivery systems
Though Central Bank rates might be necessary for businesses operating in certain countries, they clearly cannot be relied upon as the sole data source. Modern finance and accounting professionals leading global operations, need a comprehensive data provider to retrieve accurate and reliable market rates AND Central Bank rates in one flexible solution.
The OANDA difference
Having been at the forefront of the FX industry for over 20 years, OANDA is not only trusted for accurate and reliable forex data, but also for constantly adapting to new market regulations and staying within compliance of national and foreign policies. This is why OANDA offers Central Bank exchange rates for the Exchange Rates API, to automatically retrieve forex data for ERP systems, digital products, fintech apps, as well as accounting and treasury software. OANDA also offer CB rates for the popular web application Historical Currency Converter, which allows users to manually retrieve data via convenient CSV download.
Businesses using OANDA now have access to 25 Central Bank exchange rates - and the list will grow over the 2nd quarter of 2017.
This comes in addition to the world trusted OANDA Rates®, market exchange rates which include over 38,000 currency pairs dating back to 1990.