Crash Course in International Trade

8/12/2019 Crash Course in International Trade

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A Crash Course in

International Trade

Making our experience and expertise work for you!


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A Crash Course in International Trade!

This Crash Course is intended to provide you with a

basic overview of international trade. However, as each

trade relationship and transaction is unique, we encourageyou to contact us at [email protected] for more

information.
mailto:[email protected]:[email protected]


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What will you learn from the

Crash Course?The risk issues involved when buying and selling internationally

from the perspective of both the Importer and the Exporter.

The different methods used to effect payment in internationaltrade.

The various types of Guarantees used in international trade.

Definitions of important --and often confusing-- terms.


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Risk Issues in International Trade

In any business transaction,

there are risks. However,

these risks are emphasized

when dealing internationally.

Added to the commercial risks

present in a domestic

transaction are foreign

exchange as well as countryrisks.

COUNTRY RISKS

Stable political climate? War?

Revolution?

Positive economic environment?

Solid legal infrastructure?

Foreign exchange restrictions?

FOREIGN EXCHANGE RISKS

Volatile foreign currency?

COMMERCIAL RISKS

Reliable information concerning the

companys track record? Insolvency of your

trading partner?

Default or termination on your contract?


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Making and Receiving Payment Internationally :International Payment Instruments

Clean Payments

Documentary

Collections

Letters of Credit

We now introduce you to the

different payment methods

available in settling aninternational trade transaction.

The mechanics of these

methods and their advantages

and disadvantages from the

point of view of both the

Importer and the Exporter will

be discussed.


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Clean Payments

Introduction: What is a Clean Payment?

Basic Facts: Open Account & Payment in Advance

Mechanics: How does a Clean Payment transaction work?

Risk Analysis: Advantages and Disadvantages


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Clean Payments

I ntroduction: What is a Clean Payment?

Clean Payments are characterized by trust. Either the

Exporter sends the goods and trusts the Importer to pay

once the goods have been received, or the Importer trusts

the Exporter to send the goods after payment is effected.

In the case of Clean Payment transactions, all shipping

documents, including title documents, are handled

directly by the trading parties. The role of banks is

limited to clearing funds as required.


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Clean Payments

Basic Facts: Open Account & Payment in Advance

There are two types of Clean Payments: Open Account &

Payment in Advance.

Open Account. The Importer is trusted to pay the Exporter

after receipt of the goods.

Payment in Advance. An arrangement whereby theExporter is trusted to ship the goods after receiving payment

from the Importer.


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Clean Payments

Mechanics: How does an Open Account transaction work?

OPEN ACCOUNT: TheExporter ships the goods

and the documents directly

to the Importer and waits

for the Importer to sendpayment.

Exporter

Importer

2

GOODS

1

PAYMENT


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Clean Payments

Mechanics: How does a Payment in Advance transaction work?

PAYMENT IN

ADVANCE: The Importersends payment directly to

the Exporter and waits for

the Exporter to send the

goods and documents.

Note: The Payment in

Advance and Open

Account schematics vary

only in the order in which

events take place.

Exporter

Importer

2

GOODS

1

PAYMENT


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Risk Analysis: Clean Payments

Advantages to Exporter:

Assumes no risks

Disadvantages to Exporter:

None

Advantages to Importer:

None - but could secure low cost!

Disadvantages to Importer:

Assumes all risks

Opportunity cost of using companys

cash resources until goods are received.

Open Account Payment in

Advance

Advantages to Exporter:

None - but could clinch the sale!

Disadvantages to Exporter:

Assumes all risks

Advantages to Importer:

Assumes no risks

Delays use of companys cash resources.

Disadvantages to Importer:

None


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INTERNATIONAL PAYMENTS RISK SPECTRUMAs we move through the different ways to effect payment in international trade, we will build

the Risk Spectrum. The Risk Spectrum is intended to summarize the risks associated with

the payment methods in relation to the Exporter and the Importer. Notice that Open Account

and Payment in Advance sit at opposite ends of the Risk Spectrum.

LEAST

RISK TO

IMPORTER

HIGHEST

RISK TO

IMPORTER

HIGHEST

RISK TO

EXPORTER

LEAST RISK

TO

EXPORTER

Open Account

Payment in Advance


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Documentary Collections

Introduction: What is a Documentary Collection?

Basic Facts: Documents Against Payment (D/P) &

Documents Against Acceptance (D/A)

Mechanics: How does a Documentary Collection

work?

Risk Analysis: Advantages and Disadvantages ofDocumentary Collections


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I ntroduction: What is a Documentary Collection?

A method of payment used in international trade whereby the

Exporter entrusts the handling of commercial and often

financial documents to banks and gives the banks instructions

concerning the release of these documents to the Importer.

Banks involved do not provide any guarantee of payment. *

Collections are subject to the Uniform Rules for Collections

published by the International Chamber of Commerce. The

last revision of these rules came into effect on January 1,1996 and is referred to as the URC 522. TD provides copies

on request at the nearest International Trade Services office.Except in the case of avai l ized draf ts.


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Basic Facts: Documents Against Payment (D/P) &

Documents Against Acceptance (D/A)

Documentary Collections may be carried out in two

different ways:

Documents Against Payment. Documents are released to

the Importer only against payment. Also known as a Sight

Collection or Cash Against Documents (CAD).

Documents Against Acceptance. Documents are releasedto the Importer only against acceptance of a draft. Also

known as a Term Collection.


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Documentary CollectionsMechanics: How does a Documentary Col lect ion work?

The mechanics of a Documentary Collection are

easily understood when separated into the followingthree steps:

Flow of Goods Flow of Documents

Flow of Payment


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Documentary Collections:

Flow of Goods

After the Importer and the

Exporter have established a

sales contract and agree on a

Documentary Collection asthe method of payment, the

Exporter ships the goods. In a

Documentary Collection, the

Importer is known as the

drawee and the Exporter as

the drawer.

GOODS

Exporter/Drawer

Importer/Drawee


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Flow o f Documents

After the goods are shipped, documentsoriginating with the Exporter (e.g. commercial

invoice) and the transport company (e.g. bill of

lading) are delivered to a bank, called the

Remitting Bank in the Collection process. The

role of the Remitting Bank is to send these

documents accompanied by a Collection

Instruction giving complete and precise

instructions to a bank in the Importers country,

referred to as the Collecting/ Presenting Bank

in the Collection process.

The Collecting/ Presenting Bank acts in

accordance with the instructions given in the

Collection Instruction and releases the

documents to the Importer against payment or

acceptance, according to the Remitting Banks

Collection instructions.Note: The Exporters Bank and the Remitting Bank need

not be the same. Also, the Collecting Bank and Presenting

Bank need not be the same. Each role could be performedby a different bank.

Collecting/

Presenting BankImporter/

Drawee

Remitting

Bank

2

3

4

Exporter/

Drawer

GOODS

1

Documents

Documents

Documents


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Flow of Payment

Payment is forwarded

to the Remitting Bank

for the Exportersaccount. And the

Importer can now

present the transport

document* to thecarrier in exchange for

the goods.

Remitting

Bank

Presenting/

Collecting Bank

1

2

Exporter/

Drawer

Importer/

Drawee

Documents

4

3

* I n th is case, we are assuming that the

transport document is a ti tle document.

GOODS


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Risk Analysis: Documentary CollectionsAs discussed earlier, Documentary Collections may be settled in two different ways. Documents Against Payment

(D/P) refers to a Collection where the Importer receives the documents only in exchange for payment. With

Documents Against Acceptance (D/A), the Importer may obtain the documents in exchange for the acceptance of

the obligation to pay at a specified future date. These two methods of settlement carry different risks for both

Importers and Exporters.

Documents Against

Payment (D/P)

Documents Against

Acceptance (D/A)

Advantages to the Exporter:

Documents are not released to the Importer until payment

has been effected.

Less costly than a Letter of Credit.

Disadvantages to the Exporter:

Risk of refusal of payment.

Commercial and country risks not hedged.

Advantages to the Importer:

Ability to examine documents before authorizing payment.

Unlike a Letter of Credit, a line of credit is not required, and

fees are minimal.

Disadvantages to the Importer:

In the case that transport documents carry title, cannotaccess goods until payment has been made.

Advantages to the Exporter:

Less costly than a Letter of Credit.

May provide formal/legal means to collect unpaid obligation.

Disadvantages to the Exporter:

Risk of non-acceptance of documents.

Commercial and country risks not hedged.

Although bill of exchange/draft is accepted by the Importer,

there is no guarantee of payment by the banks involved.Legal enforcement of unpaid obligation costly and time-

consuming.

Advantages to the Importer:

Will receive goods before having to make payment.

Disadvantages to the Importer:

Dishonouring an accepted draft is a legal liability and may ruinbusiness reputation.


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INTERNATIONAL PAYMENTS RISK SPECTRUM

Documentary Collections offer more of a compromise in risk-taking between the Importer and

the Exporter than Clean Payments as illustrated in the diagram below.

LEAST

RISK TO

IMPORTER

HIGHEST

RISK TO

IMPORTER

HIGHEST

RISK TO

EXPORTER

LEAST RISK

TO

EXPORTER

Open AccountDocumentary Collections

Documents Against Acceptance

Documents Against Payment

Payment in Advance


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Letters of Credit

Introduction: What is a Letter of Credit?

Basic Facts:

Revocable & Irrevocable Letter of Credit

Sight & Term Letter of Credit

Confirmed Letter of Credit

Mechanics: How does a Letter of Credit transaction work? Risk Analysis: Advantages & Disadvantages


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Letters of Credit

A Letter of Credit is a written undertaking by the Importers bank, known as the

Issuing Bank, on behalf of its customer, the Importer (Applicant), promising to effect

payment in favour of the Exporter (Beneficiary) up to a stated sum of money, within a

prescribed time limit and against stipulated documents.

A key principle underlying Letters of Credit is that banks deal only in documents and

not in goods. The decision to pay under a Letter of Credit will be based entirely onwhether the documents presented to the bank appear on their face to be in accordance

with the terms and conditions of the Letter of Credit. It would be prohibitive for the

banks to physically check whether all merchandise has been shipped exactly as per

each letter of Credit.

The International Chamber of Commerce (ICC) publishes internationally agreed-uponrules, definitions and practices governing Letters of Credit, called Uniform Customs

and Practice for Documentary Credits (UCP). The last revision of these rules was

effective Jan. 1, 1994 and is referred to as the UCP 500.

I ntroduction:What is a Letter of Credit?


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Letters of Credit

Letters of Credit are eitherRevocable or Irrevocable:

A Revocable Letter of Credit

can be revoked without the

consent of the Exporter,

meaning that it may becanceled or changed up to the

time the documents are

presented. Revocable Letters of

Credit are very rarely used.

An Irrevocable Letter ofCredit cannot be canceled or

amended without the consent of

all parties including the

Exporter. Unless otherwise

stipulated, allLetters of Creditare irrevocable.

Letters of Credit may be settled

either by sight or by acceptance:

If payment is to be made at the

time that documents are

presented, this is referred to as

a sight Letter of Credit.

If payment is to be made at a

future fixed time from the

presentation of documents, this

is referred to as a term Letter

of Credit

Basic Facts: Revocable/I rrevocable & Sight/Term


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Letters of CreditBasic Facts: Confirmed Letter of Credit

Under a Confirmed Letter of Credit, a bank, called the

Confirming Bank, adds its commitment to that of the Issuing Bankto pay the Exporter under the Letter of Credit provided all terms

and conditions of the Letter of Credit are met. The Confirming

Bank is usually located in the same country as the Exporter.

An Exporter would request a Confirmed Letter of Credit if it does

not consider the financial strength of the Issuing Bank or the

country in which it is located to be acceptable risks.


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Letters of CreditMechanics: How does a Letter o f Credi t work?

The mechanics of a Letter of Credit are easily

understood when separated into the following threesteps:

Issuance

Flow of Goods

Flow of Documents & Payment

L tt f C dit


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Letters of Credit:Issuance

After the trading parties agree on a sale

of goods where payment is made byLetter of Credit, the Importer requests

that its bank (the Issuing Bank) issue a

Letter of Credit in favour of the

Exporter (Beneficiary).

The Issuing Bank then sends the Letter

of Credit to the Advising Bank. Arequest may be included for the

Advising Bank to add its confirmation.

The Advising Bank is usually located in

the country where the Exporter does

business and may be the Exporters

bank, but does not have to be.Next, the Advising/Confirming Bank

verifies the Letter of Credit for

authenticity and sends it to the Exporter.

1

Importer applies for

Letter of Credit.

3

Request to advise

& possibly

confirm the

Letter of Credit

Advice

/Confirmation

of the Letter of

Credit.

Advising/

Confirming Bank

Issuing Bank2

4

Exporter/

Beneficiary

Importer/

Applicant

Contract

Negotiations

Note: For the purpose of the Crash Course, the Advising Bank is

also acting as the Confirming Bank. However, the roles of

advising and confirmingthe Letter of Credit may be performedby two separate banks.


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Letters of Credit:Flow of Goods

Upon receipt of the Letter of

Credit, the Exporter reviews the

Letter of Credit to ensure that it

corresponds to the terms and

conditions in the purchase andsales agreement; that the

documents stipulated in the Letter

of Credit can be produced; and

that the terms and conditions of

the Letter of Credit can be

fulfilled. Assuming the Exporter

is in agreement with the above, it

arranges for shipment of the

goods.

GOODS

Exporter/Beneficiary

Importer/Applicant


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Risk Analysis: Letters of Credit

Importer Exporter

Advantages:

An undertaking from the Issuing Bank

that you will receive payment under theLetter of Credit provided that you meet all

terms and conditions of the Letter of

Credit.

Shifts credit risk from the Importer to the

Issuing bank.

Not obligated to ship against a Letter ofCredit that is not issued as agreed.

Disadvantages:

Documents must be prepared in strict

compliance with the requirements

stipulated in the Letter of Credit. Non-

compliance leaves Exporter exposed to riskof non-payment.

Advantages:

Importer is assured that, forthe Exporter to be paid, all

terms and conditions of the

Letter of Credit must be met.

Ability to negotiate more

favourable trade terms with the

Exporter when payment byLetter of Credit is offered.

Disadvantages:

A Letter of Credit assures

correct documents but not

necessarily correct goods.

Ties up line of credit.


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INTERNATIONAL PAYMENTS RISK SPECTRUM

We have completed the International Payments Risk Spectrum. Whereas payment settled via

Open Account and Payment in Advance represent a high degree of risk for one of the parties

involved, both Documentary Collections and Letters of Credit offer a compromise in risks

facing the Importer and the Exporter.

LEAST

RISK TO

IMPORTER

HIGHEST

RISK TO

IMPORTER

HIGHEST

RISK TO

EXPORTER

LEAST RISK

TO

EXPORTER

Open Account


Documents Against Acceptance

Documents Against Payment

Letters of Credit

Unconfirmed

Confirmed

Payment in Advance


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You have almost made it...

You have completed the section of the Crash Course

that deals with the different methods used to effect

payment in international trade.

Now we move to the final objective of the Course: to

look at Guarantees which are often required to support

foreign contracts.


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Guarantees

Introduction: What is a Guarantee?

Basic Facts: Bid, Advance Payment &Performance Guarantees

Mechanics: How does a transaction involving a

Guarantee work?


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Guarantees

I ntroduction: What is a Guarantee?

A Guarantee is issued by a bank on behalf of its customer, the Exporter, as financial

assurance to the Importer to be collected in the event that the Exporter defaults on certain

specified contractual obligations.

The bank that issues a Guarantee will pay the named beneficiary the amount specified on

presentation of a written demand as outlined in the Guarantee.

While there are standard Guarantee formats, Guarantees can be tailored to meet your

specific contractual needs.

Often Standby Letters of Credit are used instead of Guarantees. Standby Letters of Credit

work in much the same way as Guarantees, offering financial assurance to the Importer if

the Exporter defaults on agreed-upon contractual obligations. However, there are at least

two important ways in which Standby Letters of Credit differ from Guarantees :

Standby Letters of Credit are governed by the International Chamber of

Commerces UCP while Guarantees are subject to the laws of the country of the

Issuing Bank.

Banks in several countries, including the United States, are not empowered to issue

Guarantees, and therefore use Standby Letters of Credit instead.


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GuaranteesBasic Facts: Types of Guarantees

These types of Guarantees are commonly requested in foreign contracts:

Bid Guarantee:

An Importer will often ask foreign contract bidders to post a Bid Guarantee as

evidence of serious intent to supply the goods or services if selected. In the event that

the selected supplier is unwilling or unable to carry out the contract, the Importer can

collect the amount of the Bid Guarantee.

Advance Payment Guarantee:

An Advance Payment Guarantee covers the amount of the down-payment the Exporter

requests from the Importer and provides the Importer with some security that, if the

Exporter does not deliver under the terms of the contract, the amount of the down-

payment would be retrievable.

Performance Guarantee:

A Performance Guarantee permits the Importer to draw on the Guarantee if the

Exporter fails to perform according to the terms of the contract. For example, in the

event that the Exporter is unable to complete the contract as agreed halfway through a

project, the Importer is compensated with the amount of the Performance Guarantee.


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Guarantees

During contract negotiations, the

Importer requests that the Exporter

provide a Guarantee securing an aspect

of the contract (e.g. bid, advance

payment). The Exporter (Applicant)

enlists its bank (Issuing Bank) to issuethe Guarantee in favour of the

Importer (Beneficiary) for a specified

amount and within a stated time frame.

In the event of default by the Exporter,

the Importer would demand against the

Guarantee through the Advising Bank.

Mechanics: How does a transaction involving a Guarantee work?

1

Advice of the

Guarantee.

3

Guarantee is sent to a

correspondent bank of

the Issuing Bank for

advice to the Importer.

Applies for

Guarantee.Issuing Bank

Advising Bank

2

4

Exporter/

Applicant

Importer/

Beneficiary

Contract

Negotiations

A correspondent bankis a foreign

bank with which the Issuing Bank

has established a relationship where

secure transactions may be processed.


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Congratulations!

You made it through the Crash Course.

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