Trade Finance

Yudy Yunardy

What you need to know to get going

Sometimes getting a bigger slice of the market means needing more cakes

Having the right contacts in new markets is crucial for those first steps

Objectives

The importance of Trade Finance Distinction between Trade Finance and

regular lending Various sources of Trade Finance Various instruments of Trade Finance Challenges facing various stake holders in

need of Trade Finance

Trade Finance Background

Trade finance is more than regular lending. It refers to innovative financial products and services that assist importers and exporters to fulfill their financing needs

Trade Finance is a source of working capital for many traders in need of financing to procure, process or manufacture products before sale in future

Trade finance is also important for individual traders and firms trading internationally, because it can shape competitiveness of their contract terms

Trade finance is therefore important for any country as it facilitates international trade. As international trade increases, so does the importance of trade finance

Absence of an adequate trade finance infrastructure is, in effect, equivalent to a trade barrier

Importers facing difficulties in accessing trade finance, have limited chance to offer competitive terms to their suppliers the like of advance payment terms, Sight letters of credit, Bills avalized etc.

Conversely, exporters with limited supply of trade finance, will have difficulties in penetrating the market, because while importer may prefer to buy on open account, or on deferred terms, the supplier may not be in position to accept/offer such terms.

Trade Finance Background

Sources of Trade Finance

Commercial Banks Trading Partners (exporter/importer) Specialized house or institutions Government and related institutions

Commercial Banks

Commercial Banks are the main source of trade finance They provide pre-export financing (O/D, Term Loans) They help in the collection process They issue and confirm letters of credit They book acceptance and discounting drafts They offer fee-based services such as providing credit

and country information on buyers Other roles played by commercial banks include

Taking foreign exchange risks (spot, forward, swap etc) Taking market risks (options)

Commercial Banks

Loans

Overdraft, Term Loans

Take currency risks (Spot, Swap, forward, Options)

Take market risks (Price risk options, future, forward)

Commercial Banks

Settlement

(Terms of payments, Open A/C, Advance payments, Collections, L/C)

Summary of trade finance sources from Commercial Banks: Loans facilities, which may take the form of Working capital or

overdraft and Term loan facilities Off balance sheet financing:

Issuing performance, bid, custom, advance payment bonds etc Opening letters of credit Accepting and confirming letters of credit Bills Avalisation

Discounting documents under letters of credit Advance under red clause letters of credit Structured Finance

Commercial Banks

Trading Partners (exporter/importer) Supplier may offer credit to a buyer by releasing goods to a

buyer against bills of exchange, by which a seller can get an undertaking from the buyer to pay at a specified future date

Alternatively may decide to release the goods against promissory notes, in which a buyer promises to pay at a future date, but which offer less legal protection as compared to the bill of exchange

Under counter trade arrangements valued goods are exchanged at an agreed value without cash or credit terms, involving a barter-exchange, counter-purchase, or buy-back

Specialized house or institutions Specialized house or other trading institutions

may under forfaiting arrangement purchase from exporters receivables without recourse at a discounted rate to allow exporter access financing before maturity of the bill. In this case the receivable becomes a tradable security

Government and related institutions Governments, and other institutions like

World Bank, regional bank, community bank can be good source of trade finance especially in less developed economies where financial markets and money markets are underdeveloped

Establish scheme of guarantees to support exporters

Establish floating line of credit to support imports for and exports from specific sectors, e.g. confirmation line

Establish guarantees schemes for SME, Micro group

Embark on support policies, e.g. tax deferral for export

Government and related institutions

Instruments of Trade Finance

Letters of Credit (Documentary Credit) Bank Guarantees Pre and Post shipment finance loan facilities Buyers and Sellers credit Bills Acceptance and Avalisation Structured Finance Leasing Factoring and Forfaiting Countertrade

Letters of Credit - Definition

A Letter of Credit is a conditional undertaking issued by a bank, at the request of one of its customers, to pay a named beneficiary a specified amount of money upon presentation of documents that comply with the terms and conditions stated therein

Letters of Credit – Types

Import letter of credit/Documentary Credit Import

Import letter of credit off-shore issuance Export letter of credit/Documentary Credit

Export Commitment to pay/accept negotiate Bank to bank reimbursement Reimbursement undertaking 

Import Letter of Credit Import Letter of Credit is a term used to

describe a Documentary Credit Import (Commercial Letter of Credit) from the point of view of the importer and the issuing bank

LCs may be payable at sight or at a date in the future

Letters of Credit – Types

Documentary Credit Import A documentary credit is an irrevocable undertaking

issued by a bank, at the request of one of its customers, to pay a named beneficiary a specified amount of money upon presentation of documents in compliance with the terms and conditions stated in the Letter of Credit

An Import Documentary Credit constitutes a credit exposure on the customer

Letters of Credit – Types

Import Letter of Credit Off-Shore Issuance A variant in the processing of the Import LC is the

Offshore Issuance. This is an efficient way of issuing LCs, which eliminates the use of multiple banks in the transaction

The bank requests its foreign branches, mostly in the country of the beneficiary, to issue LCs directly to the beneficiary

The client-facing branch carries the credit risk of the buyer

Letters of Credit – Types

Export Letters of Credit Export LC is a term used by an exporter to

describe a Documentary Credit Export that is a Commercial LC

Export LCs may be payable at sight or at a date in the future

Letters of Credit – Types

Documentary Credit Export A documentary credit is an irrevocable

undertaking issued by a bank, at the request of one of its customers, to pay a named beneficiary a specified amount of money upon presentation of documents in compliance with the terms and conditions stated in the LC

Letters of Credit – Types

Confirmed Letters of Credit A confirmation to a Credit constitutes a definite

undertaking of the Confirming Bank, in addition to that of the Issuing Bank, provided that the stipulated documents are presented to that Confirming Bank and that the terms and conditions of the LC are complied with

An export LC only constitutes a credit exposure on the bank if the credit is confirmed

Letters of Credit – Types

Commitment to Pay/Accept Negotiate A variant of the advising of the LC is the

Commitment to Pay/Accept Negotiate. This is also known as a silent confirmation

This represents a commitment by the bank to an exporter to pay or negotiate or accept documents on a without recourse basis, provided the terms and conditions of the LC have been complied with

Letters of Credit – Types

Bank to Bank Reimbursement/Clean Reimbursement

This is a reimbursement service offered to branches or other banks, whereby the bank administers processes and settles claims made under Letters of Credit issued by such other branches or banks

There is no commitment issued by the bank, but the bank has the obligation to process and pay a claim if previously authorised by the LC issuing bank, provided sufficient funds or cover are available

Letters of Credit – Types

Reimbursement Undertaking This is a reimbursement service offered to branches

or other banks, whereby the bank administers processes and settles claims made under LCs issued by such other branches or banks

The Undertaking is an irrevocable commitment issued by the bank but the bank has the obligation to process and pay a claim if previously authorised by the LC issuing bank

Letters of Credit – Types

Do not cover the direct purchase of merchandise

Based on the underlying principle of LC that payment is made against presentation of documents, not necessarily shipping documents but whatever docs the applicant, beneficiary, and issuing bank may agree to

The party requesting a bank to issue an SBLC (the applicant) need not be involved in a commercial transaction at all

SBLC are payable against the presentation of documents as simple as a certificate from the beneficiary stating that the applicant has not performed some act, has not complied with a specific contract or other agreement, or has defaulted either in payment for certain goods and services or in making repayment on a loan

Standby Letters of Credit

Guarantees are Legal transactions that are unrelated to the underlying transactions

Individual commitment from Issuing Bank to pay a specified amount to thebeneficiary with the conditions set out in the guarantee

Bank that issues the guarantee may not take into objections raised either byprincipal or a third party when performing its payment obligation

In the case of disputes - unless otherwise stipulated- the law of the issuer’s countryshall prevail in the matters that are not regulated in the wording of the guarantee

In the event that the contracting parties are unable to agree on the selection of thelaw applicable to the bank guarantee, the solution may be to use a so calledstandby letter of credit (regulated by ISP98 or UCP500)

Guarantee

Bid Bond/Tender Bond

To participates in international public tenders, Company usually has to submit a bid bond along with its offer

This ensures payment of the guaranteed amount in the event of :

the bid being withdrawn before the due date

the contract not being accepted by the party submitting the bid after the contract has been awarded

the bid bond not being replaced by a performance bond after the contract has been awarded

Guarantee

Performance Bond

The Bank undertakes to pay the beneficiary the guaranteed amount at the request of the seller in the event that the supplier does not fulfil his contractual delivery obligations or does not fulfil them as per the terms of the contract

Guarantee

Payment Guarantee

This is used especially with deliveries against open account payment and can be issued to secure the full payment of the delivery of the goods or services.

The beneficiary can claim the guarantee by declaring in writing that he delivered the goods but had not received payment by the due date

Guarantee

Advance Payment Guarantee

The payment conditions for large export orders often stipulate that the buyer has to pay for the raw materials and the manufacturing costs in advance

However, prepayment of this kind is only made after the buyer has received an Advance payment guarantee, which stipulates that the prepayment will be reimbursed in the event of the seller not meeting his contractual delivery obligations and or/not providing the agreed services

Guarantee

Post Import FinanceFinancing provided for settlement of purchase under Letters of Credit

Pre-Export FinanceFinancing provided for processing of goods/shippingIt may be based on Purchase Order or Letters of Credit (given up to 90% of LC)

Post-Export FinanceFinancing provided after submission of export bills

- Collection (D/P and D/A) - LC (sight and usance)

* Discrepant

Trade Finance

Post Import Financing

Buyer Supplier

Issuing Bank Negotiating Bank

$$

REQUEST

IMPORT EXPORT

LC Issuance

LC AdvisingLC Application

Export Bills

Checking BillsChecking Bills

Request PIF

Release Docs

Send Bills

Settlement LC

Post Export Financing

Buyer Supplier

Issuing Bank Negotiating Bank

$$

IMPORT EXPORT

LC Issuance

LC AdvisingLC Application

Export Bills

Checking BillsChecking Bills

Settlement

Release Docs

Send Bills

Post Export Finance

SETTLE FINANCING

The Bank adds our guarantee (aval) to a draft accepted by a buyer. This relates to transaction conducted under documentary collection (document against acceptance)

This is similar to our acceptance in LC

Avalisation

Avalisation

Buyer Supplier

Collecting Bank Payment Bank

SWIFT Confirmation - AVAL

$$

DOCUMENTS SENT FROM SUPPLIER TO BUYER

THROUGH BANKS

BUYER ACCEPT AND ENDORSED BoE

BANK ADD OUR AVAL : OBLIGATION TO PAY ON

MATURITY DATE

SWIFT CONFIRMATION SENT TO SUPPLIERS BANK

AVAL BANK TO PAY TO SUPPLIER ON MATURITY DATE

AVALISATION LIMIT IS REQUIRED

RISK IS THE SAME ASBILL ACCEPTANCE

BoE

AVA

L

Structured trade finance

Structured Trade Finance (STF) is a specialised activity dedicated to the financing of high-value supply chains, especially upstream financing of cross-border commodity flows and limited recourse trade finance. Every loan is bespoke with each facility tailored to the specific needs of client, transaction and jurisdiction. STF facility structures can provide short term working capital or longer term funding with loans of up to five years or more

Funding requirements

Upstream Financing Pre-export finance (including

Contract Pre-payment) Tolling and processing Funding investment in capital

equipment or production assets Development or refurbishment of

production facilities (with or without project risk)

Downstream Financing Warehouse finance (for inventories

of exchange traded commodities) Receivables finance (for trade and

other receivables) Borrowing Base finance (funding a

revolving asset base) Provision of payment guarantees

for sellers of crude oil and refined products

The tools and techniques of STF are used extensively in the commodity-related sectors for the benefit of producers, processors, traders and industrial end-users alike to meet a diverse range of funding requirements which include:

Leasing

A lease or tenancy is the right to use or occupy personal property or real property given by a lessor to another person (usually called the lessee or tenant) for a fixed or indefinite period of time, whereby the lessee obtains exclusive possession of the property in return for paying the lessor a fixed or determinable consideration (payment)

Factoring

Factoring is a form of commercial finance whereby a business sells its accounts receivable (in the form of invoices) at a discount. Effectively, the business is no longer dependent on the conversion of accounts receivable to cash from the actual payment from their customers, which takes place on typical 30-to-90-day terms. Businesses benefit from the acceleration of cash flow by obtaining cash from the factor equal to the face value of the sold accounts receivable, less a factor's fee.

Factoring is considered off balance sheet financing in that it is not a form of debt or a form of equity. This fact makes factoring more attainable than traditional bank and equity financing.

There are usually three parties involved when an invoice is factored:

Seller of the product or service who originates the invoice.

Debtor is the customer of the seller (i.e., the recipient of the invoice for services rendered who promises to pay the balance within the agreed payment terms).

Factor (the factoring company)

Factoring

Forfaiting is the discounting of international trade receivables on a without recourse basis

Forfaiting

Forfaiting

Forfaiting, or Medium-Term Capital Goods Financing, means selling a bill of exchange, at a discount, to a third party, the forfaiter, who collects the payment from an, essentially, overseas customer, through a collateral bank(s), and, thus, assuming the underlying responsibility of exporters and simultaneously providing trade finance for importers by converting a short-term loan to a medium term one

Countertrade

Countertrade is exchanging goods or services that are paid for, in whole or part, with other goods or services

There are five main variants of countertrade:

Barter: Exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment

Switch trading: Practice in which one company sells to another its obligation to make a purchase in a given country

Counter purchase : Sale of goods and services to a country by a company that promises to make a future purchase of a specific product from the country

Buyback : Export of industrial equipment in return for products produced by that equipment

Offset : Agreement that a company will offset a hard - currency purchase of an unspecified product from that nation in the future

Countertrade - Types

Challenges

Lack of Security/Collaterals Absence of counter party willing to offer financing

alternatives outside the banking system Promissory notes, Bill of Exchange, Counter trade,

Forfeiting, Suppliers credit etc High costs of borrowing to compensate banks for

credit risks (Interest rates, application fee, facility fee)

Regulatory issues Difficulties for importers and banks to comply with

regulatory requirements e.g. Foreign currency controls Compliance to terms of Trade

Documentations

Absence of reliable Market information about Counter party risks and trading requirements

Missing link to buyers and sellers (Financial institutions link)

Infrastructure gap Transportation, Storage, Clearing & forwarding

especially commodities Price Volatility for export

Challenges

Poor negotiations skills for some importers/exporters which have caused them to become victims of unfavorable terms in international trade Overseas supplier insist on Advance payments,

while Exporters are forced to accept Open account terms

While overseas suppliers require L/C’s confirmed by first class bank, few of the L/C’s in favour of suppliers in Tanzania will request for confirmation

Bank charges are not shared equally

Challenges

LC - UPAS (Usance Paid at Sight)

LC allows for beneficiary to claim payment at sight, even though LC is

issued as Usance LC

Benefit (to beneficiary) :

Provide flexibility to applicant and beneficiary

Risk involved :

Issuing Bank : Applicant risk of non payment (on maturity)

Mitigation :

Provided selectively

UPAS – Usance paid at sight

Buyer Supplier

Issuing Bank Negotiating Bank$$

IMPORT EXPORT

LC Issuance

LC AdvisingLC Application

Export Bills

Checking BillsChecking Bills

Acceptance

Release Docs

Send Bills

Settlement LC

BoE

CountryRisk

IndustryRisk

TradingRisk

CurrencyRisk

Bank Risk

Transferable LC

APPLICANT BENEFICIARY

Transfer able LC

BENEFICIARIES

LC

LC

Transfer LC

LC Issued LC received & transferred

Without Recourse

An individual who endorses a check or promissory note using the phrase without recourse specifically declines to accept any responsibility for payment. By using this phrase, the endorser does not assume any responsibility by virtue of the endorsement alone and, in effect, becomes merely the assignor of the title to the paper

Off Balance Sheet

Off balance sheet usually means an asset or debt or financing activity not on the company's balance sheet. It could involve a lease or a separate subsidiary or a contingent liability such as a letter of credit. It also involves loan commitments, futures, forwards and other derivatives, when-issued securities and loans sold

Bill of Exchange - Sample

Promissory Note - Sample

Distribution Channel/Client Group Combination Delivery Channels

The delivery channels used for these products are:

Max Trad SWIFT Fax

Product Risks

The following tools are used to assess product related risks:

AIM policies and standards Business cases Product Approval Committee Operational Risk Assessment Procedure Risk Self Assessment Audit reports  

The following product risks are subject to Risk Management methods (if applicable):

Customer risk Country risk Credit risk Information Technology risk Insourcing risk Liquidity risk Market risk Operational risk Outsourcing risk Reputation risk (as part of the product integrity) Strategic Business risk (a.o. sustainability, effects on the bank's

results/equity)  

Product Risks