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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.
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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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Documentary Collections
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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Documentary Collections
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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Documentary Collections:
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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Documentary Collections:
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
Documentary Collections
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.