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IF YOU CAN’T DODGE A RISK, HEDGE IT Mitigating Risks in International Payment and Collection. September 19, 2007 National Association of Credit Managers Gateway Regional Conference Presented By: Jennifer Schwesig Armstrong Teasdale, LLP. INTRODUCTION.

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if you can t dodge a risk hedge it mitigating risks in international payment and collection

IF YOU CAN’T DODGE A RISK, HEDGE ITMitigating Risks in International Payment and Collection

September 19, 2007

National Association of Credit Managers

Gateway Regional Conference

Presented By:

Jennifer Schwesig

Armstrong Teasdale, LLP

introduction
INTRODUCTION
  • Laws applicable to bankruptcy, insolvency, security interests, and creditor and debtor rights vary drastically from country to country
  • Problems involving collections are more readily avoided before credit is extended
key issues in international trade financing
KEY ISSUES IN INTERNATIONAL TRADE FINANCING
  • Arranging for and receiving payment
  • Foreign exchange risks and controls
  • Collections
minimizing international credit risks
MINIMIZING INTERNATIONAL CREDIT RISKS
  • Risk of non-payment and collection increases in international transactions
  • May be difficult to check overseas buyer for creditworthiness
  • Goal is to minimize or eliminate the risk of non-payment or inability to receive payments
  • Determining the payment method, financing and other key terms is important
minimizing international credit risks1
MINIMIZING INTERNATIONAL CREDIT RISKS
  • Credit Risk Reduction Methods:
    • Credit Checks
    • Payment Types
    • Export Credit Guarantees and Insurance
    • Proper Documentation/Agreements
minimizing credit risks
MINIMIZING CREDIT RISKS
  • Credit Checks
    • Know the exact entity or individual you are dealing with
    • Check buyer’s credit history (if possible)
      • Reliable up-to-date information may be difficult to find
    • Suggestions:
      • Department of Commerce International Company Profile (ICP)
      • Local U.S. embassies (commercial divisions)
      • Private credit reporting services
minimizing credit risks1
MINIMIZING CREDIT RISKS
  • The type of payment works to increase or decrease credit risks
  • Types of payments
    • Open Account
    • Advance payment
    • Documentary Sales
    • Letters of Credit
    • Bills of Exchange (Draft)
    • Trade & Bank Acceptances
    • Conditional Sales Arrangements
minimizing credit risks2
MINIMIZING CREDIT RISKS
  • Open Account
    • Least secure method
    • Seller sends goods with invoice for payment
    • Advantages
      • reduction in transaction costs
      • works well with high volume shipping
    • Disadvantages
      • Perform significant credit checks on buyer (credit risks)
      • Seller loses control of goods when dispatched (shipping terms imp.)
      • Buyer may refuse to accept delivery
      • Seller must wait for payment until after the buyer has received goods
      • No risk to buyer
    • Supplement rights with title retention clause
minimizing credit risks3
MINIMIZING CREDIT RISKS
  • Best Practices for Open Account
    • Seller
      • No open account when buyer is new or cannot determine risk and reliability of buyer
      • Goods are delivered before 1st payment
      • Make sure to supply goods or services consistent with a good contract dealing with disputes and non-payment
      • Insist on an electronic transfer (cleared funds) instead of a bank draft or check
      • Define credit terms
    • Buyer
      • Inspect goods before making a payment
      • Make payment within agreed credit terms
minimizing credit risks4
MINIMIZING CREDIT RISKS
  • Advance Payment
    • Time of payment: before shipment
    • Goods available to buyers: after payment
    • Risk to exporter: none
    • Risk to importer: relies on exporter to ship goods as ordered
  • Best Practices for Advance Payment
    • Seller
      • Provide clear payment instructions (SWIFT)
      • Avoid accepting bank drafts or company checks
    • Buyer
      • Avoid this arrangement, use letter of credit instead
minimizing credit risks5
MINIMIZING CREDIT RISKS
  • Documentary Sales
    • 2 types
      • documents against payments
      • documents against acceptance
    • Helps avoid some risks in open account transaction
    • Seller uses carrier to withhold delivery of goods until buyer pays or signs a negotiable instrument to pay
    • Transaction
      • Seller ships goods and forwards draft & bill of lading (BOL)
      • Correspondent of seller’s bank notifies buyer of receipt of goods
      • Buyer pays depending on sight draft or time draft
      • Correspondent delivers BOL to buyer for buyer to claim goods
    • The BOL allows for title transfer only after payment is received
minimizing credit risks6
MINIMIZING CREDIT RISKS
  • Documents Against Payments
    • Time of payment: on presentation of draft
    • Goods available to buyer: after payment
    • Risk to exporter: If draft unpaid, must dispose of goods
    • Risk to importer: relies on exporter to ship goods as described
  • Documents Against Acceptance
    • Time of payment: on maturity of draft
    • Goods available to buyer: before payment
    • Risk to exporter: relies on buyers to pay drafts
    • Risk to importer: relies on exporter to ship goods as described in documents
minimizing credit risks7
MINIMIZING CREDIT RISKS
  • Bills of Exchange (Draft)
    • Unconditional order directing buyer to pay a fixed sum on a determined date (like check, except gives title to goods)
    • Usually used in conjunction with documentary sale
    • By accepting the draft, the buyer acknowledges the obligation to pay
    • Common payment terms 30-90 days after sight
    • Seller presents draft and any documents to bank in order to obtain endorsement, use of overseas bank correspondent and collection facilities.
    • Common documents with draft = BOL, commercial invoice, packing list, insurance etc.
minimizing credit risks8
MINIMIZING CREDIT RISKS
  • Best Practices Documentary & Bills of Exchange
    • Seller
      • Make sure satisfied with buyer and country risks
      • Make sure goods and services supplied in accordance with contract terms
      • Make sure collection instructions clear and identical to terms agreed upon in the contract
    • Buyer
      • When asked to pay or accept bill of exchange, make sure consistent with contract
      • Make sure satisfied with goods or services before instructing bank to pay or accept bill of exchange
      • Make sure correct documents received to obtain goods
minimizing credit risks9
MINIMIZING CREDIT RISKS
  • Letters of Credit
    • Most widely used method of international payment
    • Different types (documentary/commercial, standby etc.)
    • Instrument whereby a bank furnishes credit in place of the buyer’s credit
    • Autonomous document separate from the contract
    • Procedure
      • Underlying contract provides payment to seller via LOC
      • Buyer arranges for bank to open LOC for the benefit of the seller
      • LOC has precise instructions which provide payment against the delivery of a full set of documents
      • Payment made upon delivery of documents
minimizing credit risks10
MINIMIZING CREDIT RISKS
  • Documentary LOC (Commercial LOC)
    • Bank makes payment on presentment of documents detailed in LOC
    • Normally BOL, Insurance, draft & certificate of origin
  • Standby LOC (used in lieu of bank guarantee)
      • Payment made in the event buyer fails in obligation to pay
      • Seller provides documents evidencing default
      • Cost =1-3% of the transaction
  • Forms
    • Revocable v. Irrevocable
      • Revocable not enforceable, don’t use
    • Confirmed v. Unconfirmed
      • Confirmed if unfamiliar with overseas bank
    • Back-to-Back
      • Issued upon the security of an existing LOC
minimizing credit risks11
MINIMIZING CREDIT RISKS
  • Best Practices LOC
    • Seller
      • Make sure local bank as authenticated the LOC
      • Examine the LOC carefully for consistency with sales contract
      • Make sure to present all documents named
    • Buyer
      • Check credit for LOC
      • Consistency with contract
      • All necessary documents
      • Insist on terms to protect interests such as late payment dates etc.
minimizing credit risks12
MINIMIZING CREDIT RISKS
  • Other Payment Mechanisms
    • Title Retention
      • Best if goods easily identifiable and not incorporated into a finished product
      • Seller retains ownership of goods until purchase price is paid in full
      • Pay attention to INCOTERMS
    • Conditional Sales
      • If buyer defaults seller may rescind contract
    • Security Interest
      • Seller is granted a security interest in goods (more common when sale is financed, but local laws vary)
    • Promissory Note
      • Buyer’s obligation documented by promissory note
    • Still may be difficult to physically reclaim goods
minimizing credit risks13
MINIMIZING CREDIT RISKS
  • Trade and Bank Acceptances
    • Promise by drawee of the draft to pay instrument when it matures
    • Provides short-term fixed rate financing
    • Trade acceptance
      • Bank as drawee
      • Before acceptance drawee has no obligations
      • Holder can only enforce the draft is the draft is dishonored
      • Once acceptance occurs, drawee primarily liable to holder
    • Bank Acceptance
      • Non-interest bearing draft drawn by company on bank
      • Acceptance occurs by stamp approval with signature of bank
      • If bank honors acceptance, buyer must put funds in bank before payment is due
minimizing credit risks14
MINIMIZING CREDIT RISKS
  • Conditional Sales Arrangements (Contractual)
    • Seller retains ownership of goods until purchase price is paid in full
    • If buyer defaults seller may rescind contract
    • Seller often granted a security interest in goods
    • Buyer’s obligation documented by promissory note
    • Useful where buyer is end user and goods sold are easily identifiable & nonperishable
    • Still may be difficult to physically reclaim goods
minimizing credit risks15
MINIMIZING CREDIT RISKS
  • Export Credit Insurance
    • Involves insuring exporters against
      • Commercial risks
        • Non-acceptance of goods by buyer
        • Failure of buyer to pay debt
        • Failure of banks to honor documentary credits
      • Political risks
        • War, riots etc.
        • Change of government policy or political party
        • Blockage of foreign exchange (i.e. exchange controls)
        • Currency devaluation (i.e. Argentina)
minimizing credit risks16
MINIMIZING CREDIT RISKS
  • Export Credit Guarantees
    • Issued by financial institution (banks) or government agency (EXIM Bank in U.S.)
    • Assistance for companies without sufficient track records to obtain credit from banks for exports
    • Instruments to safeguard export-financing banks from losses that may occur from providing funds to exporters
agreements documentation
AGREEMENTS/DOCUMENTATION
  • INCOTERMS (2000) ICC
    • Standard trade definitions most commonly used in international sales contracts.
  • Uniform Customs and Practice forDocumentary Credits
    • UCP500 is the standard practices guideline for letters of credit
    • Standards to be followed by banks in examining LOCs
    • Applies only to LOCs referencing UCP text
  • eUCP
    • In November 2002, ICC published a new guide called eUCP to supplement UCP500 for electronic transactions
  • International Standby Practices (ISP98)
    • Governs standby LOCs in place of UCP which focuses more on commercial letters of credit
agreements documentation1
AGREEMENTS/DOCUMENTATION
  • Important to document transaction whether it is in the form of a simple purchase order or formal contract (attention to both sales and purchase forms)
  • Signed and notarized by both parties
  • Key clauses that can affect payments:
      • Title
      • Payment (currency)
      • Choice of Law
      • Choice of Forum
      • Assignability of account
agreements documenation
AGREEMENTS/DOCUMENATION
  • Title
    • Passage (Where do you want title to pass & is that consistent with the INCOTERM used?)
    • Retention (include specific language in contract)
  • Assignment of Accounts
    • Allow for assignment by seller and look for purchaser prohibitions
  • Payment
    • Note currency of contract to avoid exchange risks
    • Be specific in description of payment terms ($ recommended)
  • Choice of Law (Provision that specifies applicable law is essential)
      • Avoid uncertainty as to applicable laws
      • Usually enforceable if reasonable nexus
      • Certain issues still decided by local law
  • Choice of Forum
    • Litigation or binding arbitration?
    • Designate arbitration body and applicable rules which differ from internal rules (ICC, AAA etc.)
foreign exchange risks
FOREIGN EXCHANGE RISKS
  • In addition to forms and types of payments, collection efforts are also significantly affected by:
    • Foreign Exchange Risks
    • Foreign Exchange Controls
foreign exchange risks1
FOREIGN EXCHANGE RISKS
  • General Foreign Exchange Risk
    • Risk of loss on account of change in Forex rates during a particular period of time
    • Liability to make a future payment in foreign currency
    • Asset denominated in foreign currency
      • Overseas subsidiaries
    • Debt payable in foreign currency
      • Risk for both creditor and debtor
foreign exchange risks2
FOREIGN EXCHANGE RISKS
  • Corporate Forex Risks
    • Transaction Exposure
      • Input material of component denominated in foreign currency, manufactured domestically or finished product is for export
    • Operational Exposure
      • Effect of exchange rate on revenue and expenditures and income statement
      • Profits earned outside U.S. and converted to $
    • Translation Exposure
      • Multinationals risk associated with foreign assets & liabilities
      • Consolidated statements in common representative currency
      • Forex value of assets and liabilities must be translated into reporting currency
foreign exchange risks3
FOREIGN EXCHANGE RISKS
  • Hedging Foreign Exchange Risks Should the risk be hedged?
      • Size of the risk/transaction
      • Amount of time involved
      • Amount of money
      • Stability of foreign currency involved
      • Presence of exchange controls
foreign exchange risks4
FOREIGN EXCHANGE RISKS
  • Basic Hedging Techniques
    • Payment and sales in U.S. $ or home country currency, risk is transferred to other party
    • Internal hedge
      • Purchase amount of foreign currency needed for transaction at the time the transaction is consummated
    • Acquire asset denominated in foreign currency that equals liability
foreign exchange risks5
FOREIGN EXCHANGE RISKS
  • Basic Hedging Techniques (cont)
    • Forward Exchange Contracts
      • Agreement between 2 parties that obligates them to exchange at a specified future date (settlement date) at an agreed upon price
      • Different than futures contracts which have standard contract sizes, time periods, settlement procedures and are traded on regulated exchanges throughout the world.
      • Forward exchange clause within a contract
      • Examples:
        • Date is determined (end of month, specific date etc.)
        • Rate is fixed (watch out for transfer pricing with related parties
        • If rate fluctuates parties will renegotiate prices
foreign exchange controls
FOREIGN EXCHANGE CONTROLS
  • Risk regarding access to foreign currency
  • Government controls the availability or use of foreign currency for capital transfers & payment for current transactions
  • Forms:
    • Laws, regulations & other measures by state
    • typically through the central bank
    • Restricts availability or use of forex (directly or indirectly)
    • Domestic interest rates high to attract foreign capital and vice versa
  • Result:
    • May have restrictions on access to forex
    • Inability to pay in dollars
    • May lose dollar denominated contracts (Argentina)
dealing with default
DEALING WITH DEFAULT
  • Collecting payments overseas can be difficult and expensive
    • Negotiate with the customer first
    • Consider formal collection actions when:
      • Other remedies have been exhausted
      • The amount involved enough to warrant collection efforts
dealing with default1
DEALING WITH DEFAULT
  • Common Collection Actions:
    • Legal proceedings (vary throughout the world)
    • Arbitration (preferable from an international collection standpoint)
    • File Claim
slide35

Jennifer Schwesig

Armstrong Teasdale, LLP

One Metropolitan Square

211 N. Broadway, Suite 2600

St. Louis, MO 63102

(314) 259-4710

[email protected]

www.armstrongteasdale.com

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