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


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

    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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