INTERNATIONAL TRADE FINANCE

1. INTERNATIONAL TRADE FINANCE • Topics to be Discussed • Letters of Credit • Uniform practices for Letters of Credit • Standby Letters of Credit • Alternative Methods of Guaranteeing Performance • Alternative Methods of Financing • Seller • Buyer • Government Programs

2. International Trade Most Medium and large companies are heavily involved in international trade (exporting and importing), so it is important to know how it works and the risks involved. 2

3. The nature of the relationship between the exporter and the importer is critical to understanding the methods for import-export financing utilized in industry. The composition of global trade has changed dramatically over the past few decades, moving from transactions between unaffiliated parties to affiliated transactions. Trade Relationships 3

4. Trade Relationships 4

5. Trade Dilemma 5

6. The fundamental dilemma of being unwilling to trust a stranger in a foreign land is solved by using a highly respected bank as an intermediary. The following exhibit is a simplified view involving a letter of credit (a bank’s promise to pay) on behalf of the importer. Two other significant documents are a bill of lading and a sight draft. Trade Dilemma 6

7. Solving the Trade Dilemma 7

8. This system has been developed and modified over centuries to protect both the importer and exporter from: The risk of non-completion Foreign exchange risk And, to provide a means of financing Solving the Trade Dilemma 8

9. LETTERS OF CREDIT • Letters of Credit a commercial bank guarantee of either payment by the buyer or performance by the seller. • Purposes • Guarantees payment by the buyer (letter of credit) or to guarantee performance by seller (standby letter of credit. • Once letter of credit is issued, the seller can use instrument to finance production of goods.

10. A letter of credit (L/C) is a bank’s conditional promise to pay issued by a bank at the request of an importer, in which the bank promises to pay an exporter upon presentation of documents specified in the L/C. An L/C reduces the risk of non-completion because the bank agrees to pay against documents rather than actual merchandise. Letter of Credit 10

11. Letters of credit are also classified as: Irrevocable versus revocable Confirmed versus unconfirmed The primary advantage of an L/C is that it reduces risk – the exporter can sell against a bank’s promise to pay rather than against the promise of a commercial firm. The major advantage of an L/C to an importer is that the importer need not pay out funds until the documents have arrived at the bank that issued the L/C and after all conditions stated in the credit have been fulfilled. Letter of Credit 11

12. Letter of Credit 12

13. LETTERS OF CREDIT • Functions of Letters of Credit • Payment Instrument • In absence of letter of credit, sight or time drafts used. No Guarantee of Payment. • Letters of Credit Involves Bank in Transaction. • Performance Guarantee • In Documentary Transaction no guarantee of performance. • Payment by bank would not be released until goods and document conforms to specifications on letter of credit. • Finance Instrument • Seller can use letter of credit as collateral to finance production and exportation of good.

14. LETTERS OF CREDIT • Types of Letters of Credit • Irrevocable Letter of Credit-bank cannot revoke letter of credit. To change letter of credit, must get written agreement. • Most Popular in International Commercial Transaction • Revocable Letter of Credit-bank can revoke letter of credit. • Very Seldom Used. • Standby Letter of Credit

15. LETTERS OF CREDIT • Letter of Credit Transaction • After formation of contract, buyer arranges for bank to open letter of credit. • Buyer’s bank prepares irrevocable letter of credit. • Buyer’s bank sends irrevocable letter of credit to a US bank for confirmation. • US bank prepares a letter of confirmation to exporter along with irrevocable letter of credit • Exporter arranges for freight forwarded to deliver goods. Freight Forwarder prepares documents. • Exporter presents document to Bank indicating full compliance. Bank bound by “rule of strict compliance” • Bank reviews documents and authorizes payment

16. UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS • Uniform Customs and Practices for Documentary Credits are rules and procedure published by International Chambers of Commerce • Provisions • Care should be taken in specifying expiration dates • The applicant must specify if the letter of credit is transferable. • The applicant must specify that the letter be confirmed • The currency of the letter of credit should be designated using ISO currency code. • The applicant should designate the nominating bank

17. UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS • Uniform Customs and Practices for Documentary Credits-provisions continued. • Applicant must specify clearly whether the letter of credit will be available for partial shipment. • The letter of credit should provide transport details • Under “rule of strict compliance”, banks are authorized to reject documents if there are any discrepancies.

18. UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS • Uniform Customs and Practices for Documentary Credits-provisions continued • Description of the Goods should be clear and brief as possible. • Transportation Documents must be clear. • Insurance Documents must be clear. • Time periods for presentation of documents must be specified. • Title of Letter of Credit should specify irrevocable.

19. STANBY LETTER OF CREDIT • Standby Letter of Credit is a letter of credit that represents an obligation to the beneficiary on the part of the issuer • International Standby Practices • Standby Letters of Credit secures contractual obligations in construction contracts, service contracts, warranties, counter-trade trade obligations, secures international loans and supplies.

20. ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE • Alternative Methods of Guaranteeing Performance - Types • Performance Bond-a guarantee from an insurance company to pay insured in case of default. • Bid Bond-insure against the risk that a bidder may not honor its bid. • Credit Surety-guarantees the repayment to a bank or lender who finances an export transaction or development project. Exim Bank of World Bank

21. ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE • Types-Continued • Retention Fund-in large or government projects, a percentage is deducted from each payment due to the supplier or contractor and is retained in a fund pending completion of project. • Demand Guarantee secures performance of a non-monetary obligation.

22. SOURCES OF TRADE FINANCE • Commercial Banks - Export Financing • Borrowing against trade documents • Factoring-exporter transfers title to its account receivable to a factoring company at a discount. • Factoring (Invoice discounting) -selling at a discount, of longer term receivables or promissory notes to a buyer or financier. • Transferable Credit-suppliers accept part of the letter of credit that seller receives from buyer in export transaction. • Back to Back Letter of Credit-buyer makes arrangements with third bank to make loan.

23. SOURCES OF TRADE FINANCE • Government Assistance Programs • ECGD in UK • Other EU countries have similar government assisted programmes • Eximbank in United States- • Arranges loans, guarantees, working capital and insurance • Small Business Administration • Revolving line of credit

24. Insurance Schemes • Foreign Corporation Insurance Agency • Protects against default on exports sold under open accounts • Overseas Private Insurance Corporation • Offers performance bonds • Other Countries • Most have some insurance to protect either party. The seller against not getting paid and the buyer for defective goods.

25. In order to finance international trade receivables, firms use the same financing instruments as they use for domestic trade receivables, plus a few specialized instruments that are only available for financing international trade. There are short-term financing instruments and longer-term instruments in addition to the use of various types of barter to substitute for these instruments. Trade Financing Alternatives 25

26. Another key document for financing international trade is the bill of lading or B/L. The bill of lading is issued to the exporter by a common carrier transporting the merchandise. It serves three purposes: a receipt, a contract and a document of title. Bills of lading are either straight or to order. Bill of Lading 26

27. The word countertrade refers to a variety of international trade arrangements in which goods and services are exported by a manufacturer with compensation linked to that manufacturer accepting imports of other goods and services. In other words, an export sale is tied by contract to an import. The countertrade may take place at the same time as the original export, in which case credit is not an issue; or the countertrade may take place later, in which case financing becomes important. Countertrade 27

28. The End