1 Chapter 1b Instructor Shan A. Garib, Winter 2013

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  A kind of written document issued by a bank on application of the importer in which the bank promises to pay an exporter on certain conditions.  Importer assured money wont be released and exporter assured product wont be released until conditions met (authourized)

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  written document issued by a bank on application of the importer  the bank promises to pay an exporter on certain conditions.  Importer assured money wont be released and exporter assured product wont be released until conditions met (authorized)

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  Replace the PMT obligation of importer with that of the bank AND the banks must verify terms and conditions have been met before authorizing PMT  Banks DO NOT verify the shipments ONLY documents

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit Eg1. Importer requests cert. of origin in order to qualify for special tariff treatment upon import Eg2. If importing animal/plant products importer requests presentation of a phytosanitary cert. to ensure smooth clearance

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit Importer can request inspection certificate to verify quality of shipment from a reputable inspection firm eg the Swiss SGS Group Importer can also indicate that product must be sent in one shipment or partial and can also specify mode of transport and routing

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  The importer applies to an issuing bank to establish an L/C in accordance with the contract.  The issuing bank opens an L/C and sends it to the exporter’s bank, the advising bank.

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  If the L/C is found in accordance with the contract, the seller will get all the shipping documents ready present them to a “negotiating” bank.

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  The negotiating bank checks the documents against the L/C.  The negotiating bank sends the documents to a reimbursing bank.  The paying bank checks the documents against the L/C and reimburses the negotiating bank.

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  Finally, the issuing bank asks the buyer to buy the shipping documents.

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  Documentary credits are governed by the International Chamber of Commerce’s (ICC) Uniform Customs and Practice for Documentary Credits (UPC 500).

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  UPC Exclusions: Doc Credits that do not refer to UPC or expressly exclude them The relationship between importer and exporter or between importer and it’s bank

Forms of Trade Financing: How Many ways can you get paid? Documentary letter of Credit  UPC Exclusions: Each parties’ legal capacity which is governed by their national law Fraud Back-to-back documentary credits Prepayment of documentary credits

Confirmed Documentary Letter of Credit  Confirmed - A second bank, usually in the exporter’s country, guarantees the PMT of the importer’s bank, providing an extra layer of protection - especially important if the country or the issuing bank is considered risky.  Most like a certified check Forms of Trade Financing: How Many ways can you get paid?

More on Confirmations...  Gives the greatest degree of payment protection and an immediate payment source, provided the documents are clean.  Added cost, normally to the exporter. Exporter must instruct the importer to have the L/C issued with a request for confirmation. The confirming bank makes a credit decision based on the credit of the issuing bank and the country risk. Approval will depend also on availability under an established line of credit.

More on Confirmations...  Gives the greatest degree of payment protection and an immediate payment source, provided the documents are clean.  Added cost, normally to the exporter. Exporter must instruct the importer to have the L/C issued with a request for confirmation. The confirming bank makes a credit decision based on the credit of the issuing bank and the country risk. Approval will depend also on availability under an established line of credit.

Sight or Term PMTs Payment for products maybe on sight or over a term PMT date can be based on date of receipt (60 days) or shipment date (90 days) Exporter can sell accepted PMT undertaking at a discount to bank and get money right away Forms of Trade Financing: How Many ways can you get paid?

Confirmed Documentary Letters of Credit > the mitigation of exporter risk Possible (PMT) confirming bank can share the risk! Through insurance cover from private sector risk insurers or from export credit agencies (ECA’s are governmental) agreeing to cover risk Eg. Foreign accounts receivable insurance Insurance and Risk Mitigation: Insuring Payment, Protecting Value

Bonds, guarantees and Standby Credits Guarantee of performance, failing which a financial penalty is triggered Bid Bonds are required when large tenders are published Require parties to submit a fully developed proposal to a project If successful but fail to proceed then pays 5-10% of contract value Performance Bonds are requested to see both parties execute the project Failure to perform will trigger full payment Insurance and Risk Mitigation: Insuring Payment, Protecting Value

Bonds, guarantees and Standby Credits Advance PMT guarantees allow the importer to trigger a claim for a refund if exporter does not ship goods Bank guarantees and stand by letters of credit Provide for PMT if activity is not completed Usually for domestic transactions Eg. home renovation project by a contractor Insurance and Risk Mitigation: Insuring Payment, Protecting Value

A Three-way Partnership International financial institutions eg international finance corporation of the world bank and regional development banks eg inter-American development bank playing more of a role in trade finance provide confirmations on LOC by local banks in higher risk markets Banks, ECAs and IFIs: Trade Finance the Traditional Way

A Three-way Partnership International financial institutions eg international finance corporation of the world bank and regional development banks eg inter-American development bank playing more of a role in trade finance provide confirmations on LOC by local banks in higher risk markets Banks, ECAs and IFIs: Trade Finance the Traditional Way

Non-Bank Providers of Trade Finance GE Capital and UPS capital Niche financing solutions in partnership with the United States Export-Import Bank under their small business programmes Ibankers and Hedge Funds support financing to emerging markets Eg. North Star Trade Finance Inc. Canada Partnership of both public EDC and private organizations Loans of 100k to 5M to foreign importers of CDN goods and services Couriers, Hedge Funds and Other Players in Trade Finance

Most Common mechanisms: Importer Credits – used to finance export over med-LT Funds lent directly to foreign importer Usually for large capital projects Project Finance, Countertrade and Other Flavours

Most Common mechanisms: Supplier Credits – financial institution purchases from the exporter a foreign importer’s debt to the exporter Bank does not have to negotiate with the foreign importer 100k to 5M for 6mon to five years Project Finance, Countertrade and Other Flavours

Most Common mechanisms: Forfiting Credits – Medium term form of exporter credit provided by banks Bank purchases promissory notes due to the exporter from an importer Value of note is discounted by the exporter's bank and the exporter receives cash Exporter benefits by passing on credit risk and currency exposure to the bank turning a term credit sale into a cash transaction Project Finance, Countertrade and Other Flavours

Most Common mechanisms: Counter Trade – Sale to importer conditional on a reciprocal purchase by the exporter Instead of getting cash, exporter gets products/services Project Finance, Countertrade and Other Flavours

Most Common mechanisms: Export Leasing – mostly private companies in specific industries eg auto industry Med – LT method Exporters work with leasing companies Exporters gain a competitive edge and offer their importers alternate form of financing Used when import restrictions on purchasing foreign equipment imposed or favorable tax treatment for leasing Project Finance, Countertrade and Other Flavours

Most Common mechanisms: Project Financing – based only on profitability of project Secures PMT from the cash flow of project Assets serve as collateral eg. import robots to build car in foreign factory Exporter gets paid from sale of cars Project Finance, Countertrade and Other Flavours