WTO/ESCAP ARTNeT Capacity Building Workshop for Trade Research, Bangkok, Thailand, 22 June 2009

Trade Finance: An introduction

by Yann Duval, Trade and Investment Division, United Nations Economic and Social Commission for Asia and the Pacific (UN ESCAP)

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

SessionOverview
Part1 intrototradefinance
DefinitionandImportance Tradefinancetoolsandinstruments
Factoring Inventoryfinancing Structuredfinancing Leasing Exportcreditinsurance/guarantees Paymentterms Advancepayment,L/Cs,documentarycollection

Tradefinanceinfrastructures;Ideasforresearch

Part2 recentlit.andfindings;datasources
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

TradeFinancing?
Raisingcapital
Capitalforinvestment Workingcapital

Managingriskintradetransactions
Creditinsuranceandguarantees Paymentterms Hedging

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

(Trade)Financing Howimportantanddifficult isit?

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Financingisneededthroughoutthe tradecycle

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Pre&PostShippingFinancing
PreShipping
Priortotheshipmentofgoods. Tosupportpreexportactivitieslikewagesandoverhead costs.

PostShipping
Theperiodfollowingshipment. Ensuresadequateliquidityuntilthepurchaserreceivesthe productsandtheexporterreceivespayment.
In international trade, the trade cycle is generally longer than in domestic trade financing becomes very important Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

ObstaclestoAsiaPacificSME Competitiveness
(note:95%offirmsinAsiaareSMEs)
Importance of factor for competitiveness (%)

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org (%) Lacking factor
Source: adapted from 2009 UPS Asia Business Monitor

ProblemsencounteredbyAsiaPacific SMEs infinancingtheiractivities

Asia-Pacific Research and Training Network Source: 2009 UPS Asia Business Monitor on Trade www.artnetontrade.org

Obstaclestotradeandinvestment financing
Lackofcollateral,highcostofloan
Sometradefinanceinstrumentsexiststosolve theseproblems*

Asia-Pacific Research and countries + suitable *may not be applicable in all Training Network for smaller enterprises on Trade www.artnetontrade.org

Manytypesofassetscanpotentially beusedtosecurefinancing
Assets
Cash Accounts Receivable Inventory/Stocks Equipment Buildings / Land
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Liabilities

Factoring
Thisinvolvesthesaleatadiscountofaccounts receivable(e.g.,exportinvoices)orotherdebtassets onadaily,weeklyormonthlybasisinexchangefor immediatecash. Thedebtassetsaresoldbytheexporterata discounttoafactoringhouse,whichwillassumeall commercialandpoliticalrisksoftheaccount receivable.

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Asia-Pacific Research and Training Network Source: http://www.intfactor.com.sg on Trade www.artnetontrade.org

InventoryFinancing
Inventoriesholdupspaceandisacosttothe exporteruntilitsisshippedtotheimporter. Warehousereceipts Theseinventoriescanbea sourceoffundthroughbothsecuredandunsecured loanagainsttheinventoriesacompanyhas.

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

StructuredFinancing
StructuredFinancingisatechniquewhereby certainassetswithmoreorlesspredictablecash flowscanbeisolatedfromtheoriginator and usedtomitigaterisks(e.g.transferofforeign exchange,contractperformanceandsovereign risk),andthussecureacredit.

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

StructuredFinancing
Direct sale of rights to future production (sold in export market) to investors:

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Source: Rutten UNCTAD

STRUCTUREDFINANCE
COFFEEINKENYA 3MONTHSCREDIT
NoStructured Finance ValueofGoods AdvanceRate LoanProceeds Interestratepa US$7,000,000 50%
US$3,500,000

WithStructuredFinance US$7,000,000 80%(increasedutilisationof assetsby30%) US$5,600,000(Extracredit US$2.1mil) LIBOR+2.5%(Savingsin interestchargedoverUS$3.5 mil=US$120,000) 2.55%(Additionalupfrontfees US$59,000) US$298,000(Savingsachieved, US$6,000)

LIBOR+15%

Storage/insurance/inspection& otherprofessionalfees Totalstorageetc.etc.&interest costs

1.7% US$304,000

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Leasing
Considerwhenbuyinganytangibleassets Truelease(vs.financiallease)
Noassetownershiptransfer Leasetermlessthanlifeofequipment Maintenanceprovidedbylessor

Mainadvantage:lowerinitialexpenditure ofcash Maindisadvantage:overallcost(and commitmenttoproperty)

Asia-Pacific Research and Training Network Lease vs. Buy calculator available at: on Trade www.artnetontrade.org http://www.bloomberg.com/analysis/calculators/leasebuy.html#results

Whatisthekeydifferencebetween financinginternationaltrade transactionsanddomestic transactions?

Theadditionalrisksinvolved!!!
Countryrisk Exchangeraterisk Lackofknowledge/informationaboutyourbuyer (orsupplier) counterpartyorbuyerdefaultrisk Moredifficultandcostlytoresolvedisputes
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

ExportCreditInsurance
Exportcreditinsuranceinvolvesinsuring exportersagainstpossible:
Commercialrisksuchasnonacceptanceofgoods bybuyer,thefailureofbuyertopaydebt,andthe failureofforeignbankstohonordocumentary credits. Politicalriskarisesfromfactorslikewar,riotsand civilcommotion,blockageofforeignexchange transfersandcurrencydevaluation.
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

ExportCreditGuarantees
Issuedbyafinancialinstitution,ora governmentagency Instrumentstosafeguardexportfinancing banks fromlossesthatmayoccurfrom providingfundstoexporters.
Toassistcompanieswithoutsufficienttrack recordstoobtaincredit(and/orexportinsurance) frombanks
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

PaymentTermsAndAssociatedRisks
AdvancePayment
Timeofpayment:Beforeshipment Goodsavailabletobuyers:Afterpayment Risktoexporter:None Risktoimporter:Reliescompletelyon exportertoshipgoodsasordered

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

PaymentTermsAndAssociatedRisks
Openaccount
Timeofpayment:afterreceiptofgoodsby buyer(asagreedupon) Goodsavailabletobuyers:Beforepayment Risktoexporter:Reliescompletelyonbuyerto payaccountasagreedupon Risktoimporter:None

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

PaymentTermsAndAssociatedRisks
Lettersofcredit(L/C)orDocumentaryCredit
Timeofpayment:Aftershipmentismade(once termsandconditionsspecifiedinL/Caremet) Goodsavailabletobuyers:Afterpayment Risktoexporter:Verylittleornone Risktoimporter:Reliesonexportertoship goodsasdescribedindocuments
An L/C is an undertaking issued by a bank for the account of the buyer (the Applicant), to pay the Beneficiary (seller) the value of the Draft and/or documents provided that the terms and conditions of the L/C are complied with. Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Goods 5 BUYER 1 8
Documents

Request L/C 9

LETTER OF CREDIT CYCLE

Contact

SELLER
66

Documents 4

Advises L/C
Issues L/C Documents 7
11 ADVISING/ NEGOTIATING BANK

3 10

ISSUING Asia-Pacific Research and Training Network BANK on Trade www.artnetontrade.org

PaymentTermsAndAssociatedRisks
DocumentaryCollection(Documentsagainst payments)
Timeofpayment:Afterpresentationofdraft(billof exchange) Goodsavailabletobuyers:Afterpayment Risktoexporter:Ifdraftisunpaid,mustdisposeof goods Risktoimporter:goodsshippedarenotasdescribed inthedocuments

(Documentsagainstacceptance)
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Goods
1

BUYER
4 5

COLLECTION CYCLE

SELLER
2 7

Documents
3

Documents Documents

6 COLLECTING Asia-Pacific Research and Training Network BANK www.artnetontrade.org on Trade

Remitting Bank

PaymentTermsAndAssociatedRisks Best
Advance 5 1 Term of Payment Payment Documentary 2 4 Letter of Credit Exporters Documentary 3 3 Point of View Collection Payment after 4 2 arrival of Goods Worst Open A/C 5 1 Term of Payment (Open Invoice) Asia-Pacific Research and Training Network
on Trade www.artnetontrade.org

Worst
Term of Payment

Importers
Point of View

Best
Term of Payment

Manyofthetradefinancetoolsand instrumentsnotaccessibleincountriesof theregion NeedtobuildaTrade FinanceInfrastructure

The laws, regulations, institutions and other instruments (*) required to:
(1) Provide capital and credit to firms involved in international trade transactions (2) Manage the risks involved in these transactions, (3) Ensure international payment through efficient mechanisms (e.g., electronic systems) Asia-Pacific Research and Training Network
(*) Trained staff www.artnetontrade.org on Trade

Aretradefinanceinstitutionsavailable andfunctioning?
TradeFinanceInstitutional Structuremodel(TFIS) Level I Institutions: Direct governnmental role Level II Institutions: Full or partial government ownership but limited direct management role Level III Institutions: Market driven No or very limited government ownership

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Level IInstitutions: Directgovernnmental role CentralBank/Monetary Authority Ministry ofFinance Ministry inchargeoftrade Other financial andinsurance sector regulatory bodies

To PROVIDE WHAT? A stable and favourable macroeconomic, legal and financial environment A vision and strategy for trade development Financial and trade policies and regulations supportive of trade Trade promotion and SME development schemes
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Level IIInstitutions: Fullorpartialgovernment ownership butlimited directmanagementrole ExportCredit Insurance andGuarantee Agency NationalExportImportBank(EXIM) Other traderelated specialized financial institutions/agencies OFFERING
Specialized support to SMEs and other organization with limited access to trade credit Innovative trade related financing options, export risk management tools Tie-ups with International Trade finance firms with expertise in innovative structures and developing markets Access to financing provided by multilateral Asia-Pacific Research and Training Network financial and donor agencies on Trade www.artnetontrade.org

Level IIIInstitutions:Market driven Noorvery limited government ownership Commercialbanks Other privately owned nonbanking financial institutions (leasingcompanies,factoringhouses)

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Conclusions/ideasforresearch
Tradefinanceisanessentialenableroftrade Butlittleresearchworkinthisareaasyet
Nationalsituationoftenunclearandunmonitored(fromatrade perspective) SeeTradeFinancePointerMethodologyand50+ indicators Whichinstitutionalmodelsaremostsuitedtospecificcontext(e.g., shouldsmalleconomieshaveEXIMbanks?) Howmuchshould governmentsbeinvolvedandprovideguarantees? Manycountrieshavetakenstepstofacilitatetradefinancesincethe beginningoftheglobalcrisis?Whichofthosestepshavebeen(most) effective Havetheglobalandregionaltradefinanceschemesbeeneffectivein Asia,particularlyinLDCs? typicallyinvolvechannelingfunds throughdomesticcommercialbanks,whichmaylackcapacitytodo so effectively Istheremeritindevelopingnewregionaltradefinancearrangements, ifsowhichtype?
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Annex1
InternationalStandardsAnd ConventionsInTradeFinancing

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InternationalStandardsAnd ConventionsInTradeFinancing
Incoterms 2000
Standardtradedefinitionsmostcommonlyusedin internationalsalescontracts

UniformCustomsandPracticeforDocumentary Credits(UCP500)
UCP500istheUniformCustomsandPracticefor documentarycredit

eUCP
InNovember2002,ICCpublishedanewGuidecalleUCP to supplementUCP500. Asia-Pacific Research and Training Network
on Trade www.artnetontrade.org

InternationalStandardsAnd ConventionsinTradeFinancing
ICCUniformRulesforCollection(URC522)
Providesabasicintroductiontotheoperationof collectionsaspartofinternationaltrade

UniformRulesforBanktoBankReimbursements underDocumentaryCredits(URR525) UniformRulesforDemandGuarantees,(RDG458)

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Annex2 TradeFinancePointers

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

AGoodTradeFinance Infrastructurerequires:
Appropriatefinancialsectorregulationswell
coordinatedandnotcontradictory

Internationalandnationalfinance/bankingexpertise
(publicandprivatesectors)

Aconduciveenvironment fortrade finance(includinganeffectivelegalframework)

Whatisamorefavorableenvironmentfortradefinance development?Howdoweknowifwehaveit? Asia-Pacific Research and Training Network
on Trade www.artnetontrade.org

ITCsTradeFinancePointers(TFPs) Methodology
WhatareTFPs?
Indicatorsoffactorsthataffectthetradefinance environment Atradefinancebloodtest resultsheetbasedon52 indicators

WhatareTFPs for?
Todetectwheretofocuseffortstodevelopamore conducivetradefinanceenvironment
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

TFPs: 52 indicators in 10 areas

Macro Indicators (Indirect Effect)
1. TRADE FLOWS 2. EXTERNAL RESOURCES 3. EXTERNAL DEBT AND LIQUIDITY 4. EXCHANGE RATE

Financial Institutions & Capacity Indicators (Direct Effect)

8. FINANCIAL INSTITUTIONS 9. CAPITAL AND CREDIT RESTRICTIONS 10. COST OF BORROWING

5. MONETARY SYSTEM

6. CREDIT MARKET 7. LEGAL

Asia-Pacific Research and Training Network ENVIRONMENT on Trade www.artnetontrade.org

Trade Finance Infrastructure Development

TFPs: Data Sources Secondary sources for most indicators

World Bank Development Indicators 2003 International Financial Statistics, IMF International Trade Finance, ITC www.cofacerating.com

Supplemented by a national survey

on Legal Environment, Financial institutions, Capital & Credit Restrictions

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Combined the indicators describe the status of the Trade Finance infrastructure of a country. Benchmarks, calculated with data on all 155 developing countries, are used alongside traffic lights to depict three possible situations:
Q1: First Quartile
200

Q2: Median

Q3: Third Quartile

Favourable

Further research needed

Partially favourable

100

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 Ready Reckoner
C O M P O S IT E IN D IC E S 1. T ra d e in d ic a to r s W e ig h te d s c o re 4 .5

Combining and interrelating 52 indicators and 10 indices, a countrys overall position weighted can be plotted and compared on a Ready Reckoner .

MACROECONOMIC TRADE FINANCE ENVIRONMENT

10 1

2. 3. 4. 5. 6. 7. 8. 9. 10.

N e t re s o u rc e flo w s E x te rn a l d e b t & liq u id ity E x c h a n g e ra te p o lic y & a v a ila b ility M o n e ta r y & fin a n c ia l s y s te m C re d it m a rk e t L e g a l e n v iro n m e n t F in a n c ia l in s titu tio n s C a p ita l & c re d it re s tric tio n s C o s t o f b o rro w in g

3 6 3 3 4 3 4 3 3

.4 .1 .0 .8 .1 .3 .2 .7 .4

9 8 7 6 5 4 3 2 1 0 W E A K
2001 su rvey

G O O D

P A R T IA L
T h is s u r v e y

10

T R A D E F IN A N C E IN S T IT U T IO N A L S T R U C T U R E & C A P A C IT Y

SeeESCAP/ITCTradeFinanceInfrastructureDevelopment Asia-Pacific Research and Training Network Handbookfordetails Methodologyneedfurther on Trade www.artnetontrade.org development but interesting starting point

OptionalSlides

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KeyIssuesInTradeFinance
The mechanics & systems for arranging for and receivingpayment The Legislation and custom requirements of the exportandimportcountries Foreign exchange policy and other risks associated withinternationaltrade The institutions the operations of the banking system in operating the trade finance instruments, andpaymentsandsettlements. InfrastructureandahostofICTservices
Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Tradefinancetoolsandinstruments
ToraiseCapital
Loan/LineofCredit StructuredFinancing Leasing InventoryFinancing

ToMitigaterisks
Factoring ExportCreditInsurance ExportCreditGuarantee

TermsofPayment
AdvancePayment OpenAccount Collections(DocumentsagainstPaymentorAcceptance) LettersofCredit

Asia-Pacific Research and Training Network on Trade www.artnetontrade.org

Contract Value $10m

3. Down payment of 15% of Contract Value

Exporter
4. Delivery of Goods

Importer

5. Bank pays Loan amt to Exporter after delivery of Goods ($8.5m)

1. Bank arrange loan with Importer on 85% of Contract Value ($8.5m) Loan Amt

Commercial Bank
6. Payment of insurance fees 2. ECIGS guarantees 95% of Loan Amount ($8.075m) $425,000 of Loan Amt remain uncovered as bank risk sharing

ECIGS

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Asia-Pacific Research and Training Network on Trade www.artnetontrade.org