Trade finance

An international trade transaction, no matter how straightforward it may seem at the start, is not completed
until delivery has taken place and the seller has received payment.

Each area of international trade requires its own knowledge, from the first contact to final payment. One such
area of expertise is how to develop professional and undisputed terms of payment and how to solve currency
and trade finance questions in a competitive way. These areas are of vital importance both in the offer and in
subsequent contract discussions, not just within difficult countries or markets or in larger, more complicated
deals, but also in quite ordinary day-to-day transactions.

This is even more obvious when considering the basic structure of international trade, involving more than 150
countries, including many developing and emerging markets. In many of these markets, the structuring of the
terms of payment is the key to secure and profitable business.

International chamber of Commerce

The main sources for international trade practices are publications issued by the International Chamber of
Commerce (ICC). The standard rules of reference for the interpretation of the most commonly used trade
terms in international trade are Incoterms® (International Commercial Terms), issued by the International
Chamber of Commerce (ICC). These rules are now generally recognized throughout the world, so any other
unspecified trading terms should be avoided.

The new Incoterms 2010 consists of 11 terms, separated into two groups, namely:
1 Those applicable to all modes of transport:
 EXW: EX WORKS (... named place of delivery)
 FCA: FREE CARRIER (... named place of delivery)
 CPT: CARRIAGE PAID TO (... named place of destination)
 CIP: CARRIAGE AND INSURANCE PAID TO (... named place of destination)
 DAT: DELIVERED AT TERMINAL (... named terminal at port or place of destination)
 DAP: DELIVERED AT PLACE (... named place of destination)
 DDP: DELIVERED DUTY PAID (... named place)
2 Those only applicable to sea and inland waterway transport:
 FAS: FREE ALONGSIDE SHIP (... named port of shipment)
 FOB: FREE ON BOARD (... named port of shipment)
 CFR: COST AND FREIGHT (... named port of destination)
 CIF: COST, INSURANCE AND FREIGHT (... named port of destination)
Risk and risk assessment
Risk forms
 Product, production, and transportation risk
 Financial risk
 Political risk
 Currency risk
 Commercial risk (buyer bankruptcy risk) (special credit risk)
 Business risk
If you are unsure about the risk, you often have to choose different combinations of third-party cover through
letters of credit, bank guarantees or insurance that covers the worst possibilities.

Insurance
There is another way to bridge the gap between the parties by the approach a third party, often a credit
insurance company, to reduce the commercial risk that could not be covered through the agreed terms of
payment. It should however also be noted that most export credit insurance, taken by the seller as additional
security, could be impaired or even invalid should the seller themselves not have fulfilled – or been able to
fulfil – their obligations according to the contract.

Insurance clause A, B, C are the main clause, Key vendors for insurance:
 Allianz
 AXA
 AON
 Marsh
 American international
 Samsung fire and marine insurance

There are basically three different ways to insure the cargo

 Open insurance policy covering most or all shipments within the seller’s basic trade as agreed in
advance
 Specific insurance policy, covering specific shipments on an ad hoc basis
 Seller’s interest contingency insurance, normally only offered as a complement to the open policy

Cover Note may be issued by the insurance company to serve as proof of insurance.
Cargo insurance can be obtained directly from an insurance company or directly through the transporting
company.

Business information and credit insurance companies

 Atradius
 Coface
 D&B (formerly Dun & Bradstreet)
 Experian
Methods of payment
Cash in advance
Letter of credit
Documentary collection
Bank transfer (based on open account trading terms)
Other payments

Bank fees
The best solution for both parties is often to agree to pay the bank charges in their respective country, but
whatever the agreement, it should be included in the sales contract.

Bank transfer
Most trade transactions, particularly in regional international trade, are based on so-called ‘open account’
payment terms. This means that the seller delivers goods without receiving cash, and the buyer is expected to
pay according to the terms of the sales contract and the seller’s later invoice. The open account involves a
form of short, but agreed, credit extended to the buyer.

Terms of payment

Clean payments (Bank transfer, Cheque payment)

Seller send invoice after delivery – Buyer transfer or issue a cheque

Documentary payments
 Documentary collection (Bank collection)
 Seller send agreed documents to seller bank
 Seller bank send it buyer bank
 Buyer bank send it to buyer
 buyer approve it and instruct the bank to transfer the money

Documents used in documentary collection

 Bill of exchange
 Invoice
 Specification and separate packing
 Transport documents
 Certificate of origin
 Inspection certificate
 Insurance policy
 Other certificates

Documentary credit (Letter of credit)

The letter of credit (L/C) is a combination of a bank guarantee issued by a bank upon the request of the buyer
in favor of the seller and a payment at sight or at a later stage against presentation of documents which
conform to specified terms and conditions.

Documents presented should be in accordance with the terms and conditions of the L/C, but also in
accordance with the UCP 600 rules and with international standard banking practice
The L/C has many advantages for the seller. Payment is guaranteed and there are fewer concerns about the
buyer’s ability to pay or about other restrictions or difficulties that may exist or arise in the buyer’s country –
but only if the
seller can meet all the terms and conditions stipulated in the L/C.

L/C has certain general features that must be included in each case, particularly with regard to:
 period of validity
 time for payment
 place of presentation of documents
 level of security
 documents to be presented.

Regarding more ‘problematic’ countries, L/C confirmation is something the seller should discuss with their bank
prior to negotiations with the buyer and, if needed, obtain commitment from this bank to confirm any L/C that
may be the outcome of the negotiations. Such commitments are often issued by the banks against a
commitment fee.

Special L/Cs
‘red clause letter of credit’: where the seller can receive an advance partial payment before presentation of
documents
‘transferable’: where the seller permits the transfer of rights and obligations under the L/C to another
beneficiary, a business partner or some other supplier who will make the actual delivery.
‘revolving letter of credit’: where L/C is automatically reinstated to its original value after each presentation of
documents or when reaching a certain lower level.

Nowadays it is common practice in most countries for L/Cs to be issued as SWIFT messages in a standardized
format.

Documents
When it comes to the documents, some of them, often the invoice, may have to be certified or legalized by a
third party, often a chamber of commerce and/or the embassy of the importing country.

Shipping documents
 Commercial documents
 Commercial invoice
 Pro forma invoice
 Consular invoice
 Packing list
 Weight list
 Certificate of origin
 Inspection certificates
 Performance or Test certificates

Transport documents
 Ocean bill of lading
 Combined bill of lading
 CMR note (land transport)
 Air waybill (AWB) Interest
 Forwarders certificate of receipt (FCR)
Insurance documents
 Cover note
 Open policy
 Insurance policy
 Contingency insurance

Financial documents
 Corporate cheque
 Bill of exchange
 Promissory note

Guarantees

‘On demand guarantees’ is the strongest form of guarantees, this guarantee is then payable on the first
demand from the beneficiary and without prior approval by the principal, and without having to prove to
the issuing bank that a default has occurred.

In some cases, the credit guarantee may be replaced with more indirect support towards the lender or any
third party, in the form of a letter of support, letter of comfort or letter of awareness. These documents do not
impose any formal or legal obligations; rather they are forms of assurance on behalf of the issuer.

Export credit insurance

In many cases, the buyer does not accept the proposed terms, the bank is unwilling to take the risks involved,
or even the remaining risks may be considered by the seller as being too high.

In these cases, it is crucial to try to structure the deal in a way that enables the seller to maximize the
combined cover that can be obtained from banks, financial institutions and separate export credit insurance
companies or institutions. The seller must then explore, in advance, what is achievable before commencing
negotiations with the buyer. Having the knowledge and capability to structure such transactions, together with
banks and/or insurers, is of vital importance for the seller when dealing with political and commercial risks that
might otherwise make the transaction difficult or even impossible to deal with.
Trade finance
Being able to give or to arrange finance as part of an export transaction is increasingly important, both as a
sales argument and to meet competition from other suppliers.

The length of credit is often divided into short, medium and long term, even though such classifications are
arbitrary and depend on the purpose.

Types of trade finance

Pre-shipment finance
Through existing or additional bank credit limits, without involving the specific export documents.

Working capital insurance

Both private market insurers and official ECAs may offer pre-delivery cover, issued in the form of an insurance
policy to the exporter or directly as a guarantee to an authorized lending institution, thereby enabling the
seller to obtain a loan to finance their export of goods.

Supplier credits
the most used forms of refinancing supplier credits on short- or medium-term periods are:
 bank loans and trade finance limits
 invoice finance facilities
 export factoring
 forfaiting banks
 other medium-term refinancing.
Structured trade finance

Structure and design of practical terms of payment