INTERNATIONAL TRADE FINANCE

NGUYEN T Thanh Phuong, CITF®

Email: phuong.nguyen@ftu.edu.vn
Faculty of Banking and Finance
 Objectives
Completed subject, students will be able to:
• Advise clients appropriately on international trade and finance
• Understand the process involved in international trade
• Understand the risks involved International trade and how to
mitigate them
• Understand the current banking practices and convention
applicable to international trade
• Understand the roles and responsibilities of all parties involved
in trade finance
• Take the exam of London Institution Banking and Finance on
Trade Finance: CITF – Certificate of International Trade
Finance or CDCS (Certificate of Documentary Credit
Specialist)
 Reading
•Required reading
◦ Finance of International trade (Eric Bishop
◦ The Handbook of International Trade and Finance – Anders
Grath 2008
◦ ICC publications: Incoterms 2010; UCP 600 ; ISBP 745; BEA
1882; ULB 1930
◦ International Trade and Finance – Prof Dinh Xuan Trinh and
Dang Thi Nhan
–Supplementary reading
◦ International Trade Finance: A pragmatic approach (Tarsem
Bhogal, Arun Kumar Trivedi)

3
 Assessment
Student’s Responsibilities:
• Attend class regularly
• Participate in discussions in class
• Group assignments
Assessment:
10%: attend class and mini test
30%: group assignment
60%: 1 hour written exam
INTERNATIONAL TRADE FINANCE

Topic: Introduction to International Trade Finance

 Contents

Introduction and course overview

 The external factors faced in International trade
market
Risks involved in International trade
 Research market and method of entering an
overseas market
Role of intermediaries in international trade finance
 Foreign Trade
• Exporter v. Importer
– negotiation of a
Contract
• Exporter –
PAYMENT
• Importer -
GOODS
7
 The external factors faced in International
trade market
PESTEL model reflect the external factors affecting to
International trade market
• Political (influenced by multilateral or bilateral agreement;
historical relationship bw countries, political regime...)
• Economic (industrial growth, impact of currency fluctuation
bw countries, level inflation, employment level bw countries
affect trade..)
• Social (religious or culture differences, culture custom,
language be a barrier to trade, negotiation style bw two
countries..)
• Technology
• Environmental
• Legal
 Risks involved in international trade
• Languages and culture
• Legal issue
• Exchange and currency risk: fluctuate of foreign currency or
movement in exchange rate can create an unexpected P&L in
transaction...
• Finance: working capital cycle in international trade transaction is
great deal longer than domestic transaction, exporter want to
receive deposit before shipment (1-3 months) to buy material to
produce goods, to secure export sales, exporter can need additional
finance to facilitate the transaction
• Credit risk: buyer not paying or country with a poor credit risk of
where buyer is resident
• Transport risk: damage the good during shipment until final
destination
 Questions

A risk that buyer will not pay for the goods is also known as:
a. Credit risk
b. Financial risk
c. Legal risk
d. Exchange risk
An unexpected movement in exchange rates on a transaction can
cause an unexpected:
a. P&L
b. Income or expenditure
c. Sales or cost
d. Asset or liability
 Research market
When a business decides to enter into an overseas market, they can
conduct via research on the countries that they want trade. Many
sources of information that can be used for research:
• Government department (ex: UK trade and investment –UKTI;
International trade administration (ITA) of Department of commerce
in US
• Chambers of commerce: provide a range of services: training,
provide country report, lawyer...
• Trade mission (coordinated overseas visit buy a group of bz
individual representing their company to meet potential buyer or
seller) and exhibition /trade shows: expo to show the latest products
and services to potential buyer
• Banks
• Status enquires and credit control
• The internet and media
• Networking
 Research market
• Banks: assistance with range of services as produce economic
reports on individual countries, giving information about
standard living, consumer expenditure, foreign currency
reserves....
+ obtain credit information and reports on both potential
customers and supplier
+ advise importer or exporters all aspects of making and
receiving payment from overseas, risk involved and the
mechanisms it can offer to minimise the risk
+ advise the details in various trade finance products that
may be available and advise how these work....
 Research market
Status enquires and credit control
• Banks: can provide contain just a few line comment of
creditworthiness of customers...
• Credit reference agencies: can check in www.crediguru.com:
list of various credit reference agencies used in the world
• Credit rating agency: Fitch, Moody’s and Standard and Poor...
provide rating on credit standing of any large bz that raised
capital on international markets
• Credit insurer: provides of credit insurance will also provide
credit report
 Method of entering an overseas market

• Direct to end user

• Appointment of an agent or distributor

• Through a joint venture

• Through international franchising or licensing

Role of intermediaries in International trade finance
The bank/customer relationship:
1. To make payment through secure and reliable system
2. To collect amounts payable to its customer in respect of check
and other instruments (bill of exchange)
3. To provide regular statements
4. To keep its customers’ affairs confidential, subject only to
certain laws that require information to be disclosed
5. To have a clear complaints procedure
6. To repay advance as agreed
7. To pay reasonable charges
8. With customer; to protest against fraud and prevent criminal
activity
 Case study

PLC company is based in Vietnam. The

company has a broad international client base
and sells oil and related products across the
world. As is common in this industry, the oil is
paid in USD and PLC which reports in VND.
1.Analysis the risk that company need to
manage?
2.Provide the potential solutions for PLC
company
INTERNATIONAL TRADE AND FINANCE

Contracts and Documents be used

international trade finance
 Objectives
By the end of this topic, you should have an understanding of:
- What makes a valid contract
- Understanding the terms and condition in Sales contract
- The 1980 United Nation Convention on Contracts for
International Sale of Goods (CISG)
(A full list of signatories and their current status can be found at: www.uncitral.org/uncitral/en/
uncitral_texts/sale_goods/1980CISG_status.html)

- Trade terms – The ICC Incoterms 2010 Rules

- Financial documents: Bill of exchange & promissory note
- Other documents used in international trade : transport
documents, insurance documents….
 Foreign Trade
• Exporter v. Importer –
negotiation of a
Contract
• Exporter –
PAYMENT
• Importer - GOODS

19
A valid contract to come into effect, the following
conditions must have been met:
- There must be a firm offer and an acceptance of that
offer
- There must be an intention to create a contract
-there must be consideration − each party provides
something to the other
- there must be capacity to contract − for a limited
company that means that the nature of the business is
within the objectives set out in the company’s
memorandum and articles;
- consent must be freely given without duress or based
on false information;
- the purpose must be legal.
 The Sales Contract covers:
• Contract parties • Transfer of
• Goods, services ownership
• Price, currency • Documentation
• Delivery time • Miscellaneuos
• Trade term (Incoterm) provisions
• Transport - insurance • Law, Jurisdiction
• Payment conditions • Attachments …

21
 CONTRACT OF SALE
We need to specify above all:
• Identification of parties;
• Description of goods;
• Price of the goods (what is included?);
• Inspection of the goods – obligations and limitations;
• Quantity and quality variations in the products delivered
• Delivery periods, conditions (contract of carriage?!);
• Where exactly the goods will be delivered to the Buyer;
• Transfer of risk (Insurance?);
• Reservation of title and passing of property rights;
 Contract of sale also should cover:
• Who will be responsible for export clearance and who for
import clearance and the cost (duty, VAT);
• Who will pay what in relation to the delivery of
the goods;
• How the payment is to be done by the Buyer;
• What documents must be surrended by the Seller;
• Seller´s warranties and buyer´s complains;
• Assignment of rights;
• Force majeure clause;
• Requirements re. amendments or modifications;
• Controlling language of the contract;
• Choice of law and dispute resolution mechanism.
 INCOTERMS 2010 help a lot!:
Price of the goods (what is included?);
• Inspection of the goods – obligations and limitations;
• Delivery periods, conditions (contract of carriage?!);
• Where exactly the goods to be delivered to the Buyer;
• Transfer of risk (Insurance?);
• Who will be responsible for export clearance and who
for import clearance and the cost (duty, VAT);
• Who will pay what in relation to the delivery of
goods;
• What documents must be surrended by the Seller;
 What Incoterms do:

• CARRIAGE OF THE GOODS FROM SELLER TO

BUYER
• EXPORT, IMPORT AND SECURITY CLEARANCE
• DIVISION OF COSTS AND RISKS BETWEEN SELLER
AND BUYER
 Incoterms do not do:

• How the Seller is to deliver the goods to

the agreed point of delivery
• What the Seller or Buyer should do as matter of

precaution in his own favour – e.g. take out insurance

(except CIF and CIP)
• Transfer of property/title to the goods – matter of

applicable law – which may allow for specific

provision in the sale contract
• Breach of contract, loss, damages caused by
insufficient packaging, marking, etc.,
lief from obligations, exemptions from liability
 Incoterms® 2010
RULES FOR ANY MODE OR MODES OF TRANSPORT
• EXW EX WORKS
• FCA FREE CARRIER
• CPT CARRIAGE PAID TO
• CIP CARRIAGE AND INSURANCE PAID TO
• DAT DELIVERED AT TERMINAL
• DAP DELIVERED AT PLACE
• DDP DELIVERED DUTY PAID
RULES FOR SEA AND INLAND WATERWAY TRANSPORT
• FAS FREE ALONGSIDE SHIP
• FOB FREE ON BOARD
• CFR COST AND FREIGHT
• CIF COST INSURANCE AND FREIGHT

27
 INCOTERMS 2010 DAP
DAT
…international contract terms DDP
EXW
Importer
Exporter
CFR
CIF
CPT
Transportation Transportation
to Dock CIP to Buyer Import
Duty
FCA Dock of Dock of
FAS Exportation Importation
FOB Loading
Ocean Marine Unloading
onto
Freight Insurance Charges
Vessel
Price/Shipping Terms
Cost - Risk Equation
May only be used for sea or inland waterway transport
The seller delivers the goods on board the vessel
nominated by the buyer at the named port of shipment
or procure the goods so delivered.
The risk of loss of or damage to the goods passes when
the goods are on board the vessel and not on the
passage of the goods across ships reeling
This terms may not be appropriated where goods are
handed over to the carrier before they are on board the
vessel. As for example goods in containers, which are
typically delivered at a terminal. In such situations, the
FCA rule should be used.
The seller clears the goods for export, where applicable,
but not for import.
May only be used for sea or inland waterway transport
The seller deliver the goods on board the vessel or procures the goods
already so delivered. The risk of loss or damage to the goods passes when
the goods are on board the vessel.
This rule has two critical points. While seller must contract for and pay the
cost and freight necessary to bring the goods to the named port of
destination, the risk passes to the buyer at the port of shipment when the
seller hands over the goods to the carrier.
If the seller under its contract of carriage incurs unloading costs at the
specific point at the named port of destination, he is not entitled to recover
same from the buyer unless otherwise agreed
This terms may not be appropriated where goods are handed over to the
carrier before they are on board the vessel. As for e.g. goods in containers,
which are typically delivered at a terminal (CPT rule should be used).
The seller clears the goods for export, where applicable but not for import.
May only be used for sea or inland waterway transport
The seller deliver the goods on board the vessel or procures the goods already
so delivered. The risk of loss or damage to the goods passes when the goods
are on board the vessel.
The seller also contracts for insurance cover against the buyer´s risk of loss of
or damage to the goods during carriage on minimum cover only (ICC clause C).
This rule has two critical points. While seller must contract for and pay the
cost and freight necessary to bring the goods to the named port of
destination, the risk passes to the buyer at the port of shipment when the
seller hands over the goods to the carrier.
If the seller under its contract of carriage incurs unloading costs at the specific
point at the named port of destination, he is not entitled to recover same
from the buyer unless otherwise agreed
This terms may not be appropriate where goods are handed over to the
carrier before they are on board the vessel. As for example goods in
containers, which are typically delivered at a terminal. (CPT rule should be
used)
The seller clears the goods for export, where applicable but not for import.
 Notes for Incoterms
What are Incoterms
– A contractual code made up of acronyms (words formed with first
letter of a term.)
Origin of Incoterms
– International Rules for interpretation of trade terms was first
published in 1936 by ICC
– Current versions is 2010 publication
Purpose of Incoterms
– To eliminate barriers caused by distance, language and local business
practices;
– To eliminate uncertainties and different interpretations of trade terms
– To reduce risks and time wasted, caused by misunderstanding,
disputes and litigation;
– To provide a universal vocabulary accepted by financial institutions;
– To facilitate international commercial exchange
 Understanding the Incoterms
Buyers and sellers are encouraged to understand the Incoterms
in order to:
• Know the extent of their responsibilities;
• Know the fees that will be charged to them;
• Have control over the fee and transfer of risks;
• Be in an advantageous position in negotiations;
• Set the selling prices as equitable as possible;
• Demonstrate their competencies; and
• Reflect the best professional image to everyone with whom
they are dealing
 Major of documents in International Trade

• Financial documents:
- Bill of exchange
- Check
- Promissory note
• Commercial documents:
o Invoice
o Insurance
o Bill of lading or other document evidencing
34transport of goods
 Financial Documents/
Negotiable Instruments

MT
at sight Draft/Bill of
Exchange Promisory
note

Exporter Importer

Check

time draft/ BE
T/T
 Bill of exchange

Bill of Exchange = Document of demand issued by

seller to buyer .
“An unconditional order in writing, addressed by one
person to another, signed by the person giving it,
requiring person to whom it is addressed to be paid
on demand or at a fixed or determinable further time,
a sum certain in money to, or to the order of a
specified person or to the bearer.”
The tenor of the draft – On demand, at sight or After a
fix term or usance period
36
 Usance Draft

Term or usance draft is payable at the end of a fixed or

determinable period specified in number of days (30, 60, 90
days) after sight or from date of draft.
For example, a draft drawn on 15.2.07 is accepted by drawee
(seller) on 1.3.07. Payment term is 30 days after sight.
Therefore the draft will be payable on 31.3.07 i.e. 30 days after
sight.
Parties to the bill of exchange are:
– Drawer: Seller
– Drawee: Buyer
– Payee: The receiving party
– Acceptor: The person who accepts the bill of exchange
– Endorser: The one who endorses on reverse of bill of exchange.
37
N01-02-112(1) bill of exchange(2)
For usd 18,880.00(3) (4) Ha noi sep.14.2011 (5)

At…90days…sight of this First Bill of Exchange

(second of the same tenor and date being unpaid ) pay to
the order of Bank for Foreign Trade of Vietnam, Hanoi
branch(7) the sum of US.dollars eighteen thousand
eight hundred and eighty only (8).

To : Sanyo Co., ltd Generalexim corp.

Tokyo Japan (10) (11) Hanoi
 Commercial documents
Air waybill: A receipt from an airline company or its agent, for
goods accepted for carriage by air. It is not a document of
title.
Bill of Lading (B/L): A receipt issued by the carrier, or its
agent, to the shipper goods accepted for carriage by sea.
– Functions of B/L are:
o A receipt for goods,
o Evidence of a contract for the carriage,
o A document of title to goods, and
o A legal document in case of claims.
– The main parties to a B/L are: Shipper, Consignee, Notify
Party and Carrier
39
 Commercial documents
Multi-modal Transport Document (indicates)
– Place of receipt,
– Place of delivery; and
– Different modes of transport covered in the journey of goods.
Commercial Invoice
– A statement of goods shipped; and
– Payment due
Pro-forma Invoice
– Invoice issued prior to sale of goods for purposes of import
license.
Consular Invoice
– It is called for by importer’s country to ensure that the price is fair.
40
 Commercial documents
Insurance Policy/ Certificate
– Effective date of insurance is the most important factor
– It shows full details of risks covered
– Same currency as mentioned in credit
Certificate of Origin
– Prepared by the exporter or the Chamber of Commerce
Reasons of requirement:
Due to tax reasons
Due to political or religious reasons
Certificate of Inspection (Pre-Shipment Inspection Certificate)
– Issued by an independent inspection agency or surveyor after inspecting the
goods before shipment.
Packing and Specification List
– A summary of number of boxes, crates shipped to buyer
41
INTERNATIONAL TRADE AND FINANCE

Terms of payments
Terms of payment
 Questions
1. An importer wishes to have sufficient time to sell goods, before making payment,
whilst the exporter wishes to retain some control over the goods. Which method of
payment would be preferable to the importer?
A Documentary collection payable at sight.
B Documentary collection payable 60 days sight.
C Documentary credit payable 60 days from shipment.
D 50% payment in advance and the balance paid 60 days after shipment.
2. The least secure method of payment for an importer is:
A documentary collection.
B documentary credit.
C open account.
D payment in advance.
3. A major exporter is embarking on its first transaction with an unknown buyer. On
which terms is the exporter most likely to insist?
A Documentary collection.
B Documentary credit.
C Open account.
D Payment in advance.
 Terms of payments

• Advance payment: payment made before shipment

• Open account
• Documentary collection
• Documentary credit (L/C): undertaking of payment to
the seller’s, issuing by buyer’s bank
• Standard rule:
- Uniform custom and practice for DC – UCP 600,
2007, ICC
- Uniform rule for collection No 522 – URC 522, ICC
1995
Global Trade Rules
International standard Rules

• UCP 600 - DCs

•ISBP 745- ICC 2013
•URC 522 - Collection
•ISP98: stand-by L/C
•URDG 758 – L/G
•URR 725- DCs
 Payment in advance
(Cash in advance)
• Characteristic of Cash in advance:
- Full or significant partial payment is required, usually through
a credit card or a bank or wire transfer before the ownership of
the good transferred
- Cash in advance, especially a wire transfers: most secure and
favourable method of payment for exporters and least secure
for importers
• Pros: payment before shipment and eliminates risk of non-
payment
• Cons: May loss customers to competitors over payment terms
- No additional earning through financing operations
 T/T pre – shipment /cash in advance

BANK NHNK
bank

EX IM

Advance paymnet for performance Contract signing

L/G or Stand-by L/C Shipment
Payment Documents
 Cash in advance

• When use Cash in advance term?

• Importers is a new customer and/or has a less-established
operating history
• Importer’s credit worthiness is doubtful, unsatisfactory or
unverifiable
• The political and commercial risks of the importer’s home
country are very high
• Exporter’s product is unique, not available elsewhere or in
heavy demand
• Exporters operate an Internet-base business where the
acceptance of credit card payment is a must to remain
competitive
 Risk for Importer when Seller not to deliver the
goods ???

• The Buyer have to make advance payment

• In the event that the Seller not to deliver the goods,
The Seller have to request the bank to issue
Performance L/G in favor of the Buyer
 Bank Guarantee for Advance Payment

• At the request of the Supplier, we hereby irrevocably

undertake to pay you any sum or sums not exceeding
USD10,000.00 upon receipt of your first demand in writing
declaring that the Supplier is in breach of its obligation under
the Contract because the Supplier used the advance payment
for purpose other than toward delivery of the Goods.
• This Guarantee shall remain valid and in full effect from the
date of the advance payment received by the Supplier under
the Contract until… (insert date)
• This guarantee is subject to Uniform Rules for Demand
Guarantees, ICC Publication No 758 – URDG, 2010.

www.themegallery.com
PERFORMANCE GUARANTEE No:
• we understand that according to the conditions of the
Contract, a Performance Guarantee is required.
• At the request of the Supplier, we hereby irrevocably
undertake to pay you any sum(s) not exceeding
USD1,000,000.00 upon receipt by us of your first demand
in writing declaring the Supplier to be in default under the
Contract., without argument, or your needing to prove or
to show reasons for your demand or sum specified
therein.
• This guarantee is subject to Uniform Rules for Demand
Guarantees, ICC Publication No 758, ICC 2010
 Open account

- Under this method, this is absolute trust bw exporter and

importer built up over many years of trading relationship
- Exporter provides credit for importer by honour at future date
- Open account trade is a generous credit facility extended by
exporter to the importer to enable him to find buyers for the
products
- Role of banks: - providing the services for transfer payment at
the due date
- financing for exporter by factoring...
 Open account

Seller’s bank (3) Buyer’s bank

(3)
(2)
Seller Buyer

Contract

(1)
 Open account - Characteristics
– Risk:
Exporter faces significant risk as the buyer could default on
payment obligation after shipment of the goods
– Pros:
+ enhance the competitiveness in the global market
+ Establish and maintain a successful trade relationship
– Cons:
+ Importer’s insolvency
+ Additional costs associated with risk mitigation measures
 Risk for Exporter when Importer fails to pay

• In the event that the Buyer fails to pay the Seller any
payment by its due date or within the period set forth
in the Contract, the Buyer will pay interest to the
Seller on the amount of such delayed payment at the
rate (insert number) %.
• This interest rate that shall be applied is (insert
number %) for delay of payment
• The Buyer has to request the bank to issue L/G in
favor of the seller
Open account Terms in Competitive Markets

Open account terms may be offered in competitive

markets in the use of one or more trade finance:
1. Export Working capital Financing
2. Government-guaranteed Export Working capital
program
3. Export credit insurance
4. Export factoring
5. Forfaiting
 Documentary collection
- URC 522 (Uniform Rule for Collection), ICC 1995
- Art 2, URC define:
‘Collection means the handling by banks of documents
as defined in sub-article 2(b) in accordance with
instructions received, in order to obtain payment
and/or acceptance or deliver documents against
payment or documents against acceptance or deliver
documents on the other terms and conditions’
 Documentary collection included:
- D/P: Documents against Payment
- D/A: Documents against Acceptance
- D/TC: Documents against other Terms & Conditions
 Documents
(URC 522, ICC 1995)
• Financial documents: bill of exchange,
promissory notes, cheques or other similar
instruments used for obtaining the payment of
money
• Commercial documents: Invoices, transport
documents, documents of title or other similar
documents or any other documents whatsoever
not being financial documents
 Parties involve in Documentary Collection
• The Principal (Seller/Exporter/Drawer) who is the party
entrusting the handling of the collection to a bank
• The Remitting (Principal's/Seller's/Exporter's Bank)
which is the bank to which the principal has entrusted the
handling of a collection
• The Collecting or Presenting (Buyer's) Bank which any
bank other than remitting bank involved in processing the
collection and making presentation the documents to the
Drawee
• The Drawee (Buyer/Importer): makes cash payment or
signs a draft according to the terms of the collection
instruction/ collection order in exchange for the documents
from the presenting/collecting bank
 Documentary Collection
CONTRACT
Remitting Collecting
SHIPMENT
Bank Bank
COLLECTION
INSTRUCTION

COLLECTION
INSTRUCTION

Principal Drawee D/A, D/P, D/TC

PAYMENT/
ACCEPTANCE
 Benefits and Problems of Collection
* Benefits to the Exporter
(1) Collection provide better security than open account trading as
long as the credit status of the importer is confirmed positive
(2) Documentary collection can be used raise finance with the
following ways
- Export factoring
- Invoice discounting
- Overdraft or loan
...etc...
* Disadvantages to the Exporter
Exporter effectively loses control of the goods from that point
onwards and runs following risks: (i) buyer might refuse payment
saying goods not to satisfaction or (ii) cheat or (iii) become
insolvent
 Benefits and Problems of Collection
* Benefits to the Importer
(1) In case of D/A: Importer is granted credit facility in accordance
with the tenor
(2) Collections are cheaper in term of bank charges than L/C
(3) In term of safety, Collections are better than payment in
advance.
(4) D/A is good chance for importer to boost his turnover and profit
if he honours all accepted bills at maturity
(5) Importer can arrange finance with several ways
- Overdraft or loan
- D/A
...etc...
 Benefits and Problems of Collection
* Disadvantages to the Importer
(1) In case of D/A: Importer is granted credit facility in accordance
with the tenor
(2) Collections are cheaper in term of bank charges than L/C
(3) In term of safety, Collections are better than payment in
advance.
(4) D/A is good chance for importer to boost his turnover and profit
if he honours all accepted bills at maturity
(5) Importer can arrange finance with several ways
- Overdraft or loan
- D/A
...etc...
 Documentary collection
• D/A Riskier than D/P
• Under DP, Seller keep control of goods until buyer pays. If buyer
refuse to pay, seller can
– take the buyer to court, or
– find another buyer in the importer’s country, or
– arrange for sales by auction
– ship back to sellers country.
• Under DA:
Buyer signs, promising to pay the bill at a fixed future date. Documents
released
Seller effectively loses control of the goods from that point onwards
and runs following risks: (i) buyer might refuse payment saying goods
not to satisfaction or (ii) cheat or (iii) become insolvent
 Documentary collection
What if the Buyer Refuses the Documents?
Protest
Store
Find another buyer
Auction
Conclusion
A seller should only agree to payment under documentary
collection if:
•Seller does not have doubt on the buyer’s ability and
willingness to pay
•Buyer’s country is politically and economically stable;
•There is no foreign exchange restriction in the buyer’s country;
•The shipped goods are easily marketable or alternate buyers
can be easily found.
 Questions

(1) What are the responsibilities of banks in a Documentary

collections transaction?
(2) State the pros and cons of documentary collection transaction
to an importer and exporter
(3) State the documents under URC 522, ICC 1995
INTERNATIONAL TRADE AND FINANCE

Documentary credit
 Documentary credits – UCP 600
• Documentary Credit is a written undertaking of the Bank
towards Beneficiary issued on the instructions of the Applicant
to provide settlement as per terms and conditions of the DC
for specified time against presentation of the documents, which
strictly comply with DC terms and conditions.
• Article 2, UCP 600: “Credit means any arrangement, however
named or described, that is irrevocable and thereby constitutes
a definite undertaking of the issuing bank to honour a
complying presentation”.
– Honour means:
a. to pay at sight if the credit is available by sight payment.
b. to incur a deferred payment undertaking and pay at maturity if the
credit is available by deferred payment.
c. to accept a bill of exchange ("draft") drawn by the beneficiary and
pay at maturity if the credit is available by acceptance
 Documentary credits -Characteristics

• A DC is the written promise of a bank, undertaken on behalf of

a buyer, to pay a seller the amount specified in the credit
provided the seller complies with the terms and conditions set
forth in the credit.
• Fundamental principle of documentary credits is that banks
deal in documents and not goods. Banks are responsible for
issues relating to documents and the specific wording of the
documentary credit as opposed to issues relating to the goods
themselves.
 Banks are not concerned if a shipment is in conformity with
the documents, only that the documents are in conformity to
the wording of the credit.
 Nature of L/C?

Applicant form
? Letter of
credit
Importer
Issuing Beneficiary
Bank
National law International custom practice (UCP)
 Parties to the Credit

• Applicant (Importer): initiates the issuing of LC after

signing the contract of LC terms
• Issuing Bank
• Advising Bank: the correspondent bank of the
issuing bank
• Nominated Bank: the bank with which credit is
available or any bank in the case of a credit available
with any bank’  Art (2) – UCP 600
• Confirming Bank
• Beneficiary
 Security provided by L/C

• The Issuing Bank is always liable

• Bank risk instead of Importer´s risk
• Export´s Bank not liable unless it is a
Confirming Bank
• Confirmed L/C - two separate payment bank
undertakings
• Removal of the country risk (confirmed L/C)!

73
 Advantages of Documentary Credit
Importer
Exporter
• Payment on compliance only
• Bank undertaking • Already control over the
(bank) delivery of goods or obtained
• Independent, irrevocable using L/C
• Better negotiation power
• Clear rules (UCP 600) (credit – deferred payment)
• Documentary character • Obtain import financing from
• Possibility of issuing bank
(pre) finance • enjoy better cash management
because he does not have to
• Discounting the bill under pay in advance
usance LC
74
 Disadvantages of Documentary Credit

Exporter Importer
• Cost • Cost
• Make ensure that all • Credit facility
documents compliance with • Security provided to the Bank
the terms and conditions of LC • Risk of fraud, non-compliance
• be exposed the risk of under the contract of sale by
documents being rejected due the Exporter
to discrepancies • Once in irrevocable LC has
• If not confirmed by local been issued, it cannot be
banks, the risk of non-payment cancelled or amended without
will be happen in case of the consent of the seller or
issuing bank becomes others any claim
insolvent or other problems
associated with issuing bank... 75
 Documentary Credit Process in Vietnam

5
8
 6 7
8 Applicant Bank

5
 6 7
Contrac
t

4
76
 Risks related to parties in DC?

• What are risks/problems for each party in steps?

- Applicant
- Beneficiary
- Banks
• What is Solution?
• Example:
- Problem/Risk for importer when open L/C in step 1?
- Problem/Risk for issuing bank in step 2, step 6,7,8
- Problem/risk for beneficiary in step 5?
 SWIFT format MT 700
(Society for Worldwide Interbank
Financial Telecommunication)
 Letter of credit issued by SWIFT – MT700
• 27: Sequence of total: 1/1
• 40A: Form of Documentary Credit: IRREVOCABLE
• 20: Documentary Credit Number: LA0154N409DG
• 31C: Date of Issue: 150305
• 31D: Date and Place Expiry: 150520 AT NEGO BANK IN
SINGAPORE
• 51D: Applicant Bank – Name & Address:
• 50: Applicant: 59: Beneficiary – Name & Address:
• 32B: Current Code, Amount: USD 412,000.00
• 39B: Maximum Credit Amount:
• 41D: Available with Any Bank By Negotiation
• 42C: Draft at Sight for 100% of INVOICE VALUE in duplicate
• 42D: Drawee – Name & Address: EASTERN ASIA
COMMERCIAL BANK, VN
Letter of credit issued by SWIFT – MT700
• 43P: Partial Shipments: Not Allowed
• 43T: Transhipment: Not Allowed
• 44A: On Board/Disp /Taking Charge at: ANY PORT OF SINGAPORE
• 44B: For Transportation to: HAIPHONG PORT, VIETNAM
• 44C: Latest Date of Shippment: 150420
• 45A: Description of goods &/or Services:
• + PRICE TERMS : CIF HAIPHONG PORT (INCOTERMS 2010)
• 46A: Documents Required:
• 47A: Additional Conditions: ALL DOCS MUST BE SHOWN IN
ENGLISH
• 71B: Charges:
• 48: Period for Presentation:
• 78: Instruction to Pay/Accept/Negot Bank:
• 72: THIS IS THE OPERATIVE CREDIT INSTRUMENT SUBJECT
TO UCP 600 2007 ICC
•
 Review

• Test for Trade service

• L/C progress check
• Case studies trade finance
 Case study – Documentary credit
Question 1: A DC subject to UCP 600 has the
following stipulation:
"Purchase Contract No. 123456 dated 24 July 2007
attached herewith forms an integral part of this
documentary credit."
Is this stipulation acceptable and what are the risks?
 Article 4- UCP 600 Credits v. Contracts

• a. A credit by its nature is a separate transaction from the sale

or other contract on which it may be based. Banks are in no
way concerned with or bound by such contract, even if any
reference whatsoever to it is included in the credit.
Consequently, the undertaking of a bank to honour, to
negotiate or to fulfil any other obligation under the credit is not
subject to claims or defences by the applicant resulting from
its relationships with the issuing bank or the beneficiary.
• b. An issuing bank should discourage any attempt by the
applicant to include, as an integral part of the credit, copies of
the underlying contract, proforma invoice and the like.
Art. 5 - Documents v. Goods, Services or Performance
Banks deal with documents and not with goods, services or
performance to which the documents may relate
Question 3: A documentary credit for USD 150,000 calls for a full set of bills
of lading and an insurance certificate for cover all risks. The bill of lading
presented indicates an on board date of 15 December. Which of the following
insurance documents are acceptable? Explain your answer.
– Policy for USD 185,000
– Certificate dated 17 December
– Declaration signed by a broker on their own behalf
– Certificate subject to a franchise or excess
Question 4: A documentary credit expiring on 10 June requires the
following documents:
• Signed commercial invoice indicating goods of German origin
• Bill of lading evidencing shipment in the middle of May
• Detailed packing list
• The beneficiary presents documents on 11 June because the bank was closed
on 10 June to a national holiday with the following documents including:
Commercial invoice dated 11 June, Bill of lading indicating on board
notation of 21 May and detailed packing list without beneficiary’s signature.
• Should the issuing bank honour the presentation under such circumstance?
Question 5: Under a documentary credit calling
for a bill of lading and requiring shipment
from a Korean port to a UK port, which of the
following would
Place of be acceptable
Place of toofhonour?
Place Final
receipt loading discharge destination
B/L 27890 Busan Osaka Hamburg Southampton
B/L NK2907 Osaka Busan Southampton Hamburg
B/L 98670BL Busan Osaka Southampton Hamburg
B/L 12230899 Osaka Busan Hamburg Southampton
 Case study 2
Letter of credit A subject to UCP 600 states:
+1 original and 2 copies of beneficiary's certificate certifying that 1 set of
copies of shipping documents has been sent to the applicant within 2 days
from date of shipment.
Letter of credit B subject to UCP 600 with other identical terms and conditions
states:
+1 original and 2 copies of beneficiary's certificate certifying that 1 set of
copies of shipping documents has been sent to the applicant within 2 days
after date of shipment.
• The shipment date for the presentation is 3 May 2014.
• 1 original and 2 copies of a signed beneficiary's certificate are presented,
certifying that 1 set of copies of shipping documents has been sent to the
applicant on date of shipment. It follows that its issuance or signature date
is also 3 May 2014.
• Is this beneficiary's certificate compliant under both letter of credit A and
B? - Article 3- UCP 600
 Case study 3
• A credit subject to UCP 600 calling for 2,000 MT of chemicals does
not allow partial shipments or drawings. Two bills of lading are
presented. Bill of lading 1 of voyage No. 666 shows carriage by MV
Good Luck with 1,000 MT of chemicals to be discharged at Singapore
and bill of lading 2 of voyage No. 666 showing carriage by the same
vessel MV Good Luck with 1,000 MT of chemicals to be discharged at
Hong Kong.
• The issuing bank refuses the presentation stating:
• “According to article 31 (b) of UCP 600, shipments to two different
destinations are partial shipments that the credit does not allow”.
• The beneficiary argues that Singapore and Hong Kong are only ports
of discharge, not destinations, that are the exact words used in article
31 (b) of UCP 600. Hence there is no discrepancy.
Questions:
• Q1 Who is correct?
INTERNATIONAL TRADE AND FINANCE

Trade Finance Management

 Contents

• Short term-trade finance

- Short term trade finance?
- Trade cycle and operating cycle?
- When short-term trade finance is required?
• Medium and long term trade finance
- Buyer and seller credits
- Line of credits
- Forfeiting
- ....
 Short-term trade finance

• is provided and repaid within 2 years

• Covers purchase and sale of consumer goods
Trade cycle and Operating cycle?
- Trade cycle: the time period bw the start of supply
chain (ordering good and raw materials and receipt of
payment for corresponding sales of finished products)
- Business use working capital to finance the trade
cycle
- Operating cycle:
 Operating Cycle (OC)

– Operating cycle is the time period

between the acquisition of inventory
and when cash is collected from
receivables.

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 Working Capital Management
Operating and Cash Conversion Cycles

• Operating Cycle is:

[ 23-14]
OC  ADSI  ACP

• Operating cycle is a function of average days sales in inventory and

the average collection period.

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 Cash Conversion Cycle (CCC)

• Cash cycle is the time between cash disbursement

and cash collection.
• An estimate of the average time between when a
firm pays cash for its inventory purchases and
when it receives cash for its sales; the average
number of days of sales that firm must finance
outside the use of trade credt.

23 - 93
 Working Capital Management
Operating and Cash Conversion Cycles

• The Cash Conversion Cycle :

[ 23-15]
CCC  OC - ADSP

• The estimated time between when a firm pays cash for inventory
purchases and when it receives cash from sales.

23 - 94
 Cash Conversion Cycle (CCC)
Operating and Cash Conversion Cycles

Cash Conversion Cycle = Inventory conversion period +

Receivables conversion period -
Payables deferral period

Management of the cash cycle can make an important difference in the amount
of financing required, assets employed to generate a given level of
sales...and therefore, can affect ROA and ROE.

23 - 95
 Cash Flow Time Line
Operating and Cash Conversion Cycles

Inventory Cash
sold received

Inventory
purchased

Inventory period Accounts receivable period

Time
Accounts payable period
Cash paid for
inventory

Operating cycle (OC)

Cash Conversion Cycle (CCC)

23 - 96
 Importance of Cash Flow

• Planning to have cash available to pay bills of the business as

they become due is a critical aspect of business survival…it is
a management skill.
• Understanding the cash flow cycle of a firm can help you
manage those elements that are critical to ensuring you can
pay your bills.
• Cash flow forecasting through a cash budget provides
important information to you and to your potential funding
partners about your operating financial needs and most
particularly, the timing and magnitude of any projected cash
deficits or surpluses.
23 - 97
 The Cash Budget

• The purpose of the cash budget is to forecast

the timing and magnitude of expected cash
deficits and surpluses so that, before the fact,
you (the manager) can arrange appropriate
financing or plan an appropriate investment
strategy.

23 - 98
 Short-term Credit
• short-term loans can be secured much more quickly than long-
term credit
• short-term credit is generally more flexible
– low flotation costs
– generally no prepayment penalties
– fewer restrictive covenants
• with an upward sloping yield curve - short-term credit is
normally less expensive than long-term debt
• short-term credit may be more risky than long-term debt:
– interest rate risk exposure
– renegotiation risk
23 - 99
 Sources of Short-term Financing
• Accruals
– spontaneous source of financing
– no explicit cost to these sources
– examples:
• accrued wages
• accrued taxes

23 - 100
 Sources of Short-term Financing

• Accounts Payable / Trade Credit

– there may be no explicit cost (eg. Net 30)
– if there is a discount for early payment, then
there is an implicit cost for not taking the
discount.
– discounts lost - an expense on the income
statement can reduce net income more than
taking a loan in order to take the discount.

23 - 101
 Approximate Cost of A/P

Approximate percentage cost =

[Discount percentage/(100 - Discount percentage)]
[365/(Days credit is outstanding - Discount period)]

EAR = (1 + periodic interest rate)(number of times/year such an activity can occur) - 1

Example: assume (2/10 net 30)

Approximate percentage cost = (2/98)(365/20) = 37.2%
EAR = (1 + .0204082)18.25 - 1 = 1.4458539 - 1 = 44.6%

(This, of course, assumes that the company pays on the 30th day. The
costs will change if the firm pays later or earlier.)
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 Sources of Short-term Financing
• Bank Loans
– types:
• operating loans
• line of credit
• revolving credit agreement
– costs:
Effective ratesimple = interest/amount received = $800/$10,000 = 8%

23 - 103
 Costs of Bank Loans
Discount Interest

Interest is deducted in advance, reducing the principal

amount available to to borrower.
Effective ratediscount = interest/amount received
= interest/(Face value - interest)
= $800/($10,000 - $800)
= 8.7%
or
Effective ratediscount = 8%/(1-.08) = 8%/(.92) = 8.7%
23 - 104
 Cost of Bank Loans
Compensating Balances

Reduce the the amount of the loan available to the borrower and
effectively increase the cost of the loan.

Effective ratesimple/CB = Nominal Rate(%)/ (1.0 - CB stated as

a fraction)
= 8%/(1.0 - 0.10)
= 8%/.9
= 8.9%

23 - 105
 Commercial Paper
• short-term unsecured promissory note issued
only by the most credit-worthy of corporate
issuers
• by-passes banks and allows the firm direct
access to the money market
• is a negotiable security that does not carry a
stated rate of interest, rather, it trades at a
discount from par value.

23 - 106
 Banker’s Acceptances
• an alternative to commercial paper for smaller
firms that don’t have the credit-worthiness to
secure commercial paper financing.
• a money market instrument
• the bank “accepts” the promissory note by
stamping it “accepted”....the note therefore is
secured by the Bank’s promise to pay.

23 - 107
 Pledging of A/R
• lender has claims against the receivables as
well as recourse to the borrower.
• the risk of default on the receivable stays with
the borrower.
• the buyer of the goods does not know that the
receivables have been pledged as collateral for
a loan.

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 Factoring (Selling) A/R
• legally binding agreement between the seller of the goods and the financial
institution.
• the factoring institution receives a credit approval slip...the institution does
a credit check...if approved, shipment is made and the buyer is instructed to
make payment directly to the factoring company.
• the factor - credit check - lends - bears risk - in the process of performing
these functions, the firm that sells its receivables to a factor, eliminates the
need for an accounts receivable department and receives a net amount of
cash immediately following the sale...these funds are advanced by the
factor.
• the factor is compensated for its services and protects its interests by
charging interest, charging a commission and maintaining a hold-
back(reserve) in the case of disputes between buyer and seller over
damaged goods, returns, etc.
• once this arrangement is in place - the financing is spontaneous.
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 Inventory Financing
• Blanket Liens - gives the lending institution a lien against all of the
borrower’s inventories.
• Trust Receipts - issued for specific items of inventory. The lending
institution sends someone to the borrower’s premises to periodically
check that the numbers are correctly listed.
• Warehouse Receipts - either an independent third party warehouses the
goods, or the goods are secured in a separate location on the borrower’s
property. Warehouse financing involves:
• public notification
• physical control of the inventory
• supervision by a custodian
- used to finance the seasonal buildup of inventory.
- ensures proper warehousing practices...and inventory control.
- because of the foregoing, inventory becomes more acceptable as
collateral.
23 - 110