SPOTLIGHT Trade Finance

The practicalities of trade finance Martin Smith of AGCO explores the various payment methods in trade finance and highlights the pitfalls exporter’s should look out for.

o the treasurer, cash is king. This is to be provided as well as a whole host achieved by getting paid promptly As credit of conditions it has to comply with. Tor by arranging discounting to has expanded and Therefore, it is essential to examine bring the cash in earlier. closely the wording of the L/C when it Equally, the export finance depart- certain countries arrives. Ideally, the sales manager, the ment is there to assist the sales manager have better credit shipping co-ordinator and the export in getting the sale, and potential cus- finance representative should get tomers are likely to be attracted to your risks, so the L/C has together to review the L/C and ask the company by the offer of credit instead of moved to cover the following questions: a cash prepayment. By offering credit, of course, you must have done your more difficult does the L/C agree to what the sales homework. Much depends on what type markets not covered manager negotiated; of credit you are willing to offer as to by credit insurance can the company manufacture and how much work is done in-house. ship the goods within the time frame In this article, we will explore some of set by latest date for shipment; the various payment methods that can political risk. You may be happy to is there an inspection required? This be used, their pitfalls and their risk. accept an unconfirmed L/C if you think has to be arranged so as not to delay Much also depends on the credit option there is no political risk in the country document presentation; available in the country you are selling you are exporting to. That may be does the L/C stipulate the number of to. Here, we will deal with short-term acceptable for a sight L/C, but for a days for documents to be presented trade finance of up to 180 days pay- deferred payment L/C, you should to the ? Ideally, 21 days from ment terms. always seek confirmation. That way you date of shipment; and The various types of payment mecha- can discount the proceeds, normally are amendments required? nisms are best covered by a description from the advising bank. of each: You may receive an L/C from a It is best for the exporter to prepare a Middle Eastern country where the advis- full list of amendments to be sent to the (L/C); ing bank is informed not to add its con- customer so all the changes can be avalised bill of exchange; firmation by the opening bank. In this done at the same time and not delay the credit insurance; case, you would need to find a bank or order being shipped. It is important that forfaiting; and forfaiter which will silently confirm the the opener reacts quickly to get the bank guarantee. L/C. The difficulty for the exporter of the amendments issued by its bank. When L/C is that it calls for a list of documents dealing with Middle Eastern countries, Letter of credit for example, the exporter may only get The letter of credit is a traditional one chance to make amendments. method of payment for the exporter, For the large value L/Cs, or where the but its use has changed as the percep- exporter is uncertain, it is always best to tion of risk of the country improves. As discuss the wordings with the advising credit insurance has expanded and bank – assuming, of course, that it has certain countries have better credit been advised in the UK. At this point, risks, so the L/C has moved to cover any misinterpretations can be ironed out the more difficult markets not covered and the exporter obtains a better under- by credit insurance. standing of how the advising bank is Ideally, the exporter should look for a going to interpret what wording has to confirmed irrevocable letter of credit, be put on which documents and number whereby the advising bank agrees to of original documents as opposed to add its confirmation. This means the copies. All original documents must be will pay the exporter once docu- clearly marked ‘original’. At the end of ments have been accepted within the the day, the exporter wants to present validity of the L/C. This eliminates the Martin Smith the correct documentation as soon as

42 The Treasurer – March 2001 SPOTLIGHT Trade Finance

possible after shipment and well before exporters may be selling to the same the allocated number of days for pres- Doing your own overseas buyer), and any experience of entation expire. in-house analysis of claims and late payments. To assist the However, many banks find a large underwriter, it is best if the exporter number of discrepant documents. overseas distributors obtains the latest financial accounts of Sometimes there is enough time to cor- and customers the overseas distributor or third party rect errors before the expiry date is customer in advance. Get your own reached, but dealing with discrepancies assists the sales finance people to analyse them so you after this date has been exceeded can manager where you already have an idea whether the result in the confirmation being lost and underwriter will accept your credit limit payment being delayed. Much depends can report on the application. If getting hold of annual on the exporter knowing its customer financial health of accounts direct is difficult, then a credit because it will have to instruct its bank their customers agency report from credit agencies such to accept discrepant documents for the as Dun & Bradstreet or Graydon can bank to arrange payment. Be warned obtain the information on your intended though, that some countries are slower The Treasurer (see page 49), but the customer. This will enable you to dis- than others in getting this organised ability to offer your overseas customer cover whether the buyer is in good or and delayed payment causes the treas- credit terms of open account is a great bad financial health and anticipate the urer additional expense. advantage. NCM is not the only credit likely outcome of the underwriter’s deci- One important factor is to ensure that insurer the exporter can approach, sion will be. Sending any financial infor- the costs of finance are included within other options include Coface and Euler mation you obtain to the underwriter, the price quotation. Once the order has Trade Indemnity. Ideally, the exporter along with your application, will greatly been won and an L/C received, there will obtain credit limits from its credit speed up the response. will not only be normal bank processing insurer for as many markets as possible Increasingly, treasurers are assigning charges to take into account but also – for example, by taking out a whole their credit insurance policy to the banks confirmation fees, which will vary turnover policy – which therefore leaves to obtain discounting of the receivables according to the country risk as well as markets not willing to be covered by the at very competitive rates of interest. the length of period being covered. If credit insurer and those markets requir- They are also using the policy in securi- this is overlooked, the cost will be a ing letters of credit outside. Even then, tisation funding. direct hit on the profit margin. NCM may provide cover on an uncon- Doing your own in-house analysis of firmed L/C. The exporter should com- your overseas distributors and cus- Standby letter of credit pare the cost of the insurance premium tomers assists not only the credit insurer Another form of L/C is the standby L/C, with the cost of confirmation from the but also the sales manager where you which is useful where the exporter has bank. can report on the financial health of regular weekly and/or monthly ship- Forming a close working relationship their customers. This is particularly ments. The benefit of the standby L/C is with your credit insurer is essential, as useful where you may have a national that the amount of documentation the credit insurer has taken a variety of distributor in each export market, and required to be presented to the bank is countries and spread its risk on the mar- continuity and profitability is important limited to, perhaps, only a copy of the kets you are selling to. There are two in selling your goods within that market. invoice and evidence of shipment, but important area s for the exporter: the Deteriorating financial performance this occurs only where the customer has level of the credit limit and the length of requires investigation and may indicate, not made the payment by the due date. the payment terms. The exporter wants as well as other factors such as falling In other words, credit is given to the the underwriter to grant the credit limit market share, that it is time to change customer for, say, 30 days, and only if required and the payment terms your distributor. payment is not received would the requested. But to obtain these the exporter present documents to the underwriter will consider the political Forfaiting advising bank. The value of the standby risk of the country, the financial strength Another form of financing is forfaiting. L/C has to cover the projected ship- of the buyer, its existing exposure (other Although this article is focusing on ments over the credit period in addition short-term payment terms of up to 180 to another 30 days. days, forfaiting can extend to payment Banks are willing to use the standby There are terms of five years and more, depend- L/C as a basis for discounting where the two important ing on the risk of the country involved exporter is granting up to 180-day pay- and the bank avalising the bill of ment terms. But it is best the exporter areas for the exchange, normally in the country of the always refers to the advising bank in exporter: buyer. advance of the document being issued Under forfaiting, the exporter sends so the wording is acceptable to both the level of the out a bill of exchange to be accepted parties. credit limit and by the buyer (signed) and then the length of the counter-signed (avalised) by their NCM bank. The exporter then sells the bill of The role of NCM credit insurance is payment terms exchange to the forfaiter and collects described elsewhere in this section of the cash without recourse minus the

The Treasurer – March 2001 43 SPOTLIGHT Trade Finance

discounting costs. The forfaiter will exporter finance where the exporter is either keep it on its books until matu- Increasingly, finding difficulties. rity or sell the bill of exchange on. treasurers are Sometimes, the connection is not There are overseas companies the for- obvious and may entail the use of a faiter will accept as company risk and assigning their trade finance consultant or broker, but not require a bank avalisation. credit insurance in the long run when you collect the Most major banks have their own for- payment, a small commission fee for faiting department, with London policy to the banks their services is worthwhile. After all, Forfaiting Company (LFC) and WestLB to obtain money in the treasurer’s bank accounts amongst the specialist. discounting of the saves on overdraft interest or increases deposit interest on overnight cash. Bank guarantees receivables at very Bank guarantees are another useful tool competitive rates of Make sure everything is in order for short-term financing – not only on We have covered several methods of their own but also to enhance your interest payment here. But also the exporter credit insurance credit limits where the should not overlook the currency of underwriter is not able to provide the important the wording is adequate for invoicing and ensuring that the treas- credit limit required. Therefore, the the discounting institution to receive urer has taken out the necessary foreign bank guarantee can be used not only payment on the due date. exchange cover. for the one-off transaction but also as There are a number of banks in Care must be taken to ensure that cover for a flow market where normally London representing a whole host of necessary documentation is prepared the bank guarantee will be renewable markets around the world. The interna- and presented to the banks or forfaiters. annually. Do not forget to keep a record tional banks have all got their specialist Bear in mind that incorrect documenta- of the expiry date so that it can be niche markets where they are able to tion results in delayed payment, addi- renewed in good time and shipments offer the exporter assistance with tional bank charges, and therefore extra are not delayed. finance, whether it be Africa or Eastern costs to the treasurer. If you wish to discount the bank Europe. Through their extensive rela- guarantee ensure it is worded satisfac- tions with customers inside those mar- Martin Smith is Manager, Export torily, for example, transferable. As you kets, as well as exporters to that market, Finance, AGCO Ltd (formerly Massey want to discount without recourse, it is the bank may be able to offer the Ferguson).

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The next programme is on 24 May to 25 May 2001 For more information visit www.cranfield.ac.uk/som/finance