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  • UNITED NATIONS ECONOMIC COMMISSION FOR EUROPE ΤRADE FINANCE IN TRANSITION ECONOMIES: PRACTICAL WAYS TO SUPPORT EXPORTS AND IMPORTS SUMMARY OF PROCEEDINGS Workshop organized at Palais des Nations Geneva, November 27 and 28, 1997 Prepared for publication by Mr. Beat Haenni, consultant to UN/ECE 1
  • I. Introduction The development of transition economies' foreign trade depends largely on the availability of competitive export products on the one hand, and convertible currency funds for imports, on the other. The growth of exports proves to be one of the efficient vehicles to drive countries of central and Eastern Europe out of the transitional slump, and finance and stimulate structural transformations. From this standpoint, and, especially, in the short-run, improved trade financing and the related support by banks can contribute importantly to the successful transition. While trade finance experience is accumulated by business operators in practical cross-border operations, an exchange of opinions on this subject, involving exporters and importers from both transition and developed market economies, can play a useful role in identifying problems and offering solutions to them. II. Objective of the Workshop The workshop was held under the auspices of the United Nations Economic Commission for Europe on 27 and 28 November 1997 in Geneva. The workshop aimed at bringing together companies and organizations from transition and developed market economies actively engaged in foreign trade, and/or determined to enhance their export and import activities. The participants discussed problems arising in financing foreign trade, relating, in particular, to short-term payment maturities. Longer-term financing linked to trade in investment goods and project finance was not on the workshop's agenda. In geographical terms, the focus was on trade with and among european transition economies. III. Speakers The workshop was moderated by five experts holding managerial position in leading international companies and banks. These five speakers and moderators included: Mr. Johann J. Ackermann, Trade Financing Area Manager, Du Pont de Nemours International S.A. Mr. Werner H. Baur, Treasurer, Dow Mideast/Africa/Eastern Europe Dow Europe S.A. Mr. Edgar Walther, retired Deputy Vice-President, Swiss Bank Corporation Mr. Beat Haenni, Head International Trade Finance and Credit Management with Novartis Pharma Services Inc. Mr. Dominique Mathieu, Head of International Finance and Administration, Hoechst Marion Roussel, France. IV. Attendance The Workshop assembled representatives of private companies and banks dealing with foreign trade financing from developed market economies, transition economies of central and eastern Europe, and the CIS. A number of participants represented various business associations from transition economies, as well as Governmental and semi-Governmental Export-Import Banks and Export Credit Agencies (ECAs). The representatives of the International Trade Centre, the World Trade Organization as 2
  • well as the United Nations Conference on Trade and Development also attended the Workshop. V. Discussion and conclusions The Workshop considered practical issues of attracting and managing foreign trade finance by private companies. In particular, it addressed the problems of risk identification and assessment, appropriate payment and credit arrangements in transition economies, the role of banks and export risk insurers in facilitating funding of foreign trade, monitoring and management of the exporter=s financial risk exposure, and organization of the trade finance and international credit management functions in an exporting company. The presentations by the moderators as well as the discussion showed that trade finance and international credit management represent important vehicles of enhanced foreign trade capacity of transition economies. The exchange of expert opinions on innovative ways of risk and credit management offerred solutions to the relevant trade finance problems so far not resolved. At the same time, the participants agreed that there were no ready-made prescriptions for all cases and industries. The right mix of payment and credit instruments to be used largely depends on the nature of the sector and geographical area a company operates in, the availability of business infrastructure, financial resources available to companies involved in foreign trade and their track record. The Workshop showed that the partnership between the exporter, his bank and, where required, the insurer is a key factor in securing financial resources for production and exports. To make this co-operation efficient, the environment in transition economies should be conducive to the dissemination of know-how relating to methods and techniques used by large, medium-sized and small companies in developed market economies. At the same time, bank loans and export credit insurance in most cases can not substitute for the credit management in a company. Among other objectives, credit management seeks to develop close and informal relationships with the company=s customers, identifying their particular financing needs and assessing associated risks. It also facilitates access to external financial sources through consistently developing cooperation with the partner banks. The credit management function is particularly important in transition economies where many new foreign traders have insufficient track record and credit history. Different opinions were expressed as regards the use of export credit insurance by private traders in transition economies. While some of the participants considered the services of public and semi-private credit insurance schemes as a cost-effective tool of exporter=s risk mitigation, others thought that the risk assessment should not be left with the insurer and that the export credit insurance should not replace credit management functions in an exporting entity. Presentations at the Workshop emphasized that Governments could play a constructive role in facilitating a transfer of financial know-how to the private sector. To this end, a joint public-private organization of workshops and similar events in economies in transition could be a relatively cost-effective and efficient vehicle. 3
  • VI. Follow-up There was a consensus among the participants that similar workshops should be organized on site in transition economies themselves. This would enhance the accessibility of these events to the interested private companies and increase their cost-effectiveness as a tool of know-how transfer. While in the Czech Republic, Hungary or Poland the exporting technology is already well developed and widespread, the CIS member-States are particularly appropriate targets for future workshops. There, the dissemination of export finance and credit management expertise via the meetings convened under the UN auspices and at a reduced cost (no conference fee) to the private sector, could be particularly efficient. The UN/ECE secretariat, possibly in cooperation with the interested international organizations (for example the ITC), would lend its support to organizing such events, if the respective Governments extend invitations officially. It is important that moderators and speakers at these workshops have practical experience of operation in the business environment of countries and regions concerned. To strengthen the practical aspect of such meetings, future panellists should include members of the local business community. VII. Summary of presentations The text which follows summarizes presentations made by the moderators at the Workshop. 1. Foreign trade risks: ways and means to assess them Definition of risks As any other business endeavour, exports and, more generally, cross-border trade involve financial risks. The duty of the corporate manager is to manage those risks rather than to avoid them. Hence the assessment of risks of a commercial transaction is an important factor of export and trade success. The definitions of commercial risks are plenty, and they are not necessarily consistent with each other. Some experts define risk as two-faced, one side being the danger and the other side an opportunity. Others say that risk is just an exposure to a loss. However, whatever the definition, assessing the risk would imply assessing first, the probability of a loss, second, the temporal dimension of such probability, and finally, the cost of protection against risk. Analysis of those various components of financial risks associated with trade is part and parcel of entrepreneurial know-how of a company embarking in cross-border activities. Depending on the size of the exporting company, the assessment, monitoring and management of the financial exposure are responsibilities assigned to one or several persons. Organizationally, they are members of the Export 4
  • Finance and/or Credit Management divisions/departments. Types of risk The financial risks accompanying export transactions can be differentiated in terms of their cause, their potential impact on profitability and effectiveness of protective measures. In general terms, the risks can be classified as follows: - political risk - transfer risk - country risk - commercial risk - bank risk - foreign exchange risk - performance risk Despite divergences of opinion among experts, political, transfer and country risks usually relate to sovereign state or a country, whereas commercial or payment risk, as well as bank risk relate to an individual business operator (see Chart 1). Political risk is associated with war, riots, social unrest caused by tribal disputes, union militancy, religious divisions, large differences between social classes, mis- management of foreign debt, large deficits in government spending and balance of payments, fall in export earnings, sudden increase in food or energy imports. Transfer risk relates to inability of private borrowers or suppliers to effect foreign exchange payments due to excessive foreign exchange restrictions imposed by a central bank or Government. Country risk reflects adverse situations caused by public actions (eg. cancellation of licenses, restrictions on exports and imports, seizure of goods or prevention of sales etc.) which jeopardize economic and commercial relations with abroad. In other words, a default caused by bankruptcy is a country risk if bankruptcy is the result of mismanagement of the economy by the government. However, it relates to commercial risk if it results from mismanagement of the firm. Commercial or payment risk relates to the capacity of a company or private individual to honour its payment commitments. Solvency problems of public institutions are generally classified under country risk. Bank risk is caused by the necessity to deal with financial institutions with weak balance sheets and the potential inability to stick to their financial commitments. Performance risk usually emerges in relation to countertrade or barter transactions, in terms of timely delivery of perishable produce (vegetables, grain, and similar). In practice, this risk boils down to either country or commercial risk. Chart 1 5
  • Country and Commercial Risk Country Risk Low High A B C D E Commercial F increasing Risk risk G High H Country Risk: A - Politically stable with strong economies B - Politically stable with good economies C - Political/economic risk generally acceptable D - Political/economic risk unacceptable Commercial: E - Strong financial condition, good payment record Risk F - Good financial condition, good payment record G - Financial information limited or poor payment record H - Unacceptable risk In transition economies the proliferation of private banks during recent years has led to a laxity in state supervision of these newly created financial institutions. Increasingly, the notion of bank risk intrudes the vocabulary of the international credit manager in situations where an export transaction enjoys the support of a bank (e.g. through a letter of credit or payment guarantee). While as a rule the bank risks are of limited concern in trade finance (as this service is usually offered by reputable banks), in situations of generalized financial and economic crises the bank activities can be hampered by governments (e.g. through government-inflicted currency devaluations). As was already indicated, any foreign trade transaction involving a payment 6
  • commitment in a foreign currency creates a foreign exchange exposure. Abrupt movements of exchange rates are characteristic of the transition period, the circumstance which strongly increases the risk of loss or, in contrast, extra profit for business operators. The profitability of the export sale should in no way hinge on speculative exchange rate fluctuations. Hedging operations, safety margins included in selling prices or exchange loss clauses in the sales contracts, are precautionary measures to neutralize adverse currency fluctuations. The evaluation of export risks: methods and sources of information The country risk assessment is not an exact science. It is an ever evolving discipline, which does not offer ready-made solutions in every case. This being said, the way the potential export risk is assessed depends to a large extend on the time horizon of the asset=s exposure, the value of the exposed asset and its weight on the exporter's balance sheet. The shipment of expensive heavy equipment to be paid off over 5 years commands a different risk evaluation techniques than a consumer-good trade receivable maturing at 180 days from invoice date. While the first case requires a detailed analysis of the importer's country economic environment, the second transaction will be effected after a simple credit check (e.g. through a credit information agency) of the buyer. Irrespective of the scope of the potentially exposed asset, the evaluation methods can be analytical or empirical, i.e. driven by the exporter's own past experience in dealing with a particular country or customer. The analytical approach relies on economic and financial statistics, for example the country's foreign debt ratio or its foreign exchange reserves (see Chart 2). International financial institutions as the World Bank, the International Monetary Fund or the Bank of International Settlement provide ample data to assess country risk. This "raw" information can be supplemented by risk assessments published byspecialized services as BERI, the INSTITUTIONAL INVESTOR, International banks, the ECONOMIST INTELLIGENCE UNIT-Country Risk Service (see Box 1). Chart 2 Risk Management: Major Factors and their Weights 7
  • 1.FINANCIAL RISK Current Account, 40 % Debt Service, Liquidity/ Working Capital. 2.ECONOMIC RISK GDP growth, GDP per capita, 30 % Unemployment, Natural resources. 3.POLITICAL RISK War, law and order, 30% Democracy/ Dictatorship, Ethnic conflicts. The major shortcoming of the analytical approach is its reliance on global figures relating to the past periods. Therefore, to be more conclusive, the expert routinely has to narrow the assessment to parameters relating to the exporter's industry (empirical method). Various factors as product priority for the country, major competitors in the market, credit terms offered by competitors, nature of buyers (public or private), the efficiency of the banking system, are studied as important indicators of the risk climate. Even more focused approach is warranted in the empirical evaluation of the customer, as opposed to country, risk. It is based on the following financial and non-financial parameters: financial: customer financial statements, credit agency reports, bank information, ownership structure (parent company's financial posture), past payment record. non-financial: competitive position of the customer in the market, reputation, management quality, years in business, standards of office and production facilities, feedback received from own marketing personnel and sales force visiting the customer. 8
  • Box 1 - Monitoring Country Risk There are a number of important sources to assess country risk. The most frequently consulted Country Credit Monitor is the Institutional Investor`s bi-yearly country ranking published in March and September each year based on information provided by leading international banks. Bankers are asked to grade each of the countries on a scale of 0 to 100, with 100 representing those with the least chance of default. Altogether, 135 countries are ranked. Credit terms usually start with country ranks between 60 to 70 up to 135. The Economist Intelligence Unit`s (EIU) Country Risk Service introduces rates from 0 to 100 or from A to F. Under its Country Risk Service the EIU provides to lenders and investors quarterly risk ratings of business and financial exposure to presently highly indebted and developing countries. Political risk, and the vulnerability of loan and trade payments, are assessed for the subsequent two years, using a rigorous and consistent methodology. Credit ratings are also provided for banking sector risk, currency risk and sovereign risk. Several bank and bond rating agencies have started to assess country risks in emerging markets, developing countries and in transition economies. These rating agencies include Standard & Poor`s, Moody`s, IBCA and Thomson Bank Watch. Furthermore, the worldwide known credit information agency Dun & Bradstreet also offers country risk ratings. Rating grades of different agencies do not differ substantially from one another and have usually 7 to 8 grades. The latter are split into two -four subgrades (quartiles), starting with Investment Grade (highest quality AAA) down to Speculative Grade (between BB+ and high risk obligations B). Others have similar terminology from DB 1 (highest creditworthiness) to DB 7 (lowest creditworthiness), and AAA (most creditworthy) to D (in default). In transition economies, because of the lack of a financial audit tradition, reliable information on a company's up-to-date financial performance and posture is not readily accessible. Hence, the dependence on non-financial parameters for credit risk evaluation. 9
  • Recently, the situation has been improving, however. Internationally-exposed companies in transition economies have been adopting the generally-accepted accounting standards. Also, the "opening up" of the formerly planned economies has given rise to a new service industry specializing in credit information. As these credit- rating agencies are generally associated with western parent or sister companies, credit information on customers is becoming part of a globally accessible database. Similar to the country risk, the correctly assessed degree of customer risk translates into the appropriate credit and payment terms. Although the bank risks may not be of major concern, if doubtful institutions should become part of a trade transaction, their creditworthiness should be checked through sources as MOODY's, STANDARD & POOR'S or THOMSON BANK WATCH. THE BANKERS' ALMANAC is another good source on a bank's credit rating. Needless to say, that information on banks of countries in transition is increasingly incorporated in these information sources. To summarize, credit managers should be prepared to utilize both analytical and empirical methods to assess risk. If a company or a bank has the necessary resources to conduct this analysis in-house, the skilled credit manager uses for this purpose his or her own experience and the experience of colleagues in combination with intuition , and Αsmelling≅ of what is happening or going to happen. The result is the financial risk ceilings, as well as fine-tuned payment terms and credit policies regarding various countries and customers. All these instruments contribute to correctly balancing the sales expansion with the reasonable risk exposure of the company. 2. Payment and credit arrangements as instruments of trade finance The successful completion of an export transaction translates into timely and unobstructed settlement of the importer's payment obligation. "Timely" and “unobstructed" are the key ingredients of good trade finance and credit management performance. This involves the correct choice of payment terms, monitoring of the trade receivables exposure, the careful selection of financial instruments and arrangements supporting the export transaction (see Chart 3). The payment terms formulation has to be unequivocal and well understood, as they are the pivots to a smooth cross-border flow of funds. Chart 3 Payment Terms Determinants and Instruments 10
  • Payment Security Methods Period Open Account Cash Cash in advance Cash against Draft (CIA) Documents (CAD) Checks Cash at Sight Bill of Exchange Local Finance Deferred Payment Irrevocable Letter Tools of Credit (ILC) Swift Irrevocable (bank transfer) Confirmed Letter Counter Trade of Credit (ICLC) Guarantees Payment terms comprise the three basic components: - payment period, - security considerations, and - payment method. Payment period. The payment period shows whether the trade transaction also involves the credit transaction and if so, who - the buyer or the seller - extends the credit. From this perspective, the following modes of payment are distinguished: - cash in advance, when the buyer credits the seller; - cash at sight or cash against delivery, when the credit period is non-existent, and - deferred payment, when the seller credits the buyer. In the latter case, which is typical of trade among developed market economies, credit period not exceeding 180 days after the invoice date is prevalent. Security considerations. From the point of view of payment security, payments may be effected on the following conditions: - open account, - cash against documents, - bill of exchange, - letter of credit (L/C) confirmed or not confirmed. - cash in advance. 11
  • Each consecutive payment mode starting from the open account enhances the security of the payment for the seller. As an additional security measure, a payment guarantee from a bank is often sought by the seller. In terms of security, the choice of the most adequate payment terms is mainly governed by payment risk considerations (see Chart 4). Although a competitive market strategy may call for liberal terms, the latter may be not commensurate to the payment risk. In general the following rules apply: Risk assessment Payment terms No risk open account High risk advance payment, confirmed letter of credit, payment guarantee Cash against documents or unconfirmed letters of credit are generally used for trade transactions not exposed to country risks. Sales to markets in economic transition mostly call for secured payment terms, because of the still prevailing financial export risks. These terms are generally adapted to the industry standards as well as to the track record (collection experience) of the customer (see Chart 5). A spreading practice for these markets are "open account" transactions, covered by an umbrella bank guarantee issued by the buyer's bank and counter-guaranteed by a reputable bank in the exporter's country. On the other hand, counter-trade has become a widespread tool, especially in the CIS markets (Russia and Ukraine), where the liquidity and the banking systems create Instruments In this case, performance and price risk, as well Risk constraints. as commercial and political risk have to be assessed. in use to be assessed Cash against Documents (CAD) Commercial & Political Risk Bills of Exchange/Draft Parent Guarantee --------------------------------- Chart 4 ----------------------------------- - - Irrevocable Letter of Credit (ILC) Avalized Draft Bank & Political Risk Trade Finance Instruments Stand-by Letter of Credit Bank Guarantee in relation to Risk --------------------------------- ----------------------------------- - - Confirmed Irrevocable Western Bank Risk Letter of Credit (ICLC) --------------------------------- ----------------------------------- - - Credit Insurance Residual Risk ECA + Private 12 --------------------------------- ----------------------------------- - - Counter Trade Performance Risk, Price Risk
  • Chart 5 Payme Terms Monit oring nt Determinants Control Industry Standards System for Orders Collection History Analysis of Commercial Risk Receivables Country Risk Credit Performance 13 Commercial Strategy Report
  • Method of payment. Methods of payment are determined by the above-mentioned security considerations and generally include: - payment in cash, - payment against draft (payable at sight or at maturity), - payment by cheque, - payment through bank transfer (Swift), - payment in kind (countertrade or barter). It should be again emphasized that the correct setting of payment terms is paramount to efficient trade. These are intimately linked with the ways of settlement, enforcement of payments and monitoring of the timely liquidation of the export receivables. Those are crucial tasks of the credit management function in the exporting company. Recently, the growing competition, world-wide market integration, shortages of funds due to dried up bank credit lines or liquidity bottlenecks have increasingly incited the exporters to use supplier credits as the source of export financing. In trading with countries in transition, deferred payment terms granted by exporters have become a condition to entering these (new) markets. Suffering profit losses because of long shipping and distribution channels, importers tend to ask their suppliers to participate in the financing of product inventories, distribution lead times and bad payment habits of local customers. Supplier credits of 90 to 180 days are becoming quite customary. The supplier credit has a solid insurance infrastructure in Western Europe and other developed market economies. However, this does not yet exist in the East although gradually, credit insurance markets are becoming more active. Another issue is to promote awareness of the customers of the governmental grants and aid from the West available in the emerging markets. One of the key objectives of the exporting company Treasury Department is to channel the customers to these funds, which are especially large in the infrastructure sector. This is also a way to sell the credit risk by addressing both the lack of resources and of information. In terms of buyer's credit, banks become more active in local lending through local bank credit lines. The objective of the exporting company is to bring the customer to the local commercial bank and share the risk with this bank. As a result, the customer gets access to cheap credit and also obtains cash discounts or cash to pay the suppliers. Recently, banks have structured trade finance increasingly as multilateral deals among suppliers. Participation in development projects, e.g. water treatment or agricultural development, is also a good way to get access to the money (aid) flows available. Finally, back-to-back bank facilities can be secured through ECA's, tailor- made for certain import transactions. 14
  • The lack of customer and country risk information in transition economies encourages exporting companies to use factoring as a working capital replenishing tool. In Western Europe, factoring as a means to get liquidity only serves as a last resort because of its high cost. In Eastern Europe, however, factoring enables the exporter to get rid of receivables in the balance sheet. Unfortunately, depending on the risk involved, large parts of profits are also gone. To avoid this requires a very good understanding of the nature of risks involved, implying a strong credit management in the partner country. A lot also depends on direct working relationships with local partners. Last but not least, as was already mentioned, some exporting companies use countertrade when dealing with transition economies. Countertrade deals with spot contracts when the exchange of products occurs at the same time, or with forward contracts (agriculture), when input products are shipped today, expecting the product after the harvest. In the latter case, the credit manager has to be aware of the price risk and performance risk: either deliveries take place or contracts are reassigned. To alleviate the risk, export accounts help to block money on a transaction or safeguard it on a neutral escrow account in a bank. 3. Banks and export risk insurers as partners in trade finance International trade relies on a well functioning banking system. A close working relationship between the exporter's and importer's respective banks is conducive to a smooth and timely flow of funds generated by trade transactions. Besides acting as conduit of trade proceeds, an internationally operating bank offers a variety of supporting trade finance services. In particular, it provides credit information on buyers, assesses country risk, recommends payment methods or trade finance instruments which would secure a timely settlement. As banks administer the documents accompanying the physical movement of goods, their experience can be instrumental in deciding on the right terms of export contract. Some of the bank services relating to trade payments are presented below. Documentary Collections Under the documentary collection (ICC Uniform Rules for Collection 522, see Box 2), the exporter entrusts the shipping documents to his bank and instructs it to deliver these documents to the buyer and collect the sum due. A documentary collection provides the exporter with a certain degree of payment security, as compared with an "open account" transaction, where the buyer can take possession of the goods without any payment commitment. Nevertheless, a documentary collection is only recommended if the exporter is certain about the buyer's willingness to pay, no import 15
  • restrictions exist, and the economic, political and legal environment in the importer's country is stable. Documentary Credits (Letters of Credit) Documentary Credit (commonly known as "Letter of Credit" or L/C) is a more complex instrument also subject to uniform rules (the UCP 500 or Uniform Customs and Practice for Documentary Credits) (see Chart 6). Under documentary credit, at the request of the buyer (importer) his (issuing) bank undertakes to pay a specified amount to the exporter, provided that the latter submits the stipulated shipping documents within a given period. The exporter compares the details of the documentary credit with the selling contract and delivers the goods if both documents match. The issuing bank checks the shipping documents again, sends them to the importer and debits his account. INCOTERMS are international rules for the interpretation of trade terms enabling to avoid contradictions between partners. These rules were elaborated The function of the documentary credit is to safeguard both parties to a trade by the International Chamber of Commerce (ICC) and entered into force on 1 transaction: July 1990 (see ICC Publication No.460 ΑINCOTERMS 1990≅). - the exporter is sure that he will be paid the amount agreed upon with the importer INCOTERMSshipping documents arecontract and arrive buyer and seller, which if the are used in the sale correct between in time; should not the importer iswith thethat his account will be debited the shipperthe goods have - be confused certain contract of carriage between only when and transporter. Due to (documents arrived). been shipped INCOTERMS traders give precise directions to their transporters; this ensures that the contract of carriage is in conformity with the contract of sale. BOX 2 - INCOTERMS AND ICC Rules Basically, the INCOTERMS cover the transfer of risks and costs between seller and buyer and certain customs and insurance responibilities. Examples of INCOTERMS (1990) are given below: EXW - Ex Works (...named place) FCA - Free Carrier (...named place) 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) CPT - Carriage Paid to (...named place of destination) 16
  • CIP - Carriage and Insurance paid to (...named place of destination) DAF - Delivered at Frontier (...named place) DES - Delivered Ex Ship (...named port of destination) DEQ - Delivered Ex Quay (Duty Paid) (...named port of destination) DDU - Delivered Duty unpaid (...named place of destination) DDP - Delivered Duty paid (...named place of destination) Chart 6 Trade Finance & Banking Services : Documentary Credit (Letter of Credit) Transmission Advising Bank ∃ Issuing Bank Documents + Money + „ ο 1 & 3 3 Exporter Importer 17
  • Goods ο & Opening of Documentary Credit (Letter of Credit or L/C). ∃ Transmission of the L/C to the advising bank. „ Exporter is notified of the L/C. ο Goods are delivered and shipping documents presented to the advising bank. 1 Advising bank pays the exporter. + Shipping documents are sent off to the issuing bank, which reimburses the advising bank. 3 Issuing bank delivers shipping documents to the importer and debits his account. Pre-shipment and post-shipment finance The expressions pre-shipment finance or pre-finance refer to financing taking place before the goods have been shipped and are most widely used in the commodity trade. Post-shipment finance takes place if the deal involves an extended payment, and a bank is prepared to finance this period up to maturity, while the exporter receives immediate payment. The credit might be available against the usance draft at a certain time after shipment with discounting possibilities for sellers=' or buyers' account, depending on who bears the interest, or with the possibility of forfaiting. These options are used generally in short- and medium term. Supplier and buyer credit Medium or long-term financing is mainly used for trade in capital goods and services. Export financing can be effected in the form of supplier credit where the lending bank refinances the exporter against assignment of its export receivables. In the case of a buyer credit, the bank extends a loan directly to the buyer under the formal loan agreement, with the loan proceeds being paid to the exporter. Under buyer credit, the repayment period, depending on the amount involved, can be between 2 and 5 years, and a down payment between 15-20 % of the loan is frequent. Normally, 5 % have to be paid after the signing of the contract with the other 10-15 % upon delivery of the goods. These down payments normally represent guarantees, i.e. an irrevocable advance payment guarantee of 5 % is due to the bank if the contract is not fulfilled, and a performance guarantee of up to 10-15 % of the contract value also remains with the financing bank if the exporter can not deliver the goods in conformity with the contract terms. The funding of such a credit is normally done in the Euro market and the basis for lending is usually the Euro rate plus a certain margin. A bank's credit line can play a decisive role in mobilizing temporary funds for a 18
  • supplier or buyer financing. As was mentioned, the bank will require certain securities to collateralize the financing facility. However, a continuous operational relationship with the bank's trade finance department should result in both accommodating financing conditions and concessionary banking fees. Our impression is that the banking credit facilities in support of exports require further development in transition economies. The excessive dependence on outside financial resources (from international and multilateral financial institutions) alienates a strong "home-grown" export industry. Discounting facility The traditional discounting facility gives the exporter the possibility to send his accepted draft (from Documentary Credit, from Documentary Collection or from Commercial Transactions) to his bank and ask for a discounting under a credit line, which the bank opens for discounting purposes (see Chart 7). Discounting in its classical form refers to discounting with recourse. If at maturity the draft is not honoured, the bank has the right to charge the exporter, including interest and fees. When the discounting has been made, the exporter gets the net proceeds, i.e. the value of the draft less an interest. Forfaiting According to the forfaiting agreement with his bank, the exporter has to guarantee the authenticity of the documents and their compliance with the terms of the basic contract (see Chart 8). He gets receivables under documentary credits guaranteed by banks; he can also submit avalized (bank guaranteed) drafts under documentary collections or promissory notes from export credit transaction. All these financing instruments can be used under the forfaiting agreement. The value of receivables/ drafts/ promissory notes will be paid out by the bank less interest and risk premium. In case of forfaiting, as opposed to classical discounting, there is no recourse on the exporter. Export risk insurance Export risk insurance has become part and parcel of trade finance. Whether state or privately owned, export credit insurance agencies can play a role in mitigating exporter's financial exposure or in providing access to bank financing with an insurance policy as collateral. In the first place, the use of export insurance is particularly relevant if the exporting company has no own credit management, including country and customer information (see Chart 9). A well-developed information system on export customers and information exchange among insurers enables exporters to alleviate risk of delivering to unknown countries and buyers. In addition, a vast variety of associated services offers another advantage to exporter. Secondly, the inability to support loss due to bad debts or customer insolvency is another reason to insure export risk. In particular, in a situation of few important transactions where the credit manager is not in the position to negotiate a letter of credit, the export risk insurer eases the worries. 19
  • Finally, insurance can further spread the risk of financial exposure of export receivables beyond the risk-sharing with the banks. Banks are known to demand insurance policies as collaterals of trade finance. Chart 7 Trade Finance & Banking Services: Discounting Facilities Accepted Draft from Documentary Credit Credit Line for Discounting and/or & Accepted Draft Bank of Exporter from Exporter Documentary & Recourse is Collections ∃ feasible net proceeds: value of draft and/or & „ less interest Accepted Drafts from other Commercial Transactions & Exporter gets Accepted Drafts from Documentary Credit, Documentary Collection or from Commercial Transactions. 20
  • ∃ Exporter sells Accepted Draft to his bank at a discount. Recourse to the exporter is feasible, i.e. the bank has the right to charge the exporter in case of non-payment. „ After discounting has been made, the exporter receives the net receipts. Chart 8 Trade Finance & Banking Services: Forfaiting Guaranteed by banks Receivables from Documentary Credit Forfaiting Agreement and/or & Avalized Draft Bank of Exporter from Exporter Documentary ∃ no recourse Collection & is feasible net proceeds: and/or & „ value of Promissory Notes bank guarantee from less interest + Export Credit risk premium 21
  • & Exporter gets receivables from Documentary Credit, an Avalized Draft from Documentary Collection or Promissory Notes from other Export Credit transactions. ∃ Exporter sells the payment documents to his bank at a discount (including a risk premium). Recourse is not feasible, i.e. the bank has no right to charge the exporter in case of non-payment. „ Exporter receives the net proceeds, but the substracted risk premium may be substantial. Chart 9 Reasons to insure Export Risk - No in-house credit management available ; - Insufficient information on customers ; - Inability to support loss due to bad debts or customer insolvency ; - Benefits from additional services offered by the insurer (e.g. credit information, legal actions) ; - Spread of financial exposure in addition to the risk sharing with the bank. While export risk insurance schemes (for political or credit risk coverage) available on the market are plenty, the credit manager has to develop a thorough knowledge of alternative insurance conditions in order to evaluate their economic and administrative impact on the company. Insurance premiums, payments terms covered, deductibles, insurance period, conditions attached to claim payments, - all these elements require scrutiny. In negotiating different conditions of export insurance deals, a close cooperation with the insurance representative or broker is instrumental. Drawing on external export risk insurance not only generates advantages for the exporting company but also imposes constraints (see Chart 10). These constraints are created by additional costs involved, credit limits for certain customers or even 22
  • countries, and the lack of coverage for a particular risk (only a comprehensive coverage of a risk portfolio is proposed). The waiting period for a claim refund also represents an important shortcoming as well as, sometimes, specific conditions secluded in the fine print on the insurance policy. Finally, certain national export risk insurers apply country of origin rules to promote the national industry. This also constraints possibilities of insuring certain type of exports. Problems relating to the coverage of political and commercial risks give an example of export insurance limitations. Pure coverage of political risk as offered by insurance companies in some countries often is not very helpful for exporters. The latter usually are more preoccupied with the liquidity of the private local customer - the commercial risk - rather than the liquidity of the country's Central Bank. Only if the customer can be induced to open a letter of credit, this commercial risk will also be covered. A negotiable coverage of both political and commercial risk is needed, and this is not always attainable. Hopefully, transition economies are going to pursue the development of their governmental risk insurance schemes to enhance exports. The supply of insurance services is growing also due to the expansion of private insurance operators from developed market economies into markets in economic transition attracted by the still untapped export opportunities these countries offer. Chart 10 Limitations of Export Insurance - High cost of premiums ; - Payment terms and credit limits imposed by the insurance company ; - Comprehensive coverage instead of risk selection ; - Varying national rules of country of origin ; - Lengthy waiting period for claim refund ; - Limiting Αfine print≅ conditions on insurance policy. 23
  • 4. How to manage and monitor the exporter`s financial risk Irrespective of the size of a company's export activities, the financial exposure relating to those activities, and collection of trade proceeds have to be supervised and monitored. Therefore, the main responsibilities of the trade finance and credit manager consist in defining and implementing the "Credit and Exposure Policy", and in setting up and managing financial export schemes for all units belonging to the group. Representing an intersect of sales and finance functions (see Chart 11), the task of credit risk supervision and trade finance, as a rule, is assigned to a manager or a group of managers in the finance or accounting departments. These credit and receivables management responsibilities should be clearly defined in the respective job descriptions. Chart 11 Export Credit Management Functions Finance Credit Export Sales Management of Policy Foreign Banking Invoicing Marketing Exchange Pricing Money Accouting Payment Markets Terms Export Collecting Logistics Documentary Capital Risk Collections Investment Past Due Shipping Reporting Assessment Cash 1 and Management Insurance 24
  • In a company with important world-wide exports, the credit management and trade finance functions in the first place provide a link between groups of external and internal partners (see Chart 12). The external partners are the financial institutions, the public administrations, the traders and aid organizations, while the internal partners are the regional units, the country managers, the export units, the foreign affiliates and corporate functions (contracts, legal and fiscal). Chart 12 Credit Management: Link between Internal and External Partners Internal Partners External Partners Credit Regional Units Management Customers Country Managers & Financial Institutions Export Units Trade (Banks/Insurances/etc.) Foreign Affiliates Public Administrations Corporate Functions Finance Traders (contracts/legal/fiscal) Aid Organisations At the same time, the credit management and trade finance functions provide services instrumental to successful export activities. In particular, the credit manager is responsible for mobilizing export financing facilities with banks, the supervision of payment collection and the review of payment terms in the light of an ongoing risk assessments. The availability of adequate and up-to-date financial information on outstanding (and overdue) export payments is a prerequisite of keeping funds tied up in trade receivables under control. In summary and somewhat schematically, the major objectives (assignments) of the credit and trade finance manager are as follows: - support of the company exports; - contain the bad debt provisions, and - avoid receivable write-offs. When successfully implemented, these objectives contribute to the company’s profitability. The above-defined assignements of the credit and trade finance manager imply the 25
  • definition of country risk categories and country exposure ceilings, of customer credit limits, and supervision of approved payment terms, collection and bad debt procedures. The trade finance and credit management services as a rule involve bank relations. Banks help the credit manager to mobilise financing and share risk, streamline payment flows through the banking channels and to obtain information for country and customer risk assessments. In the same way, contacts with the export credit insurance market are paramount to acquiring risk coverage when necessary. Follow-up actions on overdue payments, periodic reviews of payment terms and billing currencies are also important activities of a credit and trade finance manager. Finally, one of his key functions is the supervision of the company`s credit and financial risk policies, and implementation of the senior management guidelines in this area. The availability of up-to-date information on sales, accounts receivables, financing cost and bank fees provides the transparancy required to assess trade finance and credit management performance in the light of the company`s export strategies and sales objectives (Chart 13). Chart 13 Credit Management and Trade Finance Process Identify Key Objectives Define Policies Provide Services 1) Develop Trade Finance Solutions ; 2) Support Money Collection ; 3) Define and Review Payment Terms & Invoicing Currency ; 4) Develop and Maintain Good 26 Relations with Financial Institutions. Transparent Results 5) Implement nd dupevise Credit
  • A ponderous impact of trade activities on a company's financial posture, justifies senior management involvement in formulating credit and risk policies. In terms of managerial qualifications, one can distinguish here the following three qualities or requirements: the know-how, credibility and approach. Know-how, or professionalism (good knowledge of the financial markets and financial tools, high negotiating skills and decision-making capacity) results in the trade finance credit management being accepted within the group as profit-generating tool. Credibility emphasizes the need to be trusted and to have good communication with peers within the group. Approach translates into dynamism, pragmatism, a pro- active strategy and initiative. To be successful, the manager needs to have all the three qualities simultaneously. An ongoing dialogue between sales and finance key personnel results in an export & credit policy as an interface between marketing considerations and the company's readiness to take financial risks. Chart 14 illustrates the outcome of this interaction: expanding export sales, satisfied customers and a timely in-flow of export proceeds. Chart 14 Trade Finance and Credit Management: Major Benefits 27 Trade Finance Decreased Increased Sales 1) and Increased 2) Limited Bad Debts Credit Management Provisions Profitability