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Trade Finance Basics (Series: Business Borrowing Basics 2020)

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Trade Finance Basics (Series: Business Borrowing Basics 2020)

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Trade is growing exponentially across the globe. In this increasingly interconnected cross-border business environment, it is time critical for companies buying and selling goods and services (and their advisors) to understand trade finance. Deploying the trade finance toolbox effectively helps importers and exporters manage working capital solutions and reduce cost.

This webinar explains the basics of letters of credit, open account, supply chain and documentary collections, how and why they are used, how much they cost, and the benefits and risks. It covers how financial institutions facilitate these funding options and explains why trade finance is a natural fit for Blockchain technology.

To view the accompanying webinar, go to: https://www.financialpoise.com/financial-poise-webinars/trade-finance-basics/

Trade is growing exponentially across the globe. In this increasingly interconnected cross-border business environment, it is time critical for companies buying and selling goods and services (and their advisors) to understand trade finance. Deploying the trade finance toolbox effectively helps importers and exporters manage working capital solutions and reduce cost.

This webinar explains the basics of letters of credit, open account, supply chain and documentary collections, how and why they are used, how much they cost, and the benefits and risks. It covers how financial institutions facilitate these funding options and explains why trade finance is a natural fit for Blockchain technology.

To view the accompanying webinar, go to: https://www.financialpoise.com/financial-poise-webinars/trade-finance-basics/

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Trade Finance Basics (Series: Business Borrowing Basics 2020)

  1. 1. 1
  2. 2. 2 Practical and entertaining education for attorneys, accountants, business owners and executives, and investors.
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  6. 6. Disclaimer The material in this webinar is for informational purposes only. It should not be considered legal, financial or other professional advice. You should consult with an attorney or other appropriate professional to determine what may be best for your individual needs. While Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate, Financial Poise™ makes no guaranty in this regard. 6
  7. 7. Meet the Faculty MODERATOR: Hajar Jouglaf - Sugar Felsenthal Grais & Helsinger LLP PANELISTS: Phil Buffington - Adams & Reese LLP Harvey Gross - New York Institute of Credit Paul Schuldiner - Rosenthal & Rosenthal Andy Arduini - Huntington National Bank 7
  8. 8. About This Webinar – Trade Finance Basics Trade is growing exponentially across the globe. In this increasingly interconnected cross- border business environment, it is time critical for companies buying and selling goods and services (and their advisors) to understand trade finance. Deploying the trade finance toolbox effectively helps importers and exporters manage working capital solutions and reduce cost. This webinar explains the basics of letters of credit, open account, supply chain and documentary collections, how and why they are used, how much they cost, and the benefits and risks. It covers how financial institutions facilitate these funding options and explains why trade finance is a natural fit for Blockchain technology. 8
  9. 9. About This Series – Business Borrowing Basics Many companies, and most of any size, use borrowed funds as part of their capital structure. Depending on the nature of the business, its size, time in business, whether it has adequate collateral, and other factors, a business has myriad options when borrowing funds. This webinar series provides a guided tour of the various borrowing options available to businesses, from both a business and legal perspective. Learn the advantages and disadvantages of different types of loans, how to select the right loan for your business, how to negotiate terms, and what happens in the event the loan is defaulted upon. Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and executives without much background in these areas, yet is of primary value to attorneys, accountants, and other seasoned professionals. Each episode brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. Each episode in the series is designed to be viewed independently of the other episodes so that participants will enhance their knowledge of this area whether they attend one, some, or all episodes. 9
  10. 10. Episodes in this Series #1: What kind of loan? Premiere date: 6/10/20 #2: Basic Concepts Applicable to All Borrowers & Lenders Premiere date: 7/8/20 #3: Alternative Structures- PO Financing, Factoring & MCA Premiere date: 8/5/20 #4: Dealing With Defaults Premiere date: 9/9/20 #5: Trade Finance Basics Premiere date: 12/4/20 10
  11. 11. Episode #5 Trade Finance Basics 11
  12. 12. What is Trade Finance? • A suite of financing solutions that helps Buyers (importers) and Sellers (exporters) of goods and services efficiently manage their working capital, mitigate risk and reduce cost • Enables secure payment, risk mitigation and financing • Includes “Traditional” Trade Finance (LCs, Collections, Standbys and Guarantees) and Supply Chain Finance (Most commonly today, Payables Finance) • Facilitates about 80% of global merchandise trade flows, or about USD $ 14 trillion annual trade 12 Trade drives global GDP. Trade financing drives trade.
  13. 13. Trade Finance Toolbox • Letters of Credit (LCs)  Defined as an irrevocable, independent undertaking by Bank to honor a presentation of complying documents (draw) by payment or undertaking to pay at a later date. 13
  14. 14. Trade Finance Toolbox (con’t) • Mechanics Example: Exporter (Seller) requires importer (Buyer) to prepay for goods shipped.  Buyer reduces risk by asking Seller to document that the goods have shipped.  Seller reduces risk by requiring Buyer to use an LC issued by Buyer‟s Bank to Seller. o Bank‟s solid credit position is substituted for Buyer‟s.  Buyer protected from risk that goods have not been shipped because an LC will require presentation of certain documents showing evidence of shipment: o E.g. the bill of lading which is a document of title, a receipt for shipped goods, and a contract between a carrier and shipper. o LC may not protect against outright fraud risk, including the provision of fraudulent documents of title.  Bank handles only the documents and not the actual goods and services. 14
  15. 15. Trade Finance Toolbox (con’t) • Open Account  Refers to trade transactions between a Seller and Buyer where transactions are not supported by any banking or documentary trade instrument issued on behalf of Buyer or Seller.  Buyer is directly responsible for meeting the payment obligation in relation to the underlying transaction.  Seller issues invoice which Buyer pays within an agreed time frame. o Source for above definitions is the Global Supply Chain Finance Forum’s Standard Definitions for Techniques of Supply Chain Finance at: https://cdn.iccwbo.org/content/uploads/sites/3/2017/01/ICC-Standard-Definitions-for- Techniques-of-Supply-Chain-Finance-Global-SCF-Forum-2016.pdf  If Bank acts as intermediary, Seller posts invoice to Bank platform, Bank performs back office processing/account reconciliation services and debits Buyer‟s account on ongoing basis. o Collects fees for these services. 15
  16. 16. Trade Finance Toolbox (con’t) • Supply Chain Finance (SCF):  Defined as use of financing and risk mitigation practices and techniques to optimize the management of working capital liquidity invested in supply chain processes and transactions.  The Physical Supply Chain is a system of organizations, people, activities, information and resources involved in moving a product or service from Seller to Buyer, either domestically or across borders. o E.g. transforming natural resources, raw materials and components into semi- finished and finished products delivered to end customer.  The Financial Supply Chain is the chain of financial processes, events and activities that provide financial support to Physical Supply Chain participants. 16
  17. 17. Trade Finance Toolbox - SCF • Applies to open account trade flows and triggered by supply chain events • Takes an “ecosystem” view of trade, with supply chains involving hundreds or thousands of suppliers • Often anchored in emerging markets • Payables Finance is currently the most popular/fastest growing SCF technique • Nascent space – Standard Definitions published in 2016 • Transparency of underlying trade flows is critical  That transparency is enabled by Bank‟s technology platform 17 http://supplychainfinanceforum.org/IC C-Standard-Definitions-for- Techniques-of-Supply-Chain- Finance-Global-SCF-Forum-2016.pdf
  18. 18. Trade Finance Toolbox • Documentary Collections  Documentary collections are an alternative to LCs that offer a degree of protection to both Buyer and Seller: oBuyer is not obligated to pay for goods before shipment and if structured properly Seller retains control over the goods until Buyer pays.  Banks act as intermediaries to the exchange of title documents for payment but are not obligated to pay. o In Documentary Collections, the payment obligation remains with the Buyer in contrast with LCs where the Bank is required to pay if all payment terms and conditions are fully met.  A key distinction between Documentary Collections and LCs is that in the case of Documentary Collections a Bank does not engage in document verification. o Recommended for use in more established/trusted relationships and/or in lower risk markets. 18
  19. 19. Why Is It Important? • Trade finance can protect Buyers from global purchasing risk by reducing Country and Seller (exporter) credit risk. • SCF and Open Account: in most popular form of SCF (trade payables financing) Buyer reduces bank debt by financing more of working capital with trade payables. • Stronger Buyer-Seller relationships  Working capital improvements for strategic Sellers who gain payment protection; Buyers get extended payment terms; and both Buyer and Sellers improve balance sheet. • Sourcing from lower cost countries to increase margins. • LC and Documentary Collections transactions can reduce Buyer non-payment risk. • Banks offer platforms for streamlined/efficient payment processing. 19
  20. 20. Who Are the Players? • Importers (Buyers of goods and services, in the letter of credit context “Applicants”) • Exporters (Sellers of goods and services, in the letter of credit context “Beneficiaries”) • Banks who finance the trade transactions. • Risk Insurers • Export Credit Agencies • Multilaterals 20
  21. 21. Letters of Credit • As defined above, an irrevocable, independent undertaking to honor a presentation of complying documents (draw) by payment or undertaking to pay at a later date. • Credit-related undertaking issued by Bank on behalf of its client the Buyer (Applicant).  Substitutes the Bank's credit standing for Buyer‟s.  Authorizes Seller (Beneficiary) to draw on issuing Bank pursuant to terms and conditions specified in the LC. 21
  22. 22. Letters of Credit • Issuing Bank obligated to pay the draw if the documents conform to LC terms and conditions.  Beneficiary should evaluate strength/reputation of LC issuing Bank. • LCs are subject to the international banking customs, practices and standards as reflected in UCP Uniform Customs and Practice for Documentary Credits – 2007 Revision – ICC Publication No.600) and ISP98 (International Standby Practices – ICC Publication No. 590).  In the US or for cross border transactions impacting US based parties, the applicable state Uniform Commercial Code will also apply. 22
  23. 23. Letters of Credit – Types of LCs • Standby: financial or performance related contingent obligation. May be Trade related.  Only expected to be drawn if customer (applicant) defaults.  Who uses? Contracting parties where one party wants financial risk mitigation against the non-performance of the counterparty.  Example: Oklahoma-based flare system company (applicant) contracted to build, install and warrant flare system for refinery in India. Oklahoma company‟s performance on the installation secured by standby LC in favor of Indian refinery as beneficiary.  May be governed by ISP98 cited above. • Commercial LC: Contingent obligation by issuing or confirming Bank to Seller as beneficiary to secure the exchange of goods or services between Buyer (applicant) and Seller.  Contingent on Seller‟s presentation of compliant documents (draw).  Expectation for LC to be drawn when goods are shipped.  Payable upon presentation by Seller of the documents specified in the LC on or before its expiration date. Documents generally evidence shipment and often inspection/insurance of goods in transit. 23
  24. 24. Letters of Credit • Why are Commercial LCs used?  Risk mitigation for Buyer because documents prove shipment has happened.  Risk mitigation for Seller that they will be paid if draw compliant pursuant to terms/conditions of LC. • What does it mean to “Advise” or “Confirm” an LC?  Foreign Buyer – US Seller. o “Advising”: Authentication of LC. o Credit standing of Issuing Bank or country of issue in question. Seller requires certainty of payment by domestic (onshore) based Bank. o Confirming Bank has same legal obligation to pay as issuing Bank. 24
  25. 25. Letters of Credit • Obligation of Applicant to Reimburse  LC Reimbursement Agreement: Issuing Bank requires Buyer (Applicant) to execute as a condition to Bank‟s issuance of LC. This Agreement memorializes Buyer‟s absolute obligation to reimburse on demand and contains other reps and warranties. • Independence Principle  LC is separate and independent from the underlying sales contract being financed. Buyer in principle should have no ability to influence or control whether or not draw is compliant: but Buyer sometimes insists on weighing in.  Fraud Risk • What are the costs involved?  A la carte services: o Flat % based on value (issuance, document examination/payment) o % p.a. (confirmation, negotiation/financing) o Out of pocket costs (SWIFT message, courier) 25
  26. 26. Letters of Credit • Recap: why are they important and how used?  While Commercial LC volumes are flat or slightly declining, utilized slightly less by large scale buyers, Standby LCs are growing in popularity.  In the Commercial LC space there is a growing need for all players (banks, importers, exporters, logistics, insurance, government bodies) to adopt digital letter of credit and related document constructs to keep pace with supply chain expectations.  Standby LCs are used to support bond issuances, term loans, and26
  27. 27. Letters of Credit • How the LC transaction works:  Buyer contracts with Seller  Buyer applies for LC; Bank issues; Seller receives advice  Seller ships goods to Buyer  Seller submits shipping documents to its Bank which, in turn, submits documents to Buyer‟s Bank to verify terms have been met and release documents against payment/acceptance to pay  Buyer instructs payment (1) upon presentation or (2) on a predetermined future date after presentation of conforming documents  Buyer‟s Bank makes payment and Seller‟s Bank credits Seller‟s account 27
  28. 28. Open Account Transactions • Defined above. In a typical open account international trade transaction, the goods are shipped and delivered on or before payment is due, in 30, 60 or 90 days. • In the vast majority of cases, this is how US domestic transactions are settled.  Option is advantageous to Buyers from cash flow/cost perspective but a risky option for Seller. o Intense competition in export markets: foreign Buyers often press Sellers for open account terms.  Open account processing leverages Banks‟ existing trade services processing capabilities: o Purchase order upload to create transactions, document examination and/or data matching, tracing and follow up for payment and payment services. o Transparency in the process: exchange and sharing of documents and document data which can be sent to Bank via electronic records or paper documents. 28
  29. 29. Open Account Processing • How it works:  Buyer contracts with Seller; sends PO details to its Bank to issue advice to Seller  Seller prepares shipping documents; submits to Buyer‟s Bank for review and authentication  Seller ships goods to Buyer  Buyer instructs its Bank to make payment after receipt of goods; Bank sends documents to Buyer (if required)  Buyer‟s Bank makes payment; Seller‟s Bank credits Seller‟s account 29
  30. 30. SCF • Defined above: SCF solutions encompass a combination of technology and services that link Buyers, Sellers, and Banks to facilitate financing during the life cycle of the open account trade transaction and repayment.  Allows Buyer to pay at normal invoice/draft due date and Seller to receive early payment.  Bank relies on creditworthiness of Buyer but SCF is not a “loan.”  “True sale” versus “financing device.” o True sale treatment critical for accounting reasons – off balance sheet treatment.  Banks typically file back-up (precautionary) UCC-1‟s against Seller‟s receivables. 30
  31. 31. SCF – Payables Finance • Many different SCF options. Most common form is Payables Finance which we will discuss in detail here:  Suppliers sell their receivables/drafts or bills of exchange relating to a specific Buyer to Bank at a discount after Buyer approves. o What is a draft or bill of exchange?  Negotiable instrument that minimizes risk of loss to the Bank by providing limited defenses to payment.  In US, governed by Article III of the UCC. 31
  32. 32. SCF – Payables Finance • Discounting is based on a formula which takes into account the time value of money, prevailing interest rates and the Buyer‟s credit profile. • Advantages:  Provides quick payment/liquidity to Seller.  Stretches out payment terms to Buyer. • Disadvantages:  Seller has no need or incentive to join the Payables Finance program.  One size fits all. Limits diversity of Seller base for global companies. 32
  33. 33. Overview of Payables Finance Process • Buyer transmits purchase orders to Seller • Seller submits invoices to Buyer • Buyer reconciles and uploads its approved invoice file to Bank‟s web platform • Seller selects and requests discount from Bank on approved invoices • Bank discounts the invoices and remits payment to Seller • Bank debits Buyer‟s account on invoice maturity date 33
  34. 34. Payables Finance 34 Supplier Presents Invoice, 30 Day Terms Day 0 Day 21 Day 30 Buyer Approves Invoice Buyer Pays Invoice Supplier Receives Invoice Payment Common Invoice Process: Supplier Presents Invoice, 120 Day Terms Day 0 Day 5 Day 120 Buyer Approves Invoice, Financier Pays Buyer Reimburses Financier Supplier Receives Invoice Payment Payables Finance Process: • Suppliers collect funds faster • Discount rate typically lower than what a supplier could access • Buyers pay later • Strengthen health of supply chain
  35. 35. Documentary Collections • In a documentary collection, Seller entrusts the collection of payment to its Bank (remitting bank), which sends documents to Buyer‟s Bank (collecting bank), along with instructions for release of the documents and payment. • Documents may be released against:  Full payment (sight terms)  Buyer‟s formal acceptance of an enclosed Trade draft/bill of exchange. Upon acceptance, Buyer‟s obligation to pay becomes firm and absolute (usance/time terms) • Funds are received from Buyer and remitted to Seller through Bank at the time and according to the instructions in the Documentary Collection cover letter from the remitting Bank. • Buyer is not obligated to take up the documents or pay for the Documentary Collection but may be obligated to pay under a related sales contract.  May involve using a draft/bill of exchange that requires Buyer to pay the face amount either at sight or on a specified future date. 35
  36. 36. Documentary Collections • How it works:  Buyer contracts with Seller  Seller ships goods to Buyer  Seller submits shipping documents to its Bank which, in turn, submits documents to Buyer‟s Bank to verify terms have been met and release documents against payment/acceptance to pay  Buyer instructs payment (1) upon presentation or (2) on a predetermined future date after presentation of conforming documents  Buyer‟s Bank makes payment, Seller‟s Bank credits Seller‟s account and goods are released to Buyer 36
  37. 37. Documentary Collections • Pros: Generally less complicated and expensive than LCs.  Banks retain control of the shipping documents until the terms of the Documentary Collection are met by Buyer (which usually means that Bank controls the discharge of the cargo) • Cons: riskier for Seller because no recourse via the Documentary Collection in the event of non-payment. Seller would have to rely on repayment remedies under the sales contract.  Seller may be stuck paying costs of demurrage and re-selling/re-directing the cargo. • Under what circumstances should Documentary Collections be used?  Recommended for use in established trade relationships, in stable export markets and for transactions involving ocean shipments • Governed by ICC Uniform Rules for Collections. 37
  38. 38. Digitization of Financial Supply Chains • Digital „eco-systems‟ are being developed connecting buyers, sellers, logistics providers, government agencies and financial institutions and will support the exchange of documents and data electronically, rather than in paper form. Some examples include:  Distributed Ledger Technology („Blockchain‟) Platforms o Marco Polo o VOLTRON  Non-Distributed Ledger Technology („Blockchain‟) Platforms o Trade Information Network • A key obstacle to adoption of paperless trade is legal uncertainly, in terms of how statutes and regulations drafted for the paper world apply to the digital world 38
  39. 39. Digitization of Financial Supply Chains • Paper-based trade finance involves ~ 200 billion data field interactions globally • About 1% of these add value • Digitization will allow the financial supply chain to catch up to the physical supply chain • Could save US $6 billion in costs on USD $16 billion in trade https://iccwbo.org/publication/global-survey-2018-securing-future-growth/ (BCG Analysis) 39
  40. 40. About the Faculty 40
  41. 41. About The Faculty Hajar Jouglaf - hjouglaf@sfgh.com Hajar Jouglaf is an associate at Sugar Felsenthal Grais & Helsinger who collaborates with clients to identify and resolve critical issues when dealing with distressed situations. Hajar also sits on the board of the Chicago Network of the International Women‟s Insolvency & Restructuring Confederation. 41
  42. 42. About The Faculty Phil Buffington - Phil.Buffington@arlaw.com Phil Buffington joined Adams and Reese in 2011 and serves as Leader of the Financial Services Team, and is a Partner in the Transactions Practice Group. For more than 30 years, Phil has served as a trusted advisor to community, regional and national financial institutions, and he routinely helps these institutions assess and analyze regulatory and litigation risks, including issues involving: His practice is focused primarily on the representation of financial institutions in corporate governance, transactional and bankruptcy matters. He serves on the Adjunct Faculty Staff of Mississippi College School of Law (Banking Law and Business Planning) and also serves as a Faculty Member at the Mississippi School of Banking (Commercial Lending I and II). He is a frequent speaker and presenter for CLE and other courses on topics related bank regulatory matters, commercial lending, secured transactions and other banking topics. 42
  43. 43. About The Faculty Harvey Gross - info@instituteofcredit.org Harvey Gross is the founder and president of HSG Services Inc. He was formerly a vice president with Bank of America for over 30 years. He served as wholesale credit manager, wholesale team leader, and account executive. Gross supervised in sales, marketing, and insolvency recoveries. He was the past chairman of the Turnaround Management Association New Jersey Chapter and is currently a board member. Gross is also the executive director of IFA Northeast Chapter, IFA Southeast Chapter and executive director of the New York Institute of Credit. 43
  44. 44. About The Faculty Andy Arduini - Andy.Arduini@huntington.com Mr. Arduini joined Huntington Bank, a $109B bank headquartered in Columbus, OH, in 2009. He has overall responsibility for Huntington‟s Global Advisory, Supply Chain & Financial Institution Practices. He is a member of the bank‟s Counterparty and Country Credit Committee and has ultimate responsibility for country risk at the bank. Mr. Arduini has cross- border business experience dating back to 2001, primarily at GE Corporate Finance and ABN AMRO prior to Huntington. He earned a MBA with a concentration in Corporate Finance at the Carey School of Business at Johns Hopkins University, a post-graduate certificate in Executive Leadership from the Wharton School of Business and maintains certifications in supply chain finance and payments from the London Institute of Banking and Finance. 44
  45. 45. Paul Schuldiner - pschuldiner@rosenthalinc.com Paul D. Schuldiner is Senior Vice President at Rosenthal & Rosenthal, a commercial finance company specializing in factoring and asset based lending. Paul leads the firm‟s newest division, Rosenthal Trade Capital, and is responsible for driving the overall business strategy for Rosenthal‟s purchase order financing and alternative inventory financing solutions. Paul is a seasoned financial executive with over 20 years of experience in the purchase order and trade finance business and has previously held senior leadership roles at King Trade Capital, and as a principal of Transcap Trade Finance . In addition to purchase order financing, Paul started his career in the asset-based lending division of a NYC based finance company and practiced as a CPA in public accounting. Paul has been featured in Women’s Wear Daily, Entrepreneur, TIME, Forbes and Bobbin Magazine and has authored articles for The Commercial Factor, The Secured Lender and ABF Journal. He has been a featured speaker and panelist at a number of national and regional industry seminars and conferences, including TMA Mid-Atlantic & Mid-America, CFA‟s Factoring & Supply Chain Finance World and Annual Conference. Paul is currently the President of the IFA‟s Northeast Chapter, the Chair of the New Jersey State Society of CPA‟s Cooperation with Bankers committee, and on the Board of Directors of the New Jersey Chapter of the Commercial Finance Association and the New Jersey Chapter of the Turnaround Management Association. Paul received his Bachelor‟s degree in Accounting from Queens College, City University of New York. 45
  46. 46. Questions or Comments? If you have any questions about this webinar that you did not get to ask during the live premiere, or if you are watching this webinar On Demand, please do not hesitate to email us at info@financialpoise.com with any questions or comments you may have. Please include the name of the webinar in your email and we will do our best to provide a timely response. IMPORTANT NOTE: The material in this presentation is for general educational purposes only. It has been prepared primarily for attorneys and accountants for use in the pursuit of their continuing legal education and continuing professional education. 46
  47. 47. About Financial Poise 47 Financial Poise™ has one mission: to provide reliable plain English business, financial, and legal education to individual investors, entrepreneurs, business owners and executives. Visit us at www.financialpoise.com Our free weekly newsletter, Financial Poise Weekly, updates you on new articles published on our website and Upcoming Webinars you may be interested in. To join our email list, please visit: https://www.financialpoise.com/subscribe/

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