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Business Credit Risk Management

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Business Credit Risk Management webinar from CMA Business Credit Services

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Business Credit Risk Management

  1. 1. A Comparison of Techniques for Mitigating Credit Risks CMA Webinar November 30, 2006 Buddy Baker, Atradius Trade Credit Insurance buddy.baker@ atradius .com
  2. 2. Identifying Export Risks
  3. 3. Identifying Risks in Cross-Border Sales <ul><li>What might go wrong </li></ul><ul><li>Commercial risks </li></ul><ul><li>Political risks </li></ul><ul><li>Transfer/economic risks </li></ul><ul><li>Foreign exchange rate fluctuation risks </li></ul>
  4. 4. Identifying Risks in Cross-Border Sales Slow payment/default Bankruptcy Contract repudiation Commercial risk Contract dispute Abusive bond drawing Financing risk Contract risk
  5. 5. Identifying Risks in Cross-Border Sales Slow payment/default Bankruptcy Contract repudiation Contract dispute Abusive bond drawing Financing risk Contract risk Commercial risk Foreign exchange control legislation Discharge of debt legislation Government repudiation of debt Payment moratorium Insurrection/overthrow/domestic turmoil Non-payment due to war Non-payment due to natural disasters Country risk Political risk Currency inconvertibility Transfer/economic risk
  6. 6. Identifying Risks in Cross-Border Sales Slow payment/default Bankruptcy Contract repudiation Contract dispute Abusive bond drawing Financing risk Contract risk Commercial risk Foreign exchange control legislation Discharge of debt legislation Government repudiation of debt Payment moratorium Insurrection/overthrow/domestic turmoil Non-payment due to war Non-payment due to natural disasters Country risk Political risk Currency fluctuation/devaluation FX risk Currency inconvertibility Transfer/economic risk
  7. 7. Identifying Risks in Cross-Border Sales <ul><li>What might go wrong </li></ul><ul><li>Commercial risks </li></ul><ul><li>Political risks </li></ul><ul><li>Transfer/economic risks </li></ul><ul><li>Foreign exchange rate fluctuation risks </li></ul>Depending on the goods, it may make a big difference whether things go wrong before or after shipment
  8. 8. Choosing Credit/Payment Terms <ul><li>The spectrum of credit/payment terms </li></ul><ul><li>Extended terms, installment notes </li></ul><ul><li>Open account, clean drafts </li></ul><ul><li>Time draft (D/A) </li></ul><ul><li>Consignment/retention of title </li></ul><ul><li>Sight draft (D/P, C.A.D.) </li></ul><ul><li>Cash against goods, C.O.D. </li></ul><ul><li>Advised letter of credit: sight & time </li></ul><ul><li>Confirmed letter of credit </li></ul><ul><li>Cash in advance </li></ul>
  9. 9. Choosing Credit/Payment Terms <ul><li>The spectrum of credit/payment terms </li></ul><ul><li>Extended terms, installment notes </li></ul><ul><li>Open account, clean drafts </li></ul><ul><li>Time draft (D/A) </li></ul><ul><li>Consignment/retention of title </li></ul><ul><li>Sight draft (D/P, C.A.D.) </li></ul><ul><li>Cash against goods, C.O.D. </li></ul><ul><li>Advised letter of credit: sight & time </li></ul><ul><li>Confirmed letter of credit </li></ul><ul><li>Cash in advance </li></ul>
  10. 10. Risk Mitigation Techniques
  11. 11. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘ Silent L/C confirmation’ </li></ul><ul><li>Standby L/C </li></ul><ul><li>Independent/demand guarantee </li></ul><ul><li>Accessory/contract guarantee, surety bond </li></ul><ul><li>Sight draft, ‘documents against payment’ </li></ul><ul><li>Avalized draft & forfaiting </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul><ul><li>Credit insurance </li></ul><ul><li>Credit derivatives </li></ul><ul><li>Forwards & futures </li></ul><ul><li>Options </li></ul>Guarantees Documentary-Draft-Collection-related techniques Open-Account-related techniques FX contracts
  12. 12. Risk Mitigation Techniques
  13. 13. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul>
  14. 14. How Letters of Credit Work: Theory Buyer Seller Contract Buyer’s Bank Letter of Credit Application
  15. 15. How Letters of Credit Work: Theory Buyer Seller Contract Buyer’s Bank Letter of Credit Application Letter of Credit
  16. 16. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Letter of Credit 3 parties 3 independent contracts
  17. 17. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Letter of Credit Principles of Letters of Credit: Independent and Documentary Goods Documents
  18. 18. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Letter of Credit Goods Payment
  19. 19. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Letter of Credit Goods Documents Payment Debit
  20. 20. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Payment Debit Letter of Credit Goods
  21. 21. How Letters of Credit Work: Reality Foreign Buyer Buyer’s Bank Advising Bank Seller’s Bank Seller Negotiating Bank Freight Forwarder Reimbursing Bank Contract L/C Appli-cation Docu-ments L/C L/C L/C L/C & Documents Documents Payment Payment Reimbursement Authorization Reimbursement Goods Goods Reimbursement Claim Debit
  22. 22. Risk Mitigation Techniques 7. A receivable in a foreign currency made be sold, including the remaining currency fluctuation risk. 8. FX exposure depends on the currency of the credit.
  23. 23. Risk Mitigation Techniques 1. It may be possible for the applicant to obtain a court injunction to stop payment of a non-negotiable L/C.
  24. 24. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul>
  25. 25. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul>
  26. 26. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Debit Letter of Credit Goods Payment
  27. 27. How Confirmed Letters of Credit Work Buyer Seller Docu-ments Pay- ment Goods Contract Confirming Bank L/C L/C Debit Documents Payment Buyer’s Bank L/C Appli-cation Docu-ments
  28. 28. Risk Mitigation Techniques
  29. 29. Problems with Confirming Banks <ul><li>The Confirming Bank is chosen by the Issuing Bank </li></ul><ul><li>The Confirming Bank has a monopoly position </li></ul><ul><li>The Confirming Bank may be an affiliate of the Issuing Bank </li></ul><ul><li>The Confirming Bank can be enjoined from making payment # </li></ul>
  30. 30. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul>
  31. 31. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul>
  32. 32. How Commercial Letters of Credit Work Seller Buyer Negotiating Bank Docu-ments Goods Contract Debit Documents Payment Pay- ment Buyer’s Bank L/C Appli-cation L/C Advising Bank L/C Docu-ments
  33. 33. Risk Mitigation Techniques
  34. 34. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul>
  35. 35. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul><ul><li>Standby L/C </li></ul>
  36. 36. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul><ul><li>Assignment of proceeds </li></ul>
  37. 37. Assignments of Proceeds <ul><li>Security interest in a contingent asset </li></ul><ul><li>Not top of the priority list (U.S. law): </li></ul><ul><ul><li>1. transferred L/Cs </li></ul></ul><ul><ul><li>2. holders-in-due-course (cut off by endorsing the L/C) </li></ul></ul><ul><ul><li>3. third-party payees(?) </li></ul></ul><ul><ul><li>4. set-off rights of Negotiating Bank/Issuing Bank </li></ul></ul><ul><ul><li>5. prior perfected assignees of proceeds with “control” </li></ul></ul><ul><ul><li>6. holder of a perfected assignment of proceeds with “control” </li></ul></ul><ul><ul><li>7. holders of general, perfected security interests </li></ul></ul><ul><ul><li>8. general creditors </li></ul></ul>
  38. 38. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul><ul><li>Assignment of proceeds </li></ul>
  39. 39. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul><ul><li>Assignment of proceeds </li></ul><ul><li>Transferable L/C </li></ul>
  40. 40. Risk Mitigation Techniques <ul><li>Letter-of-Credit-related techniques </li></ul><ul><li>Unconfirmed L/C </li></ul><ul><li>Confirmed L/C </li></ul><ul><li>‘Silent L/C confirmation’ </li></ul><ul><li>Assignment of proceeds </li></ul><ul><li>Transferable L/C </li></ul><ul><li>Standby L/C </li></ul>
  41. 41. How Letters of Credit Work: Theory Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Payment Debit Letter of Credit Goods
  42. 42. How Standby Letters of Credit Work Applicant Applicant’s Bank Beneficiary Contract Letter of Credit Application Letter of Credit Payment
  43. 43. How Standby Letters of Credit Work Applicant Applicant’s Bank Beneficiary Contract Letter of Credit Application Letter of Credit Documents Documents Payment Debit
  44. 44. Risk Mitigation Techniques 2. Preferential payment risk exists unless the standby is properly worded. 3. Country risks are covered if the L/C is confirmed by a “developed-world” bank. [7. A receivable in a foreign currency made be sold, including the remaining currency fluctuation risk.]
  45. 45. Risk Mitigation Techniques <ul><li>Guarantees </li></ul><ul><li>Independent/demand guarantee </li></ul><ul><li>Accessory/contract guarantee, surety bond </li></ul>
  46. 46. Standby L/Cs vs. Guarantees & Bonds Standby L/C Demand Guarantee Accessory/Contract Guarantee, Surety Bond Independent & payable against documents Independent & payable against documents Specified amount Specified amount Payable upon occurrence of specified event Amount of damages (usually with a maximum) Specified expiry Usually has a specified expiry Expiry event Rules: UCP or ISP (and UCC5 in the U.S.) Rules: URDG, ISP, or local law Rules: Local law
  47. 47. Risk Mitigation Techniques 4. Country risks are covered if the guarantee is a ‘local guarantee’. 5. If the principal repudiates the contract, the guarantor may do the same. Be sure you know which kind of guarantee you’re dealing with
  48. 48. Risk Mitigation Techniques <ul><li>Documentary-Draft-Collection-related techniques </li></ul><ul><li>Sight draft, ‘documents against payment’ </li></ul>
  49. 49. How Documentary Collections Work: Sight Drafts Buyer Seller Contract
  50. 50. How Documentary Collections Work: Sight Drafts Buyer Seller Contract Goods
  51. 51. How Documentary Collections Work: Sight Drafts Buyer Seller Contract Buyer’s Bank Documents Goods
  52. 52. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Documents Payment Goods
  53. 53. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Documents Payment Documents Goods
  54. 54. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Documents Documents Payment Goods
  55. 55. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Documents Documents Payment Goods
  56. 56. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Goods Documents Documents Payment Payment
  57. 57. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Goods Payment Documents Documents Payment
  58. 58. Risk Mitigation Techniques <ul><li>Documentary-Draft-Collection-related techniques </li></ul><ul><li>Sight draft, ‘documents against payment’ </li></ul>
  59. 59. Risk Mitigation Techniques <ul><li>Documentary-Draft-Collection-related techniques </li></ul><ul><li>Sight draft, ‘documents against payment’ </li></ul><ul><li>Avalized draft & forfaiting </li></ul>
  60. 60. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Goods Payment Documents Documents Payment
  61. 61. How Documentary Collections Work: Sight Drafts Buyer Buyer’s Bank Seller Contract Documents Payment Goods
  62. 62. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Accepted Draft Goods
  63. 63. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Goods Accepted Draft Documents
  64. 64. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Goods Accepted Draft Documents
  65. 65. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Goods Documents Accepted Draft Documents
  66. 66. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Goods Accepted Draft Documents Payment
  67. 67. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Payment Goods Accepted Draft Documents Accepted Draft
  68. 68. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Payment Accepted Draft Goods Payment Accepted Draft Documents
  69. 69. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Payment Documents Payment Accepted Draft Goods Accepted Draft Documents
  70. 70. How Documentary Collections Work: Time Drafts Buyer Buyer’s Bank Seller Contract Documents Accepted Draft Goods
  71. 71. How Documentary Collections Work: Avalized Drafts Buyer Buyer’s Bank Seller Contract Goods Documents adds aval Accepted Draft
  72. 72. How Documentary Collections Work: Avalized Drafts Buyer Seller Contract Documents Avalized Draft Documents Buyer’s Bank Goods Accepted Draft
  73. 73. How Documentary Collections Work: Avalized Drafts Buyer Buyer’s Bank Seller Contract Avalized Draft Documents Goods Accepted Draft Documents Payment
  74. 74. How Documentary Collections Work: Avalized Drafts Buyer Buyer’s Bank Seller Contract Avalized Draft Documents Payment Goods Accepted Draft Documents Payment Avalized Draft
  75. 75. Risk Mitigation Techniques
  76. 76. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul>
  77. 77. Risk Mitigation Techniques
  78. 78. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul>
  79. 79. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul>
  80. 80. Risk Mitigation Techniques
  81. 81. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul>
  82. 82. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul><ul><li>Credit insurance </li></ul>
  83. 83. Risk Mitigation Techniques 6. Contract repudiation insurance is available as separate coverage.
  84. 84. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul><ul><li>Credit insurance </li></ul>
  85. 85. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul><ul><li>Credit insurance </li></ul><ul><li>Credit derivatives </li></ul>
  86. 86. Risk Mitigation Techniques
  87. 87. Risk Mitigation Techniques <ul><li>Open-Account-related techniques </li></ul><ul><li>Factoring </li></ul><ul><li>Non-recourse sale of receivables </li></ul><ul><li>Credit insurance </li></ul><ul><li>Credit derivatives </li></ul>
  88. 88. Risk Mitigation Techniques <ul><li>FX contracts </li></ul><ul><li>Forwards & futures </li></ul><ul><li>Options </li></ul>
  89. 89. Risk Mitigation Techniques
  90. 90. Commercial Letters of Credit
  91. 91. Standby Letters of Credit & Demand Guarantees
  92. 92. Forfaiting
  93. 93. Sale of Receivables
  94. 94. Credit Insurance
  95. 95. Credit Derivatives
  96. 96. Foreign Exchange Contracts
  97. 97. Credit Policy Matrix <ul><li>Unconfirmed LC </li></ul><ul><li>Cash in advance </li></ul><ul><li>Demand guarantee or standby LC </li></ul>1 Low 2 Moderate 3 High 4 Very High Country Risk 4 Very High 3 High 2 Moderate 1 Low Customer Risk <ul><li>Unconfirmed or confirmed LC </li></ul><ul><li>Cash in advance </li></ul><ul><li>Local guarantee or confirmed standby LC </li></ul><ul><li>Demand guarantee or standbyLC </li></ul><ul><li>Confirmed LC </li></ul><ul><li>Cash in advance </li></ul><ul><li>Local guarantee or confirmed standby LC </li></ul><ul><li>Cash in advance </li></ul><ul><li>Confirmed LC </li></ul><ul><li>Unconfirmed LC </li></ul><ul><li>Demand guarantee or standby LC </li></ul><ul><li>Factoring </li></ul><ul><li>Credit insurance (commercial risks) </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Unconfirmed or confirmed LC </li></ul><ul><li>Local guarantee or confirmed standby LC </li></ul><ul><li>Demand guarantee or standbyLC </li></ul><ul><li>Credit insurance (commercial risks or comprehensive) </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Confirmed LC </li></ul><ul><li>Credit insurance (comprehensive) </li></ul><ul><li>Local guarantee or confirmed standby LC </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Confirmed LC </li></ul><ul><li>Credit insurance (comprehensive) </li></ul><ul><li>Cash in advance </li></ul><ul><li>Local guarantee or confirmed standby LC </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Factoring </li></ul><ul><li>D/P collections </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Credit insurance (commercial risks) </li></ul><ul><li>Unconfirmed LC </li></ul><ul><li>Authority to Pay </li></ul><ul><li>Confirmed LC </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Credit insurance (comprehensive) </li></ul><ul><li>D/P collections </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Confirmed LC </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Credit insurance (comprehensive) </li></ul><ul><li>Cash in advance </li></ul><ul><li>Confirmed Authority to Pay </li></ul><ul><li>Open account </li></ul><ul><li>D/A collections </li></ul><ul><li>Factoring </li></ul><ul><li>Open account </li></ul><ul><li>D/P collections </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Credit insurance (political & economic risks) </li></ul><ul><li>D/P collections </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Countertrade </li></ul><ul><li>Credit insurance (political & economic risks) </li></ul><ul><li>Cash in advance </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Countertrade </li></ul>Denotes ‘High to Very High Risk’ areas which may require significant risk neutralization NB: This document is for illustrative purposes only, and is not intended to delineate the recommendations of Atradius regarding risks associated with international trade <ul><li>D/P collections </li></ul><ul><li>D/A collections w/ forfaiting </li></ul><ul><li>Credit insurance (commercial risks or comprehensive) </li></ul><ul><li>Unconfirmed or confirmed LC </li></ul><ul><li>Authority to Pay </li></ul>
  98. 98. November 30, 2006 - CMA Webinar – Buddy Baker Black Slide

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