Export Finance

Text books tend to present the instruments and structures used to finance international trade as standard-sized building blocks. All you have to do is to choose the one whose measurements fit the gap, slot it into place and the job is done. But this is far from the case.

Transferring funds is not a financing structure in itself but it plays a part at one time or another in all international sales.

Because letters of credit have evolved for the benefit of parties involved in international trade the following discussion centres upon their interests.

Factoring is often assumed to mean purely the discounting of invoices. But there is more to it today and it deserves consideration as one of the range of financing techniques which trade financiers can make available to exporters.

Forfaiting in essence is the forfeiting of the right to future payment through discounting future cashflows. It is also referred to by the French term à forfait. Convention has now evolved both the word and the practice to mean the discounting or forfaiting of future trade-related receivables under credits made available by suppliers to their customers. While it is possible to discount purely financial receivables these may be shunned by some market practitioners as being more akin to working capital funding.

These structures have evolved to provide credit terms to buyers to support their purchase of bigger ticket imports. They are often, though not necessarily, guaranteed by a state Export Credit Agency (ECA) from the exporter’s country. ECA support will be dealt with later but will be mentioned where it is relevant to the structures described in this section.

State support for the finance of a country’s exports is the subject of a great deal of literature and comment. A common form of such support is via the individual Export Credit Agencies (ECA) of each state which, together with tied aid funding and other forms of support, are aimed at promoting donor countries’ commercial interests with the target market. This section will deal with the basics of who the ECAs are, what they do, how they are governed and structured and how they work.

Traditionally countertrade has been used to facilitate trade where conventional exchange of cash or credit for goods has proved difficult. It is in that sense the market of last resort. But as we shall see below that isn’t quite the whole story. Forms of countertrade and barter are now becoming common in wealthy western markets such as the United States and Europe.

It would be incorrect to describe multilateral aid agencies and the funding they provide for development projects as ‘export financing techniques’. However, with the total funds made available by these institutions for the purchase of goods and services being in the region of US$30 billion per annum its contribution to funding world trade cannot be ignored.

All and any of the export financing techniques dealt with so far could form a part of the financial package assembled to fund a project. Project financing involves structuring the financial aspects of an entire construction project, such as, for example, building and operating a toll bridge. Procurement of raw materials, plant and equipment which might involve importing them from elsewhere contributes only a limited part of the overall financing package. Other examples of projects might be the revamping and running of the water supply and waste treatment for a small town or a large city. Perhaps the project is to provide and run a public transport or telephone system for an entire country. The project may continue to operate over a number of years and even decades. The essence of the financing structure, however, is that the cash-flow derived by the project pays for its construction and operation. In other words it is revenue driven.

This part deals with the risks to take into account when appraising export financing operation. These risks have been separated out for the purpose of explanation and ways of countering and controlling them have been suggested. However, in practice most transactions are made up of elements of several different overlapping and intersecting risks. Transactions may often require balancing several of these risks against the reward for the export financier who shoulders them to a greater or lesser degree. No transaction is totally secure. If it was it wouldn’t be worth carrying out, as export financing is usually structured to grant credit or to minimise a client’s risk.

This is the risk that the buyer of goods may not pay for them or repay any financing made available when it falls due. Such default results from the state of the buyer’s own business and character. There are several methods which can be used to examine the customer to assess the state of health of the business.

For the export financier the question of political risk is that of asking whether the country or region in which a buyer is situated poses risks of non-payment under a financing arrangement. The following examples illustrate political risks of different sorts: In 1982 the Mexican government withheld payment on its debt to foreign commercial banks, precipitating a debt crisis which swept through Latin America and reverberated around the world’s financial markets.Prior to perestroika and the eventual collapse of the USSR, the Soviet Union’s credit was one of the best in the world. The end of the centralised system and the resulting political and economic transition has resulted in a weakening of the credit standing of many countries in central and eastern Europe.Civil war in Mozambique affected the ability of Tanzania, Zambia and Zimbabwe to export and import through the Indian Ocean port of Beira.

On the basis that it takes two to tango both sides of the international sales contract will face a performance risk on the other party. A financing bank may, unless it structures its financing carefully, find itself paying for the failure of one or other party to perform.

There are many risks which arise during the shipment/delivery process. Whenever a cargo is stored or in transit by road, rail, air or sea it could be damaged, lost or stolen. The loss of goods or equipment is likely to be costly for their owner and the cause of dispute between the buyer and seller. It is important that goods are fully insured at all stages of production, transit, delivery and post-delivery storage. Indeed it is a term of many supply contracts that goods will be insured by one or other party. Failure to do so is an actionable breach of contract.

A currency risk is present wherever a revenue is to be received by a party in a currency other than that in which the party normally accounts. You cannot for example know how much an incoming fee received in US Dollars is worth until selling it for your own accounting currency, say Deutschmarks, Sterling, or Hong Kong Dollars. As you do not know what it is worth to the profit and loss account it could turn out to be less than that budgeted for.

Where credit is made available in support of an export sale or contracting operation a double interest rate risk exists. On the one hand the financier faces a risk that interest receivable from a borrower or obligor may not cover his or her own funding costs. This would be a greater risk where the interest due was at fixed rate and the financier was funding his or her own lending with floating rate money. The second risk is that the borrower or obligor is faced with higher interest costs than those budgeted for and cannot afford to pay. This could occur where funding was made available at floating rates which have risen during the period of the credit arrangement.

Many export financing structures can be collateralised using goods, equipment, vessels, commodities, the real property of either the exporter or the importer or indeed cash. Whatever the security for the transaction it should never be assumed that because the transaction is secured it is without risk.

Financing international trade is, at best, an arm’s length business for most banks and financing institutions. The trade financier is likely to be thousands of miles away in one of the world’s financial centres while the goods being financed are manufactured, moved about the globe, the vessels carrying them dock and embark, goods are transhipped and finally delivered to the seller. The trade financier may be involved in dozens of transactions at the same time and cannot supervise each one, minute-by-minute. He or she is linked to the transactions by a few all-important pieces of paper. If this documentation is faulty the entire structure may come unravelled and money may be lost — and perhaps the financier’s job as well.

The costs of financing international trade need to be adequately reflected in the pricing applied to transactions in the form of risk margins, discount rates, fees and commissions. There is a risk in not doing so.

The author was once involved in the task of reorganising the trade debt outstandings of an African country. In fact, considering the hundreds and hundreds of pieces of paper and the dust-covered, hand-written ledgers where the information was stored in bank branches throughout the country in question the basic arrangements were admirably well-organised. The 60,000 separate entries which were tapped into a new database represented amounts of money owed to foreign firms, banks and individuals, paid into banks by importers, some of them local affiliates of multinational companies but awaiting foreign currency allocation from the central bank.

The risk we take on banks is not new but has forced itself onto our agenda over the last couple of years. This follows the collapse of BCCI, numerous savings and loans institutions in the USA, various Latin American banks and Barings, one of London’s oldest and most blue-chip merchant banks. The manner in which banks have entered or withdrawn from certain types of banking business has also cast doubt on whether they will be around when we need them.

This Chapter has been intended to catalogue the risks. Risk assessment is a complicated business which is unfortunately often left to relatively junior staff to assess. This happens because it is time-consuming and sometimes considered menial. While it is excellent training for new staff, risk assessment is best done in teams, either formally or informally with senior and junior staff both involved.

In dealing with the structures and risks involved in financing international trade, we have referred to shipping and other complementary documents. This chapter describes and examines some of the most commonly used of those documents.

The commercial invoice is a basic piece of evidence for this trade transaction, whether it concerns sales of goods, equipment or services (see Figure 25.1).

As the name suggests, the packing list is an inventory of how the goods were packed when prepared for transportation whether by air, sea, road or rail. Packing lists are concerned with containers, crates, bundles, cases, packages and so on and will list them in detail including weights and measures. They do not show the value of goods.

These provide instructions about the shipment to the freight forwarder. They cover not only the cargo and the routing but also details of documentation, freight payment, stowage instructions and value of cargo and are helpful for completing customs formalities. Some forwarders have similar forms of their own although SITPRO forms are widely used (see Figure 27.1).

This document travels with the cargo and is for use for non-hazardous goods. It supplies information to a shipper, carrier, forwarder and receiving authority about the shipment and can be used as a pre-shipment advice for customs authorities. The example shown in Figure 28.1 has been made out in standard form and therefore is consistent with the other documentation such as invoices and packing lists.

CMR stands for ‘Convention relative au contrat de transport international de Marchandise par Route’. It is a transport document relating to shipment by road and is both a receipt of goods shipped and evidence of contract of carriage. However, it is not a document of title. Like the packing list it notes details of packing specifications and cargo weights, although it does not list values of goods carried. An example is given in Figure 29.1.

Unlike other transport documents the marine or ocean bill of lading is a document of title. A holder of it is able to lay claim to goods. It is also a receipt for goods, evidence that the shipper received the goods for shipment and is signed by the ship’s master, carrier or agent. It is also evidence of a contract of carriage.

Figure 31.1 is an example of a letter of credit which has been prepared in line with the SITPRO documents in this part (though not with the Bill of Lading example shown in Figure 30.1).

This is the form of a letter which could be used by the beneficiary when presenting documents to a bank under a letter of credit(L/C). In this case, unlike the credit shown in Figure 31.1, the documents are being presented to the Bank for Foreign Trade PLC. The letter makes clear which documents are being presented under which L/C and gives clear instructions as to where the proceeds of the successful presentation are to be paid. An example is given in Figure 32.1.

The certificate shown in Figure 33.1 has been issued under a continuous insurance policy. It refers to the policy under which it has been issued and to the specific cargo which it covers.

The certificate shown in Figure 34.1 has been drawn in line with the invoice (Figure 25.1) and packing list (Figure 26.1) shown above. It is used to prove the origin of the goods. Certificates of origin are often required in order to conform to regulations in an importer’s country and may also be needed in order to prove that goods can enjoy a lower import tariff rate where favoured nation treatment is applicable.

The foregoing chapters of this book have been concerned with the instruments used in financing international trade, assessment of the risks involved and the documentation used to evidence trade and gain payment. Part IV illustrates how financing techniques can be adapted and applied in the context of real deals.

Schmidt, an experienced European trading company, had developed an ongoing business of purchasing large quantities of scrap metal from Braun Steel, a major steel producing firm.

Coffee prices were higher than normal due to frost and drought damage to crops in Latin America. An African coffee processor, Africof, wished to take advantage of this opportunity to get a good price on the international market. It did not have the working capital necessary to pay cash to the growers within a week of purchase and wait for payment under letter of credit to come through from the international buyers. A pre-financing facility needed to be arranged and in order to be able to cover a succession of shipments the facility had to be renewable after each drawing.

A far eastern trading company, Fetrade, was able to obtain quantities of cloves for international sale. In a separate transaction Fetrade had found a local buyer for a quantity of bicycles. Because Fetrade did not have sufficient substance it could not open a letter of credit with which to pay for the bicycles and so a simple countertrade structure was arranged through CT Bank (CTB), London which linked the two trading operations in order to provide a means of payment (see Figure 38.1).

A European manufacturer, Busbuild, sells buses and coaches to its distributor, Coachco, in Israel on an ongoing basis. It takes some time for the distributor to sell or lease them and it needs to hold a stock of vehicles for demonstration purposes. The supplier therefore grants credit to assist the distributor’s cash flow. (The process is illustrated in Figure 39.1.)

Oilco, the hydrocarbon agency of a Latin American country, invited bids from international manufacturers to supply oil drilling and pipeline equipment. As part of its bid each manufacturer was required to submit a financial proposal.

The following transaction will be explained as an export credit agency (ECA) supported line of credit based upon the Italian export credit system. The basic transaction did take place but has been altered in certain respects for the sake of illustration and discretion.