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International Payments and Trade Finance - Upstate New York Trade Conference June 19th 2014 Rochester, New York
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Seller/Exporter Buyer/Importer
Low Risk High Risk
CASH IN ADVANCE
LETTER OF CREDIT
DOCUMENTARY COLLECTION
OPEN ACCOUNT
Low Risk High Risk
Relies completely on the buyer to pay as agreed
No Risk
Relies on buyer to pay draft on presentation or maturity
No Risk Relies on exporter to ship goods as ordered
No right of inspection No right of rejection
Relies on exporter to ship goods as detailed in docs
Risk of exporters own non-performance in adhering
to all the LC requirements
Cash Against Documents
Advised Confirmed
Documents on Acceptance
Payment Methods - Risk
Risk Triangle - A Comparison of Payment Options
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Comparison of Payment Methods
Method Goods Available To Buyer Usual Time Of Payment Risk To Exporter Risk To Importer
Advance Payment After payment Before shipment None Maximum - Relies on exporter to ship goods as ordered
Letter of Credit *Confirmed *Unconfirmed (Advised)
After payment When documents are available at shipment
Virtually none Assured of quantity and also quality at shipment if inspection report is required
Documentary Collection Sight draft Documents against payment
After payment On presentation or draft to importer
If draft unpaid, good must be returned or disposed of, usually at loss
Assured of quantity, also quality, if goods are inspected before shipment
Documentary Collection Time Draft Documents against acceptance
Before payment On maturity of draft Relies on importer to pay draft
Minimal - Can check shipment for quantity and quality before payment
Consignment Before payment, exporter retains title until goods are sold or used
After use; inventory and warehousing cost to exporter
Substantial risk unless through foreign branch of subsidiary
None
Open Account Before payment As agreed Relies on importer to pay account as agreed – complete risk
None
Payment Methods - Comparison
Clean Payments
Open Account: Good for the Buyer Seller ships goods, sends documents Buyer pays according to payment terms
Cash in Advance: Good for the Seller
Buyer pays first Seller ships goods, sends documents
Payment by check, bank draft or wire
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Letters of Credit – The Basics
International Rules for LC’s
International Chamber of Commerce (www.iccwbo.org ) Commercial Letters of Credit
UCP600 (Uniform Customs and Practice for Documentary Credits)
ISBP (International Standard Banking Practice for the examination of documents
under documentary credits, #681 most recent version)
eUCP (Supplement to the Uniform Customs and Practice for Documentary Credits for Electronic Presentation)
Standby Letters of Credit
UCP600 (Uniform Customs and Practice for Documentary Credits)
ISP98 (International Standby Practices)
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International Rules for Trade Terms
International Chamber of Commerce (www.iccwbo.org ) Trade Terms
Incoterms 2010
Incoterms 2010 consists of only 11 Incoterms, a reduction from the 13
Incoterms 2000
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Letters of Credit - The Basics
Factors used in determining if a Letter of Credit is the appropriate payment mechanism 1. Credit-worthiness of buyer 2. Amount involved 3. Political risk of buyer’s country 4. Type of merchandise 5. Customs in the trade 6. Availability of foreign exchange 7. Types of exchange controls in buyer’s country 8. Payment terms offered by competitors 9. Pre-export financing for supplier Basic premise of an LC 1. Conditional promise of the issuer to pay 2. LC deals with documents only 3. LC is only as good as the Issuing Bank 4. LC is a separate contract from the sales contract
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Merchandise, Commercial, Trade
The majority of LCs issued are in payment for goods in shipment or current services performed. Payment is normally made against documents for goods shipped.
Standby
This type of LC functions like a guarantee. This type of credit can be drawn against only credit agree. It is a definite undertaking of the issuing bank. (ICC 590; ISP 98 Rules)
Revocable
A revocable letter of credit may be amended or canceled by the issuing bank at any moment and without prior notice to the beneficiary.
Unconfirmed (Advised)
Bears only the guarantee of the issuing bank. The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary.
Confirmed
Is a credit in which a second guarantee is added to the letter of credit by another bank.
Sight
Payment is at sight, which means that the drafts and documents are honored, if in order, by making payment without delay.
Time, Usance
The draft honored by accepting it for payment at a future date. Payment is delayed until the maturity of the draft.
Revolving Credit
One where the amount is renewed or reinstated without specific amendment to the credit being needed. It can revolve in relation to time or value.
Red Clause Credit
Authorizes the advising or confirming bank to make advances to the beneficiary before presentation of the documents.
Transferable Credit
Can be transferred by the original beneficiary to one or more other parties. It is normally used when the first beneficiary does not supply the merchandise himself, but is a middleman and wants to transfer all or part of his rights to the actual supplier.
Back-to-Back Credit
The seller, as beneficiary of the first credit, offers it as “security” to the advising bank for issuance of a second credit.
Letters of Credit - The Basics
Types of Letters of Credit
Letters of Credit – Unconfirmed & Confirmed
(Disclosed) Confirmation Is a second undertaking added to the letter of
credit by another bank Must be authorized by issuing bank Means the exporter gets paid from the
confirming bank, provided conforming documents are presented
Regardless of whether the issuing bank can pay or not pay.
Silent Confirmation A special arrangement outside the letter of
credit between the exporter and the advising bank
One of the key differences from a disclosed confirmation is that the silent confirmation is not authorized by the issuing bank.
Mainly used for Chinese bank issued LC’s where disclosed confirmations are difficult to obtain and the exporter wants the same benefits
Unconfirmed
Bears only the undertaking of the issuing bank.
The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary or advising bank.
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Advising vs. Confirming
Seller’s Risk
Commercial (non-payment; delays) Country Risk (political and economic)
First – risk of Confirming Bank Second – risk of Issuing Bank
Roll of Seller’s Bank Advise Authenticate and deliver LC to the Seller
(Beneficiary) Confirm Assured of payment if terms and conditions
are met Substitute for Issuing Bank risk / credit Request initiated by the Seller to the Buyer
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Sight vs. Time Payment
Draft Negotiable Instrument (an order to pay) Drawn on Issuing Bank of Confirming Bank
Payment Terms
Sight – Payable upon examination in accordance with payment terms / reimbursement instructions
Time – Time draft is payable at a fixed date in the future, draft is accepted and can be discounted Deferred Payment – LC calls for payment at a fixed date in the future, no draft
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Letter of Credit Criteria
Must have a specific expiration date Must have a specific amount of liability Must contain terms of payment Must contain specific and clear conditions for payment Issuing bank or Paying bank obligation is subject to presentation of conforming documents Applicant (buyer) has unqualified obligation to reimburse the Issuing bank for drawings under
the LC Must conform to UCP 500 or UCP version in effect at the time
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Export Letter of Credit Summary
1. Submit Pro Forma LC to Buyer 2. Review LC When You Receive it 2. Move Documents as Quickly as Possible 3. Try to Direct LC to Your Bank 4. Request Freely Negotiable LC 5. Realize Risk if Consigning Bill of Lading to Buyer 6. Banks Will Not Look to Your Contract 7. The LC Is Only as Good as the 8. Issuing/Confirming Bank
Guidelines for the Beneficiary When Reviewing the L/C
Be Sure to Verify: 1. Correct name and address 2. Sufficient Credit Amount 3. Documents Required are Obtainable and According to Terms of Sale 4. Points of Shipment and Destination are Correct 5. Insurance Coverage Requirements are Obtainable and According to Terms of Sale 6. Shipping Date Allows Sufficient Time to Dispatch Goods 7. Expiration Date Allows Sufficient Time for Presentation of Draft and Documents 8. Description of Goods is Correct and Simply Stated
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Advantages – Letter of Credit
Buyer / Importer: Unless fraud, buyer pays for what is ordered Delays payment until receipt of documents Knows latest shipping dates and can arrange distribution May obtain lower price due to reduced credit risk Seller / Exporter Shifts commercial and political risk from buyer to buyer’s bank Provides assurance and prompt payment Improve ability to obtain financing
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What Letters of Credit Can and Can’t do
Provide a means of prompt payment to the seller provided the LC requirements are fulfilled Eliminate the extensive credit investigation of the buyer since the seller’s credit risk has been
assumed by the Issuing Bank and/or the Confirming Bank Assure the buyer it will only be required to pay if the conditions of the LC are met Provide a base for a bank to engage in temporary inventory and receivable cycle finance
Letters of Credit Can Do
Letters of Credit Can’t Do Substitute for the integrity of the buyer or make background checking unnecessary Lend soundness to transactions which were not basically creditable at their inception Absolve the parties to the transaction from contractual liability Guarantee that shipment will be made by the seller Letters of Credit are separate transactions from the sales or other contracts on which they may be
based and banks are not bound by such contracts even if referenced in the LC
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Discrepancies
Potential Risks for Beneficiary / Seller: Delays payment, may result in non-payment Transaction reverts to open account (protection of using LC is lost) Additional costs Goods may be at an overseas port Difficult in re-selling product if customized or a for a specific purpose Possibility of losing goods
Potential Risks for Importer/ Buyer: Late delivery of goods (critical if seasonal) Additional costs Inability to clear goods through customs Penalties for breaching contracts with end users
According to industry information, approximately 70% of documents are discrepant
Most Common Discrepancies Incomplete or incorrect drafts Irregular invoices Insurance shortcoming Bills of Lading/ Airway bill problems Late shipments/ late presentation Inconsistency among documents Others
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Documentary Collections
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Documentary Collections - The Basics
What is a Documentary Collection?
A collection is a formal, deliberate process in which the instrument and/or document(s) is presented to the institution or person from whom collection is to be made. The ICC Uniform Rules for Collections (URC 522) are the rules governing all collections. Checks and similar items drawn on a bank is one country and deposited in another must be collected through the network of correspondent relationships between commercial banks. Whether a collection is “clean” (without documents attached) or documentary, the bank acts only as an agent. We receive a collection from our client with instructions that we must follow exactly. These instructions cover the presentation of the collection for payment, the fees to be paid, the method of transferring payment, and the procedures from non-payment. A collection is widely used by experienced exporters, but offers less security than a letter of credit. It should be used only after a thorough investigation of the importer’s current financial condition and the economic and political conditions in his country. The reason that a collection is less secure than a letter of credit is due to two factors: First, the export ships the merchandise before receiving payment; second, his assurance of payment comes not from a foreign bank but from the customer (importer) himself. The exporter is protected to some extent by the fact that the title documents are attached to a bill of exchange (the draft) which is drawn on the buying party with instructions on when and how payment is to be made. The documents and draft are then sent to a foreign collecting bank, which releases the title documents only after the customer (importer) pays as agreed. The exporter does not give up title to his merchandise, but he may incur additional shipping charges if the buyer changes his mind about accepting the merchandise. In spit of this drawback a collection remains a normal method of selling products and on that may have a to be seriously considered when selling in a highly competitive environment.
Risks to Consider
Commercial Contract Risk Competition Merchandise Risk (custom or off shelf) Client Risk (financial position) Country Risk (political and economic standing) Payment Risk
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Advantages - Collection
Advantages to Buyer (Importer) Delays payment until receipt of documents Can be financed directly by Seller through the use of time drafts (trade acceptance) More convenient and less costly than LCs
Advantages to Seller (Exporter)
Seller retains title to goods until payment or acceptance by Buyer More convenient and less costly than LCs
Risk to the Seller
Seller assumes commercial and country risk of the buyer Underlying sales agreement can be cancelled Financial position of the Buyer is a concern Country economic and political standing is a concern
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Using an Avalized Draft Payment Term
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Aval: Bank guarantee or endorsement Avalize: The act by a bank in guaranteeing payment of a bill of exchange by endorsing the bill with the words "por aval“ and signed by the bank. In instances where a buyer is requesting terms (e.g. 90 days from bill of lading date) it is possible
to arrange for the debt instrument (draft, bill of exchange) to be “Avalized” by the buyer’s bank. The avalizing bank will charge a fee from the date they add their aval through the maturity date of
the debt instrument. (Most likely, the charge is to the buyer.) Based on an approved aval, the exporter’s bank may then discount the debt instrument without
recourse to the exporter. (Discount charges are for the seller/exporter.)
Potential Risks with Avalized Drafts
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For the Seller: Governing local laws on Aval (Guarantees); i.e. not all banks will aval Operational risk by buyer’s bank releasing documents into buyer’s hands before acceptance and
aval Potential commercial dispute after the goods are shipped, draft and documents sent to buyer’s
bank The acceptance and aval may be delayed until arrival of shipment delaying discounting for seller
Buyer doesn’t accept the draft Buyer’s bank doesn’t avalize draft
The acceptance and aval may be delayed until arrival of shipment delaying discounting for seller Wells Fargo can refuse to discount any avalized draft due to insufficient credit limits with seller’s bank at
the time of discount or downgrades in the credit/country standing of the avazlizing bank
Appendix
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Definition: A Documentary Letter of Credit is a conditional bank undertaking of payment. It is a written undertaking by a bank (issuing bank), given to the Seller (beneficiary), at the request, and on the instructions of the buyer (applicant), to pay at sight or at a determinable future date, up to a stated sum of money, within a prescribed time limit and against stipulated documents. The issuing bank is extending its credit and good name for the sake of the buyer.
Letters of Credit - The Basics
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Buyer: The Documentary Letter of Credit is a conditional undertaking, payment is made on the behalf of the buyer against documents, which may represent the goods themselves or in some cases the rights to the goods themselves. Seller: The Documentary Letter of Credit is a bank undertaking, the seller can look to the bank for payment, instead of relying upon the ability or willingness of the buyer to pay. ---------------------------------------------------------------------------------------------------------------- The undertaking is conditional, and the seller only has the right to demand payment if all the requirements of the Letter of Credit are met. It is unwise for the seller to proceed with the shipment until compliance with these requirements can be made.
Letters of Credit - The Basics
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Summary: A Documentary Letter of Credit:
• Is an arrangement by banks for settling international commercial transactions. • Provides a form of security for the parties involved
• Ensures payment, provided that the terms and conditions of the letter of credit have been fulfilled.
• Is a payment based on documents only, and not on merchandise or services involved.
Letters of Credit - The Basics
Incoterms are a common set of rules and trade definitions most often used in international sales contracts. They determine which party pays the cost of each segment of transport, who is responsible for loading /
unloading, and who bears risk of loss at any given point during shipment. Incoterms were devised and are administered by the International Chamber of Commerce. Incoterms are recognized by the major trading nations of the world to reduce or remove the uncertainties
arising from different interpretations among trading partners. There are 13 Incoterms however Ex Works, Free on Board, Cost Insurance Freight, and Delivered Duty
Paid are the best known and most commonly used.
Incoterms
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Incoterms
The Incoterms 2010 are organized into two categories: 1. Incoterms for any Mode or Modes of Transport:
EXW – Ex Works FCA – Free Carrier CPT – Carriage Paid To CIP – Carriage and Insurance Paid DAT – Delivered At Terminal (new) DAP – Delivered at Place (new) DDP – Delivered Duty Paid
2. Incoterms for Sea and Inland Waterway Transport Only:
FAS – Free Alongside Ship FOB – Free On Board CFR – Cost and Freight CIF – Cost, Insurance and Freight
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Created in the following situations: Under a Letter of Credit – The buyer (applicant) of the letter of credit has been granted extended
payment terms by the seller of goods with the provision that a bank credit obligation be provided. The Issuing or Confirming Bank accepts a time draft drawn on itself by a beneficiary of the letter of credit. The Accepted draft is a direct obligation of the Bank to pay the holder on maturity.
Clean Acceptance – Bank accepts a time draft drawn on itself by a borrower as a method of short
term financing to support the trade cycle (either to refinance a sight payment under a letter of credit, collection or an open account shipment of goods).
Bankers Acceptance
Characteristics Must be used to support a current movement of goods (current is identified by the Fed as an import or
export that occurred or will occur within 30 days) Tenor of the Acceptance is up to 180 days Is intended to be self-liquidating (tenor is matched to the sales cycle) and not used for working capital
purposes Is a negotiable instrument that can be sold in the secondary market (if marketable) or discounted with the
Fed (if eligible) Borrower must attest that no other financing exists to support the shipment Interest is taken up-front (at time of discount) which generates a higher yield
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Managing Foreign Exchange Exposure
Are you exposed to foreign currency risk?
Do you import or export goods or services outside of the US? Do you send money or receive money from overseas?
Do you buy or sell your equipment overseas?
If you checked yes to any of the above boxes, then the answer is YES!
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What is currency risk?
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The risk that unexpected changes in exchange rates will: Increase/decrease cost
Increase/decrease profit margin
Create FX gains or losses on company’s income statement
Can reduce overall value of consolidated company
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How Concerned should my company be about currency risk?
It depends upon... Nature of your firm’s product or service Are substitutes readily available? Are your margins sufficient to absorb a currency shock? How frequently can you change your prices? Can you pass on increased costs to your customers in the form of higher prices?
Competitive Position Is your firm a price-taker or a price-maker? What is the functional currency of your competitors? In what currencies do your competitors sell their products or services?
Impact on Earnings/Balance Sheet What percent (%) of movement in exchange rates have a meaningful impact on your
reported earnings?
Can USD Denominated Transactions Face Currency Risk?
Yes!
Pricing overseas transactions in USD does not eliminate currency risk, it only alters its incidence and changes its nature. Pricing in USD may leave your customers or suppliers with the direct FX risk. The pricing that they perceive in terms of local currency will vary with exchange rates.
As a result, your volumes may vary and/or your counterparties may request price concessions, leaving you with potentially erratic and difficult to hedge currency risk.
It is deceptively easy for a US company to conclude that no risk exists when it is being billed by a foreign supplier in US dollars (USD). In fact, whenever businesses in two different countries are trading with one another, foreign exchange risk exists.
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There is a foreign exchange
component to every international transaction.
the question is - who bears the risk &
at what cost?
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Trade related - foreign exchange solutions
Dual Invoicing | Invoicing in Local Currency
Forward Contracts
Foreign Currency Accounts
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Foreign Exchange: Dual Invoicing
When a foreign supplier, let's say out of Europe, bills in USD, they bear the risk that the dollar might decline in value by the time they actually receive the dollars they are owed. This would result in a reduction of their profit margin measured in their home currency, the euro (EUR). If they perceive this risk exists, they are likely to increase their USD price to compensate them for the risk premium they have to bear. Conversely, while your counterparty may be quick to increase their USD price, they may be slower to reciprocate with proportional discounting upon a strengthening of the US dollar. The alternative for a US company buying from a foreign supplier would be to bear the risk, or at least consider bearing the risk if it can be proven to reduce costs. A savvy business operator can manage this process by requesting dual currency invoicing from the seller. This would be achieved by asking the seller to provide a quote both in USD and in the foreign currency of the seller. Then, the US buyer could assess whether purchasing the foreign currency could actually create a lower USD cost. Some of the benefits: • Provides detail to allow you to choose the best alternative for payment • Increases buying power by eliminating risk to the seller
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Foreign Exchange: Invoicing in Local Currency
Similarly, as an exporter in the US, you could price in USD. However, if the USD were to strengthen, your goods would become much more expensive to your customers, hence putting you at a competitive disadvantage. This could result in reduced sales. The alternative would be to bear the risk by pricing in local currency. This would keep you pricing consistent to the customer in overseas markets and you could also stand to increase your margin by capitalizing on favorable currency movements. Some of the benefits: • Increased competitiveness / consistent rate to the customer • Ability to lock in margins upfront – using hedging contracts
Forward Contracts
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From dual currency invoicing or local currency pricing, it is not a giant step to negotiate all of your international business in local currency. However, if you look to lock in pricing for future dates, you will also want to consider protecting these margins. One of the simplest instruments for doing so is the forward contract. A forward contract is an agreement to exchange a fixed quantity of currency on a pre-set future date at a preagreed rate. The terms of the contract are always set at the inception of the trade. As a result, the hedging party knows on the booking date what the exchange rate will be on the stated future date. Some of the benefits: • Certainty of exchange rate. • No fee hedge.
Foreign Currency Accounts
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A foreign currency account is an option that offers greater convenience with foreign currency transactions when foreign funds do not need to be converted right away. You can deposit foreign receivables without having to convert them to U.S. dollars, accumulate foreign funds to meet payables requirements, and transfer funds from U.S. dollar accounts or foreign bank accounts by check or wire. A foreign currency account makes foreign purchases and sales easier and more profitable by allowing you to negotiate prices and make payments in local currency, helping you become more competitive in global markets. Some of the benefits: • Eliminate unnecessary foreign exchange conversion and minimize your foreign
exchange risk. • Offer you the ability to net off foreign currency payables and receivables.
Evolution of Hedging
Immediate Currency Needs
Recognized Exposure
Forecasted Transactions
Equity/Net Investment
Must Do! Should Do! Should Do Should Do?
Immediate Needs Impending Needs
Eventual Needs
Foreign currency
receipts
Foreign currency payments
Foreign currency receivables
Foreign currency payables
Forecasted currency payables
Forecasted currency receivables
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Strategic Hedge
Foreign equity as a proxy for an eternity of foreign cash flows
Contact Information
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Lydia Gregor Trade Services Relationship Manager
917-260-1264 [email protected]
Nicole Weidlein Foreign Exchange Sales Rep
866-650-8217 [email protected]