TRADE FINANCE: INSTRUMENTS, TECHNIQUES AND PROVIDERS

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TRADE FINANCE INSTRUMENTS,TECHNIQUES
ANDPROVIDERS
Summary description This section introduces the
basics of trade finance. It discusses how
traditional techniques of pre- and post-shipment
finance relate to financing forms such as
forfaiting, countertrade, structured finance,
islamic finance, securitization, etc. all of
these techniques are all discussed in greater
detail in separate chapters. Trade finance is
available from different sources - from suppliers
to banks and institutional investors. These
various sources are discussed in some detail in
the following section. In the final sections, the
principles of loan syndication, and issues
related to lines of credit are discussed.
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Table of Contents

1. Introduction
2. Trade finance and trade payments
3. Tools of trade finance
4. Forms of trade finance
5. Sources of trade finance
6. Loan syndication
7. Examples on simple trade financing trade to more
   structured trade finance mechanisms

Click here for "GENERAL GUIDELINES FOR REDUCING
THE RISKS OF TRADE FINANCE"
Click here for " BANKS' BASIC LENDING BANK
RATIONALES"
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• Trade finance is the provision of any form of
  financing that enables a trading activity to take
  place.
• Trade financing can be given directly to the
  supplier, to enable him procure items for
  immediate sale and/or for storage for future
  activities. It could also be provided to the
  buyer, to enable him meet contract obligations.
  Or it could be given to a trader, for on-lending
  to his suppliers.
• This training program focuses on international
  commodity trade finance.

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Typical forms of international trade commodity
finance
The Transaction Chain
Flow of Goods
Trader
Producer
Consumer
Bridge Financing
BANK
Pre-shipment Financing Post-shipment Financing
Import Financing
? Trade finance requirements can be divided into
two types pre-shipment finance and post-shipment
finance. Depending on the length of credit
required, financing facilities are offered for
short-, medium- or long-term period. Commodity
trading normally require short-term finance which
is provided for up to one year. However,
commodities' producers and traders may require
medium-term (between one and five years) or
long-term (five years or longer) financing
facilities for investment or installation
projects and also for working capital issues.
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• Evolution
• Banks have been involved in international trade
  since, at least, medieval times. At that time,
  the services provided aimed at circumventing
  risks, reducing costs and effecting payment in
  the required currency.
• This basic service has undergone remarkable
  changes leading to banks now providing a wide
  range of trade and project finance services to
  their customers, using a range of financing
  instruments.
• Much of this change has been due to economic
  events such as crises in developing countries and
  the bankruptcy of major trading firms. These
  have, in recent times, precipitated the need for
  financiers to adopt innovative, structured
  financing techniques to mitigate their risk of
  losses.
• A separate chapter will emphasize the role of
  structured finance and will explain the various
  forms of structured finance, using different
  approaches.

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II. International trade finance and trade payments
International trade requires international
payments, and more specifically, trade payment
systems that make such payments safer for the
transaction and for both buyer and seller
consequently. This is discussed extensively in
the chapter on trade payment systems. Such
payment systems, including sales on Open account,
Cash in advance, Cash Against Documents (CAD) and
Letters of Credit (L/Cs) (also called documentary
credits) are not in themselves financing
instruments ? However, they can and often are
used as an element in and supports to trade
financing transactions. For example, cash in
advance may be considered a payment mechanism
that provide credit to the exporter since the
exporter will receive part of payment prior to
shipment, which will enable him to produce.
Moreover, sales on open account may be considered
as a payment mechanism that facilitate the
financing of the transaction. On one side, the
buyer is receiving the goods from the seller
before making payment, which gives him time to to
resell the goods and make payment. On the other
side, the open account lead to trade bills
invoices sent by the seller and confirmed by the
buyer, with a guarantee by the buyers bank.
These trade bills can be used to generate finance
to the seller in several ways. Similarly, CADs
result in confirmations of the buyer that they
will pay once they receive certain
documents. L/Cs generally show an irrevocable
promise to pay by a buyer once the seller has
performed as stipulated in the L/C, and banks may
feel this is sufficient comfort for them to
extend a credit to a seller enabling him to
finance his local operations prior to exports.
L/C can also be a simple way for importer to
obtain short-term finance where the bank can pay
the buyer and keep the documents until full
repayment of the loan by importer.

• Letters of credit are discussed further in
  several sections
• Documentary credits as a trade payment system
• Types of Letters of Credit
• Rules and regulations governing Documentary
  credit
• Letters of Credit as transferable instruments
• How to use letters of credit as a financing
  support
• Documents used in Documentary Credit
• Guidelines to avoid discrepancies when using
  Documentary Credit
• Standby LC

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III. Tools of international trade finance
In general terms, trade finance can be separated
into pre-shipment and post-shipment finance.
Pre-shipment finance is for the financing of one
or more of the stages in the commodity chain
before the actual export of the commodity (for
e.g. financing required to cover the installation
of plant and equipment as well as the cost of
production, packing, storage and transportation
of goods to the port of shipment). Post-shipment
finance is for the financing of the stages after
the good has been shipped for international
transport while awaiting payment. For both
pre-shipment and post-shipment finance, banks
(and other financiers) have a number of financing
tools in their toolkit. Some forms of finance
are fairly standardized and well-known by banks
and clients alike, others require a more
creative, tailor-made use of the various
tools. In this section, some of these tools are
described - this is not an exhaustive
description, but just describes some of the key
terminology and building blocks for trade
finance. The next section then describes how
these tools are used in various forms of trade
finance.
Goods not produced yet Producer signs export
contract Goods in up-country warehouses Goods
being processed locally Goods in local
transit Goods in export warehouses
Pre-shipment finance
Post-shipment finance
Goods in transit through 3rd country Goods stored
in transit port Goods at sea Goods in import
warehouses Goods in overland transport to
buyer Goods processed by buyer Goods already sold
by buyer
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Once an export contract has been signed, this
contract itself can become an instrument for a
financing. If it is evidenced by, in particular,
a letter of Credit which guarantees payment if
certain conditions are met, a bank can then
decide to provide pre-export finance to
enable the seller to meet these conditions.
Goods not produced yet Producer signs export
contract Goods in up-country warehouses Goods
being processed locally Goods in local
transit Goods in export warehouses
All these phases can result in documents which
can support a financing.
Pre-shipment finance
When goods are loaded for international
shipment, the transport agent issues a railway
bill, a bill of ladingor a similar
document. This document acts as a title document
one normally needs it to receive the goods from
the transport agent on discharge. A
financier can thus use it for security to provide
post-shipment financing.
Post-shipment finance
Goods in transit through 3rd country Goods stored
in transit port Goods at sea Goods in import
warehouses Goods in overland transport to
buyer Goods received by buyer Goods processed by
buyer Goods already sold by buyer
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When goods are in a warehouse, warehouse
receipts can be issued as evidence of their
existence. The goods can also be inspected to
ensure that they meet the requirements of the
contract. Moreover, the warehouse receipts can
be pledged or transferred (sold) to the
financier, as security.
Goods not produced yet Producer signs export
contract Goods in up-country warehouses Goods
being processed locally Goods in local
transit Goods in export warehouses
Pre-shipment finance
Post-shipment finance
Depending on the details of the sales contract,
in any of these phases the goods need to be paid
by the buyer. The payments due from the buyer are
called accounts receivable, and can be
assigned to secure a financing.
Goods in transit through 3rd country Goods stored
in transit port Goods at sea Goods in import
warehouses Goods in overland transport to
buyer Goods received by buyer Goods processed by
buyer Goods already sold by buyer
By committing proceeds from future sale to
reimbursement, buyers can obtain finance.
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Goods not produced yet Producer signs export
contract Goods in up-country warehouses Goods
being processed locally Goods in local
transit Goods in export warehouses
Both exporter and importer can assign their
portfolio of account receivables to a financier,
in return for up-front cash (invoice discounting
- Factoring). Or they could just discount or
sell the receivables of specific contracts (bill
discounting - Forfaiting).
Banks can finance processing, using so-called
trust receipts under which the processor
basically acts as agent for the bank.
Pre-shipment finance
Post-shipment finance
Goods in transit through 3rd country Goods stored
in transit port Goods at sea Goods in import
warehouses Goods in overland transport to
buyer Goods received by buyer Goods processed by
buyer Goods already sold by buyer
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IV. Forms of international trade finance

• This section describes in brief the traditional
  forms of pre-shipment and post-shipment finance,
  before discussing how other forms of financing
  can help address particular problems/risks in
  these traditional financing forms.
• Pre-shipment finance
• Pre-shipment finance is meant to enable the
  exporter the preparation of goods for export.
  Banks can provide
• Bank overdrafts (it its the provision of
  instant credit by a lending institution, i.e. the
  amount by which withdrawals exceed deposits, or
  the extension of credit by a lending institution
  to allow for such a situation) click here for
  further description.
• Term loans direct credit facilities (a
  business loan with a final maturity of more than
  one year but normally for less than 180 days,
  payable according to a specified schedule), click
  here for further description.
• Credit lines (a line of credit is an agreement
  between a financial institution and a borrower
  allowing the latter to access credit up to an
  agreed amount), click here for further
  description.
• Foreign currency denominated trade facility also
  referred to as 'off-shore', although provided
  locally. By borrowing in the export invoice
  currency, the exporter creates a natural hedge
  i.e. the export proceeds and the loan are in the
  same currency and therefore there is no currency
  risk and no need for forward cover. However, this
  availability requires guarantee.

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• Direct credit facilities
• Banks may offer direct credit facilities, in
  which the client is committed to repay the loan
  by depositing scheduled installments.
• They need to be individually negotiated, but
  interest rates are generally lower than on
  overdrafts.

• Overdrafts
• This facility is granted by a bank whereby a
  borrower is allowed to draw advances, as he
  requires, on his current account, within certain
  specified limits. Interest is charged and the
  bank may demand repayment at any time (i.e. there
  is no specific repayment schedule).
• The bank's prior approval is required and an
  application may be supported by guarantees or
  other forms of security including the bank's own
  assessment of the borrower's future performance.
• Overdraft facilities are annually renewable by
  the bank depending on the cash flow activity of
  the account. An overdraft may enable the borrower
  to make cash payments to suppliers and thus,
  benefit from the discount on prompt payments that
  suppliers often provide. Interest rates are,
  however, relatively high compared to direct
  credit facilities.
• Where the facility is used to finance specific
  exports, the aspect of exchange risk in the
  export proceeds must be noted. Banks regard the
  provision of forward exchange cover as a type of
  lending facility and therefore require that it is
  secured - usually up to 10 per cent of the value
  of cover provided.

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Line of Credit It is regarded as temporary
financing and is usually unsecured and valid for
short-time period a period of one year subject
to renewal. The expiry of the validity of the
line of credit is usually set after the end of
the firm's financial year. This would influence,
along with an assessment of creditworthiness of
the firm as evidenced by its past performance and
its future need, the amount of credit. This
credit arrangement whereby the bank puts at its
clients disposal a maximum loan balance and
agrees to finance within this balance several
contracts subsequently entered into by the
client. Lines of credit may set up for
miscellaneous goods purchases (usually known as
general purpose lines of credit) or for contracts
associated with one project (usually known as
project lines of credit).
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? Short-Term import loans and lines of
credit An importers line of credit is an
arrangement to finance one or more contracts to
be subsequently entered into by the same importer
and accepted by the bank as eligible. Lines of
credit would typically be granted by local banks
which would in turn obtain financing from an
international bank. The latter could be a
correspondent bank, sometimes part of the same
banking group than the local bank, and would
establish a line of credit available for the
local bank to draw on for general purpose or for
a specific loan. Clean lines of credit are
difficult to obtain for commodity importers
located in developing countries. Clean financing
is generally limited to borrowers that can be
regarded as good credits and, in any case, can
be more expensive than structured finance. When
the creditworthiness of the borrower is fair or
poor, local banks would only lend on a secured
basis and traditional security (e.g., mortgage on
fixed assets) are typically onerous in more than
one respect (for example a mortgage has to be
registered or up-date for each new short-term
financing, which is in any case difficult and
costly).
? Short-term "export" loans and lines of
credit Exporters are more likely than importers
to obtain clean line of credit to finance their
marketing cycle. Short-term lines of credit
would cover post-shipment or pre-shipment
financing needs. But otherwise the same comments
apply as in the case of importers. Short-term
foreign exchange lines of credit can be granted
by local banks. 1 The financing can also be
directly between the international bank and the
local commodity company. 2
For example, the same international bank as above
extended in 1995 a US10 million line of credit
directly to South Africa Sugar Association at a
price of LIBOR 0.875 (excluding commitment
fees).
For example, the Zambian subsidiary of an
international bank granted in 1996 a US1.5 mn
cotton input facility to a local cotton producer
at LIBOR 1.5 (excluding arrangement fees).
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? International banks lines of credit
International banks sometimes extend credit to
small entities in various countries using lines
of credit granted to local banks. The local bank
could be designated as finance intermediary. In
providing financing through a finance
intermediary, the local bank assumes the role of
obligor and on-lends proceeds of the facility to
sub-borrowers, usually, at its own terms.
Nevertheless, it is normal for the pricing to
sub-borrowers to bear some relationship to the
pricing from the line-providing bank.

• A typical example is the Line of Credit facility
  operated by the African Export-Import Bank, an
  international bank established by African
  Governments in partnership with both local and
  international private and institutional investors
  for the purpose of enhancing African trade. The
  bank uses its line of credit to make funds
  available to numerous small scale exporters in
  the continent. Under this facility, the local
  banks are provided funds which they on-lend to
  the exporters under an arrangement by which
  proceeds of exports are remitted to a collection
  account maintained by Afreximbank from which the
  loan is repaid and the residual sum remitted to
  the exporter through the local bank.

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• Pre-shipment finance can also provide
• Open local or international letters of credit to
  the benefit of the borrowers local or
  international suppliers
• Leasing or hire/purchase arrangements (e.g., to
  finance processing equipment - Lease Purchase is
  a term which is used to describe a type of hire
  purchase which includes a final or "balloon"
  payments at the end of an agreement, thus
  reducing monthly rental/repayments).
• Can, in several ways, provide advances against
  future export receivables, or can provide
• Guarantees.
• Pre-shipment finance is normally disbursed in
  stages. The bank evaluates the borrowers
  production (or procurement, or processing)
  operations, and fits its financing around the
  seasonality of these operations. Each tranche of
  financing is only disbursed when the borrower has
  undertaken certain activities.
• Banks prefer to structure pre-shipment finance in
  such a way that
• they can be sure that the funds that they advance
  are indeed used for preparing goods for export
  and
• the liquidation of the facility is
  semi-automatic, from export proceeds, or through
  conversion to post-shipment finance.

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Pre-shipment finance with or without letters of
credit/confirmed export orders Generally,
pre-shipment finance involves the opening of a
L/C, or at least, an export order that the bank
is able to verify (and coming from a buyer whose
credit standing he can verify). There are then
several ways to build pre-shipment finance on the
basis of the L/C e.g., it can be as a security
to receive pre-financing arrangement (usually up
to 80-85 of the sales value) or through red or
green clauses incorporated in the L/C. The
various forms are discussed in the section on
How to use letters of credit as a financing
support. Banks may also give pre-shipment
finance on the basis of a companys past export
performance. This is called a running account
facility. They can be given in the form of an
overdraft or a direct credit (as has been
described previously). Several of the main forms
of Islamic finance have, as an objective, the
provision of pre-export finance, e.g., packing
credit to enable an exporter to assemble
sufficient goods for export, or credits to
finance local pre-export processing
operations. One structured finance application
that is typically used for pre-shipment finance
is pre-payment, in which a bank operates through
an international trader to finance the
procurement, processing, transport and storage of
commodities at origin, prior to exports. In order
to stimulate exports, many governments have
programmes that either provide direct pre-export
finance to incumbent exporters, or that provide
credit guarantees to banks that provide credits.
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• Post-shipment finance
• Post-shipment finance can be given to the buyer
  or the exporter
• It can be given to the buyer who then can
  promptly pay the seller (buyers credit). It
  therefore allows the buyer not to commit his own
  funds to pay for the goods until some time after
  they have been shipped - preferably, until after
  he has already sold the goods.
• Exporter operate in a very competitive buyer's
  market and in order to conclude an export sale,
  it is critical to offer attractive credit terms
  to the overseas buyer. Thus, Post-shipment
  finance can be given to the seller so that he can
  sell on deferred payment terms to the buyer (this
  is sellers credit).
• Post-shipment finance is generally provided
  against shipping documents, as proof that the
  shipment has indeed been made. As the buyer
  normally takes possession of the goods before he
  reimburses the credit, the shipping documents
  only provide security to the bank for a limited
  period, basically while the goods are in
  international transit.
• Post-shipment finance is normally for a short- to
  medium-term period.

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Buyer's Credit A financial arrangement by which
the exporter, his bank, or other financial
institution, and export credit agency in the
country of the exporter extends a loan, either
directly to the foreign buyer, or indirectly
through a bank in the buyer's country acting on
his behalf. The credit is thus meant to enable
the buyer to make payments due to the
supplier/exporter under the contract. It is
typically a medium-to long-term loan.
Seller's Credit A Credit granted by the
exporter/supplier, usually through commercial
bank, to a foreign buyer under deferred payment
terms. Usually the importer pays a portion of
the contract value in cash and issues a
Promissory note or accepts a draft/Bill of
exchange as evidence of his obligation to pay the
balance over a period of time. The exporter thus
accepts a deferred payment from the importer, and
may be able to obtain cash payment by discounting
or selling the draft or promissory notes created
with his bank.
Bill of Exchange (Draft) An instrument of
payment frequently used in international
business. It is an unconditional written order of
payment issued (and signed) by the exporter
(Drawer) and addressed to the importer (Drawee)
to pay, on demand or at a specified future date,
a stipulated monetary sum in a given currency to
the exporter (Drawer). A sight draft calls for
immediate payment (i.e. on sight), while a time
draft calls for payments at a predetermined
future date. Promissory note An unconditional
written promise issued and signed by the debtor,
to pay on demand, or at on a specified date, a
stated amount of money to the order of a
specified person or to the notes bearer.
Promissory notes are transferred by
endorsement. Endorsement The only method
recognized in commercial law of transferring
title and/or rights on a negotiable instrument.
The transfer is achieved by writing one's name on
the instrument, usually on the reverse. The
signature must be accompanied by conditional or
restrictive wording and constitutes a contract
between the holder and all parties to such an
instrument.
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Post-shipment finance the mechanisms In much
of the world trade, suppliers give credit to
their buyers. Much of this credit is
negotiable, that is, transferable from the
exporter/supplier to a third party. In most
cases, the debt obligation, commonly referred to
as trade paper, is sold (discounted), enabling
the exporter/supplier to receive payment soon
after shipment. There are many different forms
of post-shipment finance, however, the most
popular is probably bill discounting or
negotiating draft, in which a bank discounts the
face value of a trade bill, paying the exporter a
part of this face value. The bank could also
give an advance (a credit backed by the trade
bill), which means that the bill will be used as
a collateral to obtain finance, but because the
advance may cover a smaller part of the face
value of the bill, this could be less popular.
What is a trade bill/bill of exchange? In order
to create a trade bill, the following steps are
needed 1. The exporter issues (draws) a bill
to the buyer (basically, sends an invoice) 2.
The buyer sends the exporter a confirmation of
his acceptance of the bill 3. The exporter then
endorses the bill to the bank 4. The bank then
adds its aval (guarantee). Payment can be on
delivery of the goods (sight draft), or a
certain number of days after delivery (term
draft).
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Post-shipment finance Bill discounting Bill
discounting can be possible both when the exports
were executed under a letter of credit, and when
they were made under a documentary collection ?
In the case of L/Cs, the bank will ensure that
the shipping documents that have been delivered
indeed conform to the requirements of the L/C.
Then, assuming that the payment obligations under
the L/C are by a reliable bank from a country for
which they have a credit line, the bank will
simply discount the face value of the L/C,
applying its standard discount rate for the time
until maturity. Note Documentary Letters of
Credit whether payable upon presentation of
shipping documents or up to 360 days thereafter
and other clearly defined terms, are among the
most common negotiable term debt instruments and
hold a critical function in international trade
financing. ? In the case of documentary
collections, the bank will confirm that the
export orders are indeed firm, and that the buyer
has a good credit standing. If such is the case,
they will then discount the bill. In documentary
collections as with L/Cs, the bank has recourse
to the exporter in case the buyer does not pay. ?
But there are also other post-shipment finance
mechanisms, which may provide the exporter with
non-recourse finance (in other words, the
financier bears the risk of non-payment by the
buyer). The exporter could resort to factoring,
which does not involve drafts/bills of exchange
instead, the exporter hands over the full
management of his debtor book to a factoring
company, which in turn gives him an advance (i.e.
discounting his account receivables). Or he
could use the forfaiting market, for individual
transactions/bills. In addition to L/C, and
other negotiable debt instrument, forfaiting
includes bank guarantees, bills of exchange,
promissory notes.
Click here for more
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Post-shipment finance Bill discounting in in
the absence of L/C Without the use of an L/C,
the exporter (beneficiary) can also grant
extended payment terms directly to the importer
and generally would issue bills of exchange
addressed to, and accepted by, the importer
(drawee and acceptor) who commits to pay on
demand, or at a fixed or determinable future
time, a certain sum to the exporter (drawer and,
generally, payee). Note Bills of exchange are
similar to invoices - the exporter issues a
demand for payment to an importer (or to a
guarantor). This is a trade bill, drawn by one
commercial party on another. Once it has been
accepted or endorsed by the importer, it becomes
a trade acceptance, which, with a bank guarantee,
becomes negotiable. The claim may also be
supported by promissory notes issued by the
importer (or buyer) once the commodity has been
accepted. Promissory notes are issued by the
importer directly to the exporter, usually with a
guarantee or aval from his bank. Such an
aval is generally essential for making the
notes negotiable. The importer pays for this
guarantee, but its cost is in many cases more
than offset by the lower interest rates on this
form of credit. Once an exporter has issued term
drafts/bills of exchange or have accepted
promissory notes issued by an importer/buyer, all
of which guarantee a payment at some time in the
future from the importer/buyer, he or she can
negotiate or discount (sell for less than the
face value) these instruments against cash. In
other words, rather than providing credit to
importers out of their own financial resources,
exporters do so after having obtained refinancing
from banks or other discounters.
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• Post-shipment finance Negotiable instruments
• There are three major types of such trade paper
  that can be used as a credit instrument bills
  of exchange, promissory notes and bankers'
  acceptance. In the case of bankers' acceptance,
  the exporter can ask his bank to discount the
  trade paper, in which case it becomes a bankers
  acceptance (B/A). (Bankers' acceptance are
  explained separately in sub-chapter).
• How to qualify as a negotiable instrument?
• To qualify as a negotiable instrument, the trade
  paper must meet at least three conditions
• First, the obligation that the buyer has to
  repay the debt to the exporter/supplier is
  absolute, that is without regard to performance
  of the underlying commercial transaction on the
  part of the exporter (or supplier).
  Nevertheless, the bank which originally accepts
  the trade paper will want assurance that the
  exporter/supplier will meet, or has met, his or
  her obligations under the commercial contract,
  and will generally disburse funds only after
  shipment.
• Second, the trade paper must be endorsed as
  non-recourse by each successive holder, meaning
  that the obligor remains the importer/buyer and
  that neither the exporter/supplier nor the
  previous holder(s) of the debt is(are)
  responsible for effecting repayment at maturity.
  
• Third and last, if the importer/buyer is not
  widely accepted as a highly creditworthy
  counterparty, then a guarantee must be provided
  by a third party, usually a solid bank with a
  record in international trade.

NOTE Trade paper which is provided by highly
creditworthy counterparties, or which has been
guaranteed by reputable banks, is actively traded
in a market which has as participants banks,
traders (who provide much of the liquidity) and
investors (individuals as well as investment
funds). Banks and other investors often prefer
trade paper over other debt instruments because
it is seen as self liquidating. The market where
trade paper is traded is thus both large and
liquid, and is commonly referred to as the
forfaiting market (explained in a separate
chapter) Moreover, as the value of trade paper is
based on single, real transactions, it is quite
stable, much more so than other debt instruments.
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Post-shipment finance Discounting based on
documentary collections, risks for the bank At
times, post-shipment finance is on a documents
against payment (DP) basis that is, the buyer
pays, and then receives the shipping documents.
But as this mainly covers the financing of the
goods in transit, documents against acceptance
(DA) is more common. Here, the bank has to hand
over the shipping documents to the buyer before
he receives the payment. The bank receives a
draft from the buyer committing to payment at
maturity of the draft. There is, therefore, a
risk of non-payment by the buyer (an example is
given in the Banco Santander vs. Banque Paribas
case using discounting deferred payment LC). To
mitigate this risk, banks generally take out
export credit insurance (which, however,
generally only covers up to 90 of eventual
losses), or can discount the bills without
recourse (e.g., on the forfaiting market).
How can an exporter receive post-shipment finance
if he sells his goods on consignment? Commodities
such as fruits and vegetables are often sold
under consignment implying that they will only
be sold once they have arrived at destination.
However, exporters can still obtain bank
financing for the commodity during international
transport and storage in the destination country.
They will let the bank handle the shipping
documents after shipment, and then, in order to
be able to take delivery at destination, sign
Trust Receipts or undertakings with the bank in
which they commit themselves to deliver the sales
proceeds to the bank by a specified time.
document against payment - the exporter will
release the documents only if the importer makes
immediate payment also known as sight draft or
accept the draft. document against acceptance -
the exporter will release the documents only if
the importer accept the accompanying draft,
thereby taking the obligation to pay over a
designated period of time, i.e. 30 days or 90
days also known as term draft.
25
The Banco Santander Banque Paribas case On
behalf of a petroleum-trading client, Paribas
issued a deferred payment L/C in favour of
Bayfern Ltd, an exporter. The L/C specified
payment 180 days after delivery of the documents.
Banco Santander added its confirmation before
releasing the L/C to Bayfern. After receiving
the L/C, Bayfern submitted conforming documents
to Santander, and asked the bank to discount the
L/C and pay the proceeds to its own bank. Seven
days after Santander had discounted the L/C, and
paid the proceeds to Bayferns bank, it
discovered that the certificates of quality and
quantity submitted by Bayfern were false. In
court, it was found that Paribas did not have to
reimburse Santander and this judgement was
upheld under appeal. If payment had been made at
maturity, then Santander could have expected
reimbursement. But as no payment should be made
at maturity (because the documents are
fraudulent), there is no payment obligation on
Paribas. Santander acted on its own volition
in discounting the deferred payment L/C, and
could not hold Paribas liable. It would have
been different (as was found in another case) if
the bank had actually been authorized by Paribas
to act as negotiating bank, with the L/C giving
them express authority to discount the credit.
Then, they would have acted as agent of Paribas,
and assuming they act in good faith but later
find evidence of fraud, could still expect
payment at maturity by Paribas. Based on Can
a confirming bank safely discount a deferred
payment letter of credit, Denton Hall Wilde
Sapte Banking Litigation Briefings, March 2000.
26
In SUMMARY, Pre- and Post- shipment Finance
Compared

• Pre-shipment Finance
• Finance is disbursed prior to shipment to enable
  collection of materials for export.
• Involves both performance and payment risk of the
  exporter and buyer respectively.
• Source of repayment is proceeds of the contract.
• Relatively a higher risk with higher costs.

• Post-shipment Finance
• Finance is disbursed after shipment to keep
  exporter in funds pending payment by buyers.
• Involves mainly payment risk of the buyer
• Repayment comes from proceeds of exports
• Risk is lower, especially if buyer is well known,
  hence financing cost is lower.

27
Integrating pre- and post-shipment finance Some
forms of finance can be used both for
pre-shipment and for post-shipment finance.
Bankers Acceptances are an example while they
are mostly used for post-shipment finance
(allowing a company active in international trade
to refinance its export receivables or the goods
it has received from imports), it can also be
used to finance goods in a warehouse awaiting
shipment. Banks often accept to roll pre-shipment
finance into post-shipment finance on
presentation of the proper shipping documents.
But there are other ways to link the two. For
example, warehouse receipt finance is based on
the security of goods in stock, whether in the
importing or exporting country. If export- and
import-warehouses are linked through a
door-to-door letter of credit and the transporter
provides appropriate guarantees, than a warehouse
receipt financing structure can integrate both
the pre- and the post-shipment phase. Various
structured finance tools link imports and
exports. This is explicitly so for countertrade,
but also applies to many forms of structured
finance which lend against a clients borrowing
base a discounted sum of its account
receivables, due from overseas buyers, and the
goods in stock awaiting shipment. Furthermore,
not only banks can provide trade finance.
Securitization permits access to the market of
institutional investors most easily for
post-shipment finance (refinancing a portfolio of
export receivables), but use for financing
domestic crops and for pre-shipment finance is
also possible.
Click here for an explanation and examples of the
use of Bankers Acceptances
Click here for an example of using trade
paper for grain financing in Zimbabwe
28
Using trade paper to finance domestic grain
trade the case of Zimbabwe
Until political problems caused the collapse of
its agricultural sector, Zimbabwe was a large
cereals producer (primarily growing maize), able
to export in many years. Although grain trade
continues being in the hands of a government
entity (the Grain Marketing Board, GMB), trade
has been financed, since the 1980s, by the
private sector. The mechanism used is the
issuance of trade bills several times a year,
the GMB issues trade bills, which are tendered to
the highest bidders (in the 1980s, the trade
bills, with a bank aval, were also discounted in
the international market for Bankers
Acceptances, but the declining international
reputation of Zimbabwe has put a stop to this).
The basic mechanism for issuing the bills is as
follows
Tender of trade bills
Trade bills
GMB
Agent bank
Investors
Secondary trade
Guarantee
Government
29
Zimbabwes grain bills
After 180 days, bills are claimed at face value
After 180 days, bills are claimed at face value
Tender of trade bills
Trade bills
GMB
Agent bank
Investors
Guarantee
Secondary trade
Government

• The bills are issued by the GMB 3-4 times a year,
  in tranches of 4 to 5 billion Z (70-90 million
  US, at the official exchange rate of late 2001,
  and 13-16 million US at the parallel market
  rate).
• The government provides a guarantee (which has
  never been called upon).
• Agent banks are selected each year, in principle
  through a tendering process banks generally
  form syndicates to bid on the tender.
• The winning agent banks are then responsible for
  placing the trade bills with investors, including
  other banks, pension funds and other
  institutional investors, and individual investors
  (the bills are tendered with a face value of 1
  million Z, less than 2,000 US at the official
  rate).
• The bills are placed with the best bidders in the
  tender there are no private placements and
  are then actively traded on the secondary market.
  Demand for the trade bills is normally very
  strong.

30
Zimbabwes grain bills
Farmers
After 180 days, bills are claimed at face value
After 180 days, bills are claimed at face value
grain
Z
Tender of trade bills
Trade bills
GMB
Agent bank
Investors
Secondary trade
Guarantee
Z
grain
Government
Traders
31
V. Sources of Trade Finance

• Traders (importers and exporters) have over the
  years relied on banks to provide them with short
  or medium term finance for their operations.
  Often times though, when banks are not able to
  support them due to portfolio or other
  constraints, there are other sources of finance
  available. These other sources are becoming more
  prominent in recent times due to the use of
  modern financing techniques in trade financing
  which enhances the risk quality of loans, thus
  enabling them meet the risk appetite of many
  financiers. The various sources of trade finance
  are discussed in the following slides.

32
Suppliers credit
Investment management companies
Banks
Governments
Buyers Credit
Multilateral financial institutions
Export Credit Agencies
33
1. Suppliers' Credit

• A supplier may grant a buyer credit for items
  supplied. This is possible especially in
  circumstances where both parties have had
  satisfactory transactions over a reasonable
  period and developed some form of mutual trust.
  Such arrangement, apart from lifting the buyer
  from the financial limitations, provide the
  seller with opportunity to keep his productive
  capacity engaged optimally.

34
2. Banks (local and international)

• Much of trade finance comes from the banks either
  in the form of direct advances to the traders or
  through issuing and/or advising of L/Cs
  especially when they are not cash collateralized.
  Banks may also discount bills or drafts held by
  suppliers, thus providing them with funding prior
  to maturity of their instruments.
• Banks have to provision against their loans -
  that is to say, they have to keep a certain
  percentage of their loan portfolio in safe assets
  which may, however, pay little or no interest
  rates (e.g., deposits with the Central Bank).
  Under the Basel agreement, banks now have to
  provision 8 percent of their outstanding loan
  portfolio. Under the new Basel 2 agreement,
  which will become operational in 2005,
  provisioning rules will be more tailored to the
  riskiness of individual loans. Banks may then
  have to provision as much as 50 percent of their
  loans to non-investment grade countries. This
  implies, of course, that the interest rates they
  need to charge on such loans will increase
  strongly - unless if they find ways to mitigate
  the risks.

35
3. Buyer's Credit

• It is not unusual for traders to request their
  customers to make deposits for goods deliverable
  at future dates. This is mostly for items scarce
  in supply or those supplied by monopolies. Such
  deposits made by customers enable the trader meet
  urgent working capital needs.
• A buyer may also grant direct advance to an
  exporter to enable him obtain materials for
  processing and export for his favor. Such
  arrangement is operated under a prepayment
  arrangement and may involve a lender providing
  funds to an exporter on the buyers behalf. The
  funds enable the exporter to gather stocks for
  processing and export to the buyer, who then
  makes direct payment to the lender up to the
  limit of the loan and associated interest
  charges. While the facility is in place, the
  lender takes a charge over the stock at the
  exporters place.

36
4. Export Credit Agencies
Export Credit Agencies (ECAs) are also very
instrumental to credit availability since they
provide necessary guarantees and bonds that
enable financiers to make funds available for
trade. The role of ECAs are much more relevant in
the developing economies where unstable
governments tend to erode the confidence of
lenders to expose themselves to such markets.
Export credit guarantees do not involve the
actual provision of funds to exporters but are
instruments offered by government agencies to
safeguard export-financing banks against losses
resulting from the export transactions they
finance. In this way they facilitate exporters'
access to credit and are thus powerful incentives
for exporting. By providing guarantees, ECAs
encourage local exporters to venture into
difficult environments with the hope that if
payment defaults arise, they would not lose
money. ECAs are owned by governments who use them
as instruments to encourage exports and hence
boosting local productive capacities. Notable
ECAs include the US - based Overseas Private
Investment Corporation (OPIC) and Multilateral
Investment Guarantee Agency (MIGA), and also
Export Credit Guarantee Department (ECGD) of the
United Kingdom, and COFACE of France.
37
4. Export Credit Agencies (cont'd)
Export credit insurance A policy to cover one
of the riskier areas faced by exporters i.e. the
non payment either due to insolvency of the
importer (commercial risk) or political events
(political risk). Export credit insurance is
frequently mentioned in connection with export
credit guarantees. However, while guarantees
cover bank export loans, insurance policies are
issued in favour of exporters. In many developing
countries, this type of insurance is not
available or too expensive. Several types of
export credit insurance are available they
differ from country to country according to the
needs of the business community.
The OECD provides links to all the export credit
agencies of OECD countries.
38
4. Export Credit Agencies (cont'd)

• The most widely used types of export credit
  insurance are the following
• Short-term export credit insurance Generally
  covers periods not exceeding 180 days.
  Pre-shipment and post-shipment export stages are
  covered, and protection can be provided against
  political and commercial risks.
• Medium- and long-term export credit insurance
  This type of insurance is issued for credits
  extending for long periods - up to three years
  (medium-term) or longer. It provides cover for
  financing exports of capital goods and services
  or construction costs in foreign countries.
• Investment insurance Under this type of policy,
  insurance is offered to exporters investing in
  foreign countries. The Multilateral Investment
  Guarantee Agency (MIGA), affiliated to the World
  Bank, offers this type of insurance.
• External trade insurance This type of credit
  insurance applies to goods not shipped from the
  originating country and is not available in many
  developing countries.
• Exchange risk insurance This type of insurance
  covers losses arising from the fluctuation in the
  respective exchange rates of the importer's and
  exporter's national currencies over a determined
  period of time.

39
5. Multilateral Financial Institutions

• Multilateral financial institutions also play a
  major role financing trade especially where such
  financing advances their mandates of poverty
  alleviation and common good of the people. The
  world bank world balance of payments support
  facilities provide the necessary financing window
  for many countries thereby enabling trading
  activities between such countries and the rest of
  the world.

40
6. Governments

• Government involvement in trade sometimes go
  further than providing the enabling environment
  for trade to outright advances for import
  purposes especially where such imports are export
  generative in nature. In some other instances,
  imports of essential items such as food and
  medicines receive direct government support in
  the form of advances and/or guarantees.

41
7. Investment Management Companies

• Certain institutions managing portfolios of
  varying sizes and tenor occasionally inject some
  funds into the trade finance market. Such
  institutions like insurance companies and pension
  fund managers take advantage of instruments like
  commercial papers to earn quick yields.
• Under the Basel agreement, Banks are faced with
  increasingly stringent rules on lending to
  risky countries and clients. In contrast,
  institutional investors are not limited by any
  rules on provisioning, or unduly restrained by
  country credit lines. It is therefore likely
  that the role of investors in trade finance will
  increase.

42
VI. Loan Syndication
Syndication is a process involving the coming
together of various banks and/or other financiers
for the purpose of providing finance to a single
entity. It is also known as club deal. In this
arrangement, the leader of the team (the
Arranger) divides the entire facility sum into
bits (tickets) and stratifies them in descending
order for the purpose of apportioning fees due to
participants in the transaction. Participants in
descending order may include all or some of lead
arrangers, senior co-arrangers, co-arrangers,
senior lead managers, lead managers and managers.
Fees paid to these members of the syndicate vary
according to their respective tickets. Club
deals have become increasingly important in
present day financing, enabling the banks to
share in risks across continents. The arranging
bank in most instances is the facility agents
with the responsibility to manage the
reimbursement from the borrower and then to the
funding participants. The members of the
syndicate are bound by an agreement
(participation agreement).
43
? Types of Syndication
Syndication could be under disclosure or
non-disclosure basis
Disclosure In this arrangement the identity of
all the participants are disclosed to the
borrower while the participants also know the
full terms and conditions of the facility. This
arrangement is preferred by banks because it has
some promotional appeal. Non-Disclosure In this
arrangement, the identity of participants are not
made known to the borrower. The participants in
this case sign a sub-participation agreement.
44
? Advantages of Syndication

• It enables the creation of a sizeable pool of
  funds within a short time.
• It helps in the sharing of risks and moreover, it
  makes room for both big and small banks to share
  in the same mandate through the availability of
  tickets of various sizes.
• It enables banks with relatively poor structuring
  capabilities to study those of the transactions
  they are participating in and learn therefrom.
• Syndication make for constant interaction between
  and among bankers and therefore aids in
  information flow on events in the market place.
• Syndication encourage the distribution of wealth
  since it enables developed country banks to
  participate in funding developing country
  entities.
• It can bring down pricing. This is very
  true for mandates that have over a long time or
  those that are over subscribed. The borrower may
  cash in on his strength to negotiate for better
  pricing e.g. Ghana Cocobod syndication whose
  margin has gone down by over 50bp since its
  debut.

45
Click for some Examples on simple trade financing
and more structured trade finance mechanisms
46
EXAMPLE I Short-term Pre-shipment Financing
(L/C-Based) 1. Purpose Financing to start
production for US50 million worth contracts
signed. 2. Exporter A credit worthy company in
country X. 3. Importer Various credit-worthy
buyers in safe country. 4. Lender XYZ
Bank. 5. Amount to be financed 85 of the signed
contracts value (i.e. US 42.5 million). 6. Tenor
6 months, representing shipment period. 7.
Documentation - Confirmed copies of the
L/Cs - Assignment of proceeds by the exporter
to the bank - Notification of assignment
proceeds by the exporter to the issuing bank as
well as advising bank - Acknowledgment of
assignment by the issuing bank.
Exporter/Seller (Country X)
Buyers
Sales Contract
Pre-shipment financing
Assignment of L/Cs proceeds
Request to open a sight L/C
XYZ Bank
Notification of Assignment of Proceeds
Acknowledgement of assignment
Advising of Sight L/C Proceeds
L/C Opening Bank
Advising/Negotiating Bank
Issuing Sight L/C
Notification of Assignment of Proceeds
This is a simple pre-finance transaction where an
L/C is issued from a reliable bank in a safe
country and the tenor of the finance is limited
to the shipment period only. The proceeds of the
L/C are assigned to the financing bank.
47

• EXAMPLE II Medium-term Pre-shipment Financing
  with no Bank Guarantee (Contract-Based)
• 1. Purpose To secure short-term financing at a
  lower cost than the in local market. (The total
  amount of contract is approximately US60 million
  signed to be delivered over 5 years)
• 2. Exporter A credit worthy company in country
  X.
• 3. Importer A well-known company.
• 4. Lender XYZ Bank.
• 5. Amount to be financed US7.5 million,
  repayable in 6 half-yearly installments (final
  maturity of three years).
• 6. Tenor 3 years.
• 7. Documentation
• Promissory notes issued by the exporter for
  US7.5 million (P-Note is a financing instrument
  that states the terms of the underlying
  obligation, is signed by its maker and is
  negotiable/transferable to a third party)
• Confirmed copies of the Contract stipulating i)
  quantity ii) quality iii) delivery schedule,
  and iv) take-or pay provision (a contractual
  term whereby the buyer is unconditionally
  obligated to take any product or service that he
  is offered - and pay the corresponding purchase
  price-, or to pay a specified amount if he
  refuses to take the product or service)
• - Letter of Assignment of rights and benefits by
  exporter to bank
• - Letter of Acknowledgment by importer to bank,
  confirming that any payment of goods received
  under this contract can only be affected to the
  escrow account maintained by exporter with bank
• - Charge over bank account
• - Legal opinion from the exporting country.

Seller (Country X)
Buyer
Sales Contract
Letter of Notification
Issuing P-note and Loan Agreement
Letter of Assignment of Rights and Benefits
Letter of Acknowledgment
XYZ Bank
Pre-shipment financing
This is a simple medium-term, pre-shipment
finance transaction where the borrower (the
exporter) issues P-notes to the lending bank and
payment is done automatically to the bank from
the importer through the escrow account. No
country nor business risk implication.
48
EXAMPLE III Construction financing for overseas
plants in combination with an ECA 1. Purpose
100 finance for a project in country Y. 2.
Exporter Company A in country X. 3. Importer
Company B in country Y. 4. Lender XYZ
Bank. 5. Amount to be financed 100 of the
total finance, i.e. US 42 million. 6. Constructi
on period Over 2 years. 7. Repayment terms In
4 half-yearly installments starting 2 years
after the signing of the loan agreement (i.e, 2
year grace and a total of 4 years the final
maturity). 8. Documentation Two separate loans
agreements and guarantees one for ECA and one
for the forfaitor.
Exporter/ Company A (Country X)
Importer/ Company B (Country Y)
Sales Contract
Loan Agreement for the portion not covered by ECA
Financing
Financing
XYZ Bank
Request of Guarantee
Providing a guarantee for the whole project
Providing a guarantee for the construction
Material
Government Country Y
ECA
This example represents two separate financing
agreements one with ECA and one with government.
49

• EXAMPLE IV Account Receivable-Based Financing
• Underlying transaction To trade naphtha and
  crude oil.
• Lender XYZ Bank.
• Facility Amount US 50 million for credit
  facility.
• Exporter Major oil company in Kuwait.
• 5. Trader Korea trading company in Singapore.
• 6. Importers Major oil refineries worldwide.
• 7. Tenor 30-90 days from B/L date.
• 8. Collateral Outstanding account receivables.
• 9. Facility Period 1 year.

Exporter
Buyers (Oil Refineries)
Shipment
Letter of Acknowledgment
Letter of Undertaking (remedial procedures in
case of non-performance)
Payment after 30-90 days from B/L date
Payment at shipment
XYZ Bank
Trader (Singapore)
Sales/Purchase Contract
Sales/Purchase Contract
This financing is given to the exporter once
goods are shipped and repayment is done
automatically by importer through an escrow
account.
50

• EXAMPLE V Structured Commodity Financing
• 1. Underlying transaction Aluminum billet.
• 2. Lender XYZ Bank
• 3. Borrower/Exporter Aluminum billet producer,
  Korea.
• 4. Trader Non-ferrous metal trader.
• 5. Tenor 60 days.
• 6. Security
• 100 performance guarantee by the borrower.
• Assignment of receivables
• Payment into Escrow account

Aluminum Billet Producer/ Borrower (Korea)
Non-Ferrous Metal Trader
4. Aluminum Billet
1. Performance Guarantee
3. Aluminum Ingot
5. Payment
Bank XYZ / Escrow account
Raw material supplier
2. Loan()
Structured finance mechanism through which the
supplier is paid from the bank for the raw
material sold to the exporter and repayment is
made automatically by the importer to the bank
through an escrow account