Professional Documents
Culture Documents
Paul Cowdell
Peter McGregor
Siraj Ibrahim
(Chapter 10)
Neil Chantry
(Chapter 14)
David Hennah
(Chapter 15)
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Paul Cowdell worked for many years at Midland Bank dealing with the
international trade needs of corporate clients. Now a Senior Lecturer
at Sheffield Business School in Risk Management, Corporate Treasury
Management and Derivatives, Paul has authored and co-authored
several texts and articles on international trade facilities and foreign
currency risk exposure management. Paul is an Associate and a Fellow
(ACIB & FCIB) of the Chartered Institute of Bankers, and also holds the
Institutes Diploma in Financial Services (Dip.FS). Paul also holds the
Membership Diploma of the Association of Corporate Treasurers (MCT).
He is currently a project supervisor for the Association of Corporate
Treasurers on the Membership Diploma.
Peter McGregor spent over twenty years as a practising domestic and
international banker, both in the UK and overseas, followed by a similar
period as an academic at Sheffield Business School/Sheffield Hallam
University. His main areas of teaching expertise were international
trade finance, corporate treasury management, lending and risk
management, banking and financial services law and regulation. Peter
has also been involved in writing several books and articles on financial
matters. Peter is now the Managing Director of the financial and
business education consultancy, The McGregor Education Consultancy
Ltd, with clients throughout the UK and overseas. He undertakes several
roles with ifs University College in the UK. Peter is an Associate and a
Fellow (ACIB & FCIB) of the Chartered Institute of Bankers, and also holds
the Institutes Diploma in Financial Services (Dip.FS). He is a Fellow of
the Higher Education Academy (FHEA).
Additional contributors
Siraj Ibrahim works as a banker within FI and Trade Finance for Qatar
Islamic Bank (UK). In a career spanning over ten years largely within
two global banks, Siraj has worked in the FI, Treasury and Corporate
coverage sectors. In addition, he sits on the UK Technical Committee
for the international Islamic Finance Qualification (IFQ), administered by
the CISI, and is the joint editor/other contributor for the IFQ Workbook.
He is also the UK correspondent for the Islamic Finance News.
David Hennah MIFS is Head of Trade at Misys, a leading service provider
of banking software solutions. He is now enjoying his second stint
at Misys having previously worked for Barclays, ICL/Fujitsu Services
UK and SWIFT. David is credited with launching the worlds first
international direct debit service. He also played a leading role in the
establishment of the bank payment obligation (BPO) as an accepted
market practice in international trade. He was a member of the ICC
Drafting Group on URBPO and is the author of the ICC Guide to the Uniform
Rules for Bank Payment Obligations.
The reviewers
Note to students
For the purpose of consistency this study text refers to documentary credit.
However, DC, letter of credit, LC or credit are also widely used in the
same context as documentary credit. Students should decide on their own
preference for describing the product.
1 Introduction 1
2 The international trade environment 19
3 Contracts 41
4 Intermediaries and how they operate 55
5 Documents used in international trade and
the Incoterms 2010 rules 75
6 Methods of settlement 105
7 Documentary collections 113
8 Documentary credits 131
9 Short-, medium- and long-term trade finance 161
10 Islamic trade finance 191
11 Guarantees and standby letters of credit 207
12 Export credit insurance 227
13 Foreign currencies and the exchange risk 235
14 Financial crime 249
15 Bank payment obligations (BPOs) 269
Bibliography 287
Learning objectives
u the ways in which the risks in international trade can be reduced (risk
mitigants);
A company may require raw materials or components for their product that
cannot be sourced from the domestic market. They would need to look
to overseas markets and buy the product from overseas suppliers. This is
known as importing. Another example would be when a company is unable
to manufacture or purchase the product in the domestic market and, for
reasons of cost, it is cheaper to have it manufactured overseas. A business
that imports may purchase goods for its own sales, or it may be acting as
an agent or distributor for a foreign supplier. This is covered in more detail
in Chapter 2.
Ricardo gave the example of England and Portugal. At the time, Portugal
was able to produce wine and cloth with lower labour costs than it would
take to produce the same quantities in England. However, Ricardo examined
and compared the relative costs of producing wine and cloth between the
two countries. He found that in England, although it could produce cloth
relatively easily, it was very difficult to produce good-quality wine at a
reasonable price. In Portugal, however, although it was able to produce both
wine and cloth quite easily, it was more beneficial to produce excess wine
and trade that for English cloth. England benefited from this trade, as it
was able to buy wine at a lower price and finer quality for less than it could
produce itself, and its cost for producing the cloth had not changed.
u Portugal can produce 1 litre of wine from 1 unit of production and 1 roll
of cloth from 1 unit of production;
u England can produce 1 roll of cloth from 1 unit of production, but requires
3 units of production to produce 1 litre of wine.
This simplified example relies on many assumptions that may not hold good
in the real world, such as the following:
u The wine and cloth are identical, whichever country produces them.
u The gains from comparative advantage are split evenly, as each country
gains the same, ie 1 roll of cloth.
u The wine producers in England and the cloth producers in Portugal will
not object to being closed down.
Nevertheless, the example demonstrates the basic principle that the concept
of comparative advantage is simply a logical extension of the principles of
specialisation and division of labour that results in higher overall output and
hence higher overall wealth.
The profit is achieved through the trading activity and it is basically the net
result of all of the income achieved by the business minus the expenditure
incurred.
This study text will explore the implications for those organisations that
trade internationally. It will examine the various products, services and risks
associated with international trade, and how those risks might be mitigated.
In international trade, buyers are normally importers and sellers are normally
exporters. However, some international trade is undertaken by businesses
that act as intermediaries, bringing buyers and sellers together in exchange
for a fee.
A major disadvantage of this type of entity is that a sole trader has unlimited
liability, so in the event of a creditor being owed money that the business
cannot repay, a creditor has the right to pursue the owners personal assets
for repayment. Another disadvantage is that if the owner falls ill, the business
can be put at risk.
1.3.2 Partnership
Partnerships are when two or more individuals go into business together,
with a view to making a profit. The owners are referred to as the partners
(or general partners) and they are usually equally responsible for the debts
of the partnership unlimited liability although partnerships limited by
liability are becoming more common.
u If one partner decides to leave or if one partner dies, problems may arise
in taking their share of the capital out of the partnership.
Limited partners are only liable for debts incurred by the partnership up
to their registered investment, that is the amount they have agreed to
contribute to the partnerships capital. Once limited partners have paid in
the registered investment amount to the partnership, they have no further
personal liability.
These companies can be distinguished by the letters after their name, for
example Limited or Ltd (in the UK), Inc (USA), SA (France), GmbH or AG
(Germany).
u It is a distinct legal entity, totally separate from the people who own or
run it.
u It has limited liability, so the owners are not responsible for the debts
of the company. The exception here is where a personal guarantee has
been given or if a fraud has been committed.
u Any losses incurred by the business can be carried forward and offset
against taxable profits in future years.
Shareholders have the right to attend, vote and speak at the companys
annual general meeting (AGM). It is at this meeting that all board directors
are elected.
u The laws and regulations will be different between the countries, and
smaller businesses may not have the resources to employ legal expertise
to deal with this.
u It may take additional time to ship goods from one country to another,
and additional costs relating to transport and insurance could be
incurred.
The above are just some of the risk mitigants that will be covered later in
this text.
However, there are still some fast-growing economies, for example in Asia,
and there is potential demand for exports to those countries. For example,
in July 2012 the value of UK exports to non-EU countries exceeded the value
of its exports to the EU for the first time since the 1970s. Commentators
tended to view this as a result of the comparatively faster growth of some
non-EU countries, such as China, when compared to the economies of the
EU.
The WTOs goal is: to help the producers of goods and services, exporters
and importers conduct their business. Its members are government and
country officials for the majority of the worlds trading countries.
u the removal of the automatic need for customs clearance when goods
cross EU boundaries, although customs authorities have a right to check
goods if there are any suspicious circumstances.
work with ICC members in their countries to address their concerns and
convey to their governments the business views formulated by the ICC.
1. rule setting;
2. dispute resolution;
3. policy advocacy.
The ICC also provides essential services, foremost among them the ICC
International Court of Arbitration, the worlds leading arbitral institution.
Another service is the World Chambers Federation, the ICCs worldwide
network of chambers of commerce, fostering interaction and exchange of
chamber best practice. The ICC also offers specialised training and seminars
and is an industry-leading publisher of practical and educational reference
tools for international business, banking and arbitration.
Business leaders and experts drawn from the ICC membership establish the
business stance on broad issues of trade and investment policy as well as
on relevant technical subjects. These include anti-corruption, banking, the
digital economy, marketing ethics, environment and energy, competition
policy and intellectual property, among others.
The ICC works closely with the United Nations, the WTO and inter-governmental
forums including the G20.
Chapter summary
In this chapter, you have learned:
u about the liability of the owners for business debts and how this differs
between sole traders, the various forms of partnership and the various
types of limited company;
Further resources
There are many other examples of bilateral agreements, including the
following:
u The EU has a list of all ongoing bilateral trade agreements between itself
and other trading blocs or nations. See:
Europa (2013)The EUs bilateral trade and investment agreements
where are we? [online]. Available at: europa.eu/rapid/press-release_
MEMO-13-734_en.htm
[Accessed: 3 November 2013].
u The web page bilaterals.org gives details of many of the bilateral trade
agreements that currently exist. See:
Bilaterals. org (no date) www.bilaterals.org/spip.php?rubrique168
[Accessed: 3 November 2013].
References
ICC (2012) ICC commission on taxation [pdf]. Available at: www.iccwbo.org/Advocacy
Codes-and-Rules/Document-centre/2014/ICC-Commission-on-Taxation-Handbook/
[Accessed: 6 March 2014].
Ricardo, D. (1817) On the principles of political economy and taxation. London: John Murray
[online]. Available at:www.gutenberg.org/files/33310/33310-h/33310-h.htm
[Accessed: 6 March 2014].
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. Agency theory may apply in the case of public limited companies, but
it cannot apply to a sole trader or a small partnership. True or false?
Learning objectives
By the end of this chapter, you should have an understanding of how to:
2.1.1 Political
u To what extent are the countries influenced by multilateral or bilateral
agreements?
u Are there any historical relationships between the countries that would
benefit or hinder the relationship?
u What is the political regime of the country that the business will be trading
with?
u Does the domestic country have any sanctions in place with the country
where the business wishes to trade?
2.1.2 Economic
u Is the country affected by a high level of industrial growth?
u Do the two countries share the same currency or are their currencies
pegged, for example the Hong Kong dollar and the US dollar?
u How will levels of inflation between the two countries affect trade?
2.1.3 Social
u Are there any religious or cultural differences that need to be considered?
u Are there any cultural customs that may differ between the two countries?
How is etiquette different?
2.1.4 Technological
u How can a company protect copyright or intellectual property rights?
u Does the country have certain safety standards that must be adhered to?
2.1.5 Environmental
u Some countries demand that the goods they consume are produced in an
environmentally friendly manner. Is this an issue?
u What are the policies of the countries on climate change and global
warming?
2.1.6 Legal
u Will patents that protect technology in some countries be respected in
other countries?
u Will different laws between the countries affect the way the underlying
contract is interpreted?
u Will the employment laws of certain countries, which may restrict the
minimum wage or number of hours worked, affect the price of goods
manufactured?
For some commodities, for example oil, the custom and practice is that the
pricing is denominated in US dollars. Thus even if neither the buyer nor the
seller were US-based, the price would be denominated in US dollars and both
parties would face the exchange risk.
From the point of view of the seller, the extent of the buyer risk obviously
primarily depends on the creditworthiness and integrity of the buyer.
However, subject to that point, the method of payment also has an influence.
The methods are usually shown as:
u open account;
u documentary collection;
u documentary credit;
u payment in advance.
From the sellers point of view, open account is most risky, since the goods
are despatched directly to the buyer, and the seller simply invoices for
payment. Thus, the seller loses all control of the goods at the time that
it ships them, trusting the buyer to effect payment.
Payment in advance is least risky for the seller, but it is not easy to
persuade buyers to agree such terms. Sometimes, a down payment of an
From the buyers point of view, the risk is that payment may be made but
the goods or services prove to be faulty. Hence the buyers perception of
relative riskiness of payment methods is the exact opposite to that of the
seller. Thus, for the buyer, the relative riskiness (highest risk first) is:
1. payment in advance;
2. documentary credit;
3. documentary collection;
4. open account.
Terms of payment have to be mutually agreed between the buyer and seller,
and details must be incorporated into the sales contract.
for insuring which part of the journey for goods in transit. Incoterms are
internationally accepted terms that set out the responsibilities of the two
parties as regards responsibility for transport and insurance. These terms
are covered in full detail in Chapter 5.
u Are the goods of a type commonly traded between the two countries?
u Are any of the countries involved high risk, in other words subject to
sanctions?
u Is the invoice price consistent with pricing for the goods / services
involved?
u Are the goods dual purpose, ie could they be used either for military or
non-military purposes?
u What is known of the background of the two companies? Are they related
in any way? If they are, checks are needed to confirm that the price is one
that a business would pay another in a freely negotiated deal when there
was no relationship between them.
delegation that goes out would involve a mixture of businesses and some
representation from the organisers. Sometimes companies that provide
services in international trade, such as banks, freight forwarders or lawyers
specialising in international law, will attend. In some cases, grants are
available for companies wishing to attend trade missions. Trade missions
are co-ordinated to coincide with trade exhibitions or trade shows.
2.3.4 Banks
Most banks have trade finance operations and some have managers who
are specifically targeted at helping their customers with international trade
ventures. Although their main aim will be to assist in advising how to finance
an international trade transaction, some banks will provide a wide range of
assistance.
u Through the same network, the bank can obtain credit information and
reports on both potential customers and suppliers.
u The bank can advise the buyer or seller on all aspects of making and
receiving payments overseas, the risks involved and the mechanisms it
can offer to minimise risk.
u Some banks will also provide advice about the types of trade documents
that are required, transport documents, types of invoice and insurance
documents. It must be stressed that the majority of banks would not give
this information directly; however, their international staff are usually
happy to refer their customers to professionals in these areas.
u Banks may advise their customers about currency risks and how they may
be covered.
u Banks may provide details on the various trade finance products that may
be available, and advice and literature on how these work.
Search the websites of your local banks to see what help they can give
to sellers.
A status enquiry or credit reference is a report that is collated from all of the
information and history available on a company and made available to the
enquirer, often for a fee. It is an historic look at how a company has traded.
Although these reports cannot say how the company will trade in the future,
they are a good indicator of how it has traded so far. Status enquiries and
credit references are easily available from a number of sources.
in the report will vary between the countries where they are issued. It
may contain just a few lines that comment on the credit worthiness of
its customer or it may be in more depth, commenting on the length
of time the business has been in operation, the names of directors
or principals, its business reputation or standing, and any known
detrimental information such as litigation for debt, etc.
u Credit rating agencies Fitch, Moodys and Standard & Poors are
some of the big names in this market. They provide ratings on the credit
standing of any large business that has raised capital on international
markets.
2.3.7 Networking
Other people who have recent experience in international trade are often an
excellent source of advice and information. Local chambers of commerce
or trade associations will often arrange functions such as seminars, where
businesses can network and share experiences. Speakers may include a
company that will talk about its experience of how it penetrated a market
and about the pitfalls and its successes.
The advantages for a company that decides to go via the direct exporting
route is that it has more control over the whole export process, potentially
higher profits, and can build a closer relationship with its overseas
customers, which can help with future marketing efforts. The downside to
direct exporting is that the company would need to invest more time, which
depending on the scale of the company and export sales may mean
employing more staff with specialist experience.
2.4.1.5 Co-marketing
Co-marketing is an arrangement in which one manufacturer agrees to
distribute a second overseas firms product or service. A typical example
would be when a company has a contract with an overseas buyer to provide a
wide range of products or services. The supplying company may not have the
capability to fulfil the whole of the contract, so it will turn to other domestic
companies to provide the remaining products. This second company is
then able to export its products to the international market. This has the
advantage to the second company that it is often able to export its product,
sharing the marketing and distribution costs associated with exporting.
Table 2.1 highlights the main differences between agents and distributors.
u Entry risks to the overseas market are greatly reduced by using the local
partner.
u The local partner will have greater understanding of the legal framework
and business culture of that country.
u They are complex to set up, and a great deal of time and money may be
needed to invest in finding the right partner.
Once formed, JVs will define the responsibilities and goals for each
organisation. Taxes will be paid in the country where the JV is set up to trade
from, and any profits must be expatriated back to the exporting companys
country.
Banks may be able to help with JVs. Some banks can provide advice on:
u whether there are any overseas exchange controls that could affect
remittance of dividends or capital back to the home country;
The advantage to the licensor is that they are able to establish a presence in
the overseas market, with the licensee committed to developing the market.
The main disadvantage to the licensor is that they lose control over the
manufacture of their product and, as such, run the risk that an inferior
product in their name / brand will be sold in the overseas market.
The exporting company would become the franchisor, and the overseas
company the franchisee, which would pay a licence fee or royalty for the
privilege of using the franchisors name and business model. International
franchising has been very successful for many of the fast food outlets, such
as McDonalds, Subway and Starbucks, to name but a few. It is often said
that the franchisee has a greater incentive than a direct employee in the
company, as they have invested a direct stake in the business.
u there are lower start-up costs compared with JVs or traditional selling
techniques;
Chapter summary
In this chapter, you have learned:
u that there are many external factors that influence the international
business environment, including political, economic, social, technological,
environmental and legal factors;
u that there are many risks associated with trading overseas: cultural, legal,
currency, non-payment, cash flow, economic, political and the physical
risk of loss of a cargo;
u that research is vital to a successful venture, but there are many sources
of help government bodies, the bank, chambers of commerce and the
media;
Further resources
Government and quasi-government departments providing assistance with
international trade (all websites accessed 6 March 2014):
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
2. Why is the working capital cycle longer for goods sold in international
trade, as opposed to goods sold on the domestic market?
Learning objectives
u contract management;
Once the negotiation process is completed between the parties, the next
stage is to draw up a contract. The first and most important question
that arises in any international trade transaction is what law will govern
the contract. The contract should always specify the applicable law, as
each legal jurisdiction from around the world will have different laws
and interpretations, each of which will have their own advantages and
disadvantages. For example, under English law, for a valid contract to exist
In general terms, for a valid contract to come into effect, the following
conditions must have been met:
The requirement for formal validity of a contract will differ in each different
jurisdiction around the world. Local legal advice should always be taken, as
sometimes local laws will apply, irrespective of the governing law chosen in
the contract.
When the parties involved are frequent and experienced traders, they will
usually each have a standard set of contract terms that they would like to
impose on any orders.
Once a seller has produced the contract, it will constitute their offer to the
buyer, who may respond in one of the following ways.
who may then accept the amendments proposed or go back with a further
offer for the buyer to consider.
Offers and counter-offers may flow backwards and forwards between the
parties until, eventually, mutual agreement is reached or final rejection and
abandonment of the negotiation process, perhaps to resume at a later date.
Once final agreement is reached and signed by, or validly on behalf of, both
parties, the contract will be binding on both seller and buyer, and any further
amendments will require consent of both parties, preferably evidenced in
writing.
u price;
u packing requirements;
u insurance requirements;
u method and timing of payment, and at what point risk to, and ownership
of, the goods shipped passes from the seller to the buyer.
u The seller determines whether they are able to fulfil the order and whether
any modifications are required, etc.
u Due diligence may be carried out by the seller at this point, to establish
the creditworthiness of the buyer.
u The order is processed by the seller and arrangements are made for
shipment of the goods.
For some countries, the seller has to provide the buyer with a pro forma
invoice, giving all the details of the proposed shipment. This may be required
by the buyer to comply with local import controls, or for an application to
the central bank for a release of foreign exchange, or to obtain approval for
the issue of a documentary credit.
export department will have to become familiar with, and prepare, export
documentation.
The credit control manager must understand how to manage the risks and
consider the most appropriate method of settlement. That could be payment
by open account, documentary credit, payment in advance or by bill for
collection, depending on the new customers credit standing and status
report.
To fulfil the contract, team effort is required and everyone involved must
handle their part of the transaction with care, to ensure that the export of
goods is made in accordance with the relevant contract.
Changes in costs between the dates of order and final completion are not
unusual and such risks must be allowed for, whether in raw materials, labour
costs, insurance and freight costs, or the ever-present factor of fluctuating
exchange rates. The seller will need to monitor all of these issues if the
contract is to be profitable and viable.
of legal rules governing the formation of contracts for the international sale
of goods. The CISG was developed by the United Nations Commission on
International Trade Law (UNCITRAL) and although it was signed in Vienna in
1980 it did not come into force until 1 January 1998, when it was ratified by
11 countries. It is sometimes referred to as the Vienna Convention.
Countries that have ratified the treaty are referred to within the treaty
as contracting states. The CISG is deemed to be incorporated into the
domestic law of any trade between these contracting states, unless excluded
by the express terms of the individual contract.
The major absentees from this list include India, South Africa and the UK,
which for domestic legal and governmental reasons have all decided not to
ratify the CISG.
When dealing with counterparties in countries that have not ratified the
treaty, traders need to be aware that local laws and customs will normally
apply unless otherwise specified in the contract, and they should not rely on
the terms of the treaty to cover their transactions.
The CISG is written in a style that uses plain language and is translated into
six languages. Each text is translated so that it can be easily interpreted by
the contracting states and avoids local domestic legal terminologies.
Any offer to contract must be addressed to a person, must give full details
of the goods including price and quantity, and must indicate an intention
for the person making the offer to be bound on acceptance.
Generally, once the offer has been made, it may only be subsequently
revoked if the withdrawal reaches the offeree (ie the party to whom
the offer has been made) before or at the same time as the offer has
been received or before the offeree has accepted the offer. There are
some offers that cannot be revoked, for example when the offeree has
reasonably relied upon the offer as being irrevocable.
Articles 2588 outline the sale of goods obligations of the seller and of
the buyer, the passing of risk and the obligations common to both buyer
and seller.
Under the CISG, the duty of the seller is to deliver the goods, hand over
any documents relating to them and transfer the property of the goods,
as detailed in the contract. The duty of the buyer is to take all steps which
could reasonably be expected to take delivery of the goods, and to pay
for them. In addition, the buyer is to examine the goods and advise the
seller within a reasonable time of any lack of conformity.
Although the CISG outlines when the risk passes from the seller to the
buyer, in practice it is the underlying Incoterm (such as FOB, CIF) that will
be followed (see Chapter 5 for further discussion of Incoterms).
The final provisions outline how and when the CISG comes into force,
permitted reservations and declarations, and the application of the CISG
to international sales where both trading countries have the same or
similar law.
A body of case law has been developed over the years and is available
via internet sources, for example:
UNCITRAL (2014) Case Law on UNCITRAL texts (CLOUT) [online].
Available at: www.uncitral.org/uncitral/en/case_law.html
[Accessed: 6 March 2014].
Visit the above website and examine a small sample of recent case law
entries, to familiarise yourself with the types of cases concerned.
There are also criticisms that the CISG is incomplete. For example, the CISG
does not consider electronic contracts, nor the sale of services, and it does
not govern the validity of the contract.
When this happens, there are three basic means of resolving a dispute:
Arbitration can come about either because the parties to a contract have
written an arbitration clause into the contract or because, when a dispute
has arisen, they agree to resolve the issues by arbitration.
The Court and other institutions have established rules of arbitration and
model contract terms. The London Court of International Arbitration (2014)
recommends that the following arbitration clause be inserted into contracts:
Typically, the party raising the dispute will refer the matter, with reasons, to
the arbitration court agreed upon and the other party must respond: within
30 days for submissions to the Court.
The arbitrators will then study these submissions and related documents and
hear the arguments put by the parties. The arbitrators will hear witnesses,
including experts, called by the parties and may appoint their own experts
to examine the issues.
The decision made by the arbiters, including deciding who should pay the
costs of arbitration, is binding upon the parties. However, there will be an
appeal process, for example if one party feels that the arbitrator(s) has been
biased.
Chapter summary
In this chapter, you have learned about:
u the key factors that must be evident in a contract (and that these will
differ depending on which legal system is selected);
u contract management;
References
The London Court of International Arbitration (2014) Recommended clauses [online].
Available at: www.lcia.org/Dispute_Resolution_Services/LCIA_Mediation_Clauses.aspx
[Accessed: 6 March 2014].
UNCITRAL (1985) Model law on international commercial arbitration (2006 rev. edn.) [pdf].
Available at: www.uncitral.org/pdf/english/texts/arbitration/ml-arb/07-86998_Ebook.pdf
[Accessed: 6 March 2014].
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
b. The CISG.
c. The ICCCA.
3. France and Germany are two major countries that have not yet ratified
the United Nations CISG. True or false?
6. Name three arbitration courts other than that administered by the ICC.
Learning objectives
u the basic considerations that sellers and buyers need to bear in mind
before entering into a binding export / import transaction;
u the principles that apply to the relationship between a bank and its
customers;
u Check reputation with an overseas trade body, if such a body exists for
the type of transaction under consideration.
u See whether the sellers own bank can obtain a status report via the
banking system.
4.3 Sanctions
Any breach of sanctions, even if inadvertent, could result in a prison
sentence, a heavy fine and major damage to reputation. Check the route
of the carrying vessel, as shipping via countries that are subject to sanctions
will invariably result in a breach of those sanctions, even if the goods
concerned never leave the ship until they reach the ultimate destination.
Sanctions are covered in more detail in Chapter 14.
The buyer and seller should have reached an agreement about where the
balance of risk will lie between them, and the service that will be required of
one or more banks. When a bank is asked to provide a service appropriate
to the contractual agreement between the buyer and seller, such bank must
also decide whether or not that service poses a risk to it and whether or not
it wishes to accept that risk.
Table 4.1 provides a summary of the payment options that the buyer and
seller have and the relative risk to each party of the options listed.
Table 4.1. The balance of risk between the seller and buyer
Table 4.1. (cont.) The balance of risk between the seller and buyer
u details of how the goods are to be despatched and who is responsible for
the various stages of the journey.
It is vital that the commercial contract stipulates which Incoterm will apply.
Full details of Incoterms 2010, which are produced by the International
Chamber of Commerce (ICC) and are applicable worldwide, are provided in
Chapter 5, together with details of the various documents required.
Sellers must take care to ensure that the goods shipped and any relevant
documents are in accordance with the pro forma invoice, or the buyer may
be able to refuse to accept / pay for the goods or may try to negotiate a
lower price.
Once the commercial contract and Incoterm have been agreed, each party
can make appropriate arrangements for transportation (as described in
section 4.5.1). In practice, trade bodies or chambers of commerce will be
able to advise on documentation. These bodies or a freight forwarder will
normally be able to help with documentation for duty (for example, value
added tax or VAT), customs declarations, import licences and any other
export formalities that may apply to the specific country or transaction.
A freight forwarder will book space on the appropriate transport mode which
could be, for example, by aircraft, ship, rail or road. The freight forwarder
will arrange for the goods to be collected from the sellers premises and
delivered to the carrier at the appropriate time and can liaise with its overseas
offices to co-ordinate delivery to the buyer.
u warehousing;
u name and address and other contact details of the seller and buyer;
u details of the collection and delivery address if they are different from
that of the seller and buyer;
These rules can be complex and inexperienced sellers and buyers should
leave the formalities to a suitably qualified freight forwarder or take advice
from a chamber of commerce. Typical issues covered by the regulations are:
For example, if the Incoterm EXW applies, the sellers responsibility ends
once the buyer has collected the goods from the designated place. By
implication, the buyer should insure the goods and cover should take effect
immediately the goods have been collected. However, the Incoterm EXW
does not stipulate that the buyer must insure, it merely states that all
responsibility rests with the buyer once the goods have been collected. In
such cases, the contract of sale should stipulate that the buyer must insure.
If the seller fears that the buyer may not insure the goods for the part of the
journey that is his responsibility, then the seller could arrange, and pay for,
sellers interest insurance. Sellers interest insurance would compensate the
seller if the goods were damaged in transit and as a result the buyer could
not pay for them. Naturally, the existence of any sellers interest insurance
should not be advised to the buyer.
u keep its customers affairs confidential, subject only to certain laws that
require information to be disclosed;
u provide its bank with any reasonable information that it may seek into its
activities and those of its customers;
u co-operate with the bank to protect against fraud and prevent criminal
activity in accordance with money-laundering regulations.
cover the services that make it possible for buyers and sellers to reach the
right balance of risks between transfers of ownership of the goods shipped
against being paid.
The services provided by banks can be categorised under the following broad
general headings:
u handling documents;
u providing finance.
4.9.1 Payments
There is strong pressure on financial organisations to deliver ever speedier
and more efficient means of payment for international trade between
countries. The disappearance of exchange control regulations restricting
transfers of funds in and out of countries has removed official barriers and
delays to international money transmission in most countries, although it is
important that full and accurate records of all transactions are maintained
for statistical purposes, and also to aid detection of money laundering and
other economic crimes.
Most banks now offer a full range of choices for international financial
transactions, with prices reflecting the speed with which the transaction
is completed. The rule is generally that the quicker the beneficiary (seller)
receives cleared funds in its account, the higher the charge for the
transaction. In todays IT-enabled environment, funds can be transferred
instantaneously around the world by interlinked computers at very little cost
to banks.
the messages were encoded and carried test keys, for which banks at either
end held books of code tables, enabling authentication to be achieved.
Transfers made under such systems were once called mail transfers
(MTs) or cable / telegraphic transfers (TTs) and, for a long time, both
systems ran side by side, with both being used depending on the urgency
of the transfers in question. Nowadays, funds transfer instructions are
sent between banks almost instantaneously through the interlinking of
computers, using systems such as SWIFT , and such transfers tend to be
called international payments, priority payments, express payments, or
ordinary or urgent payments, depending on the bank and type of payment
required. Authentication is by encryption built into the system.
Example
From the point of view of a German bank, a nostro account is its account
in the books of an overseas correspondent bank, denominated in foreign
currency. An example would be an account in the name of Deutsche
Bank, Frankfurt, in the books of Citibank, New York, denominated in US
dollars. Deutsche Bank is a customer of Citibank.
When funds are remitted from Germany, nostro accounts are used if the
payment is denominated in foreign currency and vostro accounts are
used if payment is denominated in euro.
Banks treat their nostro accounts in the same way as any other customer
would treat their bank account. The bank will maintain its own record of
the nostro account, known as a mirror account, and will reconcile the bank
statements against these mirror accounts.
Example 1
In this example the funds being transferred are denominated in euros.
u The French customer is debited with the euro amount, plus charges,
and this amount is credited to the euro account of the overseas bank
(this is a vostro account from the French banks point of view);
u On receipt of the advice, the overseas bank withdraws the euro from
the vostro account, converts it to local currency, and then credits the
beneficiary with the currency equivalent, less its charges.
Example 2
In this example the transfer is denominated in foreign currency.
u The overseas bank is advised that it can debit the nostro account with
the requisite amount of currency and credit the funds to the account
of the beneficiary.
The various methods of settlement all involve the same bookkeeping. The
only difference is the method by which the overseas bank is advised about
the transfer.
Example of a BIC
A typical BIC identifies the bank and branch. It would appear as follows:
MIDLGB22123.
The BIC consists of a bank code (MIDL), a country code (GB), followed by
a branch identifier number (22123).
Example of an IBAN
A typical IBAN can be up to 34 characters long and would appear as
follows: GB15MIDL40051512345678.
The IBAN consists of the country code (GB), a check number (15), the
bank code (MIDL), followed by a sort code (400515) and an account
number (12345678).
BICs are being phased out and will no longer be necessary after
1 February 2016; all of the information required to complete a payment
will be incorporated in the IBAN.
A buyer can pay by issuing their own cheque, subject to local exchange
control regulations. The sellers bank may either agree to negotiate the
cheque credit the sellers account immediately or send the cheque to
its correspondent to obtain payment, ie via a documentary collection.
Negotiation will involve a charge to the seller to cover the interest cost to the
bank for the period between paying it and receiving payment. This charge
can be built into the exchange rate if the cheque is in a foreign currency.
Negotiation will be with recourse, ie if the cheque is unpaid, the bank
will debit the sellers account to recover the amount originally negotiated.
Negotiation facilities are therefore at the banks discretion.
A collection means that the seller will only get funds when its bank receives
payment from the buyers bank.
There is an inevitable delay between the time when the cheque is collected
and the time when funds are actually remitted by the buyers bank. One
method of speeding up the process of clearing cheques is to use a lockbox
facility, which is particularly useful for sellers who sell to the USA and who
are paid by the buyers cheque. The buyer is instructed to post the cheque to
a post office (PO) box address in the USA. A local bank opens the lockbox
at least once a day and initiates the clearing of the cheques. This process
dramatically reduces the clearing time, because the cheque itself does not
have to go from the USA to the originating country and back again. Banks
may be able to organise lockbox facilities by making arrangements with
correspondent banks abroad.
Lockbox facilities are also widely available within the EU. Arrangements can
be made for the proceeds of the cheques collected via the lockbox system
to be held in a collection account with the overseas bank. The funds can
then be drawn down as and when required to meet the local currency needs
of the seller. From the sellers point of view, there is no guarantee that the
cheque will be paid.
u elimination of settlement risk the risk that one bank owing money to
another does not pay;
u cost-efficiency;
At the height of the global financial crisis, some financial markets (for
example the short-term inter-bank deposit and borrowing markets) froze.
However, the foreign exchange markets continued to function. Many
commentators believe that it was the guarantee afforded by the CLS process
that ensured confidence, and hence liquidity continued to be available.
The use of CLS has reduced the number of bank nostro / vostro account
relationships.
Example
For example, UK Bank plc may regularly send customer-initiated
transfers of funds to several beneficiaries who bank at several different
USA banks. Prior to CLS, the UK Bank plc would have needed nostro /
vostro relationships with each USA bank, the alternative being to face
delays in the internal transfer of the funds within the USA. Now, UK
Bank plc needs only one nostro account. UK Bank plc will use this nostro
account to meet its obligations to CLS as regards the transfers of funds
to US beneficiaries. It is CLS that will transfer the funds to the USA banks,
provided that UK Bank plc has sufficient balances in US dollars with CLS
to meet these obligations.
Chapter summary
In this chapter, you have learned that:
u there are basic checks and precautions, which must be taken to ensure
that a potential overseas business partner is reputable and creditworthy
and that the underlying transaction is legal;
u advice may be available from the ICC, trade bodies, banks and
government departments;
u there is a balance between the risk to the seller and the buyer, with that
risk shifting from one to the other according to the payment method
agreed;
u correspondent banks operate accounts for each other nostro and vostro
accounts and make payments from these accounts in accordance with
secure message sent on the SWIFT system;
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. All Incoterms set out the point of delivery: the point when risk and
liability pass from seller to buyer. True or false?
a. Open account.
b. Documentary collection.
c. Documentary credit.
d. Payment in advance.
a. Open account.
b. Documentary collection.
c. Documentary credit.
d. Payment in advance.
Learning objectives
Some goods do remain controlled and may not be exchanged, even between
EU members, without formality:
u military equipment;
Three of the four European Free Trade Area (EFTA) countries (Norway,
Iceland and Liechtenstein) have joined with the EU to form the European
Economic Area (EEA), whereby they have free trade agreements but customs
formalities remain in force. The other EFTA country, Switzerland, has a
separate agreement with the EU.
A few countries are on a list where trade is restricted by the USA: for
details, see the US Department of the Treasury Resource Center website
(www.treasury.gov/resource-center/sanctions/Programs/Pages/
Programs.aspx [Accessed: 21 February 2014]). The US authorities will seek
to impose their laws even on other countries exporting to these restricted
countries, if those exports contain any US components.
Find out which trade agreements, if any, your own country is a member
of, and which other countries are also members.
Note that your country may be a member of more than one group.
The UK Bills of Exchange Act 1882, applicable to the whole of the UK and
widely referred to by many legal jurisdictions, defines a bill as follows:
Figure 5.1 provides an example of a term draft (see below for an explanation
of term draft). The numbers in the figure refer to the explanations above.
Drafts have a special legal status. They are negotiable instruments unless
specifically stated not to be. Negotiable means much more than merely
transferable from one person to another.
A draft stands alone from any contract that might have caused it to be
written. Therefore, a holder of a draft who takes it in good faith and for
value takes it free from any defect in the title to it of the person from whom
the holder took it. The commercial effect of this is, for example, that a bank
that holds a draft and expects to collect money from the acceptor when
due, can sue the acceptor, or anyone else whose signature is on the bill of
exchange, for non-payment irrespective of any contractual disputes there
may be relating to the underlying goods or services.
A term draft or usance draft gives the drawee time for payment. A bank
handling a draft on behalf of the seller will first obtain the drawers
acceptance and may then:
u hold it until maturity, present it for payment and then remit the funds to
the seller;
u discount it, by paying the seller immediately the face value less a
discount to represent interest for the period between the date of payment
and the maturity date see section 9.6.2.
Note that in some countries, the rules may differ from area to area within
a country, sometimes depending on local practice or different laws in
different states.
The UK Bills of Exchange Act 1882 has many sections dealing with the
responsibilities of each party to negotiable instruments. The general rule
is that anyone who signs as drawer, acceptor or endorser is legally liable
to pay on it. But the drawer or endorser may refuse liability (except for the
validity of the document), if they add the words without recourse or sans
recours next to their signature.
u transport documents;
u insurance documents.
Bills of lading are issued and released to the seller once the goods are
loaded on board the vessel and are marked as shipped on board, with
an indication of the date the goods were shipped on board. Bills of lading
are usually issued in a set of three originals, with the number issued being
specified on the bill of lading. Once the goods are released to the bank, to
the buyer or to another entity against surrender of one original, then the
others in the set become void.
Sellers will either courier the bills of lading to the buyer or their agent (for
an open account transaction) or present them through the banking system
for collection (see Chapter 7) or for payment by documentary credit (see
Chapter 8). In the event that a buyer does not receive the bills of lading
before the ship arrives, it may face storage costs, known as demurrage
charges, which the buyer may seek to recover from whoever caused the
delay. See Missing bills of lading (section 5.3.1.2) below.
Bills of lading with this quasi-negotiable status are also issued in the
following forms:
u Liner bills of lading These are used for regular shipping services
between two ports where the carrying vessel has a designated berth.
u Charter party bills of lading These are issued to the exporter by the
owner of a ship, the master, the charterer or their respective agent. The
terms of a charter party bill of lading are subject to the contract of hire
between the ships owner and the charterer. Such bills are usually marked
subject to charter party, and are usually issued for bulk cargoes such
as oil, wheat and sugar. Because of the legal complexity involved, while
charter party bills of lading are often to the order of a named party, they
are not always considered to be documents of title, so care needs to be
exercised.
The bill of lading will give a general description of the cargo with the
statement xx boxes / crates etc shipped on board in apparently good
condition. Importers and their banks will expect to receive a clean bill
of lading with this or a very similar clause.
However, the shipping company may add adverse comments, such as Case
number 40 split and broken, which will have consequences when the
exporter seeks payment. Such a bill of lading is not a clean bill of lading.
They are documents issued by carriers or their agents that describe the
goods and contain a contract of carriage, but do not evidence title to the
goods and are not negotiable.
u will have its own set of internationally agreed rules on the transport of
hazardous cargoes;
In todays faster transport systems, goods can arrive before the transport
documents.
u include a unique number and quote the contract, purchase order or pro
forma invoice number;
u mention the seller, buyer and consignee (if different to the buyer);
u include all charges and costs for the buyers account and specify the
Incoterm (see section 5.4 below) that was agreed for shipment;
Where the seller is to be paid under a documentary credit (see Chapter 8),
the invoice is to be issued by the beneficiary of the credit, to be denominated
in the same currency as specified by the documentary credit and to contain
a description of the goods that corresponds to that in the letter of credit.
Where trade between countries attracts taxes or tariffs, then customs and
tax authorities in countries concerned often insist on the provision of special
invoices, known as customs invoices or tax invoices, containing sufficient
information for the authorities to calculate the tariffs or taxes applicable to
each transaction.
The decision as to who pays for insurance cover for all of (or each stage
of) a journey is a commercial decision, is subject to negotiation between
the parties and will form an important part of the contract. As outlined
later in this chapter, the Incoterm selected clarifies which party or parties
are responsible for arranging and paying for insurance. Banks that advance
The level and nature of insurance cover provided has been codified and will
be applicable to most cargoes. The two main codes are contained in the
clauses of the Institute of London Underwriters and the American Institute
Clauses.
Based on the London code, the General Cargo Clauses of the Institute of
London Underwriters are available at three levels of cover:
B. This level includes all of the risks in (1) and (2) above.
u poor packing;
u an unseaworthy vessel.
u the amount of insurance (frequently for at least 110 per cent of the value
of the goods);
If the certificate is issued under a sellers policy, where the seller is shown
as the assured or insured, the seller will endorse the certificate in blank, so
that it may be passed on to any holder, or to the buyers order. Under a
documentary credit, such endorsement will be completed according to the
terms of that credit.
Generally speaking, where an Incoterm sets out the obligations of the seller,
by a process of elimination, any obligation that does not appear must be the
responsibility of the buyer.
Incoterms EXW, FCA, CPT, CIP, DAT, DAP and DDP are applicable to all
modes of transport, including more than one means of transport used in
the journey. Incoterms FAS, FOB, CFR and CIF cover transport by sea or
inland waterway.
If responsibility for insuring the goods is not clearly specified in the Incoterm
used (such as CIF and CIP), then it should be made clear in the contract of
sale exactly who is responsible for insuring all parts of the journey.
To illustrate how the rules work, we will examine various documents relating
to a sale by Speirs and Wadley Ltd of Adderley Road, Hackney, London, to
Woldal Ltd of New Road, Kowloon, Hong Kong. Table 5.1 below explains the
implications, where appropriate, to both parties for the different Incoterms
that could be applied to such a sale. The various Incoterms are set out in
a logical order, starting with that which imposes least obligation on Speirs
and Wadley and ending with that which imposes the most.
With a non-negotiable bill of lading, the goods will be released to the named
consignee and the bank will have no security over the goods unless the bank
or its agent is named as consignee.
5.6 Storage
Where a bank is requested or required to store goods, either as security
or as agents for a correspondent, the bank will wish to ensure that the
storage is with a reputable warehouse or yard, and that the goods are
appropriately insured and protected against the weather, insect attack or
other risk relevant to the cargo.
Chapter summary
In this chapter, you have learned about:
u the assistance that banks can provide when bills of lading go missing,
and how banks protect themselves against the risk of doing so;
u the insurance of transport risks and the standard risk levels provided by
insurers;
References
Bills of Exchange Act 1882, London: HMSO [online]. Available at: www.legislation.gov.uk/
ukpga/Vict/45-46/61 [Accessed: 6 March 2014].
ICC (2000) Incoterms 2000. ICC Publication No. 560E.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. What legal statute covers the use of bills of exchange in the UK and is
recognised on a global basis?
4. There are two levels of cover available in General Cargo Clauses. True
or false?
6. On what date did the last revision of Incoterms come into effect?
Learning objectives
Once the negotiation process is completed between the parties, the next
stage is to draw up a contract. The first and most important question
that arises in any international trade transaction is what law will govern
the contract. The contract should always specify the applicable law, as
each legal jurisdiction from around the world will have different laws
and interpretations, each of which will have their own advantages and
disadvantages. For example, under English law, for a valid contract to exist
there must be consideration, whereas French law recognises as a contract
any agreement between parties who have negotiated in good faith.
1. open account;
2. documentary collection;
4. documentary credit;
5. payment in advance.
The selection of which payment term is used will largely depend on a number
of issues, including:
u the availability of facilities and working capital to the buyers and sellers;
Please see section 6.5 below, and Chapter 15 later, to learn how payments
under open account trade can be improved by use of bank payment
obligations (BPOs).
With the agreement of the seller, the buyer asks its bank to set up an open
account payment instrument covering the proposed purchase, incorporating
a BPO.
In simple terms, the buyers bank uploads data provided by the buyer to the
SWIFT TSU (TMA platforms are expected to be available from other suppliers
too), which passes that information to the sellers bank for relaying to the
seller for checking and agreement. Agreement will create an established
baseline that incorporates a BPO, and the buyers bank (as obligor bank)
or another named obligor bank will undertake that it will pay the sellers
bank, as long as the seller ships the merchandise in accordance with the
commercial terms agreed between the buyer and seller.
In the light of this undertaking, the sellers bank may be more inclined to
offer its client pre-shipment finance, if required.
Once the goods have been shipped, the sellers bank uploads the shipping
and logistics data, provided by the seller, to the TSU to be matched against
the established baseline. If the data match, the obligor bank is required to
settle the invoice according to the terms stated in the BPO segment of the
established baseline.
BPOs are covered by the ICCs Uniform Rules for Bank Payment Obligations
(Publication No. 750E) (2013) and are discussed in more detail in Chapter 15.
Once the seller receives the documentary credit, it can ship the goods, collate
all of the documents required by the credit and present them through the
banking system.
As it is the buyer that requests its bank to issue a credit, the amount of
the credit will be treated by its bank as a contingent liability in its credit
facility. The buyers bank must be satisfied that the buyer can reimburse it,
if the bank is required to pay out under the undertaking. Finance can be
provided against the credit for both the buyer and seller, and the credit can
be available in other forms for example to allow for an advance payment,
or to be transferable.
From the sellers point of view, receiving payment in advance of the shipment
is an ideal situation, as it appears to eliminate all risks associated with
non-payment. However, to be certain of payment, attention must be given
to how the money is paid to the seller. For example, if payment is made by
a cheque issued by an overseas institution, then time must be taken for the
From the buyers point of view, payment in advance carries the greatest
risk, as it is wholly dependent on the seller shipping the correct goods in
accordance with the contract. In addition, payment in advance can create
cash-flow problems for the buyer, as it has to wait to receive the goods.
Check your local bank transfer rules, so that you are aware of the
requirements for making or receiving advance payments, and the
transaction amounts that banks in your country are obliged to report
under local anti-money-laundering regulations.
Chapter summary
This chapter has given a brief overview of
open account;
documentary collection;
documentary credits
payment in advance;
u the risks that each method presents for the buyer and for the seller.
References
ICC (1995) Uniform rules for collections ICC Publication No. 522.
ICC (2007)Uniform customs and practice for documentary credits ICC Publication No.
600LE.
ICC (2013)Uniform rules for bank payment obligations ICC Publication No. 750E.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. Documentary collection poses the highest risk for the buyer. True or
false?
Learning objectives
By the end of this chapter, you should have an understanding of:
u what is meant by a documentary collection;
u the nature of the instructions given by one bank to another;
u the responsibilities of the parties to a collection;
u the processing and monitoring of collections;
u how documents are delivered to a buyer and how payment or
acceptance is obtained from them;
u what happens when payment is not forthcoming.
This chapter will also introduce the issue of finance, which is covered in
more detail in Chapter 9.
related documents (which may include negotiable bills of lading) to its bank
for collection of the sale proceeds, and the delivery of the documents to
the buyer, according to the terms of the sales contract. The sellers bank
will ask a correspondent bank in the buyers country to deliver to the buyer
the documents of title to the goods against payment of the amount due
(documents released against payment D/P) or against acceptance of a
term bill of exchange (documents released against acceptance D/A).
7.1.1 Definitions
URC 522 (ICC, 1995) sub-article 2 (a) defines a collection as being:
u The principal, who is normally the seller the principal entrusts the
handling of a collection to a remitting bank.
u The remitting bank, ie the bank that acts for the seller it is usually
based in the sellers own country and is invariably the sellers own bank.
u The presenting bank this is a bank used by the collecting bank where it
has been identified by the collecting bank that the presenting bank is the
banker of the drawee and is better placed to approach the drawee with a
request for payment or acceptance. It is not common to have a collecting
bank and a presenting bank.
Article 2
Article 2 defines the different types of collection instructions, and
differentiates between the various terms.
u Financial documents are those that are used to obtain payment of money,
such as a bill of exchange or promissory note.
Article 3
Article 3 identifies the main parties to a collection as the principal, the
remitting bank, the collecting bank, the presenting bank and the drawee.
Definitions of these are given above.
Article 4
Article 4 covers the form and structure of a collection. It also states that
banks will not examine documents in order to ascertain instructions and are
only obliged to act on the instructions received from the party that presented
the collection to them unless the collection instruction states otherwise.
Articles 58
Articles 5, 6, 7 and 8 give details on the procedures relating to the form
of presentation, making presentation for payment or acceptance, release of
commercial documents and creation of documents.
Article 9
Article 9 states that banks will act in good faith and will exercise reasonable
care when handling a collection instruction.
Article 10
Article 10 states that goods should not be despatched directly to a bank
nor a transport document evidence that goods are consigned to or consigned
to order of a bank without the banks prior agreement. Where no prior
agreement has been given, there is no obligation on the part of the bank
to take delivery of the goods. A collecting or presenting bank is under
no obligation to take action to store and insure goods, even if there are
instructions to that effect in the collection instruction.
Article 11
Article 11 provides a disclaimer for a remitting or collecting bank when it
utilises another bank to fulfil the instructions of a principal, and such acts
are not carried out by that other bank.
Article 12
Article 12 states that although the banks are not obliged to examine
the documents presented in detail, a bank must check that they have
received all of the documents listed on the collection instruction and in the
number stated. In the event that some documents are missing or additional
documents are received that are not listed, then they must advise the party
who sent the collection by telecommunication or other expeditious means,
without delay.
Articles 13 and 14
Articles 13 and 14 provide a disclaimer on the effectiveness of data
appearing within the presented documents, eg sufficiency, accuracy,
genuineness, falsification, etc, and against any delays or loss of
documentation in transit.
Article 15
Article 15 covers force majeure, which comes from the French definition
meaning superior force. It indemnifies banks against any responsibility or
consequences arising from interruption of their day-to-day business due to
an act of God, riots, civil commotions, insurrections, war or any event that
is beyond their control.
Articles 1619
Articles 1619 give definitions and explanations concerning payments
procedures. Article 19, in particular, covers partial payment and
differentiates between clean collections (where such payments may be
accepted, provided that such an action is authorised by the law in force
in the place where the payment is made) and documentary collections
(where partial payments are only permissible when the collection instruction
expressly permits them).
Articles 20 and 21
Articles 20 and 21 relate to interest, charges and expenses and, in particular,
the action that should be taken by a bank where these have been refused by
the drawee.
Article 22
Article 22 states that the bank that releases documents against acceptance
is responsible for seeing that the form of acceptance appears to be complete
and correct, but there is no responsibility to ascertain the genuineness or
authority of any signatory to the acceptance.
Article 23
Article 23 states that a presenting bank is not responsible for the
genuineness or authority of any signatory appearing on a promissory note,
receipt or other instrument.
Article 24
Article 24 states that a bank is not obliged to protest in the event of
non-payment or non-acceptance unless it is expressly required in the
collection instruction.
Article 25
Article 25 relates to the use of a case of need. A case of need will usually
be an agent of the exporter resident in the country where the goods have
been shipped. Where indicated, the collection instruction should specify the
scope of the powers that have been granted.
Article 26
Article 26 states that it is the collecting bank or presenting banks
responsibility and duty to advise the fate of the collection to the bank from
whom the collection was received whether paid, accepted or any advice of
non-payment or non-acceptance.
A seller would first agree with a buyer to utilise the banking system
to arrange the transfer of documents and payment or acceptance. The
seller then ships the goods and obtains the documents relating to the
shipment, such as the commercial invoice, transport document, certificate
of origin, etc. The seller will complete and sign a collection instruction form
provided by its bank and present the documents together with the collection
instruction to the bank.
u the amount to be collected and details of the draft drawn on the buyer;
u whether the seller has an agent from whom assistance can be sought in
case of need;
u whether charges are for the buyers account and whether or not they may
be waived if refused, or whether they would be paid by the seller.
The seller will sign the collection form, which would usually contain a
declaration to the effect that the bank is not liable for loss or delay due to
factors beyond its control, eg postal delays, or loss of documents in transit
to the collecting or presenting bank. The following points should be noted:
6. Where D/A terms have been agreed, a draft drawn on the buyer will
usually be enclosed with the documents, with details of acceptance
terms given on the collection instruction. Where D/P terms are agreed,
technically a draft is not required, as the documents will be released upon
payment by the buyer. Indeed, in some countries where drafts still attract
stamp duty, it is best not to enclose them with a collection instruction,
thus avoiding payment of expensive pro-rata stamp duty.
If in agreement with the sellers instructions, the remitting bank will then
send its own collection instruction (based on the instructions received from
the seller) to the collecting bank, with confirmation that the collection is
subject to the URC 522 rules and accompanied by the documents provided
by the principal. They will normally be sent by courier service.
Obtain and study a copy of your own banks (or any local banks)
documentary collection instruction, to see exactly what is included.
The collecting bank may well have a banking relationship with the buyer but,
when handling a collection, they are acting as agents for the remitting bank
and therefore owe the remitting bank the normal duty of care of an agent to
its principal. Therefore, the collecting banks duty and responsibility to the
remitting bank overrides any duty to its customer.
u If paid, the collecting bank will transfer the funds to the remitting bank,
normally via SWIFT.
u If accepted, the collecting bank will advise the remitting bank, and the
accepted draft will be handled according to the collection instruction, ie
hold it until maturity and present it to the buyer for payment, or return
it to the remitting bank for re-presentation shortly prior to the maturity
date.
u If accompanied by a term draft, then the collecting bank must obtain the
buyers acceptance prior to release of the documents.
In either case, the buyer may be allowed to examine the documents at the
bank. Or the buyer may have received copy documents, by separate post,
direct from the seller. The collecting or presenting bank may also make
copies available to the buyer to aid their decision process. Some buyers
and sellers have established electronic means of exchanging pdf format
documents for review prior to the arrival of a collection.
As explained in URC 522 article 13, banks are not responsible for the
genuineness or validity of any documents.
Once a bill is accepted, the collecting bank must inform the remitting bank
and, once payment thereof is received on the due date, funds, less any
charges, will be sent via SWIFT.
u URC 522 article 16 states that collecting banks will make payment only
to the remitting bank, unless there is some agreement to the contrary.
u When the sum payable and collected is denominated in the local currency
of the buyer, and this is the currency that will be paid to the remitting
bank, the collecting bank should not release the documents without
seeking further instructions if payment of such local currency is subject
to completion of any exchange control regulations.
u When interest is due to the seller, the collecting or presenting bank should
collect the interest due at the rate stated and for the period involved.
Unless it is specifically stated that interest may not be waived, the
collecting or presenting bank may release documents against payment
of the principal sum only (URC 522 article 20).
When the collecting bank is the consignee and releases goods to the buyer
against payment, acceptance or other terms and conditions, the remitting
bank is deemed to have authorised such action. In practice, the collecting
bank will then issue its own delivery order to the carrier, authorising release
of the goods to a specific party, usually the buyer.
In a negotiation, the sellers bank will agree to pay the seller immediately
the value of the draft. This type of arrangement would be with recourse to
the seller, meaning that if the bank were unable to obtain payment from the
importer, it would come back to the seller to retrieve its payment.
The seller would also agree to pay interest for the period between the
negotiation date and the date when the remitting bank receives payment.
Finance can also be provided to the buyer, by the buyers bank, by way of
an advance to the buyer, to help pay the sight or term draft.
The buyers bank may also provide a form of additional acceptance to the
draft accepted by the buyer. This is common in a number of European
countries and is known as avalisation, because the bank signs on the draft
with the words Bon pour aval. Clearly, with the collecting banks name
on the draft, the collecting bank effectively guarantees payment. Thus, it is
possible for financing to be raised on the draft prior to the due date on the
strength of the bank avalisation.
The prior permission of the buyer and its bank should be obtained before
submitting a collection instruction with a request for avalisation. The banks
acceptance pour aval will incur further bank charges, and, prior to the
collection being despatched, the buyer and seller must agree who will
be responsible for these charges. Collecting banks must not release the
documents unless they are prepared to avalise the draft, and to do so, they
should ensure that the buyer is financially capable of paying the draft on the
due date.
u increase the likelihood of payment for the seller, as the buyer may not be
able to obtain the goods without payment or acceptance of the collection;
u provide some assurance to the buyer that the shipment will arrive,
although the buyer will often not be able to examine the goods before
payment or acceptance of the collection;
u The security of payment for the seller is less than payment in advance, a
bank payment obligation or a documentary credit.
u The seller does not have the benefit of a bank guarantee of payment
provided by a documentary credit, and relies only upon the credit
standing of the drawee / buyer.
u Should the collection be unpaid, the costs of protecting the goods can
be high. Finding an alternative buyer, willing to pay a fair price, in a far
country, may be difficult, particularly for perishable goods.
Chapter summary
This chapter has looked at collections governed by the rules laid down in
URC 522. Collections come in three categories:
Collections are handled for a seller by its bank, which becomes the remitting
bank, from where documents are sent to the buyers bank: the collecting
bank.
u The seller is at less risk than open account sending the goods and
awaiting payment but remains reliant on the credit standing of the
buyer to a considerable extent.
u If the buyer does not pay or accept, the seller and the remitting bank are
dependent upon the collecting bank acting efficiently, if so instructed, to
store and insure the goods and, in the worst case, arrange for a sale.
u Sellers have a risk, more in some countries than others, that foreign
exchange will not be available to the buyer.
A buyers bank may also make funds available to its customer, so that it can
meet its payment obligations before they have processed and / or sold the
imported goods.
References
ICC (1995) Uniform rules for collections. ICC Publication No. 522.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
a. 645
b. 522
c. 600
d. 458
a. A documentary collection.
b. A commercial collection.
c. A clean collection.
d. A financial collection.
Learning objectives
In addition, the ICC has produced a publication giving guidance on how the
articles of UCP 600 should be interpreted and applied in the examination
of documents, called International Standard Banking Practice for the
Examination of Documents under Documentary Credits subject to UCP 600
or ISBP for short (ICC, 2013). The ISBP is a necessary companion for
UCP 600, whether the reader has a banking, logistics, legal or corporate
background; the latest version is ISBP 745.
8.1.1 Definitions
Documentary credits are very often used to settle the payment obligation of
a buyer and, in the context of an issuing bank, may be defined as:
u payment at sight;
3. Banks only deal with documents and not the goods, services or
performance to which the documents may relate. UCP 600 sub-article 14
(a) states that banks examine a presentation to determine, on the basis
of the documents alone, whether or not the documents appear on their
face to constitute a complying presentation. Documents presented by the
beneficiary must be as specified in the credit, and for most transactions
will consist of the kind of documents described in Chapter 5, eg invoices,
transport documents, insurance documents.
The applicant for a documentary credit is the buyer that asks its bank to
issue the credit. An applicant is not a party to a documentary credit.
u Advising bank the bank through which the credit is transmitted by the
issuing bank for advising to the beneficiary.
u Issuing bank the bank acting for the applicant by issuing or opening the
credit on the applicants behalf. The issuing bank gives an undertaking to
reimburse a nominated bank that has honoured or negotiated compliant
documents under the terms of the credit, even if the applicant is unwilling
or unable to pay. It also gives an undertaking to honour a complying
presentation that is made to it directly by the beneficiary.
The advising, confirming and nominated bank may be the same institution.
Article 2
Article 2 gives the definitions of terminology used throughout the rules. In
addition to the definitions of the parties involved, which are outlined above,
the following terms are defined:
u Banking day is the day on which a bank is regularly open at the place at
which an act subject to UCP 600 is to be performed.
Article 3
Article 3 gives a list of interpretations, including that all documentary credits
are irrevocable, the manner in which documents may be signed, how the act
of legalisation or certification may be evidenced on documents, the use of
terms in a credit to describe the issuers of documents, what is understood
by terms such as promptly, immediately, etc, the meaning of terms such
as from, to, until, after, etc, and terminology used to describe certain
parts of a month.
Article 4
Article 4 makes the distinction between a credit and the contract. Sub-article
4 (a) states:
Article 5
Article 5 makes the distinction between documents versus goods, services
or performance. This is an extremely important feature of a documentary
credit, and an applicant must be aware that the banks only deal in documents
and not the underlying goods, service or performance. In the event that a
beneficiary ships the wrong or substandard goods, the applicant must still
reimburse the issuing bank if a complying presentation has been made.
Article 6
Article 6 details the requirements concerning availability, the need for an
expiry date and the place for presentation.
Article 7
Article 7 covers the issuing banks undertaking, which can be summarised
as follows: the issuing bank undertakes to honour a presentation made to it
by the beneficiary, provided the documents comply with the credit. A credit
may allow a beneficiary to submit a presentation to a named nominated
bank or any bank, as specified in the credit. If a complying presentation
is received from a nominated bank, the issuing bank must reimburse that
bank, provided that the issuing bank is itself satisfied that the terms of its
credit have been met.
Article 8
Article 8 looks at the undertaking of the confirming bank. The confirming
bank gives a similar undertaking to the beneficiary as that of the issuing
bank. It will undertake to honour or negotiate a complying presentation that
is made to it or to another nominated bank. The issuing bank is obligated to
reimburse the confirming bank for any honour or negotiation that it effects,
provided that the documents conform to the terms of the credit.
Article 9
Article 9 gives details on the advising of credits and any subsequent
amendments. An advising bank is under no obligation to advise a credit
or amendment to the beneficiary. If it agrees to do so, it is required to
satisfy itself with the apparent authenticity of the credit or an amendment,
or to advise the beneficiary that it has been unable to complete this task.
Article 10
Article 10 covers amendment in more detail. As a documentary credit is
irrevocable, any amendment is subject to the consent of the issuing bank,
the beneficiary and a confirming bank (if a confirming bank is involved in
the transaction). However, once the parties to the credit have agreed to
an amendment, the amendment will become an integral part of the credit
and the beneficiary must comply with the original credit and the accepted
amendment.
Article 11
Article 11 states that an authenticated teletransmission of a documentary
credit or amendment will be deemed to be the operative credit or
amendment. A pre-advice will only be sent if the issuing bank is fully
prepared to issue the operative credit or amendment.
Article 12
Article 12 declares that a nominated bank is not obliged to honour
or negotiate, unless it is also the confirming bank or it has expressly
communicated to the beneficiary its agreement to honour or negotiate. When
Article 13
Article 13 examines fairly basic bank-to-bank reimbursements arrangements.
Banks should utilise the more extensive rules that exist in the ICCs
Uniform Rules for Bank-to-Bank Reimbursements Under Documentary
Credits (publication no. 725) (ICC, 2008).
Article 14
Article 14 gives a number of standards relating to the examination of
documents (see also section 8.1.3 below). Banks have a duty to examine
documents, on the basis of the documents alone, to determine whether they
appear on their face to constitute a complying presentation. This article gives
banks a maximum of five banking days following the day of presentation to
determine whether the presentation does comply.
Article 15
Article 15 reminds banks that once a presentation is determined to be
complying, they must honour or negotiate. In the case of the confirming
bank or nominated bank, they must also forward the documents as required
by the documentary credit.
Article 16
Article 16 looks at the scenario when discrepant documents are presented.
In this instance, the nominated, confirming or issuing bank may refuse to
honour or negotiate; however, it must notify the presenter by the close of
the fifth banking day following the day of presentation, giving details of the
discrepancies and indicating one of four statuses for the documents:
a. that the bank is holding the documents pending further instructions from
the presenter; or
b. that the issuing bank is holding the documents until it receives a waiver
from the applicant and agrees to accept it, or receives further instructions
from the presenter prior to agreeing to accept a waiver; or
Article 17
Article 17 states that at least one original of each stipulated document must
be presented. A bank may treat a document as an original if it bears an
apparently original signature, mark, stamp or label of the issuer unless the
document states that it is not an original.
Article 18
Article 18 requires that the commercial invoice must appear to have been
issued by the beneficiary (except as required in Article 38 see below),
must be made out to the applicant and must be in the same currency as the
credit. It need not be signed. The invoice must contain a description of the
goods, services or performance that corresponds with that in the credit.
Article 19
Article 19 establishes that when a transport document covers at least two
different modes of transport, the document must, among other conditions:
u appear to indicate the name of the carrier and be signed by the carrier or
its named agent, or the master or its named agent;
u indicate the place of despatch, taking in charge or shipment and the place
of final destination stated in the credit;
u be the sole original or, if issued in more than one original, be the full set
of originals as indicated on the transport document;
Article 20
Article 20 states that a bill of lading must, among other conditions:
u appear to indicate the name of the carrier and be signed by the carrier or
its named agent, or the master or its named agent;
u indicate that goods have been shipped on board a named vessel at the
port of loading;
u be the sole original or, if issued in more than one original, be the full set
of originals as indicated on the bill of lading;
Article 21
Article 21 covers non-negotiable sea waybills, the requirements of which are
similar to those detailed for bills of lading.
Article 22
Article 22 states that a charter party bill of lading must, among other
conditions:
u appear to be signed by the master or its named agent, the owner or its
named agent, or the charterer or its named agent;
u indicate that goods have been shipped on board a named vessel at the
port of loading;
u be the sole original or, if issued in more than one original, be the full set
of originals as indicated on the charter party bill of lading;
Article 23
Article 23 states, among other conditions, that air transport documents must
appear to indicate the name of the carrier and be signed by the carrier or its
named agent. In addition, they must state a date of issuance and indicate
the airport of departure and destination as stated in the credit.
Article 24
Article 24 states, among other conditions, that road, rail or inland waterway
transport documents must appear to indicate the name of the carrier and
be signed by the carrier or its named agent, or indicate receipt of the goods
by either a signature, stamp or notation. In addition, they must indicate the
place of shipment and place of destination as stated in the credit.
Article 25
Article 25 establishes, among other conditions, that courier and postal
receipts must both be stamped or signed at the place from which the credit
states the goods are to be shipped.
Article 26
Article 26 requires that transport documents must not indicate that the
goods are or will be loaded on deck. However, a clause on a transport
document stating that the goods may be loaded on deck is acceptable.
Article 27
Article 27 states that a bank will only accept a clean transport document,
ie one that bears no clause or notation that expressly declares a defective
condition of the goods or their packaging.
Article 28
Article 28 examines insurance documents and coverage. Important features
include that the date of the insurance document must be no later than the
date of shipment or the document must indicate that cover was effective no
later than the date of shipment. It must indicate the amount of insurance
coverage in the same currency as the credit. Cover notes will not be
acceptable unless required by the credit. The minimum insurance coverage
is 110% of the CIF or CIP value of the goods (see Chapter 5 for explanation
of these Incoterms).
Article 29
Article 29 permits the expiry date or last date for presentation to be
extended when that date falls on a non-banking day, except due to a force
majeure event. If the latest shipment date falls on a non-banking day, it is
not extended.
Article 30
Article 30 states that the words about or approximately when used in the
credit in connection with the amount, quantity of goods or unit price can
be construed as allowing a tolerance of not more than 10 per cent more or
less. In the event that the goods are described by weight or volume, then a
plus or minus 5 per cent tolerance in the quantity shipped is permissible,
providing the amount of the credit is not exceeded.
Article 31
Article 31 covers partial drawings and shipments, which are allowed unless
the credit states otherwise.
Article 32
Article 32 states that when a credit includes a schedule for instalment
drawings or shipments within given periods (ie a start date and an end
date), a failure to ship or present under one of the dates or instalments will
render the credit unavailable for that and any subsequent instalment.
Article 33
Article 33 states that a bank has no obligation to accept a presentation
outside its banking hours.
Articles 34 and 35
Articles 34 and 35 cover disclaimers on effectiveness of documents and on
transmission and translation, limiting the banks liability or responsibility.
Loss of documents in transit is also covered and offers some protection to a
beneficiary where a nominated bank has previously examined the documents
and determined that they comply, whether or not the nominated bank has
honoured or negotiated.
Article 36
Article 36 covers the event of force majeure, which comes from the French
definition meaning superior force. It simply means that the banks involved
with the credit assume no liability or responsibility for any consequences
arising out of any interruption in business caused by acts of God, riots, civil
commotions, insurrections, wars and acts of terrorism, or by any labour
strikes.
Article 37
Article 37 makes it clear that the issuing bank is not liable should the
advising bank not carry out its instructions, even if the issuing bank selected
the bank. The applicant remains ultimately liable for any charges that cannot
be collected from a beneficiary.
Article 38
Article 38 outlines the rules relating to a transferable credit (which are
detailed fully in section 8.4.1 below). Important features of this article are
that only certain parts of the transferable credit can be amended by the first
beneficiary, namely:
u unit price;
u expiry date;
u the name of the first beneficiary, which may be substituted for that of the
applicant in the transferred credit.
Note that, of these, the first five listed above may be reduced or curtailed. A
bank that is nominated to transfer a credit is under no obligation to do so.
Article 39
Article 39 looks at assignment of proceeds of a documentary credit. Even if
a credit is not designated as transferable, it does not affect the right of a
beneficiary to assign the proceeds under the credit. This article relates only
to the assignment of the proceeds under the credit and not the assignment
of the right to perform under the credit.
In UCP 600 article 14, it includes the default rule for the presentation of
documents after the date of shipment, ie within 21 calendar days. Ideally,
each credit will indicate the presentation period that will be applicable.
u A document must not be dated later than the date of its presentation.
u If the credit does not indicate a specific issuer for a document, such as
for an inspection certificate, then the issuer named on the document will
be accepted as submitted. Where the data content for a document is not
u Data in a document when read in context with the credit, the document
itself and international standard banking practice need not be identical
to, but must not conflict with, data in that document, any other stipulated
document or the credit.
Once the beneficiary has been given the opportunity to correct any
discrepancies, the nominated bank has several courses of action open to
it:
common feature today, due to the amount being reflected against a credit
facility).
A seller would first agree with a buyer to utilise the banking system
to arrange the transfer of documents and payment or acceptance. The
seller then ships the goods and obtains the documents relating to the
shipment, such as the commercial invoice, transport document, certificate
of origin, etc. The seller will complete and sign a collection instruction form
provided by its bank and present the documents together with the collection
instruction to the bank.
Once a seller and buyer have agreed on the principles of the underlying
sale, they agree to settlement utilising a documentary credit. There is then
a series of details that must be considered by both parties, before the buyer
asks its bank to issue the credit. These considerations include:
u the Incoterm that will apply and the associated responsibilities for each
party;
u the validity of the credit, ie the expiry date for presentation of documents
and the period for presentation;
These points must be agreeable to all sides. After all, the documentary credit
only gives certainty of payment to the seller / beneficiary if it can comply
with the terms and conditions.
Once agreement is reached on these issues, the buyer can approach its bank
for the issuance of the credit on its behalf.
The issuing bank will already have in place or will need to establish
a documentary credit facility for the buyer. As the credit is a binding
undertaking to guarantee payment either at sight or at a future date, if all
terms and conditions of the credit are met, the bank marks the credit as a
contingent liability.
This syllabus does not cover the lending process and decisions made by
the bank. However, in essence, the bank should be comfortable with the
financial standing of the buyer and its ability to undertake import business
and honour its obligations.
The bank may also wish to take security to further protect it against possible
loss. This may take the form of:
u security provided through the documents (see Chapter 5), such as:
Charges over a companys assets come in two forms: a fixed charge over
a specific asset such as property; or a floating charge over current assets
such as stocks of raw materials and finished goods, debtors (money owed
to the company) and work in progress. The value of a floating charge goes
up and down as the company trades. Should the business be unable to meet
its financial obligations to the bank, the property covered by a fixed charge
can be sold to repay debts and, if the company goes into liquidation, the
floating charge assets can be sold for the banks benefit.
Assuming that the issuing bank agrees to issue the documentary credit, the
buyer will need to complete the banks application form, giving exact details
of what is required. The application form will require the buyer to detail all
the conditions that have been agreed with the seller (as noted above) and:
u details of the sellers bank through which the credit will be advised and
add confirmation, if required; if this is not known to the buyer, then the
issuing bank would advise the credit through one of its group offices or
correspondent banks.
When the issuing bank opens the documentary credit, it will usually use
the SWIFT MT700 message type, which is used by most banks today. The
issued documentary credit will include the details on the documentary credit
application form and the following:
u date of issue;
Once the seller is in receipt of the credit, it should check that the credit
conforms to the agreed sales contract and that it is able to meet its
requirements. If the seller is not satisfied, it should immediately contact
the applicant for them to arrange a suitable amendment.
When the issuing bank is satisfied that the documents are compliant, it
will inform the applicant and debit its account. The documents will then be
released to the applicant. The limit on the import facility will be reduced by
the amount of the presentation.
If the documents are compliant and the draft is drawn on the nominated
bank, and the credit has been confirmed by the nominated bank, the draft
will be accepted to mature on the determinable due date. At the request
of the beneficiary, the nominated bank can purchase the draft and advance
funds without recourse to the beneficiary. Otherwise, the accepted draft may
be returned to the beneficiary or may be held by them until the due date and
paid on that date.
If the nominated bank has not added its confirmation, and the draft is drawn
on it, it is under no obligation to accept the draft. If it chooses not to accept
the draft, the nominated bank will forward the documents to the issuing
bank for their examination and acceptance.
When the issuing bank is satisfied that the documents are compliant, it will
be required to accept a draft payable on the determinable due date. The
documents will then be released to the applicant and they will be informed
of the due date.
On the due date, the applicants account will be debited and reimbursement
made available to the nominated bank. The import facility will be reduced
by the amount of the presentation.
u Transfers can be and usually are for less than the full value of the
transferable credit.
u There is, however, an additional risk for the applicant: the applicant may
not know the credit standing or reliability of the supplier, or even their
name.
u The contract between the buyer and the intermediary is completed in the
usual way but must allow for a transferable credit (the intermediary need
not be in the sellers country).
u The issuing bank issues the documentary credit as usual, but indicates
that it is transferable.
u When advising the credit, the advising bank will attach its form of request
for transfer for completion by the intermediary (who will become known
as the first beneficiary when the credit is transferred).
u The first beneficiary will request the transferring bank to transfer part
of the credit to the ultimate supplier(s). (The transferring bank has
discretion over this see UCP 600 sub-article 38 (a).) The supplier(s)
will be known as the second beneficiary.
u The credit, as transferred, must carry the same terms and conditions as
the transferable credit, except that: the amount of the credit, the unit
prices, the expiry date, the latest shipment date and the last date for
presentation may be reduced or curtailed; the required insurance cover
may be increased; and the applicants name may be substituted by the
name of the first beneficiary.
u The instructions from the first beneficiary to transfer must make clear
the basis upon which amendments to the transferable credit are to be
advised to the second beneficiary / beneficiaries, ie immediately or only
after instructions are provided.
Note: The fact that a credit is not transferable does not mean that the
beneficiary cannot assign to a third party part or all of the proceeds due
to it, in accordance with the assignment laws of the beneficiarys country.
See UCP 600 article 39.
The two credits operate entirely separately, but the beneficiary (who will be
the applicant of the second credit) will have to structure its credit in such
a way that, when compliant documents are presented by the beneficiary
of their documentary credit, it can use those documents (such as bills of
lading), together with any documents added or substituted by it, such as
Such credits originated in trades such as the Australian wool trade, where
European buyers agreed to finance their suppliers who, in turn, used the
funds advanced to collect and purchase wool from farmers over a wide area.
Once a sufficient quantity had been gathered, the wool would be shipped,
documents would be presented in the normal way and the advance would
be repaid out of the proceeds. Red clause-type credits are not, however,
restricted to the wool trade.
The issuing bank and the applicant are liable to reimburse a nominated bank
for any advance made and not repaid through the presentation of compliant
documents. Therefore, such arrangements are only made available to
applicants who have the appropriate financial standing, expertise and
knowledge of the trade to select reliable beneficiaries. Today, most advances
are covered by an advance payment guarantee issued by the bank of the
beneficiary, agreeing to repay the advance or any part thereof in the event
that the beneficiary does not ship the required goods or any part thereof.
Normally such credits are issued without any instructions to the advising
bank to take security or control of the goods. However, a green clause
documentary credit allows pre-shipment advances to be made as with a
red clause credit, but stipulates that advances may only be made against
goods stored to the advising banks order pending shipment. The funds
are advanced against warehouse receipts in the lending banks name. Such
green clause credits are rare nowadays.
A credit revolving in time, for example monthly, means that the credit is
available every month until the expiry date, subject to the number of times
that it is stated to revolve.
For use of the DOCDEX process, one or both parties must agree to bear the
costs involved.
Full details and the rules themselves (available in several languages) can be
found online at www.iccwbo.org/Products-and-Services/Arbitration-and-
ADR/DOCDEX/Rules/DOCDEX-Rules-in-several-languages/ [Accessed: 6 March
2014]. At the time of writing (February 2014), the DOCDEX rules are under
revision.
It should be noted that this is not an immediate service and that, generally,
decisions are given within 30 days after submission of all the paperwork for
review by the nominated experts.
Table 8.1. Documentary credits: undertakings of participants and the risks involved
Applicant That the transaction is genuine and Banks are not responsible for
import formalities will be completed the genuineness or validity of
and insurance cover arranged by documents.
the applicant, if required by the Even genuine documents do not
Incoterm used, and that insurance necessarily guarantee that the
will be arranged. contractual obligations of the
To reimburse the issuing bank, beneficiary have been fully met.
when demanded or on the due
date, when compliant documents
are submitted.
Issuing bank That on presentation of compliant The applicant will be either unable
documents it will honour as to reimburse the bank when called
stipulated in the credit. upon or may refuse to do so.
To reimburse a nominated bank That it provides a credit, the terms
that has honoured or negotiated a of which do not give the bank
complying presentation. control over the goods that it may
require.
The applicant has failed to obtain
the necessary import licences and /
or provide for insurance cover (when
for its account).
Advising bank To satisfy itself as to the apparent It advises a credit that was
authenticity of the credit or any subsequently found not to be
amendment. authentic.
To forward to the beneficiary the
credit or amendment as received
from the issuing bank.
Confirming To satisfy itself as to the apparent The issuing bank fails to honour its
bank authenticity of the credit (if it is not obligations to reimburse.
the advising bank and has already
undertaken this role).
To provide an undertaking to the
beneficiary that conforms to the
form of availability stated in the
credit.
To honour or negotiate a complying
presentation.
Table 8.1. (cont.) Documentary credits: undertakings of participants and the risks involved
Chapter summary
In this chapter, you have learned the following:
u By issuing a documentary credit, a bank adds its own name and risk to
the transaction on behalf of its applicant customer.
u Banks deal with documents only and are not concerned, when deciding
whether or not to honour or negotiate a presentation, with disputes
concerning the underlying goods, transactions or contracts.
u A banks concerns with the type of goods being imported may be relevant
to its security and reimbursement arrangements with the applicant and
may be a factor in the bank agreeing to issue the credit or not.
u Once the credit has been issued, decisions regarding settlement will be
based on compliance with the documentary requirements alone.
References
ICC (2007) Uniform customs and practice for documentary credits. ICC Publication No.
600LE.
ICC (2008) ICC Uniform rules for bank-to-bank reimbursements under documentary credits.
ICC Publication No. 725E.
ICC (2013) International standard banking practice. ICC Publication No. 745E.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
a. The seller.
d. The buyer.
d. ISP98 (1998).
Learning objectives
The working capital finances the trade cycle, which can be defined as: the
time period between the start of the supply chain the ordering of goods
and raw materials and the receipt of payment for the corresponding sales
of finished products.
International trade can impose extra strains on the working capital needs
of a business, because the period between making payment for materials
and wages and the time of receipt of payment for goods supplied will often
be longer than on domestic business. Thus for sellers the trade cycle is
usually extended. Most international trade is conducted on payment terms
agreed between seller and buyer of 180 days or less. In practice, a bank will
examine an individual companys trade cycle and tailor the length of finance
it provides accordingly.
the buyer remits the necessary funds to the seller as agreed. Open account
arrangements therefore imply a considerable amount of trust being placed
on the buyer by the seller. Once goods have been despatched or services
delivered, a seller will lose all control over payment, and is reliant on the
trustworthiness and creditworthiness of the buyer to pay.
in that currency. Some banks have the ability to provide a facility that will
net off the debit and credit balances of multi-currency accounts. Foreign
currency accounts are described in further detail in Chapter 13.
Some private sector insurers and some government bodies (for example UK
Export Finance in the UK or Coface in France) may provide insurance against
buyer and country risk. It is often possible for the sellers bank to obtain an
assignment of any proceeds of such policies. This means that the advance
is less risky and hence a lower rate of interest will apply. The security is
not 100 per cent guaranteed, since the lending banks rights will be no
better than those of its customer. In other words, the lending bank could
only claim to the extent that the customer has a valid claim on the policy. In
addition, most policies only cover up to 8595 per cent of the loss, so that
the customer will not recklessly grant credit, while relying on the insurer
to compensate all losses. Business lending decisions are not covered in the
scope of this syllabus; however, it is worth noting that a bank would usually
look to secure the overdraft facility.
u the facility will remain in place for the whole of the stated period, provided
the customer is not in breach of any of the conditions of the facility.
Banks charge a commitment fee for such facilities and they are sometimes
known as revolving credit facilities.
For an uncommitted overdraft, the bank does not charge any commitment
fee, but technically at least the bank could withdraw the facility at any time,
usually with a seven-day notice period.
With factoring (see section 9.4.2.2 below), normally only open account terms
will apply, although documentary collection could be appropriate for invoice
discounting. The factor must approve the debtors. Debtors should be well
spread, and a factor may be keener to cover the export business if the seller
has a good spread of domestic business that is offered as well.
The seller remains responsible for managing the sales ledger by:
On receipt of payment, the seller pays what is due to the discounter of the
invoice, plus charges and interest, and retains the balance.
u the seller can be relied upon honestly and promptly to account for
payments received;
u the sellers credit control and sales ledger departments have the
necessary experience and systems in place;
u the buyers are known to be bad risks or based in a country from which
obtaining payment is difficult.
without recourse discounting services, with a fee structure that reflects the
difference in risk to the discounter. The discounter will levy an additional
credit protection fee for without recourse facilities.
9.4.2.2 Factoring
A factoring service is provided by a specialist factoring company and is
similar to invoice discounting, except that the whole of the administration
and credit control of the sales ledger is taken over by the factoring company.
For this reason, the provision of this facility is known to the buyer.
A seller and a factoring company will need to agree precisely what services
are required and will be offered by the factor, taking account of the following
considerations:
u Whether the seller is prepared to pass the entire sales ledger to the
factoring company, as the factoring company will not want to take only
the less creditworthy business.
u The spread of the sellers business; too much concentration on one buyer,
say more than 30 per cent of turnover, will make the sellers business
unsuitable for factoring.
u Whether the seller has a good track record as a reliable business and
does not have a poor history of bad debts, eg customers who have failed
to pay.
For the seller, there are a number of advantages in working with a factoring
company:
provide for itself. Businesses that are not large (or are not part of a large
group) may find factoring to be very cost-effective.
factors can run credit checks on potential buyers / debtors via their
computerised credit reference systems;
the cash advance against the invoice means that there is a shorter
period when the exchange risk can apply the shorter the period, the
lower the risk;
u Book debts in the hands of the factor reduce the net assets of the
business, which may make the bank reduce the overdraft facility,
especially if the net asset value of the business was a consideration when
granting a facility. In other words, you can only lend against the debtors
once.
u A factor whose service standards are poor, particularly where this impacts
on the sellers customers, can impact adversely on the commercial
relationship between seller and buyer.
u The factor will not be able to deal with queries about the underlying
goods or services supplied without reference back to the seller.
Once an agreement is reached to proceed, the process for making use of the
service will be as follows:
u The seller raises an invoice on the buyer, with a copy to the factoring
company.
u An agreed percentage of the invoice value, say 85 per cent, is then paid
by the factoring company to the seller.
u The factoring company then enters the details onto its credit control
system, and sends out statements or chases for payment as required.
u Once the invoice is paid, the balance due of 15 per cent is paid by the
factoring company to the seller, less fees and interest charges.
Visit your local bank or access its website. Make a note of the minimum
turnover that must apply before the bank will agree a factoring or invoice
discounting facility.
In addition, the buyer can also benefit. By providing the confirmation of the
invoice acceptance, the buyer enables the supplier to obtain cheap finance
early in the transaction. Thus, the buyer may, in exchange, expect to be
allowed a longer period of credit.
Thus, both buyer and seller improve their working capital and the banks
earn interest from low-risk lending. The words win-win could be used to
describe supply chain finance.
Supply chain finance, and in particular the bank payment obligation (BPO),
is discussed in Chapter 15.
Visit your local bank branch or access its website. List the additional
benefits that supply chain finance brings to both buyer and seller over
and above those shown in section 9.5 above.
Avalisation is not always available. The prior agreement of the buyers bank
should be obtained and that bank will wish to consider the creditworthiness
and importance of its customer. In addition, each bank may have minimum
amounts below which they will not avalise. However, where the facility
is available, the interest rate or discount rate will be based on the
creditworthiness of the buyers bank as opposed to the creditworthiness
of the seller.
The seller would send its documents and draft to its bank but, instead of
signing a collection instruction, it would sign a negotiation request. The
decision to negotiate would be made by the bank like any other lending
decision.
Once agreed, the bank would immediately credit the customers account
with the full value of the draft and would debit a negotiation account. The
sellers bank would send the collection as usual to the collecting bank. When
the collection is paid, the bank will repay its negotiation account with the
proceeds and calculate interest, which will be debited to the sellers account.
u the goods, provided they have not been released to the buyer.
Banks may advance less than the face value when the seller does not need
to borrow the full amount, or when the sellers bank does not wish to lend
the full face value.
The issuing bank will have indicated in the documentary credit that the draft
is to be drawn on the nominated bank and that the credit was available
with the nominated bank by acceptance. If the presentation of documents
is compliant, the draft drawn on the nominated bank may be returned to
the beneficiary, bearing that banks acceptance. With such an accepted draft
in its hands, the beneficiary can easily raise finance by discounting the bill,
either with the nominated bank or any other bank that is willing to discount
the draft.
The beneficiary will receive a sum less than the face value of the draft drawn
or documents presented, representing interest costs for the period between
the date of the nominated banks payment and its receipt of funds from the
issuing bank.
The sellers bank would issue a letter of comfort to the supplier, indicating
that:
The letter of comfort can then be used by the supplier to raise finance from
its own bank.
Many of these loans are secured against a charge on the assets of the
company or guarantees from the directors. However, many trade finance
houses and some banks will still offer a stock facility, which provides finance
to the importer with the underlying goods being held as security. This is
sometimes referred to as a produce loan, an import loan or a warehousing
loan.
Produce loans work in various ways, and a typical example is outlined below.
1. The bank must be satisfied that the supplier of the goods is competent
and reputable, that the goods are of sound quality, and that the
ultimate buyer is creditworthy. Depending on its knowledge of the parties
involved, the bank may undertake credit checks and could possibly
require a third-party inspection certificate covering the goods. In addition,
the goods must be readily saleable, should the ultimate buyer not accept
them.
2. The bank then pays the draft in accordance with the instructions on the
collection order against a signed letter of pledge, which states that the
documents and / or goods are pledged as security to the bank.
3. The bank credits the customers current account with the agreed amount
of the advance and makes a corresponding debit entry on a produce loan
account in the customers name.
4. In accordance with the authority on the letter of pledge, the bank will
arrange with its agents to have the goods warehoused in the banks
name.
5. The agent will arrange to insure the goods, and the cost will be charged
to the customer.
6. The goods remain in the warehouse until the time comes for delivery
to the ultimate buyer. When that time comes, the customer must sign
a trust receipt. The bank will then issue a delivery order to enable the
customer to obtain the goods and take them to the ultimate buyer. The
trust receipt states that the customer holds the goods as trustee for the
bank. Under the terms of a trust receipt, a customer will generally be
required to agree that:
u the goods remain pledged to the bank and the customer holds the
goods as trustee of the bank;
u in the event of any default by the customer, the trust becomes invalid
and the bank can demand to be repossessed of the goods or any
documents of title.
7. The bank has now lost physical control of the goods and relies on the
customer to deliver them to the ultimate buyer.
8. The ultimate buyer pays directly to the bank and the proceeds are used
to clear the produce loan, including interest and charges.
Obviously all parties must be reputable and trustworthy for the procedure
to be acceptable to the lending bank.
Thus the government body will need to review a project against appropriate
international standards dealing with environmental issues or social and
human rights impacts. Essentially, the government body providing the
financial support must be satisfied that any lending involved will represent
sustainable debt for the country concerned and that the anti-bribery and
corruption procedures have been complied with.
There will also be international agreements that must also be complied with.
Buyer credit is where the sellers bank makes money available for the buyer
to pay the seller. It can be in the form of a direct loan to the buyer or a loan
via an intermediary organisation in the buyers country. This type of finance
is usually without recourse to the seller, as it is the buyer that borrows the
money. The seller also avoids the need to pay interest, as the loan is made
to the buyer.
Buyer credit facilities benefit both parties to the transaction: the seller
receives cash on delivery or acceptance of the goods or service; and the
buyer has affordable medium- or long-term finance that may not have been
readily available in its own country.
Providing medium- and long-term finance for exports is very risky, because
of the buyer, political or country risks. Hence, such finance is usually
supported by long-term insurance and / or guarantees that are mainly
provided by government agencies such as the ones listed in the further
resources at the end of this chapter. In effect, this means that although
it is the sellers bank that lends the money, they have the comfort that
a government agency will insure or guarantee the debt in the event of
default.
u There would be a minimum and maximum time period for the facility.
u The seller would liaise with the government agency and their bank to
agree the facility in the early stages of the transaction.
u There would be a minimum and maximum time period for the facility.
u The seller would liaise with the government agency and their bank to
agree the facility in the early stages of the transaction.
u The seller is paid as if a 100 per cent cash contract had been agreed:
u The buyer has time to pay the 85 per cent by borrowing at fixed or floating
rates of interest.
u a loan agreement between the lending bank and the buyer, setting
out the terms of repayment and any preconditions, including the initial
15 per cent payment to the exporter;
Once these formalities are completed, the seller receives a cash payment for
all or part of the goods or work delivered.
A variation is the project lines of credit. These are useful for major projects,
in which a number of suppliers in the same country are nominated by the
overseas buyer to provide goods and services. The financing entity will
guarantee a loan from the sellers bank to the overseas buyer or procurement
agent. The buyer can split up the loan, using it to pay various suppliers in
the sellers country on individual contracts that may be worth as little as
USD40,000 or currency equivalent. The total amount lent to the overseas
buyer will normally exceed USD5m, but, as already shown, this sum can be
divided to cover individual contracts of USD40,000 or equivalent minimum,
with credit periods of one to five years.
Visit the website of the government agency that applies to your own
country (see the further resources at the end of this chapter for a list of
some of these agencies).
List the main criteria that must apply for these agencies to provide buyer
or supplier credit facilities.
u a bank guarantee;
u The term can be anything up to ten years and repayment made by a series
of drafts or promissory notes payable at regular intervals quarterly is
typical.
Once the drafts or promissory notes have been discounted for the seller and
it has been paid, the bank or forfaiter can either hold the drafts or promissory
notes until maturity and collect payment from the drawer, or it can sell the
drafts or promissory notes on the secondary market to refinance itself. The
ultimate holder will then present the drafts or promissory notes at maturity
to the accepting party and collect payment.
u The rate of discount applied by the bank or forfaiter is usually fixed, and
subsequent changes in the general level of interest rates do not affect
the discount.
u All exchange risk, buyer risk and country risk are removed.
u The finance costs can be passed on to the buyer, if the seller is in a strong
bargaining position.
URF 800 does not change the nature of the payment claim being originated
or on-traded and, as such, can be used alongside the full and ever-expanding
range of instruments used to finance trade.
Article 1
The Uniform Rules for Forfaiting (URF) are rules that apply to a forfaiting
transaction when the parties expressly indicate that their agreement is
subject to these rules. They are binding on all parties thereto except so
far as modified or excluded by agreement.
Articles 2 and 3
Articles 2 and 3 define the various terms and interpretations that appear in
the URF, for example helpful guidance such as: where applicable, words in
the singular include the plural and in the plural include the singular.
Article 4
This article covers the without recourse position. Normally the party
purchasing the forfaiting instrument will do so without recourse, except
under specific circumstances defined in article 13b usually where bad
faith applies.
Article 5
Article 5 recommends what the forfaiting agreement should contain:
u details of the payment claim and any credit support documents, including
the amount, currency, due date and obligors;
u a list of the required documents known by the parties at the date of the
forfaiting agreement;
Article 6
This article sets out the position if the terms of the forfaiting agreement are
not fulfilled on or before the availability date.
Article 7
Article 7 covers the criteria that can be used to decide whether any
documentation that is submitted is satisfactory. In making its determination,
the primary forfaiter is entitled to take into account, without limitation,
whether:
u the required documents are supported by satisfactory evidence as to their
authenticity;
u each of the payment claims and the obligations in any credit support
document is a legal, valid, binding and enforceable obligation of the
relevant obligor;
u the payment claim and the rights under the credit support documents
are freely transferable;
u the required documents conform with the terms of the forfaiting
agreement.
Articles 8 and 9
Articles 8 and 9 relate to forfaiting confirmations and to conditions in the
secondary market.
Article 10
Article 10 relates to the responsibilities of the seller and buyer in
determining satisfactory documents in the secondary market.
Article 11
Article 11 relates to payment:
u The buyer must pay the purchase price to the seller on the settlement
date.
u Payment must be made in the currency specified in the forfaiting
agreement or forfaiting confirmation without deduction or counterclaim.
u Payment must be made in immediately available funds at the place stated
in the forfaiting agreement or forfaiting confirmation, provided the due
date for payment is a business day in that place. If the due date for
a payment is not a business day, payment must be made on the first
business day in that place after its due date.
Article 12
This article covers payment under reserve:
u The buyer must pay the purchase price to the seller on the settlement
date.
Article 13
Article 13 covers the liabilities of the parties under a forfaiting agreement.
Article 14
Article 14 covers the technicalities that need to be fulfilled in order for any
notice to be considered valid and effectively delivered.
1. by arranging for a lessor in the sellers country to buy the goods and to
lease them to the overseas buyer known as cross-border leasing;
Most banks have subsidiary or associate leasing companies that can provide
cross-border leasing facilities. These companies are also able to arrange for
overseas lessors to act, where appropriate.
The benefit to the seller is that the sale is, in effect, a cash sale and that
there is no recourse, unless it has defaulted on its commercial contracts.
Hire purchase performs a similar function to leasing, but the buyer may
be required to pay a deposit from its own resources. Once again, the legal
differences between leasing and hire purchase are outside the scope of this
syllabus.
9.12 Counter-trade
Counter-trade is a term used to describe a variety of trade contracts that,
at least to some extent, involve an agreement by the seller to reciprocate by
taking in exchange goods or services from the buyer.
It is hard to get reliable statistics showing how important this trade may be,
but some estimates put the total value of various forms of counter-trade
at around 9 per cent of total world trade. Counter-trade is certainly an
important element of trade with some developing countries and transition
economies.
9.12.1 Barter
Barter agreements are the simplest and most basic form of counter-trade.
One contract is drawn up, setting out what will be exchanged for what and
giving the terms of the exchange. Cash is not involved unless there is a
balancing sum required.
The main difficulty for the seller is the disposal of what they have agreed
to take in exchange for what has been sold. For example, a manufacturer
of water purification equipment might be expected by a poor agricultural
country to sell an agricultural commodity of which the seller has no
knowledge or experience. Such a seller may have to involve the services of
a third party, who can dispose of the agricultural products at a reasonable
price on the sellers behalf.
9.12.2 Counter-purchase
Counter-purchase is a more sophisticated form of barter. Two separate
contracts are involved: one for the sale and one for the counter-purchase.
The seller may agree to counter-purchase anything between 9 per cent
and the full value of what has been sold. The original sale goes forward
in the normal way, with payment for the goods supplied. The sellers
counter-purchase contract may be binding, or on a best-efforts basis. A
third party with the expertise to market and sell what the importing country
has to offer may be involved.
A transaction may involve the parties and stages outlined in Figure 9.1.
9.12.3 Buyback
Buyback agreements involve the supplier agreeing to take back a percentage
of what has been produced.
9.12.4 Off-set
This method is often used where a transfer of technology is involved. The
seller agrees to incorporate into the end product components or partly
manufactured goods made by the buyer to off-set the full cost of the
technology transfer to the buyer.
u The sellers additional costs will have to be recovered from the transaction
through higher prices for what is supplied and / or lower prices for the
goods taken in counter-trade.
Banks may also be asked to hold escrow accounts where funds can be held
on behalf of all parties to a transaction. For example, in Figure 9.1 above, a
bank may be asked to hold part of the money paid for the machinery by the
buyer until the seller carries out the obligation to purchase corn. Finance
may also be required: the manufacturer in Figure 9.1 may have to wait to
get paid by the trader.
Chapter summary
This chapter has been about financing the trade cycle, the time gap between
paying for supplies and labour and receiving payment. Working capital is
required to finance this gap.
Further resources
Government and quasi-government departments providing assistance with
international trade:
References
ICC (2012a) Uniform rules for forfaiting. ICC Publication No. 800E.
ICC (2012b) ICC unveils new rules for forfaiting [online]. Available at: www.iccwbo.org/
News/Articles/2012/ICC-unveils-new-rules-for-forfaiting/ [Accessed: 6 March 2014].
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
a. Barter.
b. Acceptance credit.
c. Produce loan.
d. Overdraft.
2. A bank has granted a produce loan to a buyer and the relevant goods
are currently warehoused in the banks name. The buyer now wishes to
obtain possession of the goods, so they can be delivered to the ultimate
buyer. The lending bank is happy to follow the normal procedures at
this stage.
Name:
a. the document that the buyer will be required to sign and which the
bank will retain;
b. the document that the bank will give to the customer in order to allow
him to obtain possession of the goods from the warehouse.
4. Name a form of finance for open account transactions that can allow
sellers to obtain relatively cheap post-shipment finance and at the same
time allow buyers to insist on longer periods of credit.
Learning objectives
While demand comes primarily from the worlds Muslim economies, Islamic
finance is not restricted to the Middle East and the Far East alone its
reach is global. In London, Islamic finance has helped to transform the citys
skyline, by financing, in whole or in part, developments such as The Shard,
Chelsea Barracks, Harrods and the Olympic Village.
On the retail banking side, there is also growing demand from non-Muslim
contingents; for example, a quarter of Malaysian Islamic finance customers
are not Muslim.
With an estimated annual growth rate of 1015 per cent, Islamic finance is
likely to become an increasingly important financial market in the future.
Industry forecasts estimate that Islamic investments might grow to USD2tr
by the end of 2014 and be worth nearly US$2.5tr by 2015 (Dar, 2014).
The raison dtre for this is simple. Despite the vast capabilities of human
reason, it cannot claim to have unlimited power to reach the truth. There are
numerous spheres of human life where reason is confused with desires
and where unhealthy instincts can take and have taken precedence. For
instance, in the area of economics, in conventional finance, the profit motive,
by and large, drives economic decisions. This attitude has allowed a number
of practices that cause imbalances in society, such as the activities that led
to the 20082009 financial crisis and then to a worldwide recession.
unit of the same currency, therefore there is no room for making profit
through the exchange of these units. Profit is generated when something
that has intrinsic utility is sold for money or when different currencies are
exchanged.
The Quran, whose words have not changed since its revelation over 1,400
years ago and which Muslims believe will be preserved for eternity and
relevant for all times, is the holy book for Muslims, which Muslims believe
to be the divine revelation, ie the word of God. In the Quran, the prohibition
of interest is evidenced by a number of verses. For example, the English
translation of the second chapter, Surah al-Baqarah (there are 114 chapters,
or Surahs, in the Quran), verse 275, is:
Those who take riba (usury or interest) will not stand but as stands the
one whom the demon has driven crazy by his touch. That is because
they have said: Trading is but like riba. And Allah has permitted
trading, and prohibited riba. So, whoever receives an advice from his
Lord and stops, he is allowed what has passed, and his matter is up
to Allah. And the ones who revert back, those are the people of Fire.
There they remain for ever.
u alcohol;
u tobacco;
u armaments;
u gambling;
u pork;
u conventional finance.
Financing on the basis of these two instruments creates real assets from
which profit can be generated. However, where financing on the basis of
profit-and-loss sharing is not feasible, financing on the basis of salam
(see section 10.4.3 below) and istina has been suggested by contemporary
scholars. (Istina is used to provide a facility for financing the manufacturing
10.4.1 Musharaka
Musharaka, which literally means sharing, is the ideal mode of Islamic
finance. In the context of commerce, it means a joint venture, in which all
the partners share in the profit and loss of the joint venture (see Figure 10.1).
Consequently, musharaka does not envisage a fixed rate of return, as the
return is based on the profit earned by the joint venture.
2. The ratio of profit for each partner must be a function of the profit earned
by the business, not a function of the capital invested by the partner. For
example, if Partner A and Partner B enter into a partnership in which it is
agreed that Partner A will get 20 per cent of his investment, the contract
would be invalid in Sharia. Similarly, if they agree that Partner A will be
given $5,000 per month as his share in the profit and the remaining
amount to Partner B, this would be invalid in Sharia.
4. Each partner has the right to end the contract at any time, as long as
notice to this effect is given to the other partners.
1. One of the key rules is that the seller must have physical or constructive
possession of the subject of sale. This rule has three crucial components:
ii. The seller should have acquired ownership of the subject of sale.
4. The subject of sale must be specifically known and identified to the buyer.
5. Delivery of goods sold to a buyer must be certain and should not depend
on a contingency or chance.
10.4.3 Salam
Salam is a sale contract, albeit of a special nature, in which payment occurs
today for goods to be delivered in the future (see Figure 10.2).
Initially, the purpose of a salam sale was to meet the needs of farmers who
needed funds to grow their crops and feed their families up to the time of
harvest. As salam is an exception to the general rule that prohibits forward
sales, it is subject to stricter conditions than other types of sale:
1. The buyer is required to pay the full price to the seller at the time of
contracting.
10.4.4 Murabaha
It is often assumed that Murabaha is synonymous with financing but in
fact it is a particular kind of sale, where the seller expressly mentions to the
buyer the cost of the goods purchased and adds a profit to it to arrive at the
final selling price.
So, for instance, if a customer wants to purchase a car, they would approach
their bank; the bank would purchase the car, and sell it at a mark-up to the
customer. The key point is that at some point, the bank took the risk on the
car between the time when the bank purchased it and sold it.
This is the main reason for many calls from various quarters of the industry
to move away from the overuse of the murabaha structure, as it impedes
the advance of Islamic finance from an ideological perspective.
10.5.1 Overview
Given the recent global development in Islamic finance, Islamic trade
finance could serve as one of the key growth drivers to help the
US$1.3tr Islamic finance industry to double in size. In an increasingly
globalised world, with rising trade flows, this is all the more apparent,
considering the natural synergy between conventional trade finance and
Islamic finance. Conventional trade finance is a historically low-risk activity
with an underlying commodity, while Islamic finance promotes real economic
activity, transparency and risk aversion.
From a financial point of view too, the potential for Islamic trade finance
is huge, given that the 57 member countries of the Organisation of
Islamic Cooperation, are some of the worlds largest exporters of strategic
commodities, such as oil, gas, petrochemicals and palm oil. They are also
some of the worlds largest importers of products such as soft commodities,
white goods and a host of IT, electronic, transport and other machineries.
While global trade is estimated to increase by 86 per cent between 2012 and
2026, according to a study by HSBC, trade in the Middle East and North Africa
region is expected to grow by 131 per cent (HSBC, 2012). The widening trade
corridor between the Middle East and Asia, as well as growing trade flows
to and from Africa, should translate into a rise in demand for Islamic trade
finance solutions.
2. The buyer requests the bank to purchase the goods and promises to
purchase the goods from it. (Such a promise would give the bank comfort
that it would not be burdened with the goods.)
4. The buyers bank issues the documentary credit in favour of the seller as
an invitation to purchase the goods.
5. The bank calls for documents (such as invoice, bill of lading, certificate
of origin, packing list and the insurance policy) in its name.
6. The invoice gives evidence of ownership, while the bill of lading provides
the bank with title to the goods.
8. The seller prepares the documents and sends them to the issuing bank
in exchange for accepting the offer.
10.The bank resells the goods to the ultimate buyer at cost plus agreed
profit, after obtaining and signing a murabaha sale contract.
11.The bank delivers the original documents to the ultimate buyer, duly
endorsed in favour of the buyer, which gives them ownership and title.
13.The buyer repays the amount of financing as per terms agreed with the
bank.
Musharaka is ideal for use with import and export documentary credits.
The process involving import documentary credits is outlined below as an
example.
5. The advising bank advises the documentary credit to the beneficiary (the
seller).
7. The nominated bank forwards the documents to the financing bank (the
issuing bank).
8. Upon taking up documents and paying their value at sight, the partners
sell the goods at a profit on a deferred payment basis.
2. The client gives the documentary credit under the banks lien, thus
allowing the bank to assume the role of seller to the foreign buyer.
3. The bank agrees to buy the goods from its client under a salam contract
and makes an upfront payment to it. The salam contract should include
a specific delivery date and place.
5. The agreed payment (pre-shipment finance) made by the bank to its client
is lower than the amount of the export documentary credit. The difference
is the banks profit.
For instance, the UCP 600 articles mentioned below are in conflict with
Islamic finance.
Article 2: Negotiation
Article 2 states:
The widening trade corridor between the Middle East and Asia, as well
as growing trade flows to and from Africa, will therefore greatly increase
cross-border trade flows, resulting in larger market share for Islamic trade
finance.
The ability of Islamic finance to take ownership of assets may result in Islamic
trade finance leading the way for the burgeoning Islamic finance industry and
moving towards achieving the real objectives of Islamic finance.
u the core principles of Islamic finance and how it fits within Islam;
References
Dar, H. (ed) (2014) Global Islamic finance report 2014. London: Edbiz Consulting.
HSBC (2012) Mena region an essential trade hub for global economic recovery [pdf].
Available at: https://www.hsbc.ae/1/PA_ES_Content_Mgmt/content/uae_pws/pdf/en/
newsroom/mena-essential-trade-hub-en.pdf [Accessed: 10 March 2014].
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
a. Lending
b. Depositing
c. Interest
d. Insurance
Learning objectives
As far as the bank issuing the guarantee is concerned, such documents are
contingent liabilities, which may require the bank to pay out on behalf of
its client at some future date. The bank will therefore treat the situation as
a credit facility, requiring a covering limit, or the deposit of cash cover by
the client. The bank will take a counter-indemnity from its client, usually
incorporating an authority to debit the clients account in respect of any
claims upon the guarantee.
The ICC has also produced a set of rules for demand guarantees. Guarantees
may be made subject to the ICC Uniform Rules for Demand Guarantees
ICC publication no. URDG 758 that came into force on 1 July 2010.
1. pay immediately;
2. suspend payment for a specified period (not more than 30 calendar days
following the receipt of the demand) and the automatic paying of the
demand at the end of that period, if an extension has not been granted.
Example of a guarantee
If A contracts with B to build a bridge for B, then B may require a
guarantee to be issued by the banker of A that A will build the bridge
specified in the underlying contract.
There are two broad types of guarantee, with significant legal differences:
conditional guarantees and unconditional guarantees.
The normal position in English law is that the issuer of a guarantee the
bank of A (the guarantor) in the above example has a secondary obligation.
This means that the beneficiary of the guarantee (B) must seek payment /
claim first from the person or business with which they have a contract
(A) and demonstrate that the terms of the contract have been broken or
breached, before they can claim upon the guarantor. Only if Bs claim is
unpaid by A can the guarantor be called upon.
URDG 758 states that the guarantor, like the issuer of a documentary credit,
deals with documents and not with goods, services or performance to which
the documents may relate.
u However, the majority of guarantees are issued subject to local law and
may therefore involve unfamiliar legal jurisdictions and / or may be
subject to the onerous legal requirements of the issuers country.
u The beneficiary has the satisfaction of knowing that a simple claim may
be all that is required to obtain payment from a bank.
if its bid is selected. To protect themselves, potential buyers may ask bidders
to put up a guarantee that can be called in the event that the bidder does
not contract and / or fails to meet the other bonding requirements of the
purchaser see the following descriptions. The value of such guarantees is
typically a small percentage of the contract value, say 3 per cent.
At the other end of the scale, the documentary requirements could include
one or more of the following:
As with the other ICC rules for collections and documentary credits, URDG
758 establishes that a party issuing a guarantee is not liable for the accuracy,
genuineness or validity of documents. Nor is it liable for delays beyond its
control.
URDG 758 sub-article 20(a) specifies that, unless the presentation indicates
that it is to be completed later, guarantors are required to examine a demand
within five business days following the day of presentation, to determine
whether it is a complying demand. If they decide to refuse the demand due
to it being non-compliant, they must immediately inform the presenter.
11.6 Assignment
URDG 758 allows for guarantees to be assigned, if specifically stated in the
terms. Beneficiaries may assign proceeds that they may be, or may become,
entitled to receive under the guarantee, but a guarantor shall not be obliged
to pay an assignee unless it has agreed to do so (URDG 758 sub-article
33(g)).
11.7 Demands
When a demand is made under a guarantee, the instructing party (or, where
applicable, the counter-guarantor) must be informed without delay. Once
the guarantor has examined the demand and found it to be compliant, the
sum demanded and paid will be deducted from the total sum available under
the guarantee.
11.8 Expiry
Guarantees issued subject to URDG 758 must specify an expiry date or an
expiry event (for example, hand-over of a new hospital). Where the guarantee
has expired, been cancelled or paid upon, its retention by the beneficiary
does not preserve any rights.
However, where guarantees are not subject to URDG 758, expiry can become
a contentious issue where the beneficiary is located in a country that does
not accept guarantees with an expiry date, eg in some countries in the Middle
East. Under some laws, where a guarantee is subject to a local law, that law
may dictate that the expiry date is ignored to the extent that expiry will occur
upon surrender of the original guarantee, after a certain period of time after
expiry, ie 30 days or after a designated grace period.
This causes real difficulties to both the applicant (or instructing party) and
the guarantor. Not only does a potential risk remain but, under accounting
rules, a contingent liability must also remain on the balance sheet of either
applicant (or instructing party) and guarantor, until the beneficiary gives a
written consent to cancellation or returns the guarantee. In addition, as
long as the guarantee remains outstanding, the client must pay regular
It should be noted that most banks have sets of standardised wording for
use in the more commonly issued types of guarantee. If a client requests a
guarantee that does not comply with such templates, then the wording may
need to be vetted by the banks legal experts or senior personnel within the
guarantees department before issue, taking additional time before issuance.
u a creditor;
draft and a statement issued by the beneficiary that the applicant, for
example:
u has not met the terms of a contract;
u has not paid a loan on the due date;
u has not paid for goods shipped;
u has not built a bridge successfully or on time.
Other documents, such as a certificate of non-performance from an
independent assessor or a ruling from an arbitration court, may also be
appropriate, depending on the underlying transaction.
Standby letters of credit may be issued subject to UCP 600 (as stated in
UCP 600 Article 1), but are used differently to commercial letters of credit.
A standby letter of credit is used to protect against non-performance or
non-payment. Standby letters of credit are not a primary means of making a
payment.
A standby letter of credit is a powerful tool in the hands of a beneficiary.
Being covered by the terms of UCP 600 (or ISP98 see below), there is no
possibility for the applicant or its bank to refuse to make a payment, even
if the applicant has a strong case for resisting payment, should a complying
presentation be made.
For example, in a building contract, the applicant might argue that the
labour supplied by the beneficiary was inadequate and give this as a reason
for non-performance. But this will give the applicant or the issuing bank
no grounds to refuse payment under the standby letter of credit, as the
issuing bank will pay against presentation of the specified documentation.
The applicant may, however, be able to prevent payment, if fraud is involved.
Although standby letters of credit may be issued subject to UCP 600, many
of the articles of UCP 600 are not relevant to a standby letter of credit.
Therefore, the Institute of International Banking Law & Practice (IIBLP) drafted
a set of internationally accepted rules (International Standby Practices)
specific to standby letters of credit, known as ISP98. ISP98 rules are being
increasingly used by banks globally.
A standby letter of credit, therefore, must either state clearly whether it is
subject to UCP 600 or ISP98.
u For payment against documents Rule 1.06d sets down the principle
that the issuers obligation to pay is to be decided upon only by the
examination of required documents. Rule 4.08 states: If a standby does
not specify any required document, it will still be deemed to require a
documentary demand for payment. Rule 4.11 goes on to make it clear
that any terms of a standby that do not refer to documents may be
disregarded.
u Undertakings Rule 2.01 sets out the undertakings of the issuer and
confirmer to honour a compliant presentation by payment of a sight draft
or acceptance in immediately available funds and in a timely manner.
Rule 2.05 makes it clear that the advising bank is only responsible for
the authenticity of the standby.
ISP98 also contains rules in the event of dishonour (Rules 5.015.07), notice
of which must be given in a timely manner more than seven days being
considered unreasonable.
financial difficulties (see Rules 6.116.14). The more likely event is that due
to the often long expiry dates for a standby letter of credit, the beneficiary
may merge with (or be acquired by) another company.
The proceeds due from claims under a standby letter of credit may be
assigned by the beneficiary, if the issuer and confirmer agree to and
acknowledge the assignment.
Since banks deal with documents only, they are in no position to refuse a
claim, if the correct documents are to hand.
u a call for payment that is legitimate but the sellers / contractors failure
is due to political events, wars or revolutions;
Other insurance cover may be taken out against, for example, the
expropriation of a contractors plant and equipment.
The services of a local office or agent working for the principal can mitigate
these risks.
Therefore, issuing guarantee and standby letters of credit poses a very real
credit risk for the bank. The following issues will be in the mind of the banks
credit officer as well as that of the applicant for the guarantee or standby
letter of credit.
u What is the banks experience with the applicant and the country with
respect to guarantees being called without justification?
u Are the sums involved within the applicants capacity to meet them,
without a devastating impact on its business?
u What security can the applicant offer, or should the bank hold a cash
deposit as security?
The banks credit officer will be aware that one of the commonest reasons
for a bond being called is the insolvency of the applicant. If the applicant
is unable to pay or deliver to the beneficiary under the contract, they are
unlikely to be able honour the counter-indemnity to the bank.
When the applicant is given approval, they will have to sign the banks
counter-indemnity, acknowledging, where applicable, that the guarantee will
be issued subject to URDG 758. This may also be evidenced by the wording
that appears in the application form for the issuance of the guarantee and
that is signed by the applicant. In practice, many standby letters of credit are
issued subject to local laws (see section 11.5 above, covering locally issued
guarantees) and in such cases may not be covered by URDG 758.
Governing rules UCP 600 or ISP98 URDG 758, UCP 600 or ISP98
or specified jurisdiction or local
laws of beneficiarys country
Transfer and / or ISP98 permits transfer to more URDG 758 permits assignment
assign than one party, but does not of the bond if specifically stated
allow for partial transfers. This in its terms. Proceeds may, in
differs from UCP 600 transfer any event, be assigned, but the
rules (see chapter 8). guarantor shall not be obliged
The proceeds of a claim may be to pay an assignee unless it has
assigned. agreed to do so.
Chapter summary
This chapter has been concerned with those banking products and services
that provide an undertaking that a business or government organisation
importing from, or contracting with, a banks customers will be reimbursed
in the event that the banks customer fails to perform.
u There are two types of bank undertaking, both of which are irrevocable:
u Both products pose real risks to an applicant and to the issuing bank, both
of whom will want to be certain that they understand the risks involved,
the record of the beneficiary and the tendency for unfair calling.
References
ICC (1992) Uniform rules for demand guarantees. ICC Publication No. 458E.
ICC (1995) Uniform rules for collections. ICC Publication No. 522.
ICC (1998) ISP 98 International standby practices. ICC Publication No. 590E.
ICC (2007) Uniform customs and practice for documentary credits. ICC Publication No.
600LE.
ICC (2010) Uniform rules for demand guarantees (URDG) including model forms. ICC
Publication No. 758E.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
2. What type of guarantee might a company need, when bidding for a new
contract from a client?
a. URDG 758
b. URC 522
c. ISP98
d. URBPO
Learning objectives
The previous chapters have been mainly concerned with bank services,
in particular with the processes that banks have developed to provide
assurance to exporters that payment for goods or services supplied will be
forthcoming. This chapter is about an alternative method: insuring against
non-payment by the use of credit insurance.
Broadly, the market for such insurance falls into two groups:
2. long-term, where the risk extends for more than 180 days.
Table 12.1 Main areas of credit risk and sources of risk protection
under the policy, the bank would have no claim either. Thus this security
would not be absolute.
u Policies are usually provided for between 80 and 95 per cent, ie the seller
is left with between 5 and 20 per cent of the risk.
u However, the insurer will impose limits on each buyer and may restrict
cover in certain high risk markets.
u Policies are offered at about the same level of cover, but premiums may
reflect the higher risk of a smaller spread of risk. For the seller with one
or two large buyers that are crucial to its business, this may be the best
option, particularly where a default could be catastrophic to its business.
u Once a certain pre-agreed level of loss has been sustained, the remaining
losses in the policy period will be insured.
With two countries trading within the same region, the risk is low and there
are often detailed inter-government agreements and treaties that facilitate
the single market.
But in less stable political regimes the risks can be substantial. A business
operating overseas might face any of the following situations:
The premium and limitations on cover will depend upon the insurers
view of economic and political stability in the areas for which cover is
required. Cover for some of the above risks may not be available even from
government-backed agencies, depending on the circumstances of each case.
One of the key advantages of using specialist insurers and factors, apart
from the peace of mind provided, is the access that a business has to an
insurers and / or a factors database, which can give an early indication,
before a contract is negotiated, of risks that are best avoided.
The nature and premium cost of any credit insurance purchased will take
account of:
u the spread of risk the more countries and customers offered to the
insurer, generally the lower the average premium;
u whether the business is both willing and able to accept a higher excess
than average see key customer and excess policies described above.
In the event of non-payment due to buyer insolvency, the insurer will pay
once the insolvency is proved. For other reasons for non-payment, the
insurance payout may be delayed, eg until after goods have been disposed
of, when the buyer has refused to take delivery.
u buyer insolvency;
u the buyers failure to pay within six months of the due date;
u any natural disasters, wars or civil strife that prevent the performance of
the contract.
In relation to events within the country of the government agency, the policy
might cover:
u measures introduced after the contract date that hamper the performance
of the contract.
The policy will not normally provide 100 per cent cover. Typically, the policy
will provide cover for 95 per cent of the insured risk, with the seller bearing
the remaining 5 per cent.
Chapter summary
In this chapter, you have learned about:
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
the seller.
b. Changes to import rules and licences.
4. A financially strong seller with good in-house credit control and with
turnover of several million pounds requires a product that will protect
them against buyer default if the total loss in the financial year exceeds
GBP5m. However, there is no product that can help here, as any credit
insurance must cover the whole turnover. True or false?
Learning objectives
u currency options;
This chapter introduces you to the services that banks provide to minimise
the risks that customers face when currency values go up and down.
Buyers, sellers, businesses that buy and sell goods or services overseas, and
people and businesses who invest in factories, markets or property are all
directly concerned with the change in value of the domestic currency against
a foreign currency.
The value of currencies against each other has historically been very volatile.
The customer is exposed to this volatility, if they do nothing to protect the
business against currency movements. This exposure is often termed the
exchange risk.
The conventions for giving quotations follow this pattern: the first currency
named in an exchange rate quotation is known as the base currency and the
second currency is known as the underlying or term or quote currency.
For example, if you were looking at the EUR / USD currency pair, the euro
would be the base currency and the dollar would be the underlying currency.
The price represents how much of the underlying currency is needed for you
to get one unit of the base currency; quoted this way, a EUR / USD rate of
1.2132 means that USD1.2132 is needed to buy EUR1.0000.
For some exchange rates, the quotation for the same currency pair can be
shown in two different ways, the first quote showing one currency as the
base and a second showing the other currency as the base.
For example, for the sterling / EUR quote you could see:
u EUR / GBP0.8900; or
u GBP / EUR1.1200.
The key point to remember is that the first currency is always the base
currency and the second one is the underlying currency.
Most foreign exchange rates are quoted to four decimal places, as above,
and the fourth decimal place is called a basis point or sometimes a pip.
Look for the code for your own countrys currency and the code for the
two countries with which your country trades most often.
The bank will quote a rate, as above, and will settle the transaction within
two business days. This means that the exact day when the currency will be
made available, if purchasing, must be established with the bank. For most
day-to-day transactions, a bank will accept a foreign payment instruction
and provide a foreign currency quotation at the same time. Customers can
therefore either visit their branch or provide an electronic instruction on the
banks system to make a payment and accept an exchange rate quote at the
same time.
For large sums, the delivery of the currency may be on the second business
day, and that will have to be taken into account when making payments.
A business that permanently relies on the spot market for its foreign
exchange transactions is not taking any form of hedge against possible
future movements in the exchange rate.
The alternative for the customer is to fix the rate immediately they know
that a payment is to be made or funds are to be received in the future. The
most common fixing instrument is the forward exchange contract (forward
contract).
Both bank and customer are bound by this agreement, and the transaction
must take place on the due date in accordance with the agreement and
irrespective of what the actual spot rate is at that time.
u simplicity;
u For sellers, if the foreign currency is not received at the maturity date of
the forward contract, the bank will close out: it will sell the currency to
the customer at the spot rate and immediately repurchase it at the agreed
forward rate. The resultant gain or loss will appear as a debit or a credit
on the customers account.
u Thus, if a customer cannot fulfil the terms of the forward contract, the
close-out procedure will apply. This procedure will result in either a gain
or a loss, depending on the spot rate at the date of the close-out. If
the customer made a loss on a close-out and would not or could not
reimburse the bank, the bank would incur a bad debt. Thus banks treat
forward contracts as a contingent liability, based on the maximum likely
loss that could arise on a close-out. This means that the amount the
customer could have borrowed on conventional loans or overdrafts is
reduced by the amount of the contingent liability during the life of the
forward contract.
A business that is regularly trading in Europe, for example, may have a euro
account to which euro receipts are credited and from which payments can
be made to suppliers.
This will act as its own partial hedge at relatively little cost or risk. This is
because the customer can match and net their exposures. A company trading
with several buyers and sellers in the eurozone (and indeed with others
who are willing to trade in euro as one of the two most used international
currencies) can arrange that money received from sales is credited to the
euro account from which payments to suppliers will also be made.
u that interest may be earned on the account but the rate, at times, may be
lower than paid on the home currency account;
u A call option gives the customer / purchaser the right to buy the
currency.
u A put option gives the customer / purchaser the right to sell the
currency.
u The strike price is the price agreed for the call / purchase or the put /
sale.
u The premium is the price paid by the purchaser for their call or put
option.
The price or premium is determined by: the spot price or the intrinsic value;
the time period of the contract; and the volatility of the currencies involved.
The mathematics of calculating the price is therefore complex and it is
beyond the scope of this syllabus.
u Premium: GBP586.89
To buy an option contract, a customer can use the services of the bank or can
trade on an exchange through a broker acting on their behalf. The advantage
to the customer of an option contract is flexibility and the opportunity to
take a profit on the spot market when that exists, while insuring against a
large loss.
However, options will not suit all customers, particularly for small trades
(say less than GBP10,000 per trade), either because the premium will be
relatively high for small sums or because traded option contracts are not
available for small amounts.
1. translation exposure;
2. economic exposure;
3. transaction exposure.
in its favour. Conversely, the surprise may be unpleasant, if the rate has
moved adversely.
On the other hand, hedging will introduce an element of certainty, since the
rate will be fixed at the time the business enters into a forward exchange
contract or the worst possible rate will be known if it buys a currency option
from its bank.
1. where a business has published price lists for its products denominated
in foreign currency;
This is a more difficult exposure to manage, because the business does not
know how much it will sell at the published prices, or whether it will receive
any foreign currency at all in the case of tenders, since the contract may not
be awarded.
So every business needs to have a strategy and policy for managing the risk
from the movement of exchange rates.
u How often are payments made and / or received for each currency:
Once a business has a clear picture of where the main exposure lies, it can
draw up a strategy to mitigate the risks, using the products outlined in this
chapter.
Chapter summary
u The conventions for quoting currencies place the base currency before
the underlying / quote currency so, for example, EUR / USD 1.3400 means
that USD1.34 must be provided to buy EUR1.00.
u Spot rates are available for immediate delivery (within two working days)
on all major currencies, but always buying or selling spot provides no
risk protection.
u Banks will quote a forward exchange rate, so that customers can remove
the risk of exchange rate movements between the commercial contract
date and actual receipt of the currency.
u Every business should have a strategy for dealing with its risk to currency
movements. This strategy should take account of the extent and timing
of exposures, the potential cost of not covering the risks and the
competitive position of the business.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. One very simple method of avoiding foreign currency risk between the
completion of a commercial contract and receipt / payment of the
foreign currency is to insist that all prices and invoice amounts are
denominated in home currency. Why does this not always happen?
4. A bank customer will always lose and be debited with the net settlement
in any close-out on a forward contract. True or false?
5. A small exporting business that has tight profit margins has its entire
turnover denominated in foreign currency. Give one argument for
hedging this exposure.
Learning objectives
u the risks that money laundering, terrorist financing and other forms
of financial crime present to banks;
Over the past few decades, there has been a dramatic increase in the volume
of international trade, as Figure 14.1 indicates.
Crucial to this meteoric rise in international trade is the role of banks, which
offer the services and products that allow buyers and sellers to increase their
trading activity. In any trade transaction, it is likely that one or more banks
will be involved at some point. However, banks never come into physical
contact with the goods being traded; they deal only with documentation,
and the type and amount of documentation provided varies according to the
type of transaction. For example, with documentary credits the bank may
have access to inspection certificates, commercial invoices, packing lists
and other documentation. In contrast, with open account trade, there may
be very little or no documentation available. As a result, international trade
involves an inherent risk of financial crime, particularly in relation to money
laundering.
u product type;
u jurisdiction;
u customer type;
Applying a risk-based approach means that banks can ensure that their
systems and controls will focus greater effort on high-risk areas.
Practitioners are advised to refer to the Financial Action Task Force (FATF)
Recommendations (see section 14.2.1.1 below), the Wolfsberg Group paper
(2000) on the risk-based approach, and other industry bodies.
3. Integration once the origin of the funds has been obscured, the funds
are invested in legitimate funds and assets.
Even if the source of funding for terrorist activity is legitimate, terrorists will
often attempt to disguise it in order to preserve future funding. Many of the
techniques used to do this will be the same as techniques used to disguise
the sources of the proceeds of crime.
Banks also face the difficulty of how to identify assets that are derived from
legitimate sources but are destined to fund future acts of terrorism.
The key to the prevention of both money laundering and terrorist financing
is the adoption of adequate customer due diligence procedures, both
at the commencement of a relationship and on a continuing basis (see
section 14.3.1 below).
Note that sanctions regulations overrule UCP. Additionally, note that the
use of sanctions clauses causes confusion, especially where confirmation is
required.
u responds to new threats that affect the integrity of the financial system,
such as proliferation finance (ie finance related in any way to the
development, manufacture, export or storage of nuclear, biological or
chemical weapons in contravention of national laws or international
obligations);
At the time of writing (February 2014), the FATF currently has 36 members
(34 jurisdictions and two regional organisations) that represent the major
financial centres in the world, as listed in Table 14.1.
As the list of member countries increases regularly, you are advised to visit
the FATF website (www.fatf-gafi.org [Accessed: 10 March 2014]) to check
the current membership.
u demonstrate what financial crime is, and what firms, regulators and law
enforcement agencies should do.
u Banco Santander;
u Barclays;
u Citigroup;
u Crdit Suisse;
u Deutsche Bank;
u Goldman Sachs;
u HSBC;
u JP Morgan Chase;
u Socit Gnrale;
u UBS.
u UK: www.nationalcrimeagency.gov.uk
u USA: www.fincen.gov
u Singapore: www.cad.gov.sg
u Australia: www.austrac.gov.au
u Canada: www.fintrac.gc.ca
The better a bank knows its customers and understands the basics of its
commercial relationship with them, the less likely it is to be associated with
a firm that will attempt to carry out money laundering or terrorist financing
activity.
Once the account is open and transactions are passing through the account,
bank staff should be aware of money laundering techniques. Transactions
that might put staff on notice include:
u Multiple invoicing by issuing more than one invoice for the same
goods, a seller can justify the receipt of multiple payments.
u Short shipping the seller ships less than the invoiced quantity or
quality of goods, thereby misrepresenting the true value of goods in the
documents (this is similar to over-invoicing).
u military goods;
u dual-use goods (ie products and technologies normally used for civilian
purposes but that may have a military application);
Each bank will identify appropriate red flags through its own risk-based
assessment process, or will have them defined by a regulator. The list above
is only indicative.
Take a look at the process flows and points at which checks should be
made:
Nowadays some of the main dangers to the world banking system tend to
come from criminals intent on stealing money from banks or their clients by
illegally accessing (hacking) banks IT systems, and often diverting funds
and information for their own benefit. Phishing exercises, where emails
purporting to come from banks persuade clients to reveal passwords and
other private information to criminals, are regularly found in many peoples
inboxes and often succeed in their purpose.
14.4 Regulation
Breaches in compliance with regulations and laws have cost many banks
heavily over the past few years, with banks paying multibillion-pound
settlements for alleged cases of money laundering, sanctions breaking
or misleading clients. Increasingly, legislation is aimed at the criminal
prosecution of individuals involved in processing or facilitating each
transaction.
System, the Office of Foreign Assets Control (OFAC), and the Department of
Justice.
u USA the Federal Reserve is the central bank of the United States. It is
responsible for regulating the US monetary system, as well as monitoring
the operations of holding companies, including traditional banks and
banking groups. The US Department of the Treasury was originally
created to manage government revenues, but has evolved to encompass
several different duties, including recommending and influencing fiscal
policy, regulating US imports and exports (including managing OFAC),
and collecting US revenues such as taxes; it also designs and mints all US
currency.
u Hong Kong the principal regulators are the Hong Kong Monetary
Authority, the Securities and Futures Commission, the Office of the
Commissioner of Insurance, and the Mandatory Provident Fund Schemes
Authority. They are responsible respectively for regulation of the banking,
securities and futures, insurance, and retirement scheme industries.
Chapter summary
In this chapter we have provided an overview of financial crime, focusing on
money laundering and financing of terrorist activity.
We have outlined the measures that banks must put in place in order
to prevent financial crime and some of the warning signs relating to
international trade finance transactions of which practitioners should be
aware. We have also looked briefly at other common types of financial crime
that sometimes take place through the banking system.
References
AGP (2012) APG typology report on trade based money laundering [pdf]. Available at:
www.fatf-gafi.org/media/fatf/documents/reports/Trade_Based_ML_APGReport.pdf
[Accessed: 10 March 2014].
Basel Committee on Banking Supervisions (2014) Sound managemetn of risks related to
money laundering and financing of terrorism [pdf]. Available at:
www.bis.org/publ/bcbs275.pdf [Accessed: 24 March 2014].
FATF (2010) Combating proliferation financing: A status report on policy development and
consultation [pdf]. Available at: www.fatf-gafi.org/media/fatf/documents/reports/Status-
report-proliferation-financing.pdf [Accessed: 10 March 2014].
FATF (2012) About the FATF [online]. Available at: www.fatf-gafi.org/trash/aboutfatf/
whatisfatf/aboutthefatf.html [Accessed: 10 March 2014].
Organisation for Economic Co-operation and Development (2012) OECD Stats [online]
https://stats.oecd.org [Accessed: 25 March 2014].
The Wolfsberg Group (2002a) Wolfsberg statement on the suppression of the financing of
terrorism [pdf]. Available at: www.wolfsberg-principles.com/pdf/standards/Wolfsberg_
Statement_on_the_Suppression_of_the_Financing_of_Terrorism_(2002).pdf [Accessed: 10
March 2014].
The Wolfsberg Group (2002b) The Wolfsberg anti-money laundering principles for
correspondent banking [pdf]. Available at: www.masak.gov.tr/media/portals/masak2/files/
en/Legislation/LaunderingProceedsofCrime/international_legislation/WG/correspondent_
banking_pr.pdf [Accessed: 10 March 2014].
The Wolfsberg Group (2003)Wolfsberg statement on monitoring screening and searching
[pdf]. Available at: www.wolfsberg-principles.com/pdf/standards/Wolfsberg_
Monitoring_Screening_Searching_Paper_(2003).pdf [Accessed: 10 March 2014].
The Wolfsberg Group (2011) Wolfsberg trade finance principles [pdf]. Available at:
www.wolfsberg-principles.com/pdf/standards/Wolfsberg_Trade_Principles_Paper_II_(2011)
[Accessed: 10 March 2014].
The Wolfsberg Group (2012) Wolfsberg anti-money-laundering principles for private
banking [pdf]. Available at: www.wolfsberg-principles.com/pdf/standards/Wolfsberg-
Private-Banking-Prinicples-May-2012.pdf [Accessed: 10 March 2014].
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
a. Placement
b. Layering
c. Integration
d. Folding
a. 30
b. 40
c. 50
d. 60
Learning objectives
This chapter looks at a new type of payment instrument: the bank payment
obligation (BPO).
been limited innovation in this domain over the last several decades, if not
hundreds of years. While technology has evolved to enable faster and more
efficient processing, the fundamental nature of traditional trade finance has
remained largely unchanged.
If industry forecasts for growth prove correct, by 2020 not only will the
value of world trade have doubled but there will also be an additional USD17
trillion worth of business, all being conducted on open account. In the face
of these changing market dynamics, the effective management of credit and
liquidity is of growing importance as a powerful strategic tool, not only in the
context of risk mitigation and payment assurance but also in having ready
access to cost-effective working capital finance. To achieve these goals, it
is recognised that there needs to be enhanced process efficiency, enabling
clear visibility into the physical supply chain (the movement of goods from
one place to another), linking to the financial supply chain (the movement of
money in the opposite direction) and facilitating the fast exchange of data
and speedy resolution of disputes.
It should be noted that the BPO is not a product, but rather a framework,
complete with processes, rules, standards and practices aimed at the
provision of solutions in trade and supply chain finance. It can be used
by financial service providers, to enhance a broad range of financial supply
chain product offerings.
2. the ISO 20022 TSMT messaging standards (see section 15.2.2 below),
which enable the data to be presented and matched in a structured way,
according to accepted industry practice;
3. the ICC Uniform Rules for Bank Payment Obligations (URBPO), providing
a framework for BPO transactions in much the same way as UCP 600
provides a framework for documentary credits (see Chapter 8).
To develop new products based around a BPO, a bank must: address its
product positioning relative to existing open account and documentary
solutions; and deploy a technology platform that can support communication
not only with the corporate client but also with a central TMA, such as SWIFTs
Trade Services Utility, while interacting with the banks own accounting,
credit, capital reporting and payment applications. To make these products
successful, a bank must also develop its own commercialisation plan.
u the bank that must make payment under the BPO (the obligor bank);
u the bank that receives payment under the BPO (the recipient bank);
The BPO allows for a variety of features and commercial scenarios, including
the acceptance of mismatches and amendments, the engagement of multiple
banks in one BPO transaction, the ability to handle partial shipments, and
the option to share risk among banks through the distribution of obligations
under the BPO.
The BPO transaction life cycle formally begins with an ISO 20022 message
called an Initial Baseline Submission. The counterparty bank must resubmit
an identical version of the baseline in order for the transaction to become
established. The transaction cannot be established, and therefore the BPO
cannot be established, unless both sides agree. As soon as the two baselines
match, the BPO becomes an irrevocable undertaking conditional on the
matching of the specified data.
1. The buyer and seller contract to use a BPO as the method of payment.
2. The relevant purchase / sales order data are passed to each bank.
3. After shipment, the seller provides commercial and transport data to its
bank.
4. When the commercial and transport data have been matched to the
purchase order data, the BPO is due and payment (or an undertaking
to pay at an agreed future date) will follow.
All of these steps involve interactions between buyers, sellers and their
respective banks without touching the TMA. These steps are therefore
outside the scope of the TMA service and outside the scope of the URBPO.
There are no rules governing the way in which data are exchanged between
a corporate customer and a bank. This is purely a matter for negotiation
between the customer and its selected service provider.
1. The buyers bank uses the purchase order data to submit a baseline, and
the sellers bank uses the purchase order data to resubmit the baseline.
This enables the transaction to become established.
2. Both the buyers bank and the sellers bank receive a baseline match
report, to confirm that the two baselines match.
Source: SWIFT
3. Once the goods are shipped, the sellers bank submits the invoice and
transport data to the TMA.
4. The data set match report confirms that the invoice and transport data
match the baseline and the BPO is due.
ISO 20022 is a set of standards developed by ISO for use in the financial
industry. Usage of ISO 20022 messages results in consistency and uniformity
of format and terminology through use of a common data dictionary. The
adoption of structured ISO 20022 TSMT messaging standards is mandatory
to support the exchange of BPO data through a recognised TMA.
Figure 15.2 Interactions inside the scope of the URBPO where the buyers
bank is the only obligor bank
Source: SWIFT
ISO 20022 standards are the methodology established by ISO for message
development and specify the format for commercial, transport, insurance
and certificate data sets to be submitted by a bank in relation to an
underlying BPO transaction.
that both banks agree on what the baseline looks like. This also confirms
that both banks agree on the data-matching terms and conditions. As soon
as the two baselines match, the BPO becomes an irrevocable undertaking
conditional on the matching of the specified data.
Later in the transaction life cycle, the goods will be shipped and the physical
documents sent directly from the seller to the buyer (as in a conventional
open account environment). At the same time, the seller will provide to
its bank the relevant data elements that have been extracted from the
underlying documents. The bank acting on behalf of the seller will submit
those data sets into the TMA for matching.
One material difference between a BPO and a documentary credit is that the
BPO is given by a bank (the obligor bank) in favour of another bank (the
recipient bank), whereas a documentary credit is issued by a bank in favour
When and how value is passed to the seller is outside the scope of the
URBPO, and will form part of a separate agreement between a recipient
bank (the sellers bank) and its customer. Included in the terms of such
an agreement, the recipient bank can issue another contingent obligation
towards the seller, based on the BPO received. This can have the same effect
as a silent confirmation of a documentary credit, whereby a beneficiary can
enter into a separate arrangement with a negotiating bank to commit to
negotiate the documentary credit on its due date.
15.4.1.4 Amendments
The terms and conditions attached to a BPO transaction can be amended
quickly and easily by mutual agreement between the involved banks. This
includes the ability to: create a transaction without a BPO but then add the
BPO later by way of an amendment; or change the due date of the payment.
Such flexibility can provide additional advantages in relation to the cost of
capital and hence the cost of financing.
Having multiple BPOs for a single transaction creates a wider opportunity for
trade asset distribution, for example in a lead bank model where one bank
may invite other obligor banks to participate in a risk. If multiple obligor
banks are involved in a single TMA transaction, the amount due by each
obligor bank is proportional to its share of the total of all BPO amounts. No
joint and several obligations are created.
15.4.1.6 Finance
In the absence of a documentary credit, sellers lack the collateral to obtain
finance under open account. Available options may be limited to factoring or
invoice discounting. With a BPO, a comprehensive range of financing options
can be made available, including pre-shipment and post-shipment finance.
From a cash management point of view, this is beneficial to both buyers and
sellers alike, since it delivers certainty on cash flow in and out. The ability to
provide such an absolute level of payment assurance clearly strengthens the
buyerseller relationship, possibly resulting in the opportunity to negotiate
improved terms and conditions.
Buyers who engage in a BPO contract with one or more sellers will contribute
to the streamlining of supply chain processes, resulting in enhanced risk
mitigation and improved efficiency. This may be turned into a competitive
advantage over other buyers, resulting in improved payment terms.
15.4.2.2 Finance
From a buyer perspective, a BPO is obviously safer than pre-payment. It
allows the buyer to confirm that the goods have been shipped on or before
the due date according to the required specification, before committing to
pay.
Because the electronic processing of data is faster, the buyer can potentially
get quicker access to banking services, including financing where required.
Because the BPO provides banks with greater visibility into the trade
transaction, the buyer can also benefit from specific financing services (eg
extended payables finance), tailored to working capital needs at any stage of
the transaction life cycle. This feature is similar to what is available through
the existing documentary credit practices, but offers a wider spectrum of
financing opportunities in a more timely fashion. Because it can be created
at any time during the life cycle of a transaction, and for an amount that
can differ from the total value of the goods, the BPO offers greater flexibility
than a documentary credit.
It can also help to spread payment risk across several obligor banks, for
example by instructing a lead bank to allocate the risk according to a trade
asset distribution model. This flexibility could result in lower financing costs
as well as reduced costs for the seller, creating more value in the supply chain
and potential opportunities for higher degrees of accuracy and objectivity.
For critical suppliers, a buyer may decide to offer a BPO in order to ensure
that the goods ordered continue to be delivered on time and that there are
no interruptions to the supply chain.
A seller can get financing from its bank at different stages in the transaction
life cycle. The BPO can be used to sustain the sellers working capital
in support of, for example, production (pre-shipment finance, inventory
finance), product shipment (packing and distribution loans) or business
development and growth. Failure to have access to these facilities could
prove detrimental to the sellers continued ability to trade.
At the same time, there is the added flexibility that in the event of data
mismatches being found, the buyer has the immediate discretion to accept
or reject such mismatches, so reducing the risk of extended disputes and
delay.
Buyers trade with multiple sellers across the globe, often in different
jurisdictions resulting in a variety of payment terms, and potentially using
more than one supply chain finance platform. These platforms use different
exchange mechanisms, from electronic proprietary data formats, to fax
and email. The cost of integration with corporate back-office applications
becomes prohibitive, when the number of trading players grows or varies
over time. It also implies significant on-boarding costs (ie the process
of bringing suppliers on board to participate in the financing scheme)
and lengthy know your customer processes. The BPO is designed for a
four-corner business model, involving a buyer, a seller, a buyers bank and a
sellers bank. The goal is to help buyers to reach multiple suppliers through
selected banks in the existing correspondent banking network.
Where:
u a buyer and a seller wish to trade on open account terms, but seek bank
assistance to help with the mitigation of risk;
u a buyer and a seller wish to trade on open account terms, but the seller
additionally seeks an assurance of payment from the bank;
u a buyer and a seller wish to trade on open account terms, but bank
assistance may be required to support short-term working capital
financing arrangements;
u a buyer and a seller wish to trade on open account terms but to keep
open the possibility of obtaining bank assistance for financing at any
time during the transaction life cycle;
While some banks have already conducted transactions with the use of a
BPO, others are currently involved in developing their own solutions and
have clients trying to identify potential counterparts.
The foreword to the URBPO states clearly that the use of BPOs is aimed as
a solution to supply chain financing problems. It is hoped that banks and
non-bank providers will respond with financing services to complement BPOs
and meet their clients needs, whether in international or domestic trade.
There are 16 articles in the URBPO, and the areas covered are outlined below.
Article 1
Article 1a defines the scope of the URBPO as follows:
The ICC Uniform Rules for Bank Payment Obligations (URBPO) provide
a framework for a Bank Payment Obligation (BPO). A BPO relates
to an underlying trade transaction between a buyer and seller
with respect to which Involved Banks have agreed to participate in
an Established Baseline through the use of the same Transaction
Matching Application (TMA).
Article 2
Article 2 describes the applicability and binding nature of the URBPO subject
to specific version numbering and mandatory use of ISO 20022 messaging
standards.
Article 3
Article 3 provides a list of general definitions and how these should be
interpreted in the context of the URBPO. For example:
u the recipient bank is the beneficiary of the BPO and will always be the
sellers bank;
Article 4
Article 4 provides a list of message definitions, describing all such ISO 20022
TSMT messages as may be used in a BPO transaction.
Article 5
Article 5 provides specific interpretations within the scope of the rules, eg
that branches of a bank located in different countries are considered as
separate banks.
Article 6
Article 6 indicates the separate nature of a BPO from the underlying contract.
Article 7
Article 7 describes how BPO data may be extracted from the physical
documents which, in the majority of cases, may still exist. Banks involved
in a BPO transaction deal in data, not documents or the goods, services or
performance to which the data or documents may relate.
Article 8
Article 8 covers the expiry date for the submission of data sets. The use of
Universal Time Co-ordinated (UTC) allows for the adoption of a consistent
and standard timing protocol on a global basis. UTC is recognised as the
primary standard by which world time is regulated: it is commonly used in
the synchronisation of computer systems and the internet.
Article 9
Article 9 covers the role and responsibilities of an involved bank, including
the obligation to act without delay on receipt of a message from a TMA.
Article 10
Article 10 covers the undertaking of the obligor bank, including those
scenarios in which there may be more than one obligor bank.
Article 11
Article 11 covers the subject of amendments, again including scenarios
where there may be more than one obligor bank.
Article 12
Article 12 covers the use of a disclaimer clause, consistent with other ICC
rules.
Article 13
Article 13 addresses the concept of force majeure, also consistent with
other ICC rules.
Article 14
Article 14 specifies that an involved bank cannot be held liable if a TMA is
unavailable.
Article 15
Article 15 specifies applicable law (being that of the country where the
branch or office of the obligor bank is situated).
Article 16
Article 16 confirms that a recipient bank has the right to assign any proceeds
under a BPO.
Chapter summary
This chapter has looked at the subject of bank payment obligations (BPOs)
and the ICC rules covering them:
u The BPO transaction life cycle formally begins with an ISO 20022 message
called an Initial Baseline Submission. The counterparty bank must
resubmit an identical version of the baseline in order for the transaction
to become established. The transaction cannot be established, and
therefore the BPO cannot be established, unless both sides agree. As soon
as the two baselines match, the BPO becomes an irrevocable undertaking
conditional on the matching of the specified data.
assurance of payment;
dispute resolution;
amendments;
risk mitigation;
finance.
finance;
process efficiency.
u The Uniform Rules for Bank Payment Obligations (URBPO) have been
effective since 1 July 2013.
References
ICC (2013) Uniform rules for bank payment obligations. ICC Publication No. 750E.
Review questions
The following review questions are designed so that you can check your
understanding of this chapter. The answers to the questions are provided at
the end of these learning materials.
1. In the world of trade finance, what does the term BPO mean?
2. What are the three components that must interact with one another to
facilitate the successful completion of a BPO transaction?
The publications listed below are available from the ICC online store:
store.iccwbo.org/
Chapter 1 Introduction
1. True. Ownership and management are the same with sole traders and
small partnerships. Ownership and management are not the same for
public limited companies, so there is potential for conflict, known as
agency theory here.
2. Because the value of the foreign currency may change, which can lead
to unexpected financial gains or losses unless managed very closely.
5. The three main activities of the ICC are rule setting, dispute resolution
and policy advocacy.
Note: The exchange rate could move either way, so there is the
possibility of making gains on favourable foreign exchange rate
movements as well as of making losses.
2. Once the goods are assembled, it could then take a number of weeks for
them to be shipped before they arrive at their destination. In addition, in
order to secure an export sale, the exporter may have to grant extended
sales terms. This additional time may put a strain on the working capital
facility of a business and it may need additional finance in order to fund
the time gap between shipment and receipt of payment.
6. A joint venture (JV) is a legal entity formed between two or more parties,
sometimes referred to as a co-operative agreement. The company
wishing to export would find a local overseas company with which it
would look to work together in the targeted country.
Chapter 3 Contracts
1. The correct answer is a.
3. False. India, South Africa and the UK are three major nations that have
not ratified the CISG.
4. False. For the French bank it is a nostro account; for the US bank it is a
vostro account.
4. False. There are three levels (A, B and C) in the General Cargo Clauses.
6. 1 January 2011.
2. Documentary collections.
3. Documentary credits.
4. Open account.
4. No, but it should check that documents listed on the covering schedule
are indeed enclosed.
5. Nothing. The goods will already have been released to the importer when
the bill was accepted.
4. 21 calendar days.
6. The local confirming bank will ensure that the exporter received funds
in return for a compliant presentation of documents. This is useful when
the overseas bank that opened the documentary credit is not well known,
or is in a country where the authorities might interfere with payments
out of the country.
2.
a. The document that the importer will be required to sign and which
the bank will retain is a trust receipt.
b. The document that the bank will give to the customer in order to
allow him to obtain possession of the goods from the warehouse is
a delivery order.
3. False. Factoring is only suitable where the terms of trade are simple and
straightforward. This effectively means open account terms. In addition,
it should be easy to negotiate a term bill of exchange drawn under a
documentary credit, once the bank has checked that the documents
conform to its terms (assuming that the issuing bank is sound). Thus
the documentary credit can provide post-shipment finance anyway.
3. True.
4. False.
5. The insurer will have a vast database, which will track the
creditworthiness of potential overseas buyers, and can advise the
exporter of the status of any new potential buyers who want credit.
2. No. An option gives the purchaser the right, but not the obligation, to do
something. Hence, once the premium has been paid, the option holder
has no obligations, only rights.
5. Small and tight margins imply that there will not be the financial
resources to cope with any foreign currency losses. Hence hedging
would be recommended.
4. False.
5. Phantom shipping.
4. The beneficiary of a BPO is always the recipient bank which is always the
sellers bank.