International Payments and Trade Finance - Upstate New York Trade Conference. June 19 th 2014 Rochester, New York

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1 International Payments and Trade Finance - Upstate New York Trade Conference June 19 th 2014 Rochester, New York

2 Payment Methods - Risk Risk Triangle - A Comparison of Payment Options Seller/Exporter High Risk Buyer/Importer Low Risk Relies completely on the buyer to pay as agreed OPEN ACCOUNT No Risk Relies on buyer to pay draft on presentation or maturity DOCUMENTARY COLLECTION Documents on Acceptance Cash Against Documents Relies on exporter to ship goods as detailed in docs Risk of exporters own non-performance in adhering to all the LC requirements LETTER OF CREDIT Advised Confirmed No right of inspection No right of rejection No Risk CASH IN ADVANCE Relies on exporter to ship goods as ordered Low Risk High Risk 2

3 Payment Methods - Comparison Comparison of Payment Methods Method Goods Available To Buyer Usual Time Of Payment Risk To Exporter Risk To Importer Advance Payment After payment Before shipment None Maximum - Relies on exporter to ship goods as ordered Letter of Credit *Confirmed *Unconfirmed (Advised) After payment When documents are available at shipment Virtually none Assured of quantity and also quality at shipment if inspection report is required Documentary Collection Sight draft Documents against payment After payment On presentation or draft to importer If draft unpaid, good must be returned or disposed of, usually at loss Assured of quantity, also quality, if goods are inspected before shipment Documentary Collection Time Draft Documents against acceptance Before payment On maturity of draft Relies on importer to pay draft Minimal - Can check shipment for quantity and quality before payment Consignment Before payment, exporter retains title until goods are sold or used After use; inventory and warehousing cost to exporter Substantial risk unless through foreign branch of subsidiary None Open Account Before payment As agreed Relies on importer to pay account as agreed complete risk None 3

4 Clean Payments Open Account: Good for the Buyer Seller ships goods, sends documents Buyer pays according to payment terms Cash in Advance: Good for the Seller Buyer pays first Seller ships goods, sends documents Payment by check, bank draft or wire 4

5 Letters of Credit The Basics

6 International Rules for LC s International Chamber of Commerce (www.iccwbo.org ) Commercial Letters of Credit UCP600 (Uniform Customs and Practice for Documentary Credits) ISBP (International Standard Banking Practice for the examination of documents under documentary credits, #681 most recent version) eucp (Supplement to the Uniform Customs and Practice for Documentary Credits for Electronic Presentation) Standby Letters of Credit UCP600 (Uniform Customs and Practice for Documentary Credits) ISP98 (International Standby Practices) 6

7 International Rules for Trade Terms International Chamber of Commerce (www.iccwbo.org ) Trade Terms Incoterms 2010 Incoterms 2010 consists of only 11 Incoterms, a reduction from the 13 Incoterms

8 Letters of Credit - The Basics Factors used in determining if a Letter of Credit is the appropriate payment mechanism 1. Credit-worthiness of buyer 2. Amount involved 3. Political risk of buyer s country 4. Type of merchandise 5. Customs in the trade 6. Availability of foreign exchange 7. Types of exchange controls in buyer s country 8. Payment terms offered by competitors 9. Pre-export financing for supplier Basic premise of an LC 1. Conditional promise of the issuer to pay 2. LC deals with documents only 3. LC is only as good as the Issuing Bank 4. LC is a separate contract from the sales contract 8

9 Letters of Credit - The Basics Types of Letters of Credit Merchandise, Commercial, Trade Standby Revocable Unconfirmed (Advised) Confirmed Sight Time, Usance Revolving Credit Red Clause Credit Transferable Credit Back-to-Back Credit The majority of LCs issued are in payment for goods in shipment or current services performed. Payment is normally made against documents for goods shipped. This type of LC functions like a guarantee. This type of credit can be drawn against only credit agree. It is a definite undertaking of the issuing bank. (ICC 590; ISP 98 Rules) A revocable letter of credit may be amended or canceled by the issuing bank at any moment and without prior notice to the beneficiary. Bears only the guarantee of the issuing bank. The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary. Is a credit in which a second guarantee is added to the letter of credit by another bank. Payment is at sight, which means that the drafts and documents are honored, if in order, by making payment without delay. The draft honored by accepting it for payment at a future date. Payment is delayed until the maturity of the draft. One where the amount is renewed or reinstated without specific amendment to the credit being needed. It can revolve in relation to time or value. Authorizes the advising or confirming bank to make advances to the beneficiary before presentation of the documents. Can be transferred by the original beneficiary to one or more other parties. It is normally used when the first beneficiary does not supply the merchandise himself, but is a middleman and wants to transfer all or part of his rights to the actual supplier. The seller, as beneficiary of the first credit, offers it as security to the advising bank for issuance of a second credit. 9

10 Letters of Credit Unconfirmed & Confirmed Unconfirmed Bears only the undertaking of the issuing bank. The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary or advising bank. (Disclosed) Confirmation Is a second undertaking added to the letter of credit by another bank Must be authorized by issuing bank Means the exporter gets paid from the confirming bank, provided conforming documents are presented Regardless of whether the issuing bank can pay or not pay. Silent Confirmation A special arrangement outside the letter of credit between the exporter and the advising bank One of the key differences from a disclosed confirmation is that the silent confirmation is not authorized by the issuing bank. Mainly used for Chinese bank issued LC s where disclosed confirmations are difficult to obtain and the exporter wants the same benefits 10

11 Advising vs. Confirming Roll of Seller s Bank Advise Authenticate and deliver LC to the Seller (Beneficiary) Confirm Assured of payment if terms and conditions are met Substitute for Issuing Bank risk / credit Request initiated by the Seller to the Buyer Seller s Risk Commercial (non-payment; delays) Country Risk (political and economic) First risk of Confirming Bank Second risk of Issuing Bank 11

12 Sight vs. Time Payment Draft Negotiable Instrument (an order to pay) Drawn on Issuing Bank of Confirming Bank Payment Terms Sight Payable upon examination in accordance with payment terms / reimbursement instructions Time Time draft is payable at a fixed date in the future, draft is accepted and can be discounted Deferred Payment LC calls for payment at a fixed date in the future, no draft 12

13 Letter of Credit Criteria Must have a specific expiration date Must have a specific amount of liability Must contain terms of payment Must contain specific and clear conditions for payment Issuing bank or Paying bank obligation is subject to presentation of conforming documents Applicant (buyer) has unqualified obligation to reimburse the Issuing bank for drawings under the LC Must conform to UCP 500 or UCP version in effect at the time 13

14 Export Letter of Credit Summary 1. Submit Pro Forma LC to Buyer 2. Review LC When You Receive it 2. Move Documents as Quickly as Possible 3. Try to Direct LC to Your Bank 4. Request Freely Negotiable LC 5. Realize Risk if Consigning Bill of Lading to Buyer 6. Banks Will Not Look to Your Contract 7. The LC Is Only as Good as the 8. Issuing/Confirming Bank 14

15 Guidelines for the Beneficiary When Reviewing the L/C Be Sure to Verify: 1. Correct name and address 2. Sufficient Credit Amount 3. Documents Required are Obtainable and According to Terms of Sale 4. Points of Shipment and Destination are Correct 5. Insurance Coverage Requirements are Obtainable and According to Terms of Sale 6. Shipping Date Allows Sufficient Time to Dispatch Goods 7. Expiration Date Allows Sufficient Time for Presentation of Draft and Documents 8. Description of Goods is Correct and Simply Stated 15

16 Advantages Letter of Credit Buyer / Importer: Unless fraud, buyer pays for what is ordered Delays payment until receipt of documents Knows latest shipping dates and can arrange distribution May obtain lower price due to reduced credit risk Seller / Exporter Shifts commercial and political risk from buyer to buyer s bank Provides assurance and prompt payment Improve ability to obtain financing 16

17 What Letters of Credit Can and Can t do Letters of Credit Can Do Provide a means of prompt payment to the seller provided the LC requirements are fulfilled Eliminate the extensive credit investigation of the buyer since the seller s credit risk has been assumed by the Issuing Bank and/or the Confirming Bank Assure the buyer it will only be required to pay if the conditions of the LC are met Provide a base for a bank to engage in temporary inventory and receivable cycle finance Letters of Credit Can t Do Substitute for the integrity of the buyer or make background checking unnecessary Lend soundness to transactions which were not basically creditable at their inception Absolve the parties to the transaction from contractual liability Guarantee that shipment will be made by the seller Letters of Credit are separate transactions from the sales or other contracts on which they may be based and banks are not bound by such contracts even if referenced in the LC 17

18 Discrepancies According to industry information, approximately 70% of documents are discrepant Potential Risks for Beneficiary / Seller: Delays payment, may result in non-payment Transaction reverts to open account (protection of using LC is lost) Additional costs Goods may be at an overseas port Difficult in re-selling product if customized or a for a specific purpose Possibility of losing goods Potential Risks for Importer/ Buyer: Late delivery of goods (critical if seasonal) Additional costs Inability to clear goods through customs Penalties for breaching contracts with end users Most Common Discrepancies Incomplete or incorrect drafts Irregular invoices Insurance shortcoming Bills of Lading/ Airway bill problems Late shipments/ late presentation Inconsistency among documents Others 18

19 Documentary Collections

20 Documentary Collections - The Basics What is a Documentary Collection? A collection is a formal, deliberate process in which the instrument and/or document(s) is presented to the institution or person from whom collection is to be made. The ICC Uniform Rules for Collections (URC 522) are the rules governing all collections. Checks and similar items drawn on a bank is one country and deposited in another must be collected through the network of correspondent relationships between commercial banks. Whether a collection is clean (without documents attached) or documentary, the bank acts only as an agent. We receive a collection from our client with instructions that we must follow exactly. These instructions cover the presentation of the collection for payment, the fees to be paid, the method of transferring payment, and the procedures from non-payment. A collection is widely used by experienced exporters, but offers less security than a letter of credit. It should be used only after a thorough investigation of the importer s current financial condition and the economic and political conditions in his country. The reason that a collection is less secure than a letter of credit is due to two factors: First, the export ships the merchandise before receiving payment; second, his assurance of payment comes not from a foreign bank but from the customer (importer) himself. The exporter is protected to some extent by the fact that the title documents are attached to a bill of exchange (the draft) which is drawn on the buying party with instructions on when and how payment is to be made. The documents and draft are then sent to a foreign collecting bank, which releases the title documents only after the customer (importer) pays as agreed. The exporter does not give up title to his merchandise, but he may incur additional shipping charges if the buyer changes his mind about accepting the merchandise. In spit of this drawback a collection remains a normal method of selling products and on that may have a to be seriously considered when selling in a highly competitive environment. 20

21 Risks to Consider Commercial Contract Risk Competition Merchandise Risk (custom or off shelf) Client Risk (financial position) Country Risk (political and economic standing) Payment Risk 21

22 Advantages - Collection Advantages to Buyer (Importer) Delays payment until receipt of documents Can be financed directly by Seller through the use of time drafts (trade acceptance) More convenient and less costly than LCs Advantages to Seller (Exporter) Seller retains title to goods until payment or acceptance by Buyer More convenient and less costly than LCs Risk to the Seller Seller assumes commercial and country risk of the buyer Underlying sales agreement can be cancelled Financial position of the Buyer is a concern Country economic and political standing is a concern 22

23 Using an Avalized Draft Payment Term Aval: Bank guarantee or endorsement Avalize: The act by a bank in guaranteeing payment of a bill of exchange by endorsing the bill with the words "por aval and signed by the bank. In instances where a buyer is requesting terms (e.g. 90 days from bill of lading date) it is possible to arrange for the debt instrument (draft, bill of exchange) to be Avalized by the buyer s bank. The avalizing bank will charge a fee from the date they add their aval through the maturity date of the debt instrument. (Most likely, the charge is to the buyer.) Based on an approved aval, the exporter s bank may then discount the debt instrument without recourse to the exporter. (Discount charges are for the seller/exporter.) 23

24 Potential Risks with Avalized Drafts For the Seller: Governing local laws on Aval (Guarantees); i.e. not all banks will aval Operational risk by buyer s bank releasing documents into buyer s hands before acceptance and aval Potential commercial dispute after the goods are shipped, draft and documents sent to buyer s bank The acceptance and aval may be delayed until arrival of shipment delaying discounting for seller Buyer doesn t accept the draft Buyer s bank doesn t avalize draft The acceptance and aval may be delayed until arrival of shipment delaying discounting for seller Wells Fargo can refuse to discount any avalized draft due to insufficient credit limits with seller s bank at the time of discount or downgrades in the credit/country standing of the avazlizing bank 24

25 Appendix

26 Letters of Credit - The Basics Definition: A Documentary Letter of Credit is a conditional bank undertaking of payment. It is a written undertaking by a bank (issuing bank), given to the Seller (beneficiary), at the request, and on the instructions of the buyer (applicant), to pay at sight or at a determinable future date, up to a stated sum of money, within a prescribed time limit and against stipulated documents. The issuing bank is extending its credit and good name for the sake of the buyer. 26

27 Letters of Credit - The Basics Buyer: The Documentary Letter of Credit is a conditional undertaking, payment is made on the behalf of the buyer against documents, which may represent the goods themselves or in some cases the rights to the goods themselves. Seller: The Documentary Letter of Credit is a bank undertaking, the seller can look to the bank for payment, instead of relying upon the ability or willingness of the buyer to pay The undertaking is conditional, and the seller only has the right to demand payment if all the requirements of the Letter of Credit are met. It is unwise for the seller to proceed with the shipment until compliance with these requirements can be made. 27

28 Letters of Credit - The Basics Summary: A Documentary Letter of Credit: Is an arrangement by banks for settling international commercial transactions. Provides a form of security for the parties involved Ensures payment, provided that the terms and conditions of the letter of credit have been fulfilled. Is a payment based on documents only, and not on merchandise or services involved. 28

29 Incoterms Incoterms are a common set of rules and trade definitions most often used in international sales contracts. They determine which party pays the cost of each segment of transport, who is responsible for loading / unloading, and who bears risk of loss at any given point during shipment. Incoterms were devised and are administered by the International Chamber of Commerce. Incoterms are recognized by the major trading nations of the world to reduce or remove the uncertainties arising from different interpretations among trading partners. There are 13 Incoterms however Ex Works, Free on Board, Cost Insurance Freight, and Delivered Duty Paid are the best known and most commonly used. 29

30 Incoterms The Incoterms 2010 are organized into two categories: 1. Incoterms for any Mode or Modes of Transport: EXW Ex Works FCA Free Carrier CPT Carriage Paid To CIP Carriage and Insurance Paid DAT Delivered At Terminal (new) DAP Delivered at Place (new) DDP Delivered Duty Paid 2. Incoterms for Sea and Inland Waterway Transport Only: FAS Free Alongside Ship FOB Free On Board CFR Cost and Freight CIF Cost, Insurance and Freight 30

31 Bankers Acceptance Created in the following situations: Under a Letter of Credit The buyer (applicant) of the letter of credit has been granted extended payment terms by the seller of goods with the provision that a bank credit obligation be provided. The Issuing or Confirming Bank accepts a time draft drawn on itself by a beneficiary of the letter of credit. The Accepted draft is a direct obligation of the Bank to pay the holder on maturity. Clean Acceptance Bank accepts a time draft drawn on itself by a borrower as a method of short term financing to support the trade cycle (either to refinance a sight payment under a letter of credit, collection or an open account shipment of goods). Characteristics Must be used to support a current movement of goods (current is identified by the Fed as an import or export that occurred or will occur within 30 days) Tenor of the Acceptance is up to 180 days Is intended to be self-liquidating (tenor is matched to the sales cycle) and not used for working capital purposes Is a negotiable instrument that can be sold in the secondary market (if marketable) or discounted with the Fed (if eligible) Borrower must attest that no other financing exists to support the shipment Interest is taken up-front (at time of discount) which generates a higher yield 31

32 Managing Foreign Exchange Exposure

33 Are you exposed to foreign currency risk? Do you import or export goods or services outside of the US? Do you send money or receive money from overseas? Do you buy or sell your equipment overseas? If you checked yes to any of the above boxes, then the answer is YES! 33

34 What is currency risk? The risk that unexpected changes in exchange rates will: Increase/decrease cost Increase/decrease profit margin Create FX gains or losses on company s income statement Can reduce overall value of consolidated company 34

35 How Concerned should my company be about currency risk? It depends upon... Nature of your firm s product or service Are substitutes readily available? Are your margins sufficient to absorb a currency shock? How frequently can you change your prices? Can you pass on increased costs to your customers in the form of higher prices? Competitive Position Is your firm a price-taker or a price-maker? What is the functional currency of your competitors? In what currencies do your competitors sell their products or services? Impact on Earnings/Balance Sheet What percent (%) of movement in exchange rates have a meaningful impact on your reported earnings? 35

36 Can USD Denominated Transactions Face Currency Risk? Yes! Pricing overseas transactions in USD does not eliminate currency risk, it only alters its incidence and changes its nature. Pricing in USD may leave your customers or suppliers with the direct FX risk. The pricing that they perceive in terms of local currency will vary with exchange rates. As a result, your volumes may vary and/or your counterparties may request price concessions, leaving you with potentially erratic and difficult to hedge currency risk. It is deceptively easy for a US company to conclude that no risk exists when it is being billed by a foreign supplier in US dollars (USD). In fact, whenever businesses in two different countries are trading with one another, foreign exchange risk exists. 36

37 There is a foreign exchange component to every international transaction. the question is - who bears the risk & at what cost? 37

38 Trade related - foreign exchange solutions Dual Invoicing Invoicing in Local Currency Forward Contracts Foreign Currency Accounts 38

39 Foreign Exchange: Dual Invoicing When a foreign supplier, let's say out of Europe, bills in USD, they bear the risk that the dollar might decline in value by the time they actually receive the dollars they are owed. This would result in a reduction of their profit margin measured in their home currency, the euro (EUR). If they perceive this risk exists, they are likely to increase their USD price to compensate them for the risk premium they have to bear. Conversely, while your counterparty may be quick to increase their USD price, they may be slower to reciprocate with proportional discounting upon a strengthening of the US dollar. The alternative for a US company buying from a foreign supplier would be to bear the risk, or at least consider bearing the risk if it can be proven to reduce costs. A savvy business operator can manage this process by requesting dual currency invoicing from the seller. This would be achieved by asking the seller to provide a quote both in USD and in the foreign currency of the seller. Then, the US buyer could assess whether purchasing the foreign currency could actually create a lower USD cost. Some of the benefits: Provides detail to allow you to choose the best alternative for payment Increases buying power by eliminating risk to the seller 39

40 Foreign Exchange: Invoicing in Local Currency Similarly, as an exporter in the US, you could price in USD. However, if the USD were to strengthen, your goods would become much more expensive to your customers, hence putting you at a competitive disadvantage. This could result in reduced sales. The alternative would be to bear the risk by pricing in local currency. This would keep you pricing consistent to the customer in overseas markets and you could also stand to increase your margin by capitalizing on favorable currency movements. Some of the benefits: Increased competitiveness / consistent rate to the customer Ability to lock in margins upfront using hedging contracts 40

41 Forward Contracts From dual currency invoicing or local currency pricing, it is not a giant step to negotiate all of your international business in local currency. However, if you look to lock in pricing for future dates, you will also want to consider protecting these margins. One of the simplest instruments for doing so is the forward contract. A forward contract is an agreement to exchange a fixed quantity of currency on a pre-set future date at a preagreed rate. The terms of the contract are always set at the inception of the trade. As a result, the hedging party knows on the booking date what the exchange rate will be on the stated future date. Some of the benefits: Certainty of exchange rate. No fee hedge. 41

42 Foreign Currency Accounts A foreign currency account is an option that offers greater convenience with foreign currency transactions when foreign funds do not need to be converted right away. You can deposit foreign receivables without having to convert them to U.S. dollars, accumulate foreign funds to meet payables requirements, and transfer funds from U.S. dollar accounts or foreign bank accounts by check or wire. A foreign currency account makes foreign purchases and sales easier and more profitable by allowing you to negotiate prices and make payments in local currency, helping you become more competitive in global markets. Some of the benefits: Eliminate unnecessary foreign exchange conversion and minimize your foreign exchange risk. Offer you the ability to net off foreign currency payables and receivables. 42

43 Evolution of Hedging Immediate Currency Needs Recognized Exposure Forecasted Transactions Equity/Net Investment Must Do! Should Do! Should Do Should Do? Immediate Needs Impending Needs Eventual Needs Strategic Hedge Foreign currency receipts Foreign currency payments Foreign currency receivables Foreign currency payables Forecasted currency payables Forecasted currency receivables Foreign equity as a proxy for an eternity of foreign cash flows 43

44 Contact Information Lydia Gregor Trade Services Relationship Manager Nicole Weidlein Foreign Exchange Sales Rep

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