Exporting and Importing - No Banking Facilities Required 

There has been a growth in exporting over the past decade as UK companies seek to expand their sales into new markets, helping to spread their risk by supplying their goods or services to a variety of territories around the world. Many SMEs have ventured into selling their wares around the globe, (having been persuaded by the UK Government, and perhaps assisted by UKTI), that exporting can be challenging in some instances, but can have also have very tangible benefits.

Importing manufactured goods and/or component parts has been the cornerstone of many UK businesses for decades, taking advantage of the economic benefits and technological advances in the fast growing economies of the Far East and more recently South America.

Clearly there are a whole host of commercial risks which a company must assess as they seek to commence or grow their importing and exporting activities, and there are equally a wide range of trade solutions offered by banks/financiers which can help mitigate these risks. However there is a popular misconception that any trade solution transacted via a bank or a financier must equate to an expensive facility, requiring some security to be deposited by the company to support that facility. There are a number of options available for importers and exporters which will provide them with some very real benefits in overcoming some of the risks associated with trading internationally, but without the need for the company to deposit any security with their bank/financier. 

Importing

Documentary Collections are a simple, long established method to settle cross border transactions. In essence commercial documents relating to the exported goods will be sent by the exporter to his bank together with instructions as to how and when they should be released to the importer. These instructions, which are clearly stated on a bank schedule, are sent together with the accompanying documents to the importer’s bank.

Payment can be made in one of two following ways:

Documents against Payment (also known asCash Against Documents’)

  • Documents are released to the importer in exchange for payment of the value of the invoice, or such other amount as specified in the collection schedule, or

Documents Against Acceptance

  • Documents are released against the importer’s written promise to pay that value on a future date. This ‘promise’ is usually evidenced by the importer’s signed ‘acceptance’ on a term Bill of Exchange. Payment will be made at the fixed or determinable future date.

If the contractual agreement between seller and buyer is Documents Against Payment, there are still some  benefits to the importer, compared to paying for the goods prior to shipment or paying for the goods when they are shipped. This saving of perhaps a couple of weeks can be described as taking advantage of supplier credit, helping the importer's cash flow. In addition to this the banks handling the Documentary Collection must adhere to a set of rules published by the International Chamber of Commerce, known as Uniform Rules For Collection. The current publication is URC  ICC Publication No. 522. The importer may also be able to receive a copy of the transport document sent by the exporter perhaps in PDF format, which may provide the importer with some evidence that the goods are en route, but of course it won't satisfy the buyer regarding the quality of the goods. However if the importer is able to negotiate a Documents Against Acceptance collection, this will allow the importer to take delivery of the goods, and potentially sell the goods (and even receive the proceeds of the sale) before settling the collection on the due date. To achieve this ideal situation it is likely that the seller and buyer will have developed a trading relationship over a period of time, but there are clear benefits for the importer, not least a much improved cash flow situation, significantly less bank charges then using, for instance a Letter of Credit, and no impact on their facilities with their bank.

Exporting

As mentioned above for importers, but Documentary Collections can have very defined advantages for exporters, without impinging on the company's facilities with their bank. In addition to this a very real benefit is that if the goods are transported by vessel, and the exporter obtains a full set of ocean bills of lading, which can be included with the documents under the collection, this can provide the exporter with constructive control of the goods. So, if in a worst case scenario, with the importer refusing to either pay their bank for the documents in a documents against payment item or refusing to accept a bill of exchange in a documents against acceptance item, the exporter can keep control of the goods. This may mean that an alternative buyer has to identified or even for the goods to be shipped back to the UK, but at least the goods have not been released.

The banks which help facilitate and handle the Collection again must adhere to the above mentioned URC522 rules, which affords some comfort for the exporter, with the knowledge that although payment is not guaranteed by the banks, the transaction is carefully managed in accordance with these rules.

As with importers, the costs and administration involved in using Collections is much reduced compared to Letters of Credit, but that higher cost and increased administration equates to a much greater certainty of payment when using Letters of Credit. Fundamentally the exporter only pays the bank charges relating to the handling of the Collection, and needs no facility with the bank to use Documentary Collections.             

Export Letters of Credit

A Documentary Letter of Credit (also known as a Letter of Credit) is a written undertaking given by a bank on behalf of an importer to pay the exporter an amount of money within a specified period of time, provided the exporter presents to the bank, documents which strictly comply with the terms and conditions laid down in the Letter of Credit. A Letter of Credit can be issued for any amount and in any freely traded currency. It must stipulate when payment is to be made to the exporter. It can be payable either:

  •  At sight, i.e.: immediately following presentation of conforming documents to the bank authorised to pay or negotiate under the credit, or
  •  On a term basis, i.e.: after a specified and determinable period detailed within the credit (eg: 30, 60 or 90 days after ‘sight’ or presentation of conforming documents to the bank). This type of credit will be said to be available by deferred payment or acceptance.

Letters of Credit are subject to published worldwide standards defined by the International Chamber of Commerce – Uniform Customs and Practice for Documentary Credits (UCP). All parties dealing with Letters of Credit should be aware of, and adhere to UCP, and the latest version UCP 600 was published in July 2007.

There are no banking facilities required for an exporter to receive in a Letter of Credit which will usually be advised to them by a bank in the UK. There will be bank charges which relate to the Letter of Credit, and if the advising bank in the UK has also added it confirmation, which is a separate undertaking (in addition to the undertaking given by the Issuing Bank) to pay the exporter upon a presentation of a compliant set of documents, this may add significant charges.

However the overriding benefits for the exporter are that they will  have received a conditional payment guarantee issued by a bank, received prior to the shipment (perhaps prior to the manufacture) of the goods which will not impact on any banking facilities which they may have with their own bank.

If the Letter of Credit is payable on a term basis as mentioned above, meaning that the exporter will have to wait for example either 30, 60 or 90 days, as defined in the terms, and if the UK bank has added their confirmation, the exporter can ask for an early settlement of the item. This will enhance their cash flow, but importantly it will have no impact on their facilities with their bank, as the finance will be paid without recourse, meaning that at maturity on the due date, the bank/financier is unable to seek repayment from the exporter. There will be a cost to provide this finance but it should be offered at a finer rate than any conventional unstructured finance would have been offered by the bank. This type of finance against a Letter of Credit is called discounting.     

Standby Letters of Credit

 A Standby Letter of Credit is issued in the same way as a Documentary Letter of Credit, however its function and content is that of a Bank Demand Guarantee.

Where a Standby Letter of Credit differs from a standard Documentary Letter of Credit is that whereas in the case of a standard Documentary Letter of Credit, payment is made by the bank against delivery of conforming shipping documents (eg: invoices, bills of lading, certificates etc), the bank issuing the Standby Letter of Credit undertakes to pay the beneficiary (exporter) upon presentation of a document which is effectively a demand/claim for payment.

These types of guarantees are becoming more popular with UK exporters who are selling goods to overseas buyers on a regular basis, as it cuts out the time consuming administration involved in presenting a compliant set of documents to the bank under a standard Letter of Credit. The Standby only gets drawn upon, if the buyer fails to pay the seller in accordance with their contractual agreement. This makes the Standby riskier from the buyers point of view, as the exporter could, in theory, lodge a claim which the buyer may deem as unfair, but the Issuing bank would have to honour that claim if it met with the simple criteria as laid down in the terms of the Standby Letter of Credit. These terms are usually the production by the exporter of a copy of an unpaid invoice and a simple receipt stating that payment has not been received.

However, from the exporter's viewpoint, the Standby represents a robust guarantee provided by the buyer's bank and the UK bank who will have advised the item to the UK exporter will charge a nominal administration fee of usually not more than £100. In effect the UK advising bank is just acting as slightly more than a post office, as it will have verified the apparent authenticity, confirming that the Standby has been issued by the overseas bank.

Again there will be no impact on the exporter's facilities with their own bank in using a Standby, with very appreciable payment risk benefits for the seller.            

Assignment of Proceeds - Export Letters of Credit

On receipt of a Documentary Letter of Credit the beneficiary may request the advising bank to accept an irrevocable instruction to pay all or part of the proceeds to a third party. Such instructions are called “assignment of proceeds”. Proceeds of Documentary Letters of Credits payable at sight or on a deferred basis can be assigned to a third party, but importantly that entity will only get paid if the beneficiary presents a compliant set of documents under the Letter of Credit and the banks pay the item.

However, from an exporter's (beneficiary of the Letter of Credit) viewpoint, it is possible to assign the proceeds as detailed above, without impacting on any banking facilities, but there will be a cost levied by the bank which assigns the proceeds to the third party. The potential of this assignment may enable the exporter to negotiate with a supplier on improved terms, having promised an extra layer of comfort (without absolute certainty) in terms of payment. 

Forfaiting

The actual word "forfaiting" is derived from a French phrase "a forfait" which translates to mean to surrender or to relinquish the rights to something. This is very much what happens in this trade finance offering, as an exporter would agree to surrender or relinquish the rights to claim for payment on goods or services delivered to a buyer, in return for a cash payment from a forfaiter.

The majority of examples of forfaiting transactions involve the forfaiter purchasing, without recourse to the exporter, Bills of Exchange or Promissory Notes which are payable at a determined future date. Once the Bills or Notes have been sold to the financier, the exporter has no further involvement with the collection of the debt. Most Bills of Exchange will have been guaranteed or avalised by a bank, meaning that that bank are obligated to pay the Bill at maturity.

In real terms this form of finance is used by larger corporate organisations selling everything from commodities to capital equipment with credit periods from a minimum of 90 days to 5 years.

When the bank/financier purchases the Bill or Note it may either retain the asset on its own books or use its own network to syndicate or sell down the risk purchased. This is widespread in the more specialised trade finance banks.

The important point to stress is that the exporter does not need to tie up his facilities, as the risk lies with the entity which has added their name as an aval on the Bill.    

The intermediary

Transferable Letters of Credit - A Transferable Letter of Credit is used in cases where there are three parties to a transaction; an Importer (Buyer), Exporter (Supplier), and an intermediary party, such as a broker, who is responsible for arranging the sale.

The buyer's bank issues the Letter of Credit in favour of the intermediary who is known as the first beneficiary. The Letter of Credit must stipulate that it can be transferred, and the advised bank which handles the item must be in agreement that they will effect the transfer, as they are under no obligation to do so. If they are willing to transfer the Letter of Credit, having changed a select few terms as allowed in Uniform Rules for Letters of Credit (UCP 600) article 38 (with those changes in line with instructions from the intermediary), they will effect this transfer to a second beneficiary as nominated by the intermediary. Goods are shipped by the second beneficiary, usually directly to the buyer, and documents are presented through the banks, with the intermediary making a margin.

The great benefit for the intermediary is that the bank which effects the transfer of the Letter of Credit will not require any security or to mark any facilities against the intermediary. The usual requirements are that the intermediary pays the bank's transfer fees at the time the Letter of Credit is transferred to the second beneficiary and generally the intermediary is known to the bank, as fraud is a major concern in these types of trade transactions. However, a transferable letter of credit can enable an intermediary to negotiate and handle very large value contracts, which would be unachievable if the intermediary had to arrange independent facilities with his/her own bank to support this business.        

In summary it is possible for exporters and importers to mitigate risks, enhance their cash flow and trade successfully with partners around the world and not necessarily have to negotiate large facilities (or any facilities) with their banks/financiers. However, it is all down to the negotiating skills of the trader, together with the demand for their goods or services and also to a certain extent the customs and practices pertaining to certain territories around the world.   

 

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Written 10th january 2013 by Richard Casburn at MJ Hayward Associates Ltd - www.mjhayward.co.uk

 

Relevant Training Courses

Letters of Credit Workshop for Exporters

Advance Guide to Letters of Credit & Finance

Risk Management and Finance for Importers

 
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