Understanding International Trade Finance

By Akorede Mark Badmus (FCA)

My desire to be of positive impact to my generation and to give back to the profession that has been of tremendous blessings to my career has inspired me to write this book ‘Understanding International Trade Finance’. Of my twenty-eight years in banking, I have been remarkably involved in Trade Finance in the last twenty years and I have identified the knowledge gap that exists in this specialized area of financial services and global trade at large. This book is based on my practical experiences of the last eighteen years across different geographies that has culminated in writing of this book in your hand.

One intriguing personal experience in this field was that of a friend that travelled abroad and bought a car at an ex-works price and thought he had made a good bargain until about six months of waiting for the car to arrive from abroad, but nothing turned up and he complained to me;

I examined the documents and noticed that the invoice reads “ex-works.” I told him that the price he paid for the car does not cover the cost of shipping the car and that it is his responsibility to arrange for this, then he realised it wasn’t really a good bargain after all.

Are you a banker, importer, exporter, student, trade finance practitioner etc.? This book, ‘Understanding International Trade Finance’ is a must-read book for you.

I would like to specially express my profound gratitude to my family for their love and support in the course of writing this book.

Also, my colleagues and friends for their encouragements in the actualization of this project.

Above all, I am sincerely thankful to God for the grace, courage, and strength for in writing this book.

• Language: English
• Publisher: Newman Springs Publishing, Inc.
• Release date: Mar 24, 2021
• ISBN: 9781636920955

Book preview

Chapter One

Chapter One: Introduction to Trade Finance

Trade finance can be described as the provision of bank credit facilities to meet a company’s borrowing needs in relation to their international trade activities. The traditional analysis of the balance sheet would give us a view on the company’s financial status, but would provide very little information regarding their trading activity, and thus, make it difficult to formulate meaningful facilities.

Trade finance techniques can be used to bridge the funding gap between any credit provided in the terms of trade (negotiated by the exporter and importer) and the need to fund stock and debtors. Historically, within many banks this funding gap has been financed by overdraft facilities. Furthermore, it is fully acknowledged that in many instances traditional domestic working capital finance continues to offer a perfectly adequate solution to customers involved in international trade. However, a major advantage of trade finance products and techniques is the additional comfort, which a bank can gain through transactional control.

In the trade finance environment, it is possible to break trade related business into its constituent parts and thereby gain a better view of potential areas of risk. Structured loans can be used in place of overdrafts, which whilst very flexible, are also open-ended from a risk perspective. Trade finance structured loans typically have rolling limits and maturity dates set to coincide with the borrower’s cash flow generated by the sale of goods.

Trade finance structures, therefore, offers a bank huge advantages:

Use of trade finance instruments (for example, documentary collections, documentary credits, etc.) enables the bank to exercise transactional control and mitigate risks.

Credit facilities are more closely, matched to the customer’s transactional requirements and trade cycle. Unlike conventional overdrafts, moneys borrowed cannot be easily diverted into supporting general working capital or indeed financing losses.

Repayment is more closely linked to the sale of underlying goods. Any delay in repayment gives an early warning of liquidity problems.

Structured facilities increase the quality of account information for the bank which therefore improves their ability to monitor risk.

In certain circumstances the bank will have a prior security interest in the goods financed enabling the bank to sell the underlying goods.

The increased levels of comfort which the bank can acquire through trade finance techniques has a positive effect on their willingness to make credit facilities available to their customers involved in international trade. Thus the use of trade finance products by a bank offers a number of advantages for their customers.

The bank may be prepared to make trade finance facilities available even if the customer’s normal credit facilities are fully extended or the customer’s balance sheet does not support the level of limits requested.

Specific facilities for individual transactions enable the customer to evaluate the profitability of individual transactions, including financial costs.

For the customer with a strong credit standing and balance sheet the bank may be prepared to offer a lower margin than on a conventional overdraft in recognition of the superior transactional control and improved risk profile.

Terms of Trade

The method of payment is generally agreed, by the exporter and the importer at the time the sales contract is negotiated; importers and exporters have naturally opposing views of risk in international trade. A payment structure, which is totally satisfactory for an importer, invariably involves a high element of risk for the exporter and vice versa. It is possible to consider this situation as a Risk Ladder on which the risks for the importer gradually increase as you go higher, whilst the corresponding risk for the exporter gradually decreases.

Terms of Trade

Risk Ladder

The method of payment used will usually depend on the following:

The negotiations between the exporter and importer before the sales contract is signed. An importer who is very keen to obtain goods from a particular source (perhaps due to quality or price) may have little choice other than to accept the exporters request for a certain type of payment method.

The commercial practice in the countries involved. For example, open account trading is normal practice for trade between the UK and EU countries and North America. On the other hand, for trade between the African and UK, documentary credits are widely used.

When negotiating the method of payment the exporter/importer should bear in mind that their decision on this matter will affect not only the risk of payment/non-payment but also the alternative trade financing mixtures available. The principal trade financing instruments and techniques are described in detail in this book.

Characteristics of Trade Finance

Transaction specific: Financing specific transactions usually with identifiable source of repayment.

Short term: Tenor in accordance with the trade cycle (cash conversion cycle), typically less than 180 days.

Self-liquidating: Financing underlying trade flow which generates cash for repayment.

Self-securing: Transaction may be secured by underlying goods.

Against credit of third party: Bank may advance to client against another party’s credit limit, e.g., LC negotiation against bank limit.

Mix of fee and interest income: An array of products (e.g., LC, guarantees) generating fee income complementing interest income from trade assets.

Chapter Two

Chapter Two: Incoterms

What are Incoterms?

Incoterms are set of international rules of interpretation of most commonly used terms in international trade.

These rules are given by ICC (International Chamber of Commerce) and are designed for achieving uniformity and thus avoiding/minimizing the uncertainties of different understanding in different countries.

Incoterms clarifies three aspects in trade; they are the following:

Who bears the transport cost (i.e., freight or carriage)?

Who bears the insurance cost?

At what point in the movement of goods, ownership, or risk gets transferred to the buyer, and respective obligations?

Highlights for Revision of Incoterms

To apply Incoterms for domestic sale contracts

To provide electronic means of communication the same effect as paper communication

To cope with the revision of the Institute Cargo Clauses

To consolidate D terms and abolished DAF, DES, DEQ, and DDU

To add security-related clearances

To allocate terminal handling charges between parties

To include obligation to procure goods shipped as an alternative to the obligation to ship goods under String Sale

Terms used in Incoterms 2010

Carrier: it is the party with whom carriage is contracted.

Customs formalities: comply with any applicable customs regulations which may include documentary, security, information, or physical inspection obligation.

Delivery: it is used to indicate where the risk of loss of or damage to the goods passes from the seller to the buyer.

Delivery document: a document used to prove that delivery has occurred.

Electronic record or procedure: electronic message is equivalent with the corresponding paper document.

Packaging: the packaging of goods to comply with contract or fit for transportation.

Incoterms 2010 Classes

All Modes of Transport including Multimodal

EXW: Ex Works named place of delivery (usually no transport document is called for)

FCA: Free Carrier named place of delivery

CPT: Carriage Paid To named place of destination

CIP: Carriage and Insurance Paid To named place of destination

DAT: Delivered at Terminal named terminal at port or place of destination

DAP: Delivered at Place named place of destination

DDP: Delivered Duty Paid named place of destination Sea and Inland Waterway Transport Only

FAS: Free Alongside Ship named port of shipment

FOB: Free on Board named port of shipment

CFR: Cost and Freight named port of destination

CIF: Cost Insurance and Freight named port of destination

EXW, EX-Works (Named Place of Delivery)

E Group

In Ex Works, the seller/exporter/manufacturer merely makes the goods available to the buyer at the seller’s named place of business. This trade term places the greatest responsibility on the buyer and minimum obligations on the seller.

The seller does not clear the goods for export and does not load the goods onto a truck or other transport vehicle at the named place of departure.

The parties to the transaction, however, may stipulate that the seller be responsible for the costs and risks of loading the goods onto a transport vehicle. Such a stipulation must be made within the contract of sale.

Usually recommended for domestic Trade and the place of Delivery is Domestic to Seller.

Examples

EXW (Ex Works) ABC Factory, Paris, France

EXW (Ex Works) XYZ Printing Plant, Singapore

Modes of Transport Covered

All modes of transport including multimodal. Usually there is no transport document associated with this incoterm.

FCA, Free Carrier (Named Place of Delivery)

F Group

In Free Carrier, the seller/exporter/manufacturer clears the goods for export and then delivers them to the carrier specified by the buyer at the named place.

If the named place is the seller’s place of business, the seller is responsible for loading the goods onto the transport vehicle.

A carrier can be a shipping line, an airline, a trucking firm, or a railway. The carrier can also be an individual or firm who undertakes to procure carriage by any of the above methods of transport including multimodal.

The named place of delivery is usually domestic to the seller.

Example

FCA (Free Carrier) ABC Shipping Lines Hamburg Germany.

Modes of Transport Covered

All modes of transport including multimodal.

FAS, Free Alongside Ship (Named Port of Shipment)

F Group

In Free Alongside Ship, the seller/exporter/manufacturer clears the goods for export and then places them alongside the vessel at the named port of shipment

The parties to the transaction, however, may stipulate in their contract of sale that the buyer will clear the goods for export

The Free Alongside Ship term is commonly used in the sale of bulk commodity cargo such as oil, grains, and ore

The named port of shipment is usually domestic to Seller

Examples

FAS (Free Alongside Ship) Port Elizabeth South Africa

Modes of Transport Covered

Used only for ocean or inland waterway transport.

FOB, Free on Board (Named Port of Shipment)

F Group

In Free On Board, the seller/exporter/manufacturer clears the goods for export and is responsible for the costs and risks of delivering the goods on board the named vessel at the named port of shipment

The key document in FOB transactions is the On Board Bill of Lading

The Free on Board term is commonly used in the sale of bulk commodity cargo such as oil, grains, and ore

The named port of Shipment is usually Domestic to Seller

Examples

FOB (Free on Board) Vessel ABC Buenos Aires, Argentina

Modes of Transport Covered

Used only for ocean or inland waterway transport

CFR, Cost and Freight (Named Port of Destination)

C Group

In Cost and Freight, the seller/exporter/manufacturer clears the goods for export and is responsible for delivering the goods on board the ship at the port of shipment (not destination)

The seller is also responsible for paying for the costs associated with transport of the goods to the named port of destination. However, once the goods are on board the ship at the port of shipment, the buyer assumes responsibility for risk of loss or damage as well as any additional transport costs

With CFR, the named port of destination is domestic to the buyer.

Examples

CFR (Cost and Freight) Singapore Port

Modes of Transport Covered

Used only for ocean or inland waterway transport.

CIF, Cost Insurance, and Freight (Named Port of Destination)

C Group

In Cost, Insurance and Freight, the seller/exporter/manufacturer clears the goods for export and is responsible for delivering the goods on board the ship at the port of shipment/loading (not destination).

The seller is responsible for paying for the costs associated with transport of the goods to the named port of destination. However, once the goods are on board the ship at the port of shipment, the buyer assumes responsibility for risk of loss or damage as well as any additional transport costs.

The seller is also responsible for procuring and paying for marine insurance in the buyer’s name for the shipment up to the port of discharge.

With CIF, the named port of destination is domestic to the buyer.

Examples

CIF (Cost Insurance and Freight) Mombassa Port Kenya

Modes of Transport Covered

Used only for ocean or inland waterway transport.

CIP, Carriage, and Insurance Paid To (Named Place of Destination)

C Group

In Carriage and Insurance Paid To, the seller/exporter clears the goods for export, delivers them to the carrier, and is responsible for paying for carriage and insurance to the named place of destination.

However, once the goods are delivered to the carrier at the place of shipment, the risk transfers from the seller to the buyer.

The seller is responsible for procuring and paying for insurance cover up to the destination.

In CIP, the named place of destination is domestic to the buyer.

Examples

CIP (Carriage and Insurance Paid to) Hong Kong.

Modes of Transport Covered

All modes of transport including multimodal.

Incoterms Table

Chapter Three

Chapter Three: International Trade Documentation

There are many documents, which are used for one purpose or another in international trade. They can be categorised under the following general headings.

Transport documents (bill of lading, air waybill or combined transport bill of lading, etc.). A transport document is a document that indicates loading on board or dispatch or taking in charge. Its functions are to provide evidence of a contract of carriage, evidence of receipt of the goods (by the carrier) and, in some cases, they are also documents of title, giving the holder of the documents title to the possession of the goods.

Commercial documents: the most important of these is the invoice

Insurance documents

Official documents required by government regulations.

Financial documents, e.g., the bill of exchange or the promissory note.

Bill of Lading

A maritime or marine bill of lading is a transport document for goods shipped by sea. In spite of the considerable growth of container transport, the marine bill of lading is still the most common transport document for exporting to Africa, Asia and the Middle East (particularly when payment by the overseas buyer for the goods is arranged through the banking system).

A bill of lading has three separate functions.

It is evidence of a contract or carriage between the shipping company and either the exporter or