Trade Finance Guide PDF

30// A Guide to Trade Finance 2.6.5 Workflow 2.6.6 In practice In view of the fact that the concept of confirmation does not exist with a demand guarantee, and in order to facilitate such transactions, it is normal practice that a counter-guarantee is issued by one bank, in favour of another bank...

30// A Guide to Trade Finance 2.6.5 Workflow 2.6.6 In practice In view of the fact that the concept of confirmation does not exist with a demand guarantee, and in order to facilitate such transactions, it is normal practice that a counter-guarantee is issued by one bank, in favour of another bank, to support the issuance of a guarantee by that other bank. Figure 9: Workflow of direct and indirect demand guarantees Applicant/Seller Beneficiary/Buyer Applicant/Seller Beneficiary/Buyer To achieve the same result as confirmation, i.e. another (local or preferred) bank giving an undertaking to a beneficiary, a counter-guarantee is issued in favour of that bank as an inducement for them to issue its own guarantee in favour of the beneficiary. Contract Contract Application Application Guarantee Guarantee Counter-Guarantee Guarantor Direct Copyright© 2020 Deutsche Bank AG. All rights reserved Counter-Guarantor Guarantor Indirect Source: TradeLC Advisory “ Direct guarantee. The seller’s bank provides the guarantee directly to the buyer with the seller giving the bank a counter indemnity. Due to local regulations or commercial practice, the buyer may insist that their own bank provides the guarantee. “ Indirect guarantee. The seller arranges for his bank to instruct the local bank to issue a guarantee to the buyer. The seller’s bank provides a counter guarantee to the local bank for the issuance and the seller provides their counter indemnity in the usual way. Such a document may incorporate the required wording of the guarantee to be issued by the guarantor or issuing bank, or request issuance in the standard form of the guarantor for the type of guarantee that is to be issued. //31 32// A Guide to Trade Finance 2.7 Standby credits 2.7.1 Definition Although very similar to demand guarantees, the functional variations are primarily in terminology and practice. The term ‘standby letter of credit’ originated in the US. They were introduced due to the legal statute that banks in the US were not allowed to issue guarantees. This prohibition has since been repealed with the introduction of URDG 758, and it is accepted that banks can now issue demand guarantees in addition to standby credits. Copyright© 2020 Deutsche Bank AG. All rights reserved Issuing banks will look for certainty in the text with regards to the expiry provision, the form and presentation of any demand and the application of any additional conditions. It is not unusual that the standby will include the wording for the demand that is to be presented, should it be necessary for the beneficiary to make a claim. When documents such as a copy of a transport document and/or a copy of an (unpaid) invoice are to be presented together with a demand, the standby should specifically indicate the data requirements for such documents as they will not be examined in the same manner as they would under a documentary credit. 2.7.2 Essential basics 2.7.4 Types of standby A standby credit represents a secondary obligation covering default only. In essence, this instrument provides security against non-performance as opposed to performance (as is the case with a normal documentary credit). A wide variety of types exist but those more commonly seen in trade finance transactions are listed below.15 Most of these will be familiar to those acquainted with demand guarantees. “ Performance − agreeing to undertake, deliver and/or complete contractual obligations. “ Advance payment − undertakes repayment of all or part of a percentage of the value of a contract that has been paid by the beneficiary to the applicant as a down payment, advance payment, or deposit, upon the signing of the contract. “ Bid or tender bond − ensures a bidder (applicant) cannot alter its tender proposal, or withdraw from the tender process, before the tender is awarded. “ Counter − a standby issued by one bank, in favour of another bank, to support the issuance of a standby, guarantee, documentary credit or other form of undertaking, by that other bank. Standbys can be subject to a variety of rules in addition to, such as International Standby Practices (ISP) 98, UCP 600 or URDG 758. However, ISP98 is the most appropriate.14 ISP98 was introduced in 1998 due to the fact that many facets of UCP were inappropriate (if not incorrect) for the handling of standby credits. 2.7.3 Key considerations As is the case with a guarantee, it is common for a beneficiary to provide an applicant with its preferred wording for the issuance of a standby, very often with an instruction that the wording cannot be amended in any way. Alternatively, an applicant and beneficiary will agree the text as part of their sale contract negotiations and deliver it to the bank for issuance on an “as is” basis. Where an issuing bank maintains standard clauses for inclusion in its standby issuance, it is advisable to make these known or available to regular applicants of a standby, so that they do not agree a text that may not be possible to issue without some form of amendment, enhancement or internal legal approval. //33 34// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved “ Financial − supports a financial obligation to pay or repay. “ Insurance − reinforces applicant obligations in respect of insurance or re-insurance activity. “ Direct-pay − not necessarily related to a default and is likely to be the primary means of payment rather than secondary which is normally the case. “ Commercial − acts as a security for payment of goods or services not settled by a buyer under other arrangements i.e., via open account trading or documentary collection. 2.7.6 In practice An applicant and beneficiary should be aware that banks will often maintain standard text or clauses that they are required to insert into a standby, from a regulatory or internal policy perspective, and should seek the intended issuing bank’s concurrence on the wording before any formal agreement is reached on the final text. ISP98 Model Forms, designed by a team of standby bankers and attorneys and aligned with ISP98 (ICC Publication No. 590), are the most widely used rules for standbys.16 2.7.5 Workflow The Institute of International Banking Law & Practice (Institute) began releasing the ISP98 Model Forms on 15 May 2012. They are intended to help standby users, including their regulators, to develop sound, workable, and appropriate texts for standbys in light of specialised standby practices and laws worldwide and can also be used for demand guarantees subject to ISP98. Figure 10: Workflow of standby credits Issuance Importer Contract 1 Settlement Goods/services/ performance Exporter Importer 1 Exporter Payment Standby LC application Advising of standby LC 2 5 Issuing bank Advising bank 6 Issuing bank Standby LC issuance Transmission 3 Receipt 4 2 6 Negotiating bank Payment Payment 6 Examination of demand 4 Source: TradeLC Advisory Presentation of demand Resolution of discrepancies (if any) 5 Demand Examination of demand 3 2.8 ICC Rules and standards As explained in Section 1.4.2, the ICC has become a leading global rulemaking body for the banking industry, not only producing universally accepted rules and guidelines for international banking practice, but also providing leading edge research and analysis. In trade finance, it is vital to gain an understanding of existing and developing rules and practice and then to implement appropriate procedures and guidelines in order to ensure more certainty and reduce lending risk. //35 36// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 2.8.2 URDG 758 The first release of an ICC publication addressing rules for demand guarantees was in 1992 with URDG (Uniform Rules for Demand Guarantees) ICC Publication No. 458. The rules achieved relative success but never attained global adoption, partially due to the article covering demands for payment, which was seen by many in the trade community as not in line with practice. 2.8.1 UCP 600, URR 725, ISBP 745, eUCP The most widely used set of ICC rules, Uniform Customs and Practice for Documentary Credits (UCP), was introduced in 1933 to alleviate the disparity between national and regional rules on letter of credit practice. Since then, there have been six revisions, the current version known as UCP 600. Justification for the existence of UCP 600 revolves around four essential tenets: “ Harmonisation as opposed to differing customs. “ Common understanding of terms and intentions. “ The ability to rely on a set of contractual rules that would establish uniformity in practice, so that practitioners would not have to cope with a plethora of often conflicting national regulations. “ A platform in which to conduct business between countries with widely divergent economic and judicial systems. The rules are supplemented by: “ ICC Uniform Rules for Bank-to-Bank Reimbursements under Documentary Credits (URR 725). “ International Standard Banking Practice for the Examination of Documents under UCP 600 (ISBP publication No. 745). “ ICC Supplement to the Uniform Customs and Practice for Documentary Credits for Electronic Presentation (eUCP Version 2.0). In 2010, a revision of the rules was introduced, URDG 758. This revision provided an opportunity to bring all comments, experiences, criticisms and feedback regarding URDG 458 and the practice of demand guarantees into a new revised and comprehensive set of rules. This version is more exact and avoids the possibility of misinterpretation, which existed with URDG 458. In addition, it is made more transparent and readable by following the logical sequence of a guarantee lifecycle. 2.8.3 ISP98 The International Standby Practices (ISP98) became effective on 1 January 1999. It is considered to be more suitable for standby credits than UCP 600, which focuses primarily on commercial letters of credit and contains a number of rules that are not suitable or applicable for typical standbys. ISP98 contains the following sections: General provisions; Obligations; Presentation; Examination; Notice, Preclusion and Disposition of documents; Transfer, Assignment and transfer by operation of law; Cancellation; reimbursement obligations; Timing; Syndication and participation. //37 38// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 2.9 “UCP was introduced in 1933 to alleviate the disparity between national and regional rules on LC practice” Dispute handling and arbitration The ICC rules remain the most successful set of private rules for trade ever developed. However, no rules can protect you from bad practice, poor application of the rules, mishandling, or dishonest parties. 2.8.4 URC 522 Problems and misunderstandings do occur which can give rise to a dispute. In such circumstances, it is always hoped that the parties can reach a mutual understanding and agreeable conclusion. The worst-case scenario is that the dispute will end up in a court of law. The Uniform Rules for Collections (URC) were originally introduced in January 1979, under ICC Publication No. 322. The latest revision, Publication No. 522, came into effect on 1 January 1996. However, there does exist an intermediate stage, one of arbitration, whereby the parties concerned may agree to an independent assessment of the issue under dispute. The purpose of the URC is to set a standard under which all parties to a documentary collection are aware of their roles and responsibilities. The rules are applicable when indicated in the collection instruction. Whilst there are a number of formal arbitration services, including the ICC International Court of Arbitration, a less formal alternative exists in the form of a rapid, cost-effective, document-based procedure known as the ICC Rules for Documentary Instruments Dispute Resolution Expertise (DOCDEX). In July 2019, the ICC released a Supplement for Electronic Presentation (eURC) Version 1.0 (refer Section 10.8.1). 2.8.4 URF 800 The Uniform Rules for Forfaiting entered into effect on 1 January 2013 and sets out clear procedures along with model agreements for both corporates and financial institutions engaged in monetising receivables using forfaiting. URF 800 contains model agreements.17 2.8.5 URBPO The Uniform Rules for Bank Payment Obligations demonstrates ICC’s support for payment method using electronic data matching.18 They were adopted in April 2013. The rules define the BPO as “an irrevocable and independent undertaking of an obligor bank to pay or to incur a deferred payment obligation and pay at maturity a specified amount to a recipient bank in accordance with the conditions specified in an established baseline”. The purpose of DOCDEX is to provide parties with a specific dispute resolution procedure that leads to an independent, impartial and prompt expert decision settling disputes involving trade finance instruments, undertakings or agreements.19 DOCDEX was first launched in 1997 as an alternative dispute resolution system for parties using ICC rules relating to letter of credit transactions. In 2002, the scope of the DOCDEX rules was broadened to also encompass cases relating to URC and URDG. In November 2014, the Banking Commission approved a new set of DOCDEX rules that additionally caters for transactions subject to ISP98 and also trade finance transactions that are not subject to ICC rules. The process is monitored and handled by the ICC International Centre for Expertise. //39 40// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 1 3 Supply chain finance 3.1 Definition Supply chain financing is a generic term that typically covers the financing of open account transactions along the supply chain from development to distribution. Enabling accessible financing along the entire physical supply chain ensures exponential benefits to all entities involved in a trade transaction. Traditional trade finance has provided enormous benefits to traders but the problem has been that many of these solutions are predicated upon a paper environment. Dematerialisation into a digital format has proved to be the way forward. In modern times, efficient and speedy global modes of transport, combined with containerisation, have transformed the physical supply chain. However, due to the intrinsic need for paper, the financial supply chain has not kept pace with physical supply chains. The major challenge is to transparently, digitally and efficiently share information across the numerous involved entities in a trade transaction including suppliers, buyers, logistics, financial institutions, insurers, etc. Figure 11: Benefits of supply chain finance Figure 12: What financial intermediaries provide buyers and sellers Banks Buyers and suppliers “ Learn more about the business of its clients thereby enabling enhanced data integration, advanced financing solutions, and automated processing, particularly in a digital environment “ More accessible risk mitigation and improved working capital flows “ Reduced operational costs “ Lower transaction cost enabling reduced transaction pricing “ Automated processes including reconciliation, settlement, forecasting and monitoring “ Shorter transaction processing times and completion Source: TradeLC Advisory Closer matching of the physical, financial and information supply chains will continue to fuel the development of innovative financing solutions. Integration of data and information is, and will be, the basis of future trade solutions. Technology-based, automated, digital, paperless, online solutions to enable lower financing and operating costs, improving timeliness and improving efficiency and effectiveness Assistance in optimising working capital Financing which includes, but is not limited to, pre-shipment, warehouse, post-shipment and receivables purchase Additional access points across the supply chain allowing improved and increased financing opportunities Support multiple entities, in particular numerous suppliers. Modern supply chains can be very intricate and complex Risk mitigation as has been available for more traditional means of settlement and finance Source: TradeLC Advisory //41 42// A Guide to Trade Finance 3.2 Physical and financial supply chains Globalisation and the proliferation of technology have transformed business as we know it. But digitalisation (see Section 10) is a priority for one industry in particular: trade finance. Greater use of technology could bring numerous benefits to the industry with the increased transparency a digital process brings and even help plug the trade finance financing gap, estimated at US$1.5trn by the Asian Development Bank.20 The integration of physical, financial and information supply chains is stimulating ever more innovative financing solutions and such coordination of data and information will be the basis for future trade finance offerings as digital information becomes more readily attainable, convenient and available. The key to this success has been, and will continue to be, common standards for the sharing of data and information. Each party involved in a trade transaction needs to have access to data easily, cheaply and quickly. Copyright© 2020 Deutsche Bank AG. All rights reserved 3.3 Moving towards standardisation A relatively modern development, supply chain finance has often suffered from differing interpretations across industries and geographies. This has prompted a number of attempts in recent years to provide a common framework for understanding. The Euro Banking Association (EBA), in 2013, defined supply chain finance as, “The use of financial instruments, practices and technologies to optimise the management of the working capital and liquidity tied up in supply chain processes for collaborating business partners. SCF is largely ‘event-driven’. Each intervention (finance, risk mitigation or payment) in the financial supply chain is driven by an event in the physical supply chain. The development of advanced technologies to track and control events in the physical supply chain creates opportunities to automate the initiation of SCF interventions.”21 More recently, in 2016, Bankers Association for Finance and Trade (BAFT), EBA, Factors Chain International (FCI), ICC and the International Trade and Forfaiting Association (ITFA) jointly produced a paper under the auspices of the Global Supply Chain Finance Forum (GSCFF) entitled “Standard Definitions for Techniques of Supply Chain Finance”22. As mentioned on the ICC and GSCFF websites, the intent of this initiative is to help create a consistent and common understanding in respect of supply chain finance starting from the definition of terminology, to be followed by advocacy in support of global adoption of the standard definitions. Definitions include: “ Receivables discounting “ Forfaiting “ Factoring “ Factoring variations “ Payables finance “ Loan or advance against receivables “ Distributor finance “ Loan or advance against inventory “ Pre-shipment finance “ Bank payment obligation //43 44// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 3.5 //45 Forfaiting The without recourse purchase of future payment obligations represented by financial instruments or payment obligations (normally in negotiable or transferable form), at a discount or at face value in return for a financing charge (synonyms include without recourse financing, discounting of promissory notes/bills of exchange).25 The term “forfait” comes from the French expression to “relinquish a right”. In the context of forfaiting, the exporter will relinquish their rights to receive the proceeds on the due date in return for an immediate payment, at an agreed interest rate for the discount, and thereby pass all risks and responsibility for collecting the debt to the forfaiter. Figure 13: Summary of forfaiting transactional flow 3.4 2 Contract Receivables discounting Seller Buyer Sellers of goods and services sell individual or multiple receivables (represented by outstanding invoices) to a finance provider at a discount (synonyms include Receivables Finance, Receivables Purchase, Invoice Discounting).23 In June 2019, the GSCFF released a new guidance document, Market Practices in Supply Chain Finance: Receivables Discounting Technique, which focuses on receivables discounting a technique and form of receivables purchase; flexibly applied in which sellers of goods and services sell individual or multiple receivables (represented by outstanding invoices) to a finance provider at a discount.24 3 Delivery of goods 1 5 Commitment to acquire notes/bills Delivery of notes/bills 6 4 Delivery of notes/bills Cash payment less discount costs 4 7 7 Presentation for payment at maturity Forfaitor Source: www.tradefinance.training 8 Repayment at maturity Guarantor 8 46// A Guide to Trade Finance Forfaiting is usually experienced in transactions with tenors of more than 180 days and up to 10 years. The average is in the region of three to five years. Given the periods involved, it can be seen that forfaiting is used in large contracts and projects, long-term repayment plans to assist importers and high value transactions. Debt should be evidenced by a legally enforceable and transferable payment obligation such as a bill of exchange, promissory note, or a letter of credit. Copyright© 2020 Deutsche Bank AG. All rights reserved //47 Figure 14: Summary of factoring transactional flow 1 Invoice Buyer Seller 3 Advance funds la nc e fu nd s Further support and information on forfaiting is available from ITFA at www.itfa.org 7 In te 6 re st /f ee s Ba “Each party involved in at trade transaction needs to have access to data easily” 5 Payment 3.6 Factoring 4 Copy invoice Sellers of goods and services sell their receivables (represented by outstanding invoices) at a discount to a finance provider (commonly known as the ‘factor’). A key differentiator of factoring is that typically the finance provider becomes responsible for managing the debtor portfolio and collecting the payment of the underlying receivables (synonyms include receivables finance, invoice discounting, debtor finance).26 2 Copy invoice Factor Source: TradeLC Advisory The factor takes on the credit control and debt collection, and advances funds to the seller prior to maturity. The seller informs the buyer that the invoice has been transferred to a factor and sends copies of invoices to the factor (although the factor may issue the invoices on behalf of the seller). This is primarily without recourse with up to 90% of invoice value advanced. ‘Two-factor international factoring’ is when the seller’s domestic factor uses a local factor in the country of the buyer. 3.7 Payables finance Further support and information on factoring is available from FCI at www.fci.nl For further information on payables finance, together with examples of use cases, see Deutsche Bank’s Payables Finance: A guide to working capital optimisation.28 A buyer-led programme within which sellers in the buyer’s supply chain are able to access finance by means of receivables purchase. The technique provides a seller with the option of receiving the discounted value of receivables prior to the actual due date and typically at a financing cost aligned with the credit risk of the buyer.27 48// A Guide to Trade Finance 3.8 Loan or advance against receivables Financing made available to a party involved in a supply chain on the expectation of repayment from funds generated from current or future trade receivables (synonyms include receivables lending, receivables finance, trade receivable loans).29 3.9 Distributor finance Financing for a distributor of a large manufacturer to cover the holding of goods for re-sale and to bridge the liquidity gap until the receipt of funds from receivables following the sale of goods to a retailer or end-customer (synonyms include buyer finance, dealer finance, channel finance).30 3.10 Loan or advance against inventory Financing provided to a buyer or seller involved in a supply chain for the holding or warehousing of goods (either pre-sold, un-sold, or hedged) and over which the finance provider usually takes a security interest or assignment of rights and exercises a measure of control (synonyms include inventory finance, warehouse finance, financing against warehouse receipts).31 3.11 Pre-shipment finance A loan provided by a finance provider to a seller of goods and/or services for the sourcing, manufacture or conversion of raw materials or semifinished goods into finished goods and/or services, which are then delivered to a buyer (synonyms include purchase order finance, packing credit finance).32 It can often be the case that pre-shipment financing is required by the seller in order for goods to be produced. This is particularly relevant for goods that have long production or delivery periods. It can also be a requirement for large value transactions wherein the production costs Copyright© 2020 Deutsche Bank AG. All rights reserved may be very high. Pre-financing can be utilised to establish new or enhanced production facilities, acquire raw materials from suppliers or even to meet running costs to complete any new contracts. 3.12 Trade finance securitisation Securitising trade receivables allows companies to raise capital by selling, on a revolving basis, a selection of receivables to a legally separate, bankruptcy-remote special purpose vehicle (SPV). Trade finance securitisations are typically baskets of assets, such as supply chain finance, and documentary credits with an average life of 180 days, and many being less than 90. For this reason, assets have to be replenished on a regular basis, which entails considerable administrative commitment. Securitisation of trade finance has been gradually gaining traction with institutional investors because of the asset class’s low default rates, diversity and granularity, which provides additional sources of trade finance capital. Deutsche Bank’s TRAFIN 2018-1 securitisation, refinancing TRAFIN 2015-1 is an example of such a structure in action.33 //49 50// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 4 1 Structured trade and commodity finance Commodity collaterised trade finance structures are used in both emerging markets and those within the OECD. They rely on self-liquidating cash flows generated from the trading of commodities to support the finance structure and mitigate associated credit and transfer risks. Lender syndicates sometimes comprise several financial institutions, each taking a “ticket” of the overall loan package. 4.1 Pre-export finance/prepayment finance (PXF/PPF) This is where performance-based lending is structured around an export contract between an exporter (the seller) and an off-taker (the buyer) and the proceeds of the exports are typically used to enhance the repayment of the loan. In addition, the credit risk of the borrower can be monitored through the performance by the borrower under the export contract.34 4.1.1 PXF A PXF structure refers to a loan made to a producer (exporter) of commodities based on the value (price and quantity) of commodities to be sold and delivered to an eligible off-taker. When the exporter ships/ delivers the goods, the eligible off-taker then pays to an off-shore collection account pledged to the security agent on behalf of the lenders. The proceeds of the exports can be applied for the debt service under the loan agreement. The lender has full recourse to the exporter, who is at “Commodity collaterised trade finance structures...rely on self-liquidating cash flows generated from the trading of commodities” all times legally obliged to pay back the loan even in case the eligible offtaker defaults. There are structural enhancements (security) for the lender in the form of pledge(s) over the export contracts, pledged receivables arising from such contracts and, in some cases a pledge over commodities exported. The ultimate credit risk remains at all times with the exporter. If the value of the export contracts pledged (after applying the agreed cover ratio) falls below the drawn amount the exporter is typically obliged to top up the collateral by delivering additional volumes under the export contract or to pledge cash to the security agent in order to secured the repayment of the loan. PXF facilities are typically term loans with a pre-determined amortisation schedule. The exporter must ensure the size and timing of their shipments are sufficient to meet the debt service requirements. There is no prepayment or acceleration of payments if the exporter receives a payment from the off-taker that is greater than the scheduled amortised loan payment. 4.1.2 PPF Under a PPF facility the loan is provided to the off-taker under an export contract. The off-taker advances the loan to the exporter to pre-pay (part of) a pre-agreed export agreement for the delivery of a certain amount of goods. The exporter then ships/delivers the commodity to the off-taker and the loan is discharged by payment from the off-taker [through the collection account] for the delivery. A PPF facility is typically provided with limited recourse to the off-taker and with full recourse to the exporter. The off-taker is only liable to repay the loan to the extent of its limited recourse portion in case the exporter does not perform under the export agreement, i.e. fails to deliver the goods. If and when the exporter delivers, the off-taker is liable to pay for such deliveries. If the exporter delivers and the off-taker does not pay for such delivery, the lender(s) have a claim for payment of that specific shipment to the off-taker and could step-in by virtue of the pledged export agreements to claim back the delivered commodities and attempt to resell //51