Trade Finance When an exporter sells goods to an importer and has to allow the buyer a credit period before having the payment for the goods, the seller may suffer a cash shortage. When an importer buys goods from an exporter and has to pay the seller immediately on receipt of the documents or goods, the importer may encounter a cash flow problem. Trade Finance Therefore, banks and finance companies offer different kinds to facilities to importers and exporters in order to solve their problems of insolvency. The cash granted in forms of loans and advances assists the liquidity position of an importer or an exporter. Export Facilities - Overdraft The overdraft facility for the current account might be unsecured or secured by the accountee’s property or personal guarantee. Overdraft is used as a short-term finance to assist cash flow because the interest rate is high. There is a limited amount provided over a period of time which is subject to review annually. Overdraft interest is charged only on the actual amount overdrawn on a daily basis. Therefore, overdraft is suitable for customers with temporary liquidity needs and is very flexible. Export Facilities - Packing loan Packing loan is offered by a banker to an exporter to finance the purchase of raw materials for producing the goods to be exported or the goods for resale. So it is a pre-shipment finance. The exporter must provide information required like the Sales Contract (for D/P or D/A) or the Documentary Credit for the transaction in order to apply for the packing loan. A packing loan may be granted against the deposit of the documentary credit as the collateral. Under the packing loan agreement, the customer must present the shipping documents to the bank granting the loan before the latest shipment date and expiry date of the documentary credit. Export Facilities - Advance against collection It is a post-shipment finance. The remitting bank agrees to advance a certain percentage of the value of the goods under a D/P or D/A collection to the exporter before obtaining payment from the importer. The interest might be deducted from the amount if the payment date is known. Export Facilities - Negotiation of Documentary Credit documents (with or without recourse) The negotiating bank offers advance to the exporter on the basis of the documents sent for payment under an irrevocable letter of credit and obtains reimbursement from the paying bank or issuing bank. The advance may be a certain percentage of the amount of the bill of exchange. For negotiation with recourse, if payment is not ultimately obtained from the issuing bank or paying bank, the negotiating bank will be able to claim repayment from the beneficiary of the advance plus interest. Export Facilities - Negotiation of Documentary Credit documents If the documents are presented for negotiation without recourse, it is the responsibility of the negotiating bank to check the documents and to make the judgment that the documents are complied with the terms and conditions of the documentary credit. Because once it has paid the bill, it has no right of recourse to the exporter. Export Facilities - Bills discounted under documentary credit available by acceptance An acceptance credit requires the bills of exchange to be drawn on the issuing bank or a paying bank in the beneficiary’s country. The beneficiary presents the draft and the shipping documents for acceptance. After checking the documents and accepting the bill of exchange, the beneficiary may ask his bank to discount the bill of exchange in order to get immediate fund to assist his liquidity. The discounted bill of exchange will be kept by the bank until maturity to obtain payment from the issuing bank or the paying bank. Export Facilities - Acceptance credit facility under documentary collection Similar to documentary acceptance credit, when the exporter engages in a series of transactions with the importer, he may apply for an acceptance credit line from his bank with the documents under documentary collection as security. Then the exporter is authorized to draw a term bill on his bank, acting as the acceptance house, which is processing the documentary collection for him. This bill of exchange is separate from the underlying trade bill of exchange which is drawn on the importer. When the bill has been accepted by his bank, it becomes an “eligible bill”. Export Facilities - Acceptance credit facility under documentary collection The exporter will discount it with a discount house, which can be another commercial bank, a merchant bank or a finance company, at a fine rate of interest. Then his account will be credited with the face value of the bill less discount charges and acceptance commission. Export Facilities - Acceptance credit facility under documentary collection At the maturity date, the discount house will present the eligible bill to the acceptance house for payment. By this time, the exporter’s bank (i.e. the acceptance house) should have obtained the reimbursement from the importer under the trade bill. An acceptance credit is usually granted on a with- recourse condition. The bill of exchange drawn by the exporter on his bank must have an expiry date later than that of the trade bill of exchange under the documentary collection. Export Facilities - Factoring Factoring is the purchase of trade debts (accounts receivables) by a finance company, with or without recourse, after deducting the finance company’s administration fee and the interest of the advance. The seller obtains immediate cash before the buyer’s payment for the goods sold on Open Account. Some factoring companies also provide their clients with a sales ledger accounting service and bad debt protection. Export Facilities - Factoring Factoring serves young growing companies in the early stage of development to obtain finance when their owners have few tangible personal assets to support the companies for expansion. Instead of undertaking the credit control function, they can concentrate their effort in production and marketing. Export Facilities - Factoring Firstly, the seller prepares an invoice to the factor to have an assignment stamp on the invoice which details that the debt has been assigned to the factor. Secondly, the invoice is sent to the buyer. The factor releases the agreed percentage of the invoice value, usually up to 80%, with the customer after charging an administration fee for the credit control and a discount rate which is the equivalent of bank interest. When the invoice is due, the factor receives the payment from the buyer. The unfinanced portion of the invoice value 20% is returned to the customer. Export Facilities - Factoring With a recourse factoring, if the factor is not paid by the buyer when the invoice is due, the customer has to return the advance to the factor. With a non-recourse factoring, the customer receives the added benefit of protection against bad debts. But the customer has to pay the factor a bad debt protection premium. Import Facilities - Import loan Import loan is offered by a banker to an importer for D/P or D/A transactions, which might be secured by the importer’s property or by the imported goods only. The bank will pay the exporter immediately under D/P at sight or at maturity of the draft under D/A on behalf of the importer. Then the importer will repay the bank at maturity of the loan. Import Facilities - Shipping Guarantee The importer’s bank gives a guarantee to the carrier that the responsibility for the goods can be transferred to the bank, which enables the importer to obtain delivery of the goods without presentation of the bill of lading. Shipping Guarantee is often used when the goods arrive at the destination before the receipt of the shipping documents. A shipping guarantee is usually a pre-printed form provided by the shipping company signed by the importer and countersigned by the importer’s bank. Import Facilities - Shipping Guarantee Because the bank will lose physical control of the goods upon signing a shipping guarantee, it requires protection such as full margin of deposit or a trust receipt line. Import Facilities - Trust Receipt (T/R) The bank pays the seller for the goods on behalf of the buyer and obtain repayment of the amount plus interest from the buyer at the maturity of the T/R. By the trust receipt, the customer agrees to hold the proceeds of sale of the goods as the banker’s security in place of the goods themselves. A trust receipt should only be used in the case where the goods were previously in the actual or constructive possession of the banker and were duly pledged to the banker. Import Facilities - Trust Receipt (T/R) Trust Receipt is usually granted with the documentary credit line. The importer who takes delivery of goods against a T/R agrees to hold the goods in trust for his bank and acknowledges the bank’s interest in the goods. He also undertakes to repay the bank from the sales proceeds. Import Facilities - Hire purchase Hire purchase is also called instalment finance. The seller receives payment immediately from the bank or finance company while the buyer obtains the goods immediately and pays for the goods by instalments. The ownership of the goods will conditionally passed to the buyer after the payment of the last instalment. Import Facilities - Forfaiting Forfaiting is a method of providing medium-term finance to the importer for capital goods by banks or finance companies. Firstly, the exporter negotiate with the importer who wants medium-term finance for the purchase of the machinery or equipment. Import Facilities - Forfaiting Secondly, the importer must make a down-payment (deposit) for the purchase, and balance is to be paid by regular instalments within a period of 5 years to 7 years. Thirdly, the importer has to issue a series of promissory notes to the exporter, or accept a series of bills of exchange drawn by the exporter. Fourthly, the exporter’s bank acts as the forfaiter who discounts the series of promissory notes or bills of exchange at a fixed or floating interest rate. So that the exporter receives cash immediately from the forfaiter while the importer can obtain the machinery or equipment immediately. Finally, the importer pays for the promissory notes or bills of exchange on their maturity dates. Import Facilities - Leasing Leasing is used for capital goods including aircrafts, ships, industrial equipment, construction equipment, etc. A lease is a contract of hiring of goods whereby the owner of the goods, the leasor, delivers the goods to its customer, the leasee, who obtains possession of and the right to use the goods but not the ownership in consideration of the payment of rental. Import Facilities - Leasing Firstly, the customer signs a Lease Contract with a leasing company for the capital goods. Secondly, the leasing company pays the seller for the goods immediately after delivery. Then, the leasee pays rentals to the leasing company periodically for the use of the capital goods which is still owned by the leasing company. Lastly, the leasing company will usually sell the capital goods to the leasee after a certain period of time or to another party who wants to buy the capital goods second-handed. Import Facilities - Leasing There are some advantages of leasing. Firstly, leasing provides up to 100% of the cost of the capital goods and no deposits are required from the leasee. Secondly, the lease rentals are tax deductible. Thirdly, lease is not a borrowing and does not use up the customer’s capital or credit lines. Lastly, if there are tax allowance to the lessor arising from the ownership of the capital goods, the costs of leasing can even be reduced as compared to the hire purchase. Export Credit Insurance In today's increasingly competitive trading environment, the offer of credit payment terms seems inevitable if exporters seek to grow their business. Therefore, export credit insurance helps to safeguard an exporter's interests while promising wider access to trade financing. Export credit insurance provides protection against the risks of non-payment involved when offering credit terms to overseas buyers. Hong Kong Export Credit Insurance Corporation In Hong Kong, the Export Credit Insurance Corporation (ECIC) has made focused efforts to enhance the professional standards of its credit risk assessment to increase the confidence of the banking community in accepting ECIC policies as valid collateral discounted against export bills. In fact, most banks in Hong Kong have always been willing to accept ECIC policies as secondary collateral for export loans. Hong Kong Export Credit Insurance Corporation The Hong Kong Export Credit Insurance Corporation (ECIC) was created by statute in 1966 to encourage and support export trade though the provision of insurance protection for Hong Kong exporters against non-payment risks arising from commercial and political events. Its capital is wholly-owned by the Government of the Hong Kong Special Administrative Region which also guarantees its contingent liability, currently standing at $12.5 billion. Hong Kong Export Credit Insurance Corporation ECIC was established under the Hong Kong Export Credit Insurance Corporation Ordinance (Chapter 1115). The Corporation provides a wide range of insurance facilities to Hong Kong exporters of both goods and services who trade with overseas buyers on credit terms, usually of up to 180 days. The facilities cover two main types of non-payment risks for goods exported and services rendered arising from buyer risks and country risks. Hong Kong Export Credit Insurance Corporation When an exporter is engaged in export trading on credit payment terms, such as Document against Payment (D/P), Documents against Acceptance (D/A) and Open Account (O/A), he is exposed to "non-payment" risks. Unforeseeable political, social and commercial factors can also prevent payments from the importer to the exporter. Hong Kong Export Credit Insurance Corporation Risks covered can be classified as buyer risks and country risks. Buyer risks include: Insolvency and bankruptcy Default in payment Failure or refusal to take delivery of goods Hong Kong Export Credit Insurance Corporation Country risks include: Blockage or delay in foreign exchange remittance Cancellation of import licences Import bans Payment moratorium War, revolution, riot and natural disaster Hong Kong Export Credit Insurance Corporation ECIC facilities cover not only exports shipped and re-exported from Hong Kong, but also those transported directly from suppliers' countries to their destination without passing through Hong Kong. The indemnity provided is normally 90% of the loss incurred. Comprehensive Cover Policy The most popular ECIC product is the Comprehensive Cover Policy, which applies to the export and re- export of goods from Hong Kong, and to the external trade of goods manufactured outside Hong Kong, on credit periods of up to 180 days. Tailor made facilities or variations on the standard cover are available. Medium and long term cover may also be offered to cover exports of capital goods for credit periods of up to 5 years or even longer if required. Comprehensive Cover Policy All protection commences from the date of shipment. The CCP covers both your domestic exports and re- exports from Hong Kong or from the following countries or areas: China Singapore Indonesia South Korea Macau Sri Lanka Malaysia Taiwan Philippines Thailand Comprehensive Cover Policy For all events of loss, the maximum percentage of indemnity is 90%. For insolvency or bankruptcy of the buyer, claims are settled as soon as all relevant documents are submitted. Where the buyer fails to pay for goods he has taken delivery of, claims are settled 4 months from the due date of payment. Where the buyer fails or refuses to take delivery of the goods, claims are settled immediately after the resale of goods. For any other event of loss, claims are settled 4 months after the occurrence of the event. Comprehensive Cover Policy Premium rates are calculated on the basis of the volume of insurable business, the spread of risks, the destination and the terms of payment. In general, the riskier the country and the longer the credit periods, the higher the premium rates. Cover on Sales to Oversea Buying Office in Hong Kong There has been a tendency for overseas buying offices in Hong Kong to act as the principals in their own right in transactions with local manufacturers or suppliers. Where credit sales are involved, the local manufacturer is exposed to the risks of non-payment and has no legal right to pursue payment from the parent company of the buying office. Cover on Sales to Oversea Buying Office in Hong Kong To protect the exporters, ECIC has created a facility to cover the credit risks arising from sales by Hong Kong manufacturers and suppliers to buying offices set up in Hong Kong. To be eligible for cover, the goods involved in the transaction must be intended for export to the parent company of the buying office or the parent's designated consignees. Documentary evidence such as contracts, transport documents, export declarations, etc. is normally sufficient for this purpose. Cover on Sales to Local Exporters It is a common practice for Hong Kong manufacturers to supply goods to local exporters who in turn sell the goods to overseas buyers. Where credit sales are involved, the local manufacturer is exposed to the risks of non- payment in the event the local exporter defaults or becomes insolvent. Therefore ECIC has created a facility to cover the credit risks arising from sales by Hong Kong manufactures to exporters in Hong Kong. Small and Medium Enterprises Policy Hong Kong owes much of its success to the flexibility and agility of the small and medium enterprises (SMEs) which make up most of the firms in the services sector. SMEs in general however are lack of manpower. Whilst devoting their main energy towards new business acquisition, they tend to overlook the risks inherent. The Small and Medium Enterprises Policy gives the SMEs a comprehensive protection over accounts receivable from exported goods or services. Cover on Export of Services Services are tradable internationally and increasingly so. To keep up the momentum of growth, Hong Kong also needs to promote and support the export of services in order to enhance its position as an international commercial and financial centre Cover on Export of Services ECIC provides comprehensive protection to the Hong Kong service sector when rendering services to overseas clients on credit terms. Tailor-made policies will now be available to cater for the unique requirements of the service industry. Cover usually starts on the date of rendering services. Other functions of ECIC Apart from insurance cover, ECIC provides a credit advisory service to exporters, offering advice on the extent of credit which it is prudent of them to offer their buyers. The service draws on a computerized worldwide database that includes some 70,000 buyers, whose credit-worthiness is regularly monitored by ECIC’s underwriters. The credit information is derived from an international network made up of credit information agencies, banks and other credit insurers. Other functions of ECIC Insurance policies issued by ECIC are accepted by the banking community as useful collateral for discounting export bills. The protection accorded to a policyholder may be extended to the policyholder's bank by a letter of authority, which enables claims to be paid directly to the bank and can be instrumental in helping policyholders obtain the banking facilities they need. Other functions of ECIC With a worldwide network of lawyers and debt- collectors available to call on, the ECIC is in strong position to assist in solving payment problems and advising policyholders on practical actions for preventing or minimizing losses wherever they trade. Tutorial Exercise Distinguish between short-term and long-term trade finance from the chapter. Discuss the advantages and disadvantages of the following import facilities : Factoring Trust Receipt Shipping Guarantee Short-term Trade Finance Overdraft Packing Loan Advance against collection Negotiation of Documentary Credit documents Discounting Bill of Exchange Acceptance Credit Facility Factoring Short-term Trade Finance Overdraft Import Loan Shipping Guarantee Trust Receipt Long-term Trade Finance Hire purchase Forfaiting Leasing Advantages of Factoring to the Seller Factoring service allows the seller to be more competitive in the market by granting credit terms to the buyers. Factoring service enhance the seller’s cash flow. Factoring service leads to a gain in controlling administrative costs and improvement in debt management. The exporter can concentrate on manufacturing, marketing, etc. Disadvantages of Factoring to the Seller The factoring charges and interests are expensive to the seller which reduce the profit margin. There may be adverse effect on the seller’s image because the factor deals with the overseas buyer in debt collection. Therefore, invoice discounting is preferred because the overseas buyer may be unaware that the documents are purchased by the finance company. Advantages of Trust Receipt T/R allows the importer to take delivery of the goods for further processing or sale before paying for the goods, which enhances the importer’s liquidity. This trade finance is self-liquidating in the sense that the customers repay the bank from the sales proceeds. Disadvantages of Trust Receipt T/R is granted to customers of high integrity or against adequate collateral. T/R is a short-term trade finance, overdue interest is high. The bank loses physical control of the goods. The customer’s credit-worthiness may worsen or the goods may be obsolete, so the security dependent on the goods may be risky to the bank. Advantages of Shipping Guarantee The importers can possess the goods immediately upon arrival. The importers can avoid paying demurrage charges. Disadvantages of Shipping Guarantee The importer must pay the bill even there are discrepancies in the documents. Margin deposit or Trust Receipt may be required to support the shipping guarantee.
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