TRADE FINANCE IN INDIA 2018 - PWC
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Trade
Click to launch
finance
in India
2018
Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and Case
trade finance methods transactions internationally credit currency (PCFC) factoring studies Contacts
Introduction to
international
trade
International trade
Introduction
•• International trade is the exchange of capital,
goods and services across international borders or
territories.
•• It allows both buyers and sellers to expand their
markets for goods and services that otherwise may
not be made available to them.
•• All countries have different assets or strengths
in terms of land, labour, capital, technology and
natural resources. Hence, most countries usually
focus on those products and services in which
they possess a comparative or absolute advantage
through specialisation. However, such specialisation
may result in excess production capacity for certain
goods and services and also result in an opportunity
cost in terms of inadequate production of other
goods and services.
•• It reduces dependency on the domestic market by
expanding customers’ demand in other countries.
•• It enhances economic growth and contributes
significantly to the country’s gross domestic product.
•• International trade presupposes the existence of a
sufficient level of geopolitical peace and stability to
facilitate smooth trade between nations.
2 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international finance of international trade receiving payments Buyer’s credit in foreign and Case
trade methods transactions internationally credit currency (PCFC) factoring studies Contacts
Need for
trade
finance
International trade
The trade dilemma
A
1. The exporter ships the goods.
Importer Importer’s preference Importer
•• International trade must work around a
fundamental dilemma.
2. The importer pays after goods are received.
•• Imagine an importer and an exporter who would
like to do business with one another.
•• Due to the distance between the two, it is not
possible to simultaneously hand over goods with
one hand and accept payment with the other.
B •• The importer would prefer arrangement ‘A’,
1. The importer pays for the goods. portrayed at the top of the adjacent figure, while
the exporter’s preference, ‘B’, is shown at the
bottom of the figure.
Importer Exporter’s preference Importer
2. The exporter ships the goods.
3 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international finance of international trade receiving payments Buyer’s credit in foreign and Case
trade methods transactions internationally credit currency (PCFC) factoring studies Contacts
Need for
trade
finance
International trade
Bank as an intermediary
Introduction for import/export
to international trade
•• The fundamental dilemma of being
1. The importer obtains the bank’s unwilling to trust a stranger in a foreign
promise to pay on its behalf. land is solved by using a bank as an
intermediary. A simplified view of such a
Importer structure is presented alongside.
•• The importer obtains the bank’s promise to
pay on its behalf, knowing that the exporter
6. The importer 2. The bank promises the
pays the bank.
will trust the bank. The bank’s promise to
exporter it will pay on
pay is called a letter of credit.
behalf of the importer.
•• The exporter ships the merchandise
Bank to the importer’s country. Title to the
5. The bank ‘gives’ merchandise is given to the bank on a
merchandise to document called an order bill of lading.
the importer. 4. The bank pays The exporter asks the bank to pay for the
the exporter. goods, and the bank does so.
•• The bank, having paid for the goods, now
passes title to the importer, whom the bank
Exporter trusts. At that time or later, depending on
3. The exporter ships ‘to their agreement, the importer reimburses
the bank’, trusting the the bank.
bank’s promise.
4 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international finance of international trade receiving payments Buyer’s credit in foreign and Case
trade methods transactions internationally credit currency (PCFC) factoring studies Contacts
Need for
trade
finance
International trade
Benefits of the system
•• Once the importer and exporter agree on terms, the seller usually prefers to maintain legal title to the goods until paid, or at
least until assured of payment.
Protection
•• The buyer, however, will be reluctant to pay before receiving the goods, or at least before receiving title to them.
against risk of •• Each wants assurance that the other party will complete its portion of the transaction.
non-completion •• The letter of credit, sight draft and bill of lading are part of a system carefully constructed to determine who bears the
financial loss if one of the parties defaults at any time.
•• In international trade, foreign exchange risk arises from transaction exposure.
Protection •• If the transaction requires payment in the exporter’s currency, the importer carries the foreign exchange risk. If the
against foreign transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk.
exchange risk •• Transaction exposure can be hedged; but in order to hedge, the exposed party must be certain that payment of a specified
amount will be made on a particular date.
•• Most international trade involves a time lag during which funds are tied up while the merchandise is in transit.
Financing •• Once the risks of non-completion and exchange rate changes are disposed of, banks are willing to finance goods in transit.
the trade •• A bank can finance goods in transit, as well as goods held for sale, based on the key documents, without exposing itself to
questions about the quality of the merchandise or other physical aspects of the shipment.
5 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Need for Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade of international trade receiving payments Buyer’s credit in foreign and Case
trade finance transactions internationally credit currency (PCFC) factoring studies Contacts
Trade
finance
methods
Overview of trade finance methods
Buyer’s Pre-shipment
credit credit
Trade finance
Letter of methods
credit
Post-shipment
credit
Forfaiting
and
factoring
6 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Need for Trade Making and Pre- and post-shipment Forfaiting
international trade finance receiving payments Buyer’s credit in foreign and Case
trade finance methods Timeline and structure internationally credit currency (PCFC) factoring studies Contacts
of international trade
transactions
Time and events
Export Documents Settlement
Price quote Goods are Goods are
contract are of the
request shipped received
signed accepted transaction
Negotiation Trade execution
Documents are
presented
Financing period
•• In order to understand the risks associated with international trade transactions, it is helpful to understand the sequence of events.
•• The two primary risks associated with an international trade transaction are currency risk and risk of non-completion.
•• The risk of default on the part of the importer is present as soon as the financing period begins.
7 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Need for Trade Making and Pre- and post-shipment Forfaiting
international trade finance receiving payments Buyer’s credit in foreign and Case
trade finance methods Timeline and structure internationally credit currency (PCFC) factoring studies Contacts
of international trade
transactions
Understanding the trade finance needs of corporates
Broad stages of the business value chain during the working capital cycle
Increased open
account
Procurement of raw materials Conversion of raw materials transactions
Sale of finished goods
into finished goods
Trade finance needs
Global trends in trade finance
Increased use
in the
Asia-Pacific
region
Fund-based
Pre-shipment Bill
Buyer Cash Cash Cash
facility
credit in foreign discounting/
credit/supplier credit/overdraft credit/overdraft credit/overdraft
currency factoring/for
credit facility facility facility
(PCFC) faiting
Increased
proportion of
US dollar
funding
based facility
Bank guarantee/
Non-fund
standby letters Foreign / Bank Foreign / Bank Foreign/
of credit inland letter of guarantee/ inland letter guarantee/ inland letter
(SBLCs) credit SBLC of credit SBLC of credit
Intense
Insurance protection provided by the Export Credit Guarantee Corporation of India Limited competition
among
Trade finance plays two pivotal roles—providing working capital tied to and in support of international trade transactions banks
and providing means of reducing payment risk.
8 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Clean payments
•• ‘Clean payments’ are characterised by trust. Either the exporter sends the goods and trusts the importer to pay once the
What is a clean goods have been received, or the importer trusts the exporter to send the goods after payment is effected.
payment? •• In the case of clean payment transactions, all shipping documents, including title documents, are handled directly by the
trading parties. The role of banks is limited to clearing funds as required.
•• There are two types of clean payments: Open account and payment in advance. The payment in advance and open account
Basic facts and schematics vary only in the order in which events take place.
mechanics •• Open account: The importer is trusted to pay the exporter after receipt of the goods. The exporter ships the goods and
pertaining to clean documents directly to the importer and waits for the importer to send payment.
•• Payment in advance: An arrangement whereby the exporter is trusted to ship the goods after receiving payment from the
payments importer. The importer sends payment directly to the exporter and waits for the exporter to send the goods and documents.
Open account: Payment in advance:
Risk analysis under •• Disadvantageous to the exporter since it •• Advantageous to the exporter since it takes no risks and receives
assumes all the risks the payment in advance
clean payment
•• Advantageous to the importer since it does •• Disadvantageous to the importer since it assumes all the risks
transactions not take any risks; delays the outflow of and incurs the opportunity cost of outflow of cash resources
cash resources before receiving the goods
9 PwC Trade finance in India 2018
Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Clean payments
•• A method of payment used in international trade whereby the exporter entrusts the handling of commercial and
What is often financial documents to banks and gives the banks instructions concerning the release of these documents to the
importer. The banks involved do not provide any guarantee of payment.
documentary •• Collections are subject to the uniform rules for collections published by the International Chamber of Commerce (ICC)
collection? under Uniform Customs and Practice for Documentary Credits (UCP) 600 and International Standby Practices
(ISP) 98.
•• Documentary collection may be carried out in two ways:
Basic facts of •• Documents against payment: Documents are released to the importer only against payment. It is also known as a ‘sight
documentary collection’ or ‘cash against documents’ (CAD).
collection •• Documents against acceptance: Documents are released to the importer only against acceptance of a draft/bill of
exchange. It is also known as ‘term collection’.
10 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Documentary collection
Flow of goods Flow of documents Flow of payment
•• After the importer •• After the goods are shipped, documents originating with the exporter (e.g.•• Payment is
and the exporter commercial invoice) and the transport company (e.g. bill of lading) are forwarded to the
have established a delivered to a bank, called the remitting bank in the collection process. remitting bank
Mechanics contract and agree on for the exporter’s
•• The role of the remitting bank is to send these documents accompanied
pertaining to documentary collection by a collection instruction giving complete and precise instructions to a account. And
as the method of the importer
documentary payment, the exporter
bank in the importer’s country, referred to as the collecting/presenting
can now present
bank in the collection process.
collection ships the goods. In the transport
documentary collection, •• The collecting/presenting bank acts in accordance with the instructions document to the
the importer is known given in the collection instruction and releases the documents to the carrier in exchange
as the ‘drawee’ and the importer against payment or acceptance, according to the remitting for the goods.
exporter, as the ‘drawer’. bank’s collection instructions.
Legend: Flow of goods,
documents and payment Exporter/drawer 1 Remitting bank
3 2
Flow of goods
2
Flow of documents 1
Flow of payment Presenting/
Importer/drawee 3 collecting bank
11 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Documentary collection
Documents against payment (D/P) Documents against acceptance (D/A)
Advantages to exporter: Advantages to exporter:
•• Documents are not released to the importer until •• Less costly than a letter of credit
payment has been effected •• May provide formal/legal means to collect unpaid obligation
•• Less costly than a letter of credit
Disadvantages to exporter:
Disadvantages to exporter: •• Risk of non-acceptance of documents
Risk analysis •• Risk of refusal of payment •• Commercial risk and country risk remain
under •• Commercial risk and country risk remain •• Although bill of exchange/draft is accepted by the importer, there
documentary Advantages to importer: is no guarantee of payment by the banks involved
collection •• Ability to examine documents before authorising •• Legal enforcement of unpaid obligation is costly and time-
payment consuming
•• Unlike a letter of credit, a line of credit is not Advantages to importer:
required, and fees are minimal •• Will receive goods before having to make payment
Disadvantages to importer: Disadvantages to importer:
•• In the case that transport documents carry title, •• Dishonouring an accepted draft is a legal liability and may ruin
cannot access goods until payment has been made business reputation
12 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Letters of credit
•• A letter of credit is a written undertaking by the importer’s bank (issuing bank) on behalf of its customer, the importer
(applicant), promising to effect payment in favour of the exporter (beneficiary) up to a stated sum of money, within a
prescribed time limit and against stipulated documents.
What is a letter •• A key principle underlying letters of credit is that banks deal only in documents and not in goods. The decision to pay
under a letter of credit will be based entirely on whether the documents presented to the bank appear, at face value, to be in
of credit? accordance with the terms and conditions of the letter of credit. It would be prohibitive for banks to physically check whether
all merchandise has been shipped exactly as per each letter of credit.
•• The ICC publishes internationally agreed-upon rules, definitions and practices governing letters of credit, which are called
UCP and referred to as UCP 600.
•• Letters of credit are either revocable or irrevocable:
– A revocable letter of credit can be revoked without the consent of the exporter, meaning that it may be cancelled or
changed up to the time the documents are presented. Revocable letters of credit are very rarely used.
Basic facts and
– An irrevocable letter of credit cannot be cancelled or amended without the consent of all parties, including the
mechanics exporter. Unless otherwise stipulated, all letters of credit are irrevocable.
pertaining to •• Letters of credit may be settled either by sight or by acceptance:
letters of credit – If payment is to be made at the time that the documents are presented, this is referred to as a sight letter of credit.
– If payment is to be made at a future fixed time from the presentation of documents, this is referred to as a term letter
of credit.
13 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Letters of credit
Issuance Flow of goods Flow of documents and payment
•• After the trading parties agree on a sale of •• Upon receipt of the letter of •• After the goods are shipped, the exporter
goods where payment is made by a letter of credit, the exporter reviews presents the documents specified in the letter of
credit, the importer requests that its bank the letter of credit to ensure credit to the advising/confirming bank.
(the issuing bank) issue a letter of credit in that it corresponds to the •• Once the documents are checked and found to
favour of the exporter (beneficiary). terms and conditions in comply with the letter of credit (i.e. without
•• The issuing bank then sends the letter of the purchase and sales discrepancies), the advising/confirming bank
credit to the advising bank. A request may agreement; that the forwards these documents to the issuing bank.
be included for the advising bank to add its documents stipulated in •• The drawing is negotiated, paid or accepted as
confirmation. The advising bank is usually the letter of credit can be the case may be.
Mechanics located in the country where the exporter produced; and that the terms •• In turn, the issuing bank examines the documents
pertaining to does business and may be the exporter’s and conditions of the letter of to ensure they comply with the letter of credit. If
bank, although it does not have to be. credit can be fulfilled.
documentary the documents are in order, the issuing bank will
•• Next, the advising/confirming bank •• Assuming the exporter is in obtain payment from the importer for payment
collection verifies the letter of credit for authenticity agreement with the above, it already made to the confirming bank.
and sends it to the exporter. arranges for shipment of the •• Documents are delivered to the importer to
goods. allow it to take possession of the goods.
Exporter/ 4 Advising/ Exporter/beneficiary
beneficiary confirming bank Exporter/ 2 Advising/
Advice/
1 Request to drawer confirming bank
confirmation of the 3
letter of credit advise and 1 4
Contract possibly 5
3
negotiation confirm the 6
Importer applies Goods Importer/drawee Issuing bank
letter of credit 7
Importer/ for letter of credit Legend: Flow of goods documents and payment
Issuing bank
applicant 2 Importer/applicant Flow of goods Flow of documents Flow of payment
14 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Letters of credit
Importer Exporter
Advantages: Advantages:
•• The importer is assured that, for the exporter to •• An undertaking from the issuing bank that the exporter will receive
be paid, all terms and conditions of the letter of payment under the letter of credit provided that it meets all the terms
credit must be met. and conditions of the letter.
Risk analysis
•• Ability to negotiate more favourable trade •• Shifts credit risk from the importer to the issuing bank.
for letters of terms with the exporter when payment by letter •• Not obligated to ship against a letter of credit that is not issued as
credit of credit is offered. agreed.
Disadvantages: Disadvantages:
•• A letter of credit ensures correct documents but •• Documents must be prepared in strict compliance with the
not necessarily correct goods. requirements stipulated in the letter of credit.
•• Ties up the line of credit. •• Non-compliance leaves the exporter exposed to risk of non-payment.
15 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment methods in international trade
Comparison of payment methods in international trade
Method Time of Goods available to Risk to Risk to Least risk Highest risk
payment buyer exporter importer to exporter to importer
Prepayment Before shipment After payment None Relies completely on
the exporter to ship the
goods as per the order
Letter of credit When shipment is made After payment Very little or none, Assured shipment made,
depending on credit but relies on the exporter
terms to ship goods described
in documents
Sight draft; documents On presentation of draft After payment If draft unpaid, must Same as above
against payment to buyer dispose of goods (unless importer can
inspect goods before
payment)
Time draft; documents On maturity of drafts Before payment Relies on buyer to pay Same as above
against acceptance drafts
Consignment At the time of resale by Before payment Allows importer to sell None, improves cash
importer inventory before paying flow of buyer
exporter
Highest risk Least risk
Open account After shipment Before payment Relies completely on None to exporter to importer
(as agreed) buyer to pay as agreed
16 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Guarantees
•• A guarantee is issued by a bank on behalf of its customer, the exporter, as financial assurance to the importer to be collected in
the event that the exporter defaults on certain specified contractual obligations.
•• The bank that issues a guarantee will pay the named beneficiary the amount specified on presentation of a written demand as
outlined in the guarantee.
What is a
•• While there are standard guarantee formats, they can be tailored to meet specific contractual needs.
guarantee? •• Often, standby letters of credit are used instead of guarantees. Standby letters of credit work in much the same way as
guarantees, offering financial assurance to the importer if the exporter defaults on agreed-upon contractual obligations.
However, there are at least two important ways in which standby letters of credit differ from guarantees:
– Standby letters of credit are governed by the ICC’s UCP, while guarantees are subject to the laws of the country of the issuing bank.
The following guarantees are commonly requested in foreign contracts:
•• Bid guarantee: An importer will often ask foreign contract bidders to post a bid guarantee as evidence of serious intent to
supply the goods or services if selected. In the event that the selected supplier is unwilling or unable to carry out the contract,
the importer can collect the amount of the bid guarantee.
Types of •• Advance payment guarantee: An advance payment guarantee covers the amount of the down payment the exporter requests
guarantees from the importer and provides the importer with some security that, if the exporter does not deliver under the terms of the
contract, the amount of the down payment would be retrievable.
•• Performance guarantee: A performance guarantee permits the importer to draw on the guarantee if the exporter fails to
perform according to the terms of the contract. For example, in the event that the exporter is unable to complete the contract as
agreed halfway through a project, the importer is compensated with the amount of the performance guarantee.
17 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Guarantees
•• During contract negotiations, the
2 Applies for a guarantee
importer requests that the exporter Exporter/ Issuing
provide a guarantee securing an applicant bank
aspect of the contract (e.g. bid,
advance payment). The exporter
(applicant) enlists its bank (issuing 3
bank) to issue the guarantee in favour 1
of the importer (beneficiary) for a The guarantee
specified amount and within a stated is sent to a
Mechanics of time frame. corresponden
guarantees •• In the event of default by the
Contract
negotiation
t bank of the
issuing bank
exporter, the importer would demand for advice to
payment against the guarantee the importer.
through the advising bank.
•• A correspondent bank is a foreign
bank with which the issuing bank Advice of the guarantee 4
has established a relationship where Importer/ Advising
beneficiary bank
secure transactions may be processed.
18 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Pre- and post-shipment Forfaiting
international trade finance of international trade Buyer’s credit in foreign and Case
trade finance methods transactions Making and credit currency (PCFC) factoring studies Contacts
receiving payments
internationally
Payment instruments in international trade
Guarantees/SBLCs
For issuing bank For applicant For beneficiary
•• Compliance checks on the parties •• As documents lack intrinsic value, •• Evaluation of credit and cross-border
and understanding the underlying additional documents may be risk on the issuing bank.
purpose of the standby. required to support a demand •• Understanding the risk of automatic
•• Obtaining satisfactory documentation certification, e.g. copy of unpaid reduction or automatic termination
Potential risks/ and reimbursement agreement from invoices or transport documents or against documents which the applicant
challenges to the obligor. Evaluating credit risk. certification issued by an independent can present directly to the issuing bank.
arbitrator or copy of court judgement.
consider •• Clear documentary conditions need to •• Understanding documents and/or
be mentioned to minimise the risk of •• Effectiveness of standby is against conditions that are required in order
conditions being misinterpreted by the clearly defined conditions, e.g. to draw, and avoiding documents which
beneficiary and possible rejection by effectiveness of advance payment are issued and/or signed by
the applicant in the event of a dispute standby after receipt of the the applicant.
under the underlying contract. advance payment.
19 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments credit in foreign and Case
trade finance methods transactions internationally currency (PCFC) factoring studies Contacts
Buyer’s
credit
Payment instruments in international trade
Buyer’s credit
•• Buyer’s credit is short-term credit given to an importer (buyer) from overseas lenders such as banks and other financial
institutions for goods it is importing. Overseas banks usually lend credit to the importer (buyer) based on a letter of comfort
(a bank guarantee) issued by the importer’s bank. For availing this service, the importer’s bank or buyer’s credit consultant
What is buyer’s charges a fee called an arrangement fee.
credit? •• Buyer’s credit helps local importers gain access to cheaper foreign funds that may be closer to London Interbank Offer Rate
(LIBOR) rates, as against local sources of funding which are more costly.
•• It is regulated as per the RBI’s Master Circular on External Commercial Borrowing (ECB) and Trade Credit, 2014, which
specifies norms for amount, maturity and ceiling charges.
•• It is beneficial to both parties as the exporter gets paid on the respective due date, whereas the importer gets an extended
date for making an import payment as per the cash flows.
Basic facts and •• The importer can deal with the exporter on sight basis, negotiate a better discount and use the buyer’s credit route to
avail financing.
mechanics •• The funding can be in any currency, depending on the terms of trade and availability of LIBOR. The currency of imports can
pertaining to be different from the funding currency, which enables importers to take a favourable view of a particular currency.
buyer’s credit •• The importer can use this financing for any form of trade—namely, open account, collections or letters of credit.
•• Buyer’s credit involves cost such as interest (LIBOR plus bank spread), letter of credit issuing fees, hedging cost and
withholding tax.
20 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments credit in foreign and Case
trade finance methods transactions internationally currency (PCFC) factoring studies Contacts
Buyer’s
credit
Buyer’s credit
The mechanics of buyer’s credit are depicted below:
1
An importer imports goods using
either a letter of credit,
collections or an open account.
6
On the due date, the importer either
requests for the rollover of the buyer’s
credit or recovers the funds from the 2
importer and retires the liability of the An importer approaches the
importer towards the bank against the issuing bank or arranges for a
letter of undertaking. buyer’s credit quote.
5 3
The issuing bank makes the
The issuing bank arranges for a an
payment to the exporter and thus
offer letter at the best possible rates
settles the liability of the importer
from the funding bank.
towards the exporter. 4
The funding bank, on receipt of
the letter of undertaking, credits
the NOSTRO account of the
issuing bank with the funds.
21 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Forfaiting
international trade finance of international trade receiving payments Buyer’s Pre- and post- and Case
trade finance methods transactions internationally credit shipment credit in factoring studies Contacts
foreign currency
(PCFC)
Payment instruments in international trade
PCFC
•• ‘Pre-shipment’ means any loan or advance granted or any other
credit provided by a bank to an exporter for financing the purchase,
processing, manufacturing or packing of goods prior to shipment, on
What is the basis of a letter of credit opened in his favour or in favour of some
pre-shipment other person, by an overseas buyer or a confirmed and irrevocable
order for the export of goods from India or any other evidence of an
credit? order for export from India having been placed on the exporter or
some other person, unless the depositing of export orders or a letter of
credit with the bank has been waived.
•• The applicant needs to arrange a ‘fund-based line of credit’ from an
authorised dealer/bank.
Basic facts and •• To make the credit available to exporters at internationally
competitive rates, the cost of the loan is quoted in LIBOR plus bank
mechanics spread.
pertaining to •• A major cost/challenge for an Indian exporter will be rupee depreciation
against the currency in which the loan is drawn.
pre-shipment
•• Interest is charged on credit up to 270 days at the rate decided by the
credit bank within the ceiling rate arrived at on the basis of Benchmark Prime
Lending Rate (BPLR), relevant for the entire tenor of the export credit
under the respective category.
22 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Forfaiting
international trade finance of international trade receiving payments Buyer’s Pre- and post- and Case
trade finance methods transactions internationally credit shipment credit in factoring studies Contacts
foreign currency
(PCFC)
PCFC
•• ‘Post-shipment credit’ means any loan or advance granted or any
other credit provided by a bank to an exporter of goods/services from
India from the date of extending credit after the shipment of goods/
What is rendering of services to the date of realisation of export proceeds as per
post-shipment the period of realisation prescribed by Foreign Exchange Department
(FED), and includes any loan or advance granted to an exporter, in
credit? consideration of, or on the security of any duty drawback allowed by
the government from time to time. As per the current instructions of
FED, the period prescribed for realisation of export proceeds is 12
months from the date of shipment.
•• Post-shipment advance can mainly take the form of:
Basic facts and (i) Export bills purchased/discounted/negotiated
mechanics (ii) Advances against bills for collection
pertaining to (iii) Advances against duty drawback receivable from the government
buyer’s credit •• This type of credit is available for a maximum period of 365 days,
depending upon the underlying bill and bank’s policy.
23 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Forfaiting
international trade finance of international trade receiving payments Buyer’s Pre- and post- and Case
trade finance methods transactions internationally credit shipment credit in factoring studies Contacts
foreign currency
(PCFC)
RBI guideline for the pricing of PCFC
1 Pre-shipment credit (from the date of advance)
(a) Up to 270 days
(b) Against incentives receivable from the government covered by the Export
Credit Guarantee Corporation of India (ECGC) guarantee up to 90 days
2. Post-shipment credit (from the date of advance)
(a) On-demand bills for transit period (as specified by the Foreign Exchange
Dealers’ Association of India [FEDAI])
(b) Usance bills (for total period comprising usance period of export bills, transit
period as specified by the FEDAI and grace period, wherever applicable)
(i) Up to 180 days
(ii) Up to 365 days for exporters under the Gold Card Scheme
(c) Against incentives receivable from the government (covered by the ECGC
guarantee) up to 90 days
(d) Against undrawn balances (up to 90 days)
(e) Against retention money (for supplies portion only) payable within one year
from the date of shipment (up to 90 days)
Note:
1. Since these are ceiling rates, banks would be free to charge any rate below the ceiling rates.
2. Interest rates for the above-mentioned categories of export credit go beyond the tenors prescribed above and are deregulated. Banks are free to decide the rate of interest,
keeping in view the BPLR and spread guidelines.
24 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment
international trade finance of international trade receiving payments Buyer’s credit in foreign Case
trade finance methods transactions internationally credit currency (PCFC) Forfaiting studies Contacts
and
factoring
Forfaiting and factoring
•• In normal course of business, the exporter is unable to clock the collection and reinvest in producing additional
goods even after shipment to the importer due to long credit periods or the aging of invoices. This negatively impacts
the exporter’s cash flow.
What is factoring •• Factoring and forfaiting are two similar routes to finance accounts receivables of an exporter. They differ on the basis of
the type of underlying consideration and the credit period given to the importer. The bank/arranger buys the accounts
and forfaiting? receivable for a margin.
•• Factoring typically involves the purchase of an exporter’s accounts receivable with a short credit period and invoiced
goods, whereas forfaiting is a term used for financing long-term credit periods ranging between six months and
seven years for underlying securities being capital goods, commodities and high-value merchandise.
•• To make the exporters more competitive, this facility is available in major convertible currencies charged as part of a
Basic facts and bank’s commitment fees plus bank spread over and above the respective currency’s LIBOR.
mechanics pertaining •• Days of grace, added to the actual number of days until maturity for the purpose of covering the number of days normally
to factoring and experienced in the transfer of payment, are applicable to the country of risk.
•• Such transactions are normally done on a non-recourse basis with a marginal risk for the arranger/bank given that the
forfaiting final payment is generally guaranteed by the letter of credit from the importer’s bank.
25 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment
international trade finance of international trade receiving payments Buyer’s credit in foreign Case
trade finance methods transactions internationally credit currency (PCFC) Forfaiting studies Contacts
and
factoring
Forfaiting and factoring
Differences Factoring Forfaiting
Extent of finance (invoice value) 75–80% 100%
Credit worthiness Bank does the credit rating in case of The forfaiting bank relies on the creditability of the availing bank.
non-recourse factoring transactions.
Sales administration Day-to-day administration of sales No services are provided.
Recourse With or without recourse Always without recourse
Sales By turnover By bills
Term Short term Medium term
Credit extension The bank provides credit protection after doing a credit check of the importer/receiving a letter of credit.
Invoice sale The exporter hands over invoices to the bank; the assignment is created at this stage.
Cash advances The bank credits the exporter’s bank account as per the terms agreed on before receiving payment from the importer.
The bank collects payment from the exporter (if the arranging bank is not a collection agent) and follows up on
Receivable collection
overdue invoices.
Remit collected funds The bank repays previous advances and remits the balance to the client (if the bank is a collection agent).
Financial reporting The bank provides transaction reports and statements to the client.
26 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and
trade finance methods transactions internationally credit currency (PCFC) factoring Contacts
Case
studies
1. Outsourcing of preparation 2. Use of letters of credit in
of documents by a large commodity trading
multinational to its bank
As with many companies, a large Asia-based subsidiary of a European electronics The trading of commodities is a global business, with goods constantly being
manufacturer was facing staffing pressures. The subsidiary found that it did not shipped from one side of the world to the other and to all points in between.
have the correct skill set among existing staff to prepare the full set of documents Typically, UK-based commodity traders will act as middlemen, sourcing
needed to support letters of credit. With the company preparing about 2,000 goods from one country or region and selling them in another, adding value
sets of documents a year, the proportion of errors resulted in a large number of by providing logistics and other services to facilitate the transaction. Sales
discrepancies in the documents which the company presented to the bank. As a can often be to buyers in emerging, developing or economically challenging
result, the company saw an adverse impact on its days sales outstanding (DSO) countries, where the risk of non-payment is a major concern for the seller. The
and decided to outsource this non-core activity to its bank. value of individual commodity shipments can be relatively high (often million
The bank had specialist teams responsible for originating and checking all USD), and failure to collect the sale proceeds can have a serious effect on the
such documents, and today the bank prepares the full set of documents for seller’s own financial condition.
the company. The solution was implemented in a short time frame and to the One way to mitigate this risk is for the seller to insist that the buyer arranges
company’s satisfaction, using dedicated resources at the bank. Not only did for its bank to issue a letter of credit in favour of the seller prior to the shipment
the bank improve efficiency by using its own expertise in the preparation of of the goods. Payment under the letter of credit is conditional upon the seller
documents, it was also able to reduce the risk of discrepancies by simplifying presenting the required documents through its bank. These typically include,
the company’s own internal processes. amongst others, bills of lading (or other title documents), invoice, certificate of
As a consequence, the company has effectively shortened its collection cycle, origin, and certificate of weight/quality.
resulting in an improvement in the company’s DSO to three to four days. This arrangement provides a degree of comfort to both parties. The seller
Moreover, when establishing the outsourced arrangement, the bank’s trade can arrange for goods to be shipped, with the knowledge that they will be
advisors also reviewed the company’s processes, leading to further operational paid for provided that the appropriate documents are presented as required
savings and reduced staff costs. under the letter of credit; and the buyer can refuse payment if the documents
Thus, this move had both cost and revenue benefits. The company started by presented do not conform to the requirements of the letter of credit. For
outsourcing trade documents prepared by at least one of its divisions to the example, the certificate of quality indicates that the goods are not of the
bank. It is now considering opportunities to further expand this service. correct specification.
27 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and
trade finance methods transactions internationally credit currency (PCFC) factoring Contacts
Case
studies
2. Use of letters of credit in commodity trading
The trading of commodities is a global business, with goods constantly However, it should be remembered that the letter of credit is a bank-to-bank
being shipped from one side of the world to the other and to all points in instrument, and while it does provide comfort in respect of the buyer’s ability
between. Typically, UK-based commodity traders will act as middlemen, to pay (albeit with the support of the bank), it does not protect the seller in the
sourcing goods from one country or region and selling them in another, event that the buyer’s bank is unable to make the required payment on the due
adding value by providing logistics and other services to facilitate the date as a result of, for example, its own liquidity problems, or situations outside
transaction. Sales can often be to buyers in emerging, developing or its control, such as the imposition of foreign exchange controls. Also, buyers
economically challenging countries, where the risk of non-payment increasingly require extended credit terms, such that they pay for the goods at
is a major concern for the seller. The value of individual commodity some agreed future date (e.g. 60, 90 or 180 days from the date of shipment),
shipments can be relatively high (often million USD), and failure to which puts pressure on the seller’s cash flow and ability to do more business.
collect the sale proceeds can have a serious effect on the seller’s own By adding its ‘confirmation’ to the letter of credit, the seller’s bank agrees that,
financial condition. provided the correct documents are presented (the seller’s bank will check the
One way to mitigate this risk is for the seller to insist that the buyer documents before sending them overseas), it will pay funds to the seller on the
arranges for its bank to issue a letter of credit in favour of the seller due date in the event that the buyer’s bank is unable to do so, thereby effectively
prior to the shipment of the goods. Payment under the letter of credit is removing the bank and country risk factors for the seller. If the letter of credit
conditional upon the seller presenting the required documents through allows for payment at an agreed future date, the seller’s bank may also agree
its bank. These typically include, amongst others, bills of lading (or to discount the proceeds—that is, advance funds to the seller (less an agreed
other title documents), invoice, certificate of origin, and certificate of discount) ahead of the actual due date, thereby improving the seller’s cash flow.
weight/quality.
This arrangement provides a degree of comfort to both parties. The seller
can arrange for goods to be shipped, with the knowledge that they will
be paid for provided that the appropriate documents are presented as
required under the letter of credit; and the buyer can refuse payment
if the documents presented do not conform to the requirements of the
letter of credit. For example, the certificate of quality indicates that the
goods are not of the correct specification.
28 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and
trade finance methods transactions internationally credit currency (PCFC) factoring Contacts
Case
studies
3. ‘Letters of credit are too expensive’
This was what an Asian buyer from an Irish exporting company stated when he What benefit would the confirmed letter of credit have provided
convinced the exporter to make a sale on open account terms. The Asian buyer to the exporter?
obtained 60 days credit, which was to be calculated from the date of the invoice.
•• A guarantee of payment on the due date from Allied Irish Banks
The value of the order was 1,00,000 USD and the goods were dispatched and
(provided the terms and conditions of the letter of credit were
invoiced by the Irish exporter on 15 April 2006. The payment from Asia was due
complied with).
on 14 June 2006. The payment eventually arrived on21 August 2006, over two
months late. The delay in payment cost the exporter 1,700 USD, as it resulted in •• No risk of non-payment as a result of problems with the buyer or the
his account being overdrawn by this amount for 68 days at 9% per annum. Asian economy.
So, are letters of credit too expensive? •• A definitive date for the receipt of funds, particularly important for
devising proper currency hedging strategies.
The Irish exporter could have insisted on receiving a confirmed letter of credit
through Allied Irish Banks. The following costs would have applied at that time: •• The opportunity to receive the payment in advance of the due date
through non-recourse discounting of the receivable.
Particulars Amount
Conclusion
Confirmation fee 250 USD
Please note that this case has not accounted for the costs the Irish exporter
Acceptance commission (@ 1.5% pa for 60 days) 250 USD incurred in chasing the debt with the Asian buyer. In addition, if the exporter
had sold his foreign currency receivable on a forward basis to his bank for
Negotiation/payment fee 150 USD
the original due date, they may have incurred a further cost in cancelling or
Out of pocket expenses (estimate) 60 USD rearranging the forward contract.
Total letter of credit cost 710 USD Letters of credit, although they appear to be expensive, do provide real and
tangible benefits to companies. In this case, the Irish exporter only lost 1,700
Interest cost as a result of late payment 1,700 USD
USD. Of course, if the Asian buyer had not paid at all, they would have lost
Benefit of using letter of credit 990 USD the whole 1,00,000 USD.
The letter of credit seems expensive because the costs are very visible and linked
to each transaction. The benefits, on the other hand, are intangible.
29 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and
trade finance methods transactions internationally credit currency (PCFC) factoring Contacts
Case
studies
4. Securitisation of receivables
Large companies that generate a sufficient volume
of receivables may be able to raise finance through
securitisation. The following case study is an example
of how this technique can be used. It also shows how
the proceeds from a transaction can be used in a
variety of ways.
Case study
An international chemicals distribution group
wanted to open a 250 million EUR funding facility by
securitising trade receivables denominated in euros
and dollars. The receivables were originated by the
group’s operating subsidiaries in the US and a number
of European countries.
The group’s bank and two other banks arranged for
the establishment of a special purpose vehicle (SPV)
in Ireland. Using funds raised via the issue of A1/P1-
rated commercial paper (CP) into the asset-backed
commercial paper (ABCP) market, the SPV purchases
the receivables directly from the company (indirectly in
the case of Italy and the US). The structure is operated
without recourse to the company, which receives funds
at the cost of the CP issuance, plus a credit-related
margin on any drawn funds. This facility has freed
cash for the distribution company and allowed it to
refinance some acquisition financing.
30 PwC Trade finance in India 2018Trade finance in India 2018
Introduction to Need for Trade Timeline and structure Making and Pre- and post-shipment Forfaiting
international trade finance of international trade receiving payments Buyer’s credit in foreign and
trade finance methods transactions internationally credit currency (PCFC) factoring Contacts
Case
studies
5. Implementation of a cash and trade solution by the division of a major
international retail company
The regional division of a major international retail company wanted From the company’s perspective, only one file is uploaded to the
to improve the efficiency of its cash management structure, improve its bank. The bank then manages the entire payables process, even for
working capital (via an extension to its days payable outstanding [DPO]) and those suppliers participating in the SCF. This reduces the
strengthen its supply chain to reduce the risk of disruption. company’s workload and minimises the touchpoints between the bank
The solution involved the division centralising its treasury operations and and corporates.
establishing a true end-to-end payables solution, including a supply chain finance The bank’s cash management system generates a series of reports back
(SCF) programme. As part of this process, the company was able to automate a to the company, giving the latter visibility on all the flows it requires.
number of its cash and trade processes, including its accounts payable function. Once the system has executed the payment run on behalf of the
Central to the success of the SCF is the way the company has minimised its company, all payments are automatically reconciled, whether or not the
involvement in the accounts payable process. The company uploads all of its supplier is part of the SCF programme.
approved invoices (payables) automatically from its ERP system to its bank As a result of implementing the SCF programme, the company
on a daily basis. Invoices relating to suppliers which participate in the SCF strengthened its relationships with its strategic suppliers, who were
programme are filtered by the bank on receipt to its trade platform. Other all able to participate. With the bank placing the credit risk on the
invoices are forwarded directly to the bank’s cash management system. company when financing its suppliers, the company was able to
Once the invoices from suppliers in the SCF appear on the bank’s trade reduce the risk of supplier default. At the same time, this supply chain
platform, suppliers have the option of selling them to the bank to accelerate financing element allowed the division to mitigate the impact on
cash receipt. If the supplier chooses a discounted payment, the bank pays it suppliers from extending DPO by up to 90 days (thereby improving its
on a next-day basis. The bank then collects payment from the company’s cash working capital).
management account on the invoice due date. If the supplier does not discount Finally, the automated solutions and the reduction in the number
the invoice, payment information is uploaded to the bank’s cash management of bank relationships have given the regional treasury much greater
system. This then initiates payment from the company’s account to the supplier visibility and control over the group’s regional operations.
on the invoice due date. Invoices relating to suppliers not participating in the
SCF programme are paid via the bank’s cash management system.
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