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Effects of Late or Non-payments/Activities

Activity
Discuss the following issues:
 * What are the characteristics of risk evaluation?
 * What are differences in “in-country” (domestic) vs. international credit risk?
 * How does risk differ country by country? Compare and contrast different countries assigned to groups or individuals.
 * What global current events have changed (increased/decreased) the risk of doing business in a particular country?

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Effects of Late or Non-payments/Assessment

Assessment
{The tenets (principles) of risk assessment rely on -the customer for the most information. +gathering as many facts on the customer as possible. -your sales department for key data. -having financial statements for all customers.
 * type=""}

{Recognizing the “risk/reward” of international credit means -reducing outstanding receivables as much as possible. -having flexible credit policies for international customers. +knowing and apply the components of the “costs” of credit. -getting the customer to agree on the “shortest” terms possible.
 * type=""}

{The “Eight C's" of credit risk evaluation for the global seller provide -the sales department with necessary information. -assistance to a buyer in improving the relationship with a seller. -a simple checklist for the customers to complete. +research on the customer and the international environment.
 * type=""}

{The “risks and rewards” element of international credit differs from domestic or “in-country” credit decisions because -there is normally more profit available in international sales transactions. +more factors impact both risk and reward in the international scene. -there is normally more pressure from sales to sell internationally. -financial statements on international customers are, by nature, more comprehensive than those of domestic customers.
 * type=""}

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Payment Methods for International Transactions/Methods of Payment

Methods of Payment
Methods of payment include the following:
 * open account
 * documentary collections
 * documents against acceptance
 * documents against payment
 * letter of credit
 * confirmed letter of credit
 * advised letter of credit
 * cash in advance

Open Account
A seller ships the goods and all the necessary shipping and commercial documents directly to a buyer. This buyer agrees to pay the seller’s invoice at a future date ( net 15 days, net 30 days or with a discount offered--for example, 1% if paid within 20 days of invoice date).

Documentary Collections
A documentary collection is a payment mechanism in which a seller uses a bank as his/her "agent" in collecting payment from a buyer located overseas. After shipping the goods, the seller submits a draft (a demand for payment) and the relevant shipping documents to the bank. The draft will include instructions to release the documents to the buyer upon the buyer’s payment or acceptance of the draft. The seller’s bank sends the documents, draft, and collection instructions to a branch or correspondent bank in the buyer’s country. This bank carries out the seller’s collection instructions and, upon receipt of payment from the buyer, remits payment to the seller’s bank for the credit of the seller.

Documentary collection procedures are uncomplicated. After shipping the goods, the exporter submits to the bank:
 * shipping documents, including the bill of lading conveying title to the goods, as well as other documents related to the shipment.
 * a draft, also called a bill of exchange, demanding payment from a buyer. Depending on the agreed terms of sale, this may be a sight draft, demanding payment on presentation, or a time draft, demanding payment at some stated future time after presentation or after the bill of lading date.
 * instructions to the bank as to how to handle the transaction. Note that a documentary collection requiring payment before the release of documents may sometimes be transacted without a sight draft. Under cash against documents (CAD) terms, the documents are released to a buyer against receipt of payment. CAD terms are generally used when the government of the importing country requires tax stamps affixed to drafts; by eliminating the draft, both buyer and seller avoid stamp taxes.
 * release documents to a buyer upon payment of the sight draft, which is known as a documents against payment, or D/P collection; or release documents to a buyer upon acceptance of the time draft, a documents against acceptance, or D/A collection.

The seller’s bank, called the remitting bank, sends the documents, draft, and instructions to one of its branches or correspondent banks in the buyer’s country. This bank, called the collecting or presenting bank, contacts the buyer and informs him/her that the documents have arrived and can be obtained when he/she complies with the payment terms, which may be documents against payment or documents against acceptance.

Documents against Acceptance (DA)
A buyer is required to "accept" a seller’s time draft, thus acknowledging obligation to pay at the specific future date. The time of payment occurs at maturity of an accepted time draft, 30, 60 or 90 days after date of acceptance or date of bill of lading.

Documents against Payment (DP)
A buyer is required to pay a seller’s sight draft in order to obtain shipping documents. Payment is made on presentation of the sight draft by a bank to the buyer, usually one or two weeks after shipment. Under D/P terms, the seller, through a bank acting as an agent, is able to retain control of the goods until the buyer pays. Under certain circumstances, such as to meet legal requirements of the importing country or to obtain a government permit for foreign exchange, the buyer will require possession of the documents before payment. The seller should inquire as to the practice in specific countries. Air shipments are often made under documentary bill collections. The buyer, as direct consignee of the non-negotiable air waybill, will be able to take possession of the goods before meeting his/her payment obligations.

Letter of Credit
A commercial letter of credit is, essentially, an agreement in international trade whereby a bank assumes a conditional obligation on behalf of its customer, a buyer, to make payment to a seller. Payment is conditional upon a seller’s compliance with the terms and conditions specified in the letter of credit. These terms and conditions require the seller to present stipulated documents, which are usually those required for transport, commercial, and official purposes ( bill of landing, commercial invoice, insurance certificate, consular invoice). Once the seller has complied with the documentary requirements of the letter of credit, prompt payment is secured. In effect, a bank in the letter of credit transaction substitutes its credit standing for that of the buyer. Thus, the seller, who is the beneficiary of the letter of credit, has the undertaking of a bank to pay when the terms and conditions of the credit have been complied with. On the other side, the buyer is assured that payment will not be made unless the seller meets the conditions stipulated in the letter of credit.

The buyer’s bank substitutes its creditworthiness for that of its customer and agrees to honor a seller’s demand for payment if that seller complies with all the requirements specified in the letter of credit.

Confirmed Letter of Credit
In addition to the standard letter of credit, this instrument carries the undertaking of a second bank, usually in the seller’s country, to honor the seller’s demand for payment upon presentation of documents specified in the credit.

A second bank, usually in the seller’s country, gives its undertaking to the letter of credit issued by the buyer’s bank and promises to pay the seller upon that party’s compliance with the terms and conditions of the credit.

If the seller does not want to lessen risk, this seller may require that the letter of credit be confirmed by a bank in his/her country (or in some third country). A bank that confirms the letter of credit adds its commitment to pay to the original credit. Since the seller can look to the confirming bank for payment, he/she is protected against the financial risk of the issuing bank and the political risk of the importing country. To the extent that the credit standing of the confirming bank is undoubted, this is the most favorable type of letter of credit from the seller’s point of view.

Advised Letter of Credit
A letter of credit issued by the buyer’s bank (the issuing bank) may be advised to a seller by a bank, usually in his country--called the advising bank--without any undertaking on the part of that bank, except that it must use reasonable care to check the authenticity of the credit which it advised.

As the issuing bank undertakes to pay the seller, the advised letter of credit relieves the seller of the financial risk of the buyer. However, as beneficiary of the advised credit, the seller is subject to the financial risk of the issuing bank, which may not be willing or able to make payment when due. In addition, the seller is subject to political risk of the importing country: that is, the risk that sovereign action of the government may block the transfer of funds regardless of the issuing bank’s ability or willingness to pay the credit.

Cash in Advance
The seller requires receipt of payment from the buyer before shipping goods. Payment may be made by wire-fund transfer from the buyer’s bank to the seller’s bank, or by company check, credit card, or other agreed upon means.

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Payment Methods for International Transactions/Comparing Methods of Payment and Risk

Comparing Methods of Payment and Risk
The following chart offers a comparison from lowest to highest risk to an exporter/seller and importer/buyer (permission to use image, granted by Wm Hindon, VP, JP Morgan, 2004). The following chart lists the methods of payment discussed in the prior section in risk order to both the exporter (seller) and importer (buyer).

On the left side of the chart, you see the risk evaluation of the methods of payment from the perspective of an exporter or seller. For example, selling products or services on a “cash in advance” basis has a low uncertainty” or “low risk” to the seller because “cash” or funds are made available to the seller prior to the sale. A letter of credit, next on the “level of certainty/uncertainty” scale, is also a sound method of payment, although there could be discrepancies in the documents that could possibly affect payment. The same applies to the documentary collections. When “open account,” the last item on the list, is considered as to an exporter’s certainty/uncertainty of payment, the international manager should understand that by agreeing to “open account” (selling on net 30-day payment terms) there is a risk element of when and if payment will be made.

On the right side of the chart, you can see the level of uncertainty in terms of payment made by the importer or buyer. For example, if the importer (buyer) pays “cash in advance” for a product or service, the “uncertainty” is that money is paid before the product/service is available. What if there is a quality problem or delay in receiving the product or service which has already been paid for by the buyer? The buyer has no recourse. At the other end of the scale, the buyer has a low level of “uncertainty” if he/she has been “given” open account (30 days to pay) for product or service that has been delivered. The buyer has the product/service but has not yet paid for the invoice.

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Payment Methods for International Transactions/Summary

Summary
This discussion has focused on how to identify a variety of payment methods available to a risk manager. Businesses who sell in the 21st century global market appreciate that secured transactions are not only way transact business when selling internationally if they want to be both competitive and grow their business. A significant responsibility of a credit manager is to understand the use of the various payment terms in a competitive business environment. However, an international manager is not the only person who needs to learn to describe and apply the various payment methods that will apply to buyers. Senior financial management of the seller as well as the “business” people – marketing, operations – are well-advised to seek information as to payment decisions with buyers so that they are able to evaluate payment terms. Payment terms are an important component of the relationship with buyers. A pro-active international manager involves other business units and individuals, such as those in sale management, not only in the process of “why” certain credit terms are determined for a buyer, but also “how” they are determined.

Even though in most organizations the credit risk group has the responsibility of establishing and determining payment terms of customers, good business judgment in an organization should be exercised by bringing in internal customers to the decision process since they have stakes in the relationship with existing or potential buyers.

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Payment Methods for International Transactions/Resources

Resources
US Dept of Commerce – www.export.gov MSU Globaledge Modules – http://globaledge.msu.edu - Export Financing – Receiving Payment

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Payment Methods for International Transactions/Activities

Activity
Divide the class in half (exporter and importer). Present each side with the following scenario:

Importers
 * You are a new company (in business two years) and you are interested in placing a fairly large order with your foreign supplier.
 * Your goal is to purchase the products and resell them to your customers.
 * You need the product to be shipped within two weeks, and it will take six weeks for you to receive the product once it ships.
 * Once you receive the product, you will repack it and ship it to your customer within one week. You have agreed to receive payment from your customer 60 days after you ship.
 * In order to fund this scenario, you have requested open account payment terms from your vendor at Net 120 Days on Invoice and will pay in their currency.

Exporters
 * You are a well-established company that has been selling your products overseas for 15 years, although you have never sold to a customer in this new market.
 * You currently hold inventory of the product this customer wants to purchase, so you do not need to manufacture additional products.
 * You never extend open payment terms to new customers; however, this customer is also talking to your biggest competitor and may place the order there if you do not comply.

Task Negotiate payment terms and discuss each group’s needs and concerns. Is there a compromise available that would please both companies?

Alternatives To create new scenarios, you can include one or all of the following caveats:
 * 1. the currency in the importer’s country has devalued by 25%.
 * 2. there are rumblings of a dock strike in the importer’s country.
 * 3. the exporter wants to conduct a credit check in order to extend payment terms. The importer has agreed to supply the necessary information and will wait four weeks for the shipment to depart.
 * 4. the exporter has to manufacture the necessary products and will require funds to purchase raw materials.
 * 5. the exporter has never sold products overseas.

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Payment Methods for International Transactions/Assessment

Assessment
{The method of payment that carries the greatest risk for the exporter is -cash in advance. -letter of credit. -documentary collection. +open account.
 * type=""}

{The method of payment that carries the greatest risk for the importer is +cash in advance. -open account. -letter of credit. -documentary collection.
 * type=""}

{When shipping under a letter of credit the exporter is guaranteed payment when -the importer has received and inspected the goods at the port of import. +the exporter has complied with all terms and conditions as specified in the letter of credit. -the exporter has shipped the product and the bill of lading notes it as clean. -the importer advises the bank that the funds can be safely transferred to the exporter.
 * type=""}

{A documentary collection differs from a letter of credit in that -the exporter does not send the documents to a bank. -the importer does not receive the documents for a bank. -the fees for a documentary collection are greater than for a letter of credit. +the exporter cannot transfer risk to a banking institution.
 * type=""}

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Mitigating Techniques for Commercial Risk/Commercial Banks-Mitigation

Commercial Banks - Mitigation
Commercial banks, the largest financial sector in most countries, are usually short-term lenders. The principal international trade products that they offer are loans, letters of credit and documentary draft collections.

If a seller wants a third party to assume the risk of nonpayment on behalf of a buyer, it is important that this seller have a positive relationship with financial institutions. Understanding the way banks operate in terms of making funds available to buyers can provide an international credit manager with a more complete understanding of the risk associated with extending credit to a buyer.

International credit managers may work with a buyer in helping to find working capital financing, if the buyer does not already have a banking relationship. Of course, the credit worthiness of the buyer is critical to obtaining either short-term or long-term financing. When an international credit manager encounters a situation where shipments need to be made and there is little justification for open credit, a letter of credit can also be used as a bank financing opportunity for the international transactions.

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Mitigating Techniques for Commercial Risk/Loans

Loans
There are many similarities between the ways banks and companies manage credit. Both have similar processes. Credit management at a bank starts with credit analysis. Before a bank creates any exposure, someone needs to prepare a credit analysis describing the prospective borrower's financial condition. Based on the credit analysis and the bank’s risk management policies, a borrower is assigned a risk rating. Banks tend to be more formal about this process because extending credit is a core line of business for banks. Risk ratings usually range from very good to unacceptable. Several levels, 1 through 4, will be considered acceptable, though with different acceptability structures for each level; one or two levels will be considered marginal or "watch list," while remaining levels will be deemed unacceptable.

Risks may not lie entirely in a borrower's financial condition! In trade finance, as in export credit management, risk ratings must also factor in cross-border risks that may cause non-repayment of a loan, such as political events, the economic situation, or even acts of God and nature (earthquakes, monsoons) in the country of the borrower.

When a risk rating is assigned, the next step is to designate a credit limit and indicate permitted structures that may include sub-limits. Some structures may require collateral. The limits and sub-limits will be based on the desire of a borrower or a lender to diversify the risks-- not to lend too much money to any one borrower, or to too many borrowers in any one country or industry. Country limits are particularly important in trade finance. A political or economic event may disrupt payments from all borrowers in a country.

An international credit management system must be able to aggregate all exposures in a country, check that they are within the country limit, and block creation of new exposures that would cause that limit to be exceeded. Limiting factors include different limits for different types of risk: trading risk, risk related to loan, risk related to guarantees and tenor which includes short, medium and long-term trade finance. A lender may also have overall country limits, then limits for each sector (financial, industrial, government), and then limits for each borrower (by tenor and type of risk). With increased regulations and capital adequacy, this whole area of risk management has become very complicated.

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Mitigating Techniques for Commercial Risk/Letter of Credit

Letter of Credit
The letter of credit process begins after a buyer and seller conclude a sales contract providing for payment by a letter of credit. The buyer then instructs his bank--the issuing bank--to issue a letter of credit in favor of the seller. The sales contract may call for either a
 * sight letter of credit pursuant to which the issuing bank agrees to make payment upon presentation of a sight draft and the required documents, or
 * time letter of credit pursuant to which the issuing bank agrees to accept a time draft and pay at maturity upon its presentation with confirming documents.

The issuing bank then delivers or transmits the credit to a bank in the seller’s country--the advising bank--that may also be the asked to confirm the credit. The advising/confirming bank notifies the seller that the credit has been issued. Once the seller has been advised that a letter of credit has been issued in his/her favor and is certain that he/she can satisfy the stated terms and conditions, the goods are shipped and required shipping documents assembled.

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Mitigating Techniques for Commercial Risk/Documentary Draft Collection

Documentary Draft Collection
This type of document is archaic--if you haven’t seen it before, it may not make much sense. A documentary draft or bill of exchange is very similar to a letter of credit in that it is an agreement between a buyer and seller. (A simple check is the most familiar type of draft to most people.) Documentary drafts are still widely used, however, in many countries whose commercial law is based upon the Napoleonic Code. They were primarily used in domestic commerce as a way of facilitating transactions between individuals and companies who had faith in one another. The use of documentary drafts in global commerce began as a result of trade between companies in countries whose commercial law was based upon the Napoleonic Code, and they were also used in the United States. Using a draft is a multi-step process:
 * 1. A seller writes out a draft in his/her own favor (to his/her own account).
 * 2. When the buyer accepts the draft (signed it to accept payment), the draft then becomes a trade acceptance. A trade acceptance is a form of commercial paper that is both endorsable and liquid.
 * 3. In many countries, failure to satisfy a trade acceptance can lead to an immediate seizure of the personal assets of the acceptor.
 * 4. In order for the documentary draft to work, a third party acts as a guarantor of the draft.

The third party will guarantee payment of the draft upon presentation of the proper documents. While some companies would act as guarantors as a favor to special customers or clients, banks became involved as the third party. In certain letter of credit transactions, documentary drafts are also used as a backup to create additional assurance that a buyer will pay his/her obligations to a seller via a third party, in most instances a bank.

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Mitigating Techniques for Commercial Risk/Accounts Receivable Financing-Transference or Mitigation

Accounts Receivable Financing –Transference or Mitigation
Accounts receivable financing is a particular form of collateralized lending. In addition to banks, finance companies offer accounts receivable financing to both sellers and buyers. The collateral taken is receivables; and financing is with recourse to the seller or buyer, depending on the agreement. For example, a transaction could look like this: the product that the buyer is acquiring is used as collateral. If the buyer defaults, the seller gets his money, but the lender has the right to attach or “go after” the buyer and try to recoup the loss.

Normally a finance company will offer this type of financing for up to 70 percent of the eligible accounts receivable. Each buyer and location must be acceptable credit risks. With this method, a buyer is able to borrow money against its short-term open account receivables. Generally, this is a very expensive financing option. If a bank loans without recourse, then it is left holding the debt and cannot go after the originator of the loan or contract.

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Mitigating Techniques for Commercial Risk/Governments-Transference

Governments- Transference
Many governments are involved in supporting international trade and investment. International trade and investment are considered the two key engines that drive economic growth. Governments set the tone for economic development through policies and actions. Most want to foster exports as opposed to imports; exports create internal jobs, while imports create jobs in other countries.

As a result, most major economies have created specialized governmental institutions that are known as “ECA’s,” or Export Credit Agencies. An ECA provides insurance or loan guarantees through that country’s financial institutions and shares any losses with the bank in the event of a non-payment, depending on the agreement between the ECA and the country’s banks. By providing this type of guarantee, the ECA supports an exporter’s or seller’s ability to extend credit.

ECA financing is very difficult to arrange. It is usually supported by government credit agencies. Normally, the payment for the project is for five years and longer. A credit manager or project-finance banker can determine what kind of project or government-supported financing best fits the situation.

An example of an “ECA” is the US Export-Import Bank. The Ex-Im Bank works within a set of policies that focus on creating US jobs and adhering to US positions and regulations. As a result, it has certain restrictions on utilizing its programs that may prevent some buyer companies from getting financial support. In order to insure that their programs are creating jobs in the US, participating companies must ship all products overseas from the US, and support may be limited to the US content of the products. In addition, the final manufacturing stage must be in the US, and some programs require shipment on US vessels. Finally, with few exceptions, no product can be shipped to a military buyer. Within these restrictions, the Ex-Im Bank can support a variety of trade transactions under numerous programs.

The Ex-Im Bank's programs cover a variety of needs. In some cases, a company that needs financing, that is, a buyer requires pre-export financing assistance, which is offered through pre-shipment insurance and a working capital loan guarantee program.

Post-shipment assistance is provided through short, medium, and long-term programs. All the Ex-Im Bank's short-term export programs are insurance programs. These include programs to protect sales to an individual buyer called single-buyer insurance or many buyers at the same time, multi-buyer insurance, including programs designed specifically for small businesses-- the small business program and the environmental program. All goods covered under these programs must have at least 50% US content.

The Ex-Im Bank's medium-term programs include insurance, guarantees and direct loans. It is a requirement of any such program that the buyer make a 15% down payment based on the transaction value. A maximum of 85% of the FOB value, plus up to 15% in local costs in the destination country, are covered under these programs.

Under its long-term facility, the Ex-Im Bank offers both guarantees and project finance programs.

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Mitigating Techniques for Commercial Risk/Factoring-Transference

Factoring-Transference
Factoring can be described as the outsourcing of credit and collections. In other words, a seller pays another company, a factor, to collect payments from a buyer. The factor buys the accounts receivable--product or services that the buyer wants-- and pays the seller directly. The factor owns the receivables and goes after the buyer if the buyer does not pay the factor.

Its use in international trade goes back centuries. Cross-border factoring differs from domestic factoring in that the factor does not purchase the receivables unless and until they become past due.

When a factor guarantees payment and a seller needs the payment before it is due, the seller can borrow from the factor at some cost to the seller. The factor makes all credit decisions for the seller and collects all receivables from approved buyers. Unless the reason for non-payment is a dispute between the seller and buyer, the factor pays 100% of past-due receivables. Factors allow sellers to pick the customers they want to include, though not individual invoices. A rule of thumb is that factoring costs about twice as much as credit insurance.

A limitation on factoring is that it only exists in countries with laws that support the buying and selling of receivables--common in developed countries, but not emerging markets. If cost and range of risk coverage are issues, it is usually more satisfactory to use a letter of credit or export credit insurance. Most factors are "niche" players, usually concentrating in select regions of the world. There are certain industries, such as textiles and clothing, where factoring is considered a part of doing business.

The problems factoring presents to most companies are that most factors don't cover the riskiest countries and the service may be cost prohibitive for companies with tight profit margins.

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Mitigating Techniques for Commercial Risk/Forfaiting-Transference

Forfaiting-Transference
The name forfaiting is derived from the French term for the technique a forfait. It refers to the concept that a seller forfeits the right to a future payment on a receivable in return for immediate cash. This may sound similar to factoring. The objective of a forfaiter is to purchase such financial instruments at a low price and sell them at a high price, garnering a trading profit in the process. Frequently, forfaiters require that these instruments be avalized (guaranteed) by a buyer's bank, thereby enhancing marketability.

Because there is little potential profit in small transactions and because buyers balk at signing promissory notes and obtaining bank avals on short-term transactions, forfaiters tend to find a niche in medium-term transactions, such as capital goods.

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Mitigating Techniques for Commercial Risk/Banker's Acceptances-Transference

Banker’s Acceptances -Transference
A banker’s acceptance is a method of financing that banks can use to provide customers with short-term (six months or shorter) financing for trade transactions. Acceptances may be less expensive than more traditional trade financing methods. A banker’s acceptance is a time draft drawn on, and accepted by, a bank. By accepting the draft, a bank indicates its commitment to pay the stated amount of the draft on a specified future date. The draft may then be sold to an investor for a money market rate of return base on the credit risk of the bank.

Acceptance financing has been used for decades as a form of bank loan. The ability to fix rates for periods of up to 180 days protects the borrower from adverse movements in interest rates up to six months. Banks offer banker’s acceptances in a wide range of maturities to match their customer’s sales cycles and payment terms. A banker’s acceptance begins with a financial instrument issued in negotiable form, commonly called a “time draft” or “usance draft.” This is a draft drawn on a bank usually by an importer or exporter for a certain sum of money payable in the future. The drawee’s bank thereupon signifies acceptance of the obligation by stamping the work “accepted” across the face of the draft.

Traditionally, importers used bankers' acceptances to finance imports into the United States. Today acceptance financing is used to finance a wide range of activity such as imports, exports, domestic shipments, domestic purchases, and commodity warehousing of readily marketable products.

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Mitigating Techniques for Commercial Risk/Credit Insurance-Mitigation

Credit Insurance - Mitigation
You carry insurance on your car such that, in the event of an accident, you can get your car repaired or replaced without having to pay for all the expense of the repair or replacement. Export credit insurance is similar. It is an insurance protecting the exporter in case a credit-related non-payment should arise unexpectedly. It is not a means of payment.

Sellers consider credit insurance when selling into a part of the world where there may be political or commercial turmoil. For other sellers, credit insurance may be considered when selling for a first time in a part of the world where concerns for profit may outweigh the buyer’s concern for nonpayment.

By insuring commercial transactions, a company safeguards against the potentially devastating effects of a loss caused by the insolvency or protracted default of one or more of its customers. For international trade, external factors such as import and trade restrictions can also interfere with the successful completion of the contract of sale. A seller may be faced with a buyer’s insolvency, bad debts or even bankruptcy.

Credit insurance protects a seller against a wide range of commercial and political risks and can provide a competitive edge by enabling a seller to
 * expand sales
 * protect a seller’s balance sheet against bad debts
 * boost borrowing power, since lenders will have a “comfort level” with this protection
 * stabilize cash flow
 * enable new markets to be developed.

Credit insurers require a seller to be part of the credit decision. A seller has to satisfy the credit insurer that he/she has adequate credit controls in place in order to be paid in the event of a default.

Insurance coverage is available for legally enforceable indebtedness and usually commences when goods are "shipped or delivered." However, for many companies, business is complex and requires flexibility from the insurer, so one common variation for insurance is pre-delivery cover (or work-in-progress). If goods are tailor-made, the policyholder may not be able to resell them if the original buyer has become insolvent or the contract is frustrated before delivery. The policyholder is therefore exposed to the risk from date of contract. The extent of cover provided varies between insurers but will normally begin on the effective date of the contract, with claims calculated in relation to costs incurred in the manufacture of the product before the date of loss.

Business credit insurance covers a company's accounts receivable, which can, typically, represent more than 40% of its assets. This protection insures against unexpected bad-debt losses outside of the insured's control as a result of commercial and/or political risks, such as insolvencies, protracted default, repudiation, acts of war and government regulations or restrictions.

Credit insurance covers trade credit, insuring accounts receivable which are generally defined as short-term (360 days or less) and not secured by other guarantees. With a credit insurance policy in place, the company can be certain that valid ( non-disputed) accounts receivable will be paid by either the debtor or the insurer.

With most comprehensive export credit insurance policies, exporters are protected against both credit and political risks. Insurance companies will normally insure between 80 and 90% of the commercial (credit) risk and 85 to 100% of the political risk in a transaction.

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Mitigating Techniques for Commercial Risk/Summary

Summary
There are four types of risk responses a seller can take regarding nonpayment by the buyer: A credit manager can choose one or more of the techniques discussed in this lesson as a means of managing the risk of nonpayment.
 * Avoidance: Don’t sell on credit.
 * Transference: Ask a third party to assume the risk, such as the buyer’s bank.
 * Mitigation: Take precautions that reduce the probability that nonpayment will occur, such as performing a complete credit check.
 * Acceptance: Establish a contingency allowance for nonpayment accounts.

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Mitigating Techniques for Commercial Risk/Resources

Resources
FCIB - www.fcibglobal.com MSU Globaledge Modules – http://globaledge.msu.edu

Export Financing–Sources of Export Insurance
US Dept of Commerce – International Company Profile – www.export.gov US Export Import Bank - www.exim.gov US Small Business Administration - www.sba.gov

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Mitigating Techniques for Commercial Risk/Activities

Activity
Task 1 Visit the Ex-Im Bank and SBA website. Evaluate the current mitigating techniques available to US exporters. Discuss the options and determine the best option for each of the following circumstances:
 * 1. You are a small US company that assembles products made from imported materials.
 * 2. You are a large US company that has been involved in the export market for 15 years. You have just received a US$30 million order from new customer in Singapore. The order needs to ship in nine months.
 * 3. You are a medium-sized foreign company with offices located in the US. You have just received an order for your US products from your long-time customer in Germany. You require working capital to produce the products

Task 2 Visit the exim.gov website and
 * 1. check the country limitation schedule.
 * 2. download an application form for the appropriate export credit insurance cover.

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Mitigating Techniques for Commercial Risk/Assessment

Assessment
{A common technique to avoid payment risk is to -complete a thorough credit check on new customers. -request bank support for customers. -sell to customers where credit risk insurance is available. +insist that customers wire funds in advance of shipment.
 * type=""}

{The decision as to when to utilize techniques to mitigate payment risk is -determined by the contract signed by the importer. +determined by the exporter’s desire to reduce its risk. -determined by the exporter’s country law. -provided by the sales department who know their customers.
 * type=""}

{A common technique of transference of payment risk is -countertrade. -purchasing credit insurance. +forfaiting the receivable. -requiring a letter of credit.
 * type=""}

{Credit insurance can be purchased from +Ex-Im Bank. -the SBA. -local banks. -the Chamber of Commerce.
 * type=""}

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Methods of Payment/Cash in Advance (Prepayment)

Cash in Advance/Prepayment
Cash in Advance/Prepayment occurs when a buyer sends payment in the agreed currency and through agreed method to a seller before the product is manufactured and/or shipped. Upon receipt of payment this seller then ships the goods and all the necessary shipping and commercial documents directly to the buyer.

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Methods of Payment/Documentary Collections

Documentary Collections
Using a documentary collection process requires that a seller ship the product and create a negotiable document, usually a draft or bill of exchange. The draft and shipping documents are then processed either through a buyer’s bank (the collecting bank) or through the seller and buyer’s banks. Upon arrival at the buyer’s bank, the buyer is notified to make payment; then the documents are released and used to clear the shipment through customs upon arrival.

The primary advantage of documentary collections is that a seller who extends credit terms to a buyer under a D/A collection obtains an enforceable debt instrument in the form of a trade acceptance. The seller’s rights to payment are protected under the negotiable instruments law of that buyer’s country. In the event this buyer defaults or delays payment at maturity, the possession of the trade acceptance may put the seller in a stronger position before the court than if he/she had sold under open account, in which evidence of indebtedness is provided by the unpaid commercial invoice alone. In addition, a bank presenting a collection on behalf of a seller may obtain prompt payment from a buyer who might be inclined to delay payment if the seller were invoicing under open account.

A documentary collection is best used for ocean shipments where original bills of lading are required. An original bill of lading is a document of title which enables a buyer to gain possession of the goods. When all the originals of a bill of lading are sent to the collecting bank, it is in the interest of the buyer to effect payment in order to obtain title to the goods.

Documentary collections may be more competitive than letter of credit terms because they are less costly and do not require the buyer to tie up his/her local bank credit lines.

There are a variety of terms associated with documentary collections that should be understood:
 * Buyer = Importer
 * Seller = Exporter
 * Remitting Bank = Exporter’s Bank >> receives payment
 * Collecting Bank = Importer’s Bank >> transmits funds from buyer to seller
 * Bill of Exchange/Draft – document issued by exporter and used for remittance of funds
 * Time/Usance Bill of Exchange – tenured at 30, 60, 90, 120 or 180 days, etc.

There are four types of processes available to buyers and sellers: 1. D/P – Documents against Payment 2. D/A – Documents against Acceptance 3. Clean Collection 4. Cash Against Documents

D/P – Documents against Payment
The export documents and the bill of exchange provided to a collecting bank are only made available to an importer when payment is made. The collecting bank then transfers the funds to the seller through the remitting bank.

D/A – Documents against Acceptance
The export documents and a time/usance bill of exchange are sent to a remitting bank. The documents are then sent to a collecting bank with instructions to release the documents against a buyer’s acceptance of the bill of exchange.

Clean Collection
The exporter creates a bill of exchange, which is sent without any export documents to a buyer for collection through the remitting bank to the collecting bank. There is less security for an exporter since the documents are sent directly to the importer.

Cash Against Documents
This process lacks the security and legal protection of a documentary collection since the exports documents are sent through a remitting bank to a collection bank without a bill of exchange. It is, however, still a collection through the banking system.

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Methods of Payment/Letters of Credit

Letters of Credit
A letter of credit is a bank instrument that can be used to even the risk between a buyer and a seller since a seller is guaranteed to receive payment if when he/she has  complied with the exact requirements of this buyer. A letter of credit offers a seller numerous advantages but only if that seller complies exactly with its terms and conditions of the transaction. In addition to providing reduced risk for both a seller and a buyer, there are many variables that can be used with a letter of credit to reduce the political and commercial risks that may accompany the transaction as well as provide extended terms to a buyer through the letter of credit instrument.

The terminology that is used when working with letters of credit is very specific and should be understood.

Involved Parties:
 * Applicant = Buyer/ Importer
 * Beneficiary = Seller/Exporter
 * Opening Bank = Importer’s Bank >> Issues L/C
 * Advising Bank= Exporter’s Bank >> Advises L/C
 * Confirming Bank = Advising Bank or 3rd Party Bank >> Confirms L/C
 * Paying Bank = Any Bank as Specified in L/C >> Pays the Draft

Activities and Terms:
 * Advice – review and approval of L/C
 * Amendment – change to L/C
 * Confirmed – the commercial, political and economic risk of the transaction absorbed by the confirming bank
 * Discrepancy – mistake in the documentation
 * Documentation – documents required within L/C
 * Draft – negotiable order to pay
 * Sight Draft – payment assured upon shipment and presentation of documents in compliance with its terms
 * Time Draft – bank assurance of payment at the maturity of the banker’s acceptance with option of obtaining immediate funds by discounting the BA (30, 60, 90 days at sight or acceptance)
 * Irrevocable – cannot be changed without approval from beneficiary or advising bank
 * Issuance – opening of L/C
 * Negotiation – review of documents
 * Revocable – can be changed without approval of beneficiary or advising bank

Types of L/Cs:

 * Back-to-Back – credit and terms of a transaction rollover to a new transaction upon completion, which eliminates the need to apply or issue a new L/C for identical shipments
 * Confirmed – credit risk taken by bank and agreement to pay (fee charged)
 * Straight – payable only at paying bank
 * Negotiation – payable at negotiating bank
 * Sight – payable at acceptance of documents
 * Standby – used by the beneficiary for payment should the applicant not pay the exporter directly
 * Transferable – part or all of the proceeds from the L/C may be transferred to another party, used by sales brokers or agents to disguise buyers and sellers
 * Usance – time draft based on invoice, bill of lading, or documents, up to 180 days

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Methods of Payment/Open Account

Open Account
Open account occurs when a seller ships the goods and all the necessary shipping and commercial documents directly to a buyer who agrees to pay a seller’s invoice at a future date. Open account is typically used between established and trusted traders.

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Methods of Payment/Combining Methods of Payment

Combining Methods of Payment
The important thing to remember about methods of payment is that they are not absolute. They can be combined in many ways to reduce risk for all of the parties involved. For example, should a new customer require custom-made products, but cannot afford 100% prepayment, an exporter could offer 50% prepayment to cover the cost of manufacturing and 25% payment at invoice date and 25% payment 90 days after invoice.

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Methods of Payment/Summary

Summary
Having completed this lesson, you should be able to describe the methods of payment available for international transactions and the situation when each is appropriate. You should understand when payments will be made and the risks associated with each method of payment both to the buyer and the seller. Finally, you should know the benefits of agreeing to a particular method of payment and what kind of financing options it may or may not provide for the buyer and/ or seller.

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Methods of Payment/Resources

Publications
Exporting from Start to Finance 3rd Edition, L. Wells and K. Dulat, McGraw Hill. International Trade: Financial Services for Importers and Exporters, JP Morgan/Chase Bank, 2000. Handbook of International Credit Management, second edition, edited by B.W. Clarke. Gower Publishing, 1995. Practical Export Trade Finance, E. W Perry, Dow Jones-Irwin, 1989.

Web Resources
Letters of Credit:
 * www.chase.com (FAQs)
 * www.informafinancial.com
 * www.allbusiness.com
 * www.qualitylc.com

Attachments
Letter of Credit Application Sample L/C Collection Form Payment Comparisons

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Methods of Payment/Activities

Instructions for the Instructor:
1. Select a product the class would be interested in buying/selling. 2. Identify the country of origin of the product and a country of destination. 3. Discuss the political and economic situations of each country. 4. Divide the class in half with one side being the importer and the other the exporter. 5. Moderate a negotiation between the two sides as they try to secure the best method of payment for their company based on the scenarios provided. Remember to play devil’s advocate for both companies.

Scenario 1
The importer is a new company with little importing experience. The exporter has been involved in international business for ten years.

Optimum Outcome
While it is important to take into consideration the political and economic environment of both countries, based on the content information the best solution for an exporter would be 100% prepayment. Prepayment would be the worst outcome for the importer. A compromise with a percentage due prepaid and the remaining due at invoice date or on open terms would be less risky to the importer and still provide cost coverage for the exporter.

A new company with little international experience may have no business credit and pose a significant risk to an exporter. A compromise of part of the invoice prepaid and part on open terms reduces the risk for an importer, provides expense coverage for an exporter, and relies on this exporter’s experience and cash flow to support the growth of his/her business.

Scenario 2
An importer and exporter have been doing business together for five years. Over that period of time there have been three instances where this exporter has shipped late and the importer has had cash flow problems.

Optimum Outcome
While it is important to take into consideration the political and economic environment of both countries, based on the content information and this particular scenario, the best solution would be a letter of credit. Because both parties have experienced performance problems, there may be issues of trust. However, the parties do have an established relationship which may push them to agree to an L/C with terms, or a documentary collection to avoid the high bank fees.

Scenario 3
An importer is a well-established company that buys products from around the world. The exporter is a small company new to international business.

Optimum Outcome
While it is important to take into consideration the political and economic environment of both countries, based on the content information and this particular scenario, the best solution would be a percentage of the order prepaid and the remainder on a documentary collection. In this scenario, the exporter will need cash to manufacture since it is a small company and with little international experience will be hesitant to ship on open terms. As a newcomer to export, a letter of credit may be expensive and difficult to fulfill correctly. A documentary collection provides reduced risk for the importer and exporter while avoiding the cost and resources required in a letter of credit.

Scenario 4
Change the product and countries. Work through Scenarios 1-3 again.

Optimum Outcome
The answers may change based on the political and economic situation with in and between the countries involved in each scenario.

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Methods of Payment/Assessment

Assessment
{As an exporter requesting Cash against documents for the payment terms on their international transaction. The exporter is not required to include a _____________________ along with the export documents. -shipper’s export declaration +bill of exchange -commercial invoice -packing list
 * type=""}

{A letter of credit reduces credit risk to the exporter by -allowing the exporter to ship any product they have available to the importer once the letter of credit is received. -requiring the importer to pay all of the banking charges for the letter of credit. -allowing the importer to accept more than they ordered and that is identified in the letter of credit. +requiring the importer to pay should the exporter comply exactly with the terms and conditions of the letter of credit.
 * type=""}

{Open account payment terms is the best option for an international transaction -in every situation and in every market. -only when the importer is a new company. +when a long-term relationship has been established. -when the exporter has been doing business for many years.
 * type=""}

{Cash in advance or prepayment provides reduced risk to the -importer -broker -banks +exporter.
 * type=""}

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Buyer's Risks/Ensuring Timely Payment

Ensuring Timely Payment
One approach to country risk assessment is to use “CAMEL” to analyze:
 * Capital Adequacy = financial status based on a country's balance of payments
 * Asset Quality = economic and financial strength based on a country's combined natural, human, and general economic resources
 * Management Quality = a government's fiscal, monetary, credit policies and politics and how well these are implemented
 * Earnings Potential = internal and external variables that affect how well a country is achieving its capabilities
 * Liquidity = a nation's foreign exchange cash flow prospects

To ensure timely payment, an international manager needs to determine what the risk really is. These determining factors come in various forms:
 * non-payment
 * late payment
 * currency devaluation
 * import restrictions
 * bank problems
 * government issues
 * debt chains
 * tariff changes
 * shipping difficulties
 * pilferage

When measuring risk to determine how prompt payments can result, an international manager should attempt to put real values on the potential loss. These will have to include the absolute cost in cash terms and the cost in relation to the anticipated profit/loss. The company's risk tolerance (established by the credit management policy) will have to be taken into consideration as well the company's specific objectives in a given country, since the goal of "maximum market penetration," for instance, will point to different defensive measures than an objective that reads "maximum cash flow."

A check of the possible options for mitigating risk will reveal a number of possibilities, which need to be evaluated for anticipated benefits and costs. Alternatives could be:
 * agreement to open account terms
 * insistence on draft terms
 * unconfirmed L/C
 * confirmed L/C
 * insurance
 * arranging payment from an account the importer has abroad
 * forfeiting/Factoring
 * cash in advance
 * refusal to ship

Because of the different way in which international markets now finance themselves and the implications such have for a risk to a seller, the following questions should be asked in the normal assessment of variables that determine country risk:
 * Does the country have a fixed exchange rate and free movement of international capital?
 * Is the exchange rate overvalued or widely deemed to be?
 * Has a country with similar characteristics recently experienced a currency crisis?
 * Is there a large budget deficit and much government debt outstanding, especially short-term, needing constant rollovers at rising interest rates?
 * Is there loose monetary policy and high inflation?
 * Is the domestic economy in, or at risk of, recession?
 * Is there a large current-account balance-of-payments deficit?
 * Is there an asset-price boom, especially a credit-driven one, occurring?
 * Is there a large volume of bad debt in the banking sector, coupled with a poor system of bank supervision?
 * Has there been a lot of unhedged foreign currency borrowing?
 * Are accounting standards poor, with few disclosures requirements, ambiguous bankruptcy proceedings, etc.?
 * Is there socio-political uncertainty?

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Buyer's Risks/Facilitating External Financing

Facilitating External Financing
To understand the risks of external financing, the following questions need to be asked:
 * What is external financing?
 * How can it be viewed and understood?
 * How does CAMEL play a role in external financing as it has been described above?
 * What are the issues and factors that need to be considered when determining external financing?

The answers can be grouped by both commercial and political risk categories as discussed below.

Commercial Credit Risk

 * Nature of the business
 * Financial strength of the buyer
 * Nature of the relationship with the buyer--new buyer or a frequent customer, dealer/distributor, or a subsidiary/affiliate
 * Buyer’s record of meeting local and international payment obligations
 * Ownership of buyer, private or public sector
 * Potential loss if shipment is not accepted:
 * value of the shipment (marginal pricing concept--cash invested in the goods, high or low profit at the margin)
 * types of goods, perishable or specially manufactured where total loss might result if shipment were refused
 * likelihood of shipment being refused-- a change in market conditions for commodity shipments may induce buyer to refuse shipment).

Sources of information to help companies identify commercial credit risk are:
 * credit reports from independent agencies, banks, etc.
 * customer-supplied financial data
 * industry intelligence

Political Risks

 * Political conditions in buyer’s country
 * Stability of the local, state and federal governments
 * Possibility of import license cancellation, or other unexpected actions that would result in the non-acceptance of the shipment
 * Possibility of coup, civil disturbance, etc.
 * Possibility of change in foreign exchange regulations that could delay or disrupt payment

Economic Risks

 * Economic conditions in buyer’s country including expected and recent changes
 * Economic trends-- inflationary, recessionary, etc.
 * Currency exchange control regulations
 * Currency flow regulations
 * Country’s balance of payments

Sources of information to help companies identify political and economic risks are government and private agency intelligence reports including the following:
 * Chase World Guide for Exporters
 * Chase Econometrics Country Reports
 * International Monetary Fund Data
 * World Bank Data
 * CIA World Fact Book
 * US Department of Commerce – Country Commercial Guides
 * US State Department – Country Reports

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Buyer's Risks/Summary

Summary
After completing this lesson, you should be able to describe the ways to ensure timely payment and both the economic and political risks factors that influence payment results. Included in the ability to recognize the ways risk factors influence payment is knowing when alternative means of financing need to be considered.

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Buyer's Risks/Resources

Resources
Association of Executes in Finance, Credit & International Business (FCIB) – ww.fcibglobal.com Chase Publications – www.chase.com (see World Guide for Exporters & Chase Econometrics Country Reports) International Monetary Fund Data – www.imf.org World Bank Data – www.worldbank.org The CIA World Fact Book – www.cia.gov US Department of Commerce – Country Commercial Guides – www.export.gov US State Department – Country Reports - www.state.gov

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title: Buyer's Risks/Resources


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Buyer's Risks/Activities

Activity
Activity 1 As the international manager, you have been asked by your new boss to meet and to explain international risk issues. You will need to identify the key points as well as the differences in assessing risk in the US vs. factors that apply internationally. Prepare a one- page outline that you will use to discuss commercial, economic and political risks.

Activity 2 Select a country(ies) and identify economic and political issues that may affect a company’s risk both positively or negatively. Identify the sources of information and the type of information found at each source.

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Buyer's Risks/Assessment

Assessment
{Which of the following approaches to assessing country risk is most likely to reduce overall company risk? +Using a systematic approach to assure a consistent, relevant, and objective assessment -Relying on briefings about anticipated “global trends” from experts in international affairs -Talking to someone in the company who has some knowledge of the country from a prior visit -Rating each country according to a pre-established criteria set to assure fairness
 * type=""}

{Political risk is best defined as the inability of a foreign customer to pay its debts in full and on time as a result of -a change in the currency exchange rates. +actions of their government. -a failure of the banking system. -lack of funds in the customer’s account.
 * type=""}

{After the recent election in your buyer’s country the currency was drastically devalued, which will make it difficult for your buyer to pay you on time. This would be considered -commercial risk. -country risk. +economic risk. -political risk.
 * type=""}

{Your new international customer has been in business for less than one year and is owned by an individual with little industry experience. When evaluating your risk, this customer shows significant -country risk. +commercial risk. -economic risk. -political risk.
 * type=""}

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International Regulations/ICC

ICC
The International Chamber of Commerce was founded in 1919 with a goal to serve world business by promoting trade and investment, open markets for goods and services, and the free flow of capital. ICC activities cover a broad spectrum--resolving disputes through arbitration, making the case for open trade and the market economy system, helping business become self-regulated, fighting corruption, and combating commercial crime.

ICC model contracts make life easier for small companies that cannot afford high legal costs by providing templates.
 * ICC is a pioneer in business self-regulation of e-commerce.
 * ICC codes on advertising and marketing are frequently reflected in national legislation and the codes of professional associations.
 * ICC has direct access to national governments all over the world through its national committees. The organization's Paris-based international secretariat feeds business views into intergovernmental organizations on issues that directly affect business operations.
 * The ICC also sets rules and standards:
 * Arbitration under the rules of the ICC International Court of Arbitration is on the increase. Since 1999, the Court has received new cases at a rate of more than 500 a year.
 * ICC's Uniform Customs and Practice for Documentary Credits (UCP 500) are the rules that banks apply to finance billions of dollars worth of world trade every year.
 * ICC Incoterms are standard international trade definitions used every day in countless transactions.

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International Regulations/Uniform Customs and Practice (UCP) for Documentary Credits

Uniform Customs and Practice (UCP) for Documentary Credits
International standards of letter of credit practices were established for bankers by the International Chamber of Commerce. Historically, the UCP has been revised about every ten years to keep up with changing practice; the most recent revision, UCP600, was completed in 2006 and was put into effect July 1, 2007. Although the UCP defines rights and obligations of the various parties in a letter of credit transaction, it is not law; so any given letter of credit is subject to the UCP only to the extent indicated in the letter of credit itself.

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International Regulations/Uniform Customs and Practice – Electronic Supplement (eUCP)

Uniform Customs and Practice – Electronic Supplement (eUCP)
The electronic supplement to UCP 500 was first launched in April 2002. It was also updated and is now part of the UCP600. The eUCP provides a general framework of principles for dealing with the electronic documents (shipping, customs clearance and banking documents) being presented in letter of credit transactions. This document outlines the steps to authenticate documents and gives presentation requirements as well as the steps to take if a document is corrupted. The creation of this supplement shows the need and willingness of the ICC to maintain its currency in the world of business and the changes in technology that affect business.

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International Regulations/Uniform Rules for Collections

Uniform Rules for Collections
The Uniform Rules of Collections are the international standards of draft collection practices established for bankers by the International Chamber of Commerce. The Uniform Rules are not law but are more properly viewed as a handbook for banks used to establish common understanding of terminology and expectations.

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International Regulations/ICC International Court of Arbitration

ICC International Court of Arbitration
The International Chamber of Commerce has applications that can impact timely payments. In particular, there are arbitration mechanisms available that can help parties reach an amicable settlement for payment issues. A final and enforceable decision can generally be obtained only by recourse to the courts or by arbitration. Because arbitral awards are not subject to appeal, they are much more likely to be final than are the judgments of courts of first instance. Although arbitral awards may be subject to being challenged (usually in either the country where the arbitral award is rendered or where enforcement is sought), the grounds of challenge available against arbitral awards are limited.

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International Regulations/INCOTERMS

INCOTERMS
The Incoterms are internationally accepted commercial terms defining the respective roles of buyer and seller in the arrangement of transportation and other responsibilities and clarifying when the risk/liability for the merchandise transfers from seller to buyer. They do not define the transfer of title. They are used in conjunction with sales agreements, payment terms and other methods of transacting sales. It is very important for an international manager to understand the relationship between Incoterms quoted in a transaction and their relationship to the payment terms that have been agreed to for the transaction, since risks may change for a buyer and/or seller when these issues are analyzed.

For example, if the seller agrees to open account payment terms of Net 90 days invoice date and quotes Incoterms of CFR port of destination, the seller’s commercial risk has increased significantly. Why? In this scenario the seller will not be paid until 90 days after the invoice date and, per the Incoterms, will cover the transportation costs and maintain ownership of the goods while in transit to the port of destination; however, the seller will not be responsible for insuring the goods. Should the product be damaged during shipment, the seller is relying on the buyer to pay for the goods and submit the insurance claim and wait for reimbursement, which could happen if the buyer and seller have a good relationship. However, the seller could loose everything in this situation – the goods and payment.

Specific Incoterms have application to timely payment. Some examples of Incoterms follow:

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International Regulations/WTO

World Trade Organization
The World Trade Organization (WTO) is the only global international organization dealing with the rules of trade between nations. At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business.

The WTO can be involved in dispute settlements that may result from untimely payments. The WTO’s procedure for resolving trade quarrels under the Dispute Settlement Understanding is vital for enforcing the rules and therefore ensuring that trade flows smoothly.

A dispute arises when a member government believes another member government is violating an agreement or a commitment that it has made in the WTO. The authors of these agreements are the member governments themselves; the agreements are the outcome of negotiations among members.

Ultimate responsibility for settling disputes also lies with member governments, through the Dispute Settlement Body.

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International Regulations/Summary

Summary
An international manager armed with information about organizations that create international regulation requirements will be better equipped to understand the resources available in decision- making. By having an overview of the way these organizations function, there is the increased likelihood for timely payment from the buyers.

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title: International Regulations/Summary


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International Regulations/Resources

Resources
International Chamber of Commerce – www.iccwbo.org ICC Resources – www.iccbooksusa.com The World Trade Organization – www.wto.org World Trade Press Publications – www.worldtradepress.com FCIB Online Resource Library, – www.fcibglobal.com Exporting from Start to Finance, Third Edition, L. Wells and K. Dulat.
 * Dictionary of International Trade
 * International Finance

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title: International Regulations/Resources


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International Regulations/Activities

Activity
Activity 1 Using the Incoterms Circle Chart, choose an Incoterm for a transaction.
 * Identify the responsibilities for the buyer and seller
 * Identify the risks to the buyer and seller

Activity 2 Choose a method of payment as discussed in Task 1 and an Incoterm.
 * Identify the responsibilities for the buyer and seller
 * Identify the risks to the buyer and seller
 * Determine if your choice is the best combination of Incoterm and method of payment
 * Determine what could be a better or worse choice

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International Regulations/Assessment

Assessment
{Many international business regulation are created by the -Association of Freight Forwarders. -buyer’s local government. +the International Chamber of Commerce. -US Department of Commerce.
 * type=""}

{The Incoterms were created to clearly define -the best method of shipping an order from the seller to the buyer. +when ownership of merchandise passes from the seller to the buyer. -the least risky method of payment the seller should quote the buyer. -how funds will be transferred from the buyer to the seller.
 * type=""}

{The UCP which defines the rights and obligations of banks and businesses involved in documentary transactions is considered -a legal and binding document. -contractual law by the governments. -flexible and adaptable to each transaction. +a guideline for practices.
 * type=""}

{The goal of the WTO is to help -governments maintain control over business. +importers and exporters conduct their business. -smaller companies succeed in international business. -big companies maintain dominance in international business.
 * type=""}

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Funds Remittance/Checks

Checks
A check is a negotiable instrument issued against deposited funds to pay a specified amount of money to a specific person/company upon demand. This method of fund remittance is normally utilized for an international transaction when a local country representative will pick up a check or the check is given directly to the international manager by the buyer. Checks can be drawn on banks located in any country depending on where a buyer holds accounts. A check drawn on a bank in a seller’s country is less risky since the seller can verify availability of funds. The most risk is found with a company check drawn on a bank outside the seller’s country.

In order for the seller to receive funds, a check must be deposited/cashed. If the check is deposited in a seller’s account and the check is drawn on an overseas bank, the funds will not be available to the seller until the check is sent overseas for clearance and the funds are transferred to the seller’s bank. The relationship between the banks involved, the countries involved, and the currency of the check will determine how long it will take and the fees that will be charged.

Some examples follow:
 * Bill of Exchange-- an order by one person for a second person to pay a third. The tenor is the period of time from issue of the bill of exchange until maturity.
 * Clean-- without supporting documentation
 * Documentary-- with supporting documentation
 * Sight-- on demand, calling for payment as soon as presented to the drawee
 * Term/time/usance-- payable at a fixed future date or at a determinable future date
 * Draft-- an instrument signed by a drawer to a drawee requesting payment at a future time to a third party, often the drawer.

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Funds Remittance/Banker's Drafts

Banker’s Drafts
This draft is similar to a check. However, it is a time draft drawn on a bank by a bank; and once accepted by the drawee bank, it becomes an unconditional obligation of the bank to honor at maturity.

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Funds Remittance/Electronic Funds Transfers

Electronic Funds Transfers
Electronic funds transfers (also commonly known as wire transfers or TT) are a quick and effective method of transferring money between buyers and sellers, in particular when buyer and seller are located in different countries. This term is often misused in international transactions to mean a prepayment, which is not the case, since funds can be electronically transferred at any time during the transaction as agreed by buyer and seller.

The process works this way:
 * A customer/buyer contacts its bank and arranges for the funds transfer.
 * A seller's bank name, address, ABA number, routing number and account number are identified as the receiving bank and recipient respectively.
 * The remitting bank issues a payment order to the receiving bank requesting the payment to be credited to the third party beneficiary or the seller.
 * The remitting bank at the request of its customer, called the "by order of" party, issues a funds transfer.
 * The receiving bank must be a correspondent of the remitting bank to the extent that the receiving bank can verify the authenticity of the instructions.
 * Payment orders are sent by telex or via an inter-bank telecommunication system known as SWIFT.

Note: The authenticity of these messages is assured through sophisticated data encryption.
 * The receiving bank will honor requests sent to it by remitting banks only when the receiving bank feels assured that the remitting bank will reimburse it for any outlay of funds, which can be accomplished in any of the following ways:
 * A remitting bank can assure reimbursement by authorizing the receiving bank to charge its account with them. This rule applies when the remitting bank requests payment to be made in the receiving bank's local currency.
 * A remitting bank can assure reimbursement by crediting their account with the receiving bank. In the case of American banks remitting US dollars abroad, the credit would be posted to the receiving bank's US dollar account.  If foreign banks specify that they have credited the account of a US bank, then the credit would normally be in their local currency.
 * Money transfers can also be accomplished between remitting and receiving banks even when there are no direct accounts between the two. To do so, the remitting bank transfers the funds into the receiving bank's account via their US correspondent bank.  The US correspondent bank, the covering bank, would then advise the receiving bank of the credit.
 * When payment is to be made in the local currency of the receiving bank and the remitting bank does not maintain an account in that particular currency, payment must be made through a third correspondent bank. This action is usually accomplished by requesting the covering bank to issue a payment order on behalf of the remitting bank.  In this case, the true remitting bank would be the third party bank while the original remitting bank would be an additional "by order of" party to the transfer.  No direct payment order would be sent by the original remitting bank to the receiving bank.  The original remitting bank would authorize the covering bank either to charge its account or would transfer covering funds by wire transfer to the correspondent bank.  An exchange rate would have to be agreed upon between the remitting bank and the correspondent bank.

Example:
 * If ABC Bank receives an application for a payment of 400,00 Pakistan rupees in Pakistan and ABC Bank does not maintain a Pakistan rupee account, payment could be made through a third party correspondent bank such as XYZ Bank in New York.
 * ABC Bank would request XYZ Bank to issue their payment order for 400,000 Pakistan rupees on behalf of ABC Bank's customer and authorize XYZ Bank to charge ABC Bank's account in US dollars, using a prevailing rate of exchange.
 * If the rate of exchange were 0.0292, then XYZ Bank would charge ABC Bank's account $11,680.00 plus funds transfer charges and issue the payment order directly to the receiving bank for the payment of 400,000 rupees.
 * XYZ bank then would assure reimbursement to the receiving bank by authorizing it to charge its Pakistan rupee account.

For exporters (sellers), the primary concern is receiving fund transfers in a timely fashion. The fastest method of doing so is using an overseas remitting bank that maintains an account with the beneficiary's receiving bank. Then fund transfers are typically received within one to two business days. However, if the transfer must be made through an intermediary bank, such as the remitting bank's US correspondent, it will take longer, typically four to seven business days.

It is critical that a foreign buyer asked to remit payment by wire transfer has the following information:
 * the seller's full name and address
 * the city and state of the seller's bank
 * the bank's ABA and routing number
 * the seller's account number
 * the exact name in which the account is maintained
 * the amount to be wired
 * the currency of the funds to be wired

A buyer's bank should instruct its US correspondent bank that the payment is to be wire transferred to the seller's bank. A failure to provide specific instructions to the buyer can result in delays in receiving funds transfers. Errors can even result in electronic funds transfers being credited to the wrong account or returned to the remitting bank as undeliverable.

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Funds Remittance/Money Orders

Money Orders
A money order is a financial instrument issued by a bank or other institution allowing the individual named on the order to receive a specified amount of cash on demand. It is often used by people who do not have checking accounts. It is a limited tool since it can be used only for certain currencies in certain amounts.

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title: Funds Remittance/Money Orders


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Funds Remittance/Cash or Bank Notes

Cash or Bank Notes
The exchange of bank notes or cash is seldom used in international transaction because of the risk of loss or forgery.

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title: Funds Remittance/Cash or Bank Notes


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Funds Remittance/Credit Cards

Credit Cards
With the increase in online business, international payments made through consumer/business credit cards are becoming more common. These transactions are limited to the credit available on the credit card and often incur high fees for a seller as well as a buyer for currency exchanges.

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Funds Remittance/SWIFT

SWIFT
SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a computer-based standardized message writing system that connects worldwide participating banks, primarily for the purpose of communicating payment information. When an issuing bank instructs an advising bank by an authenticated teletransmission to advise a documentary credit or an amendment to a credit, the teletransmission will be considered to be the operative instrument. This is called SWIFT.

 * Most documentary credits are transmitted electronically either by telex or through the SWIFT interbank telecommunication system. When documentary credits are transmitted in this way the telecommunication itself becomes the actual documentary credit or “operative instrument.”  Should the issuing bank send a mail confirmation, the advising bank is under no obligation to compare the two instruments to ensure that they are identical.
 * Sometimes, an issuing bank will send a brief telex/SWIFT message to the advising bank to let the bank know the "brief details" of the documentary credit and to advise that "full or complete" details will follow by mail. The issuing bank must send the actual documentary credit by mail without delay.  The "pre-advice" is not the operative instrument.  Once an issuing bank has issued a pre-advice, it must issue the operative instrument without delay unless the pre-advice indicates that the issuing bank may choose not to issue the credit.  Should the latter happen, the "beneficiary" should exercise extreme caution before taking any action to begin production or otherwise act as if the credit were on its way.
 * If a bank uses an advising bank to have the documentary credit advised to the beneficiary, it must also use the services of the same bank for advising an amendment(s).

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title: Funds Remittance/SWIFT


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Funds Remittance/Summary

Summary
Having completed this lesson, you should now understand the many methods by which funds can be transferred between buyer and seller and the risks associated with each form of funds transfer.

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title: Funds Remittance/Summary


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Funds Remittance/Resources

Publications
SWIFT Channel Between Corporations and Banks, Treasury and Risk Management, Vol. 15, Issues, 9, October 2005, pp. 16-17.

Web Resources
SWIFT:
 * www.swift.com
 * www.bizhelp24.com

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title: Funds Remittance/Resources


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Funds Remittance/Activities

Activity
This activity is designed to negotiate and debate risks associated with funds remittance.

Instructions to Instructor 1. Divide the class into even groups of 2-3, half being buyers and half being sellers. 2. Select a country for each group to represent. 3. Connect a group of buyers with a group of sellers and provide each set with a method of payment of prepayment or open account. 4. Have them discuss the risks of each of the funds remittance methods and the risks associated with each. 5. Have each group negotiate and agree upon a method of funds remittance.

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title: Funds Remittance/Activities


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Funds Remittance/Assessment

Assessment
{The SWIFT System is -a type of bank guarantee to ensure payment. -the law governing funds remittance. +a method to communicate payment information between banks. -used to get the best US dollar exchange rate.
 * type=""}

{Funds remitted through a company check, drawn on a foreign bank will arrive in the seller’s account -immediately after the seller deposits the check. +when the foreign bank confirms and remits funds. -2-3 business days after the check is deposited. -after the buyer deposits the funds and approves transfer.
 * type=""}

{A wire transfer is used to remit funds +in a quick manner under the sales agreement. -before the goods are shipped. -before the goods arrive. -after the documents are sent.
 * type=""}

{Funds remittance and methods of payment are -are the same thing and can be used interchangeably. -never used together since they are confusing to a buyer and seller. -are used only in international transactions. +used together to ensure timely payment between buyer and seller.
 * type=""}

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title: Funds Remittance/Assessment


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Letters of Credit/Letters of Credit

Letters of Credit
Documentary or letters of credit, as they are more commonly referred to, come in many forms. These options were created to make this banking instrument flexible and applicable to a wide variety of business transactions. The different types of letters of credit can be used in many combinations or independently. The type of letter of credit chosen for a transaction is based on the parties and countries involved, the risks associated with the transaction as well as the products or services being bought and sold.

To easily understand the different types of letters of credit, an international manager must be comfortable with the terminology and definitions of the parties and actions associated with this banking instrument, including, but not limited to, terms such as applicant, beneficiary, issuing bank, advising bank, discrepancy, and amendment.

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title: Letters of Credit/Letters of Credit


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Letters of Credit/Types of Letters of Credit

Types of Letters of Credit
=

Unconfirmed
An unconfirmed irrevocable letter of credit provides a commitment by the issuing bank to pay, accept, or negotiate a letter of credit. An advising bank forwards the letter of credit to the beneficiary without responsibility or undertaking on its part except that it must use reasonable care to check the authenticity of the credit which it advised. It does not provide a commitment from the advising bank to pay, so the beneficiary is reliant upon the undertaking of the overseas bank. The beneficiary is not protected from the credit risk of the issuing bank nor the country risk.

payments.

Transferable Credit
Under a transferable letter of credit a beneficiary (the first beneficiary) can ask the issuing/advising/confirming bank to transfer the letter of credit in whole or in part to another party/ies such as supplier/s (second beneficiary/ies). A transferable letter of credit is usually used when the beneficiary is not the manufacturer/original supplier of some/all of the goods/services. This process enables the beneficiary to pay the manufacturer/original supplier by letter of credit. If the bank agrees, this bank, referred to as the transferring bank, advises the letter of credit to the second beneficiary/ies in the terms and conditions of the original letter of credit with certain constraints defined in Article 48 of UCP 500.

In general, unless the letter of credit states that it is transferable, it is considered non-transferable.

Assignment of Proceeds
The right to the proceeds of a letter of credit can sometimes be assigned where the beneficiary of a letter of credit is not the actual supplier of all or part of the letter of credit and wants the bank to pay the supplier out of funds received from the letter of credit. The beneficiary may choose this option if he or she
 * does not want to request a transferable letter of credit from a buyer in order to keep the buyer from knowing who is the actual supplier of the goods.
 * does not have the necessary credit with the bank to issue a new letter of credit to a supplier.

An assignment of proceeds takes the form of an irrevocable instruction from the beneficiary to the bank requesting that it pay the supplier out of the proceeds of the letter of credit which becomes due when documents are presented in compliance with the terms of the letter of credit.

Revolving
Although infrequently used today, revolving letters of credit were a tool created to allow companies conducting regular business to issue a letter of credit that could “roll-over” without the company having to reapply, thus enabling business flow to continue without interruption as long as the terms and conditions, quantities, and other transaction details did not change. In addition, if a letter of credit were a revolving one, there were few ways to stop it from rolling over; so, should a conflict arise between the parties while the letter of credit was in place or should the products change, there was little recourse for either party. In the business world today, the fact is that, unless required by law or because of high risk, on-going business is usually conducted without of letters of credit.

Standby
As is the case with the revolving letter of credit, standby letters of credit are infrequently used today. A standby letter of credit is one which is issued as a back-up or form of insurance for the seller should the buyer default on the agreed-upon payment terms. A standby letter of credit is issued in the same way a documentary credit is in that the collateral needed for issuance is required by the issuing bank and the beneficiary must comply with every detail as outlined in the letter of credit. The problem with this instrument is that the applicant has no guarantee, other than the seller’s word, that the standby will not be drawn against even if payment is made as agreed. This situation is challenging, especially if the letter of credit is confirmed and the advising bank sees only documents pertaining to the shipment as outlined in the letter of credit and has no knowledge of other payments being made.

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Letters of Credit/Summary

Summary
Having completed this lesson, you should now understand the different types of letters of credit that are available. Although letters of credit can be issued in many forms, there are only a few that are regularly used today. By having a complete understanding of all forms, you can better negotiate payment terms and avoid agreeing to a situation that could increase your company’s risks.

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Letters of Credit/Resources

Publications
Exporting from Start to Finance 3rd Edition, L. Wells and K. Dulat, McGraw Hill. International Trade:Financial Services for Importers and Exporters, JP Morgan/Chase Bank, 2000. Handbook of International Credit Management, second edition, edited by B.W. Clarke. Gower Publishing, 1995. Practical Export Trade Finance, E. W Perry, Dow Jones-Irwin, 1989. The Global Entrepreneur, James Foley, 2nd Edition, Jamric Press, 2004.

Web Resources
International Chamber of Commerce – www.iccwbo.org ICC Resources - www.iccbooksusa.com

Letters of Credit:
 * www.chase.com (FAQs)
 * www.informafinancial.com
 * www.allbusiness.com
 * www.qualitylc.com

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title: Letters of Credit/Resources


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Letters of Credit/Activities

Activity
1.   As the exporter, you have just received a confirmed transferable letter of credit. What are the characteristics of this type of letter of credit?

2.   As the exporter, you have just received a confirmed standby letter of credit. What are the characteristics of this type of letter of credit and when will you use it?

3.   As the importer, you have applied to your bank to issue a non-transferable irrevocable letter of credit. What are the characteristics of this type of letter of credit?

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Letters of Credit/Assessment

Assessment
{A confirmed letter of credit includes a -funds transfer in US Dollars only. -a request for only a draft and commercial invoice. -a freely negotiable credit for the seller. +second bank's promise to pay upon complying document presentation.
 * type=""}

{Unless otherwise stated, all letters of credit are considered -revocable. -confirmed. +irrevocable. -transferable.
 * type=""}

{A transferable letter of credit allows the beneficiary to transfer the _____________ to a secondary beneficiary. +letter of credit -funds -documents -liability
 * type=""}

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Types of Payments/Types of Payments

(At) Sight
This type of payment indicates immediate payment to the seller after
 * presentation of sight draft (bill of exchange)
 * presentation of conforming documents
 * the stipulated (advising, confirming or issuing) bank has had reasonable time to examine documents
 * the documents are found to be in order

It is important to recognize that “immediate” does not mean within hours, but within a reasonable period of time. To be on the safe side, it is wise to anticipate a minimum of 72 hours/3 business days after the above steps have taken place.

Deferred Payment
In this situation, payment is made to a seller at a specified or determinable future date stipulated in the letter of credit or documentary collection, providing that the documents are found to be in order. An example is 60 days after date of transport document or invoice date. No draft is called for under this type of payment. It is important to remember that a buyer will have credit/collateral/cash tied up until payment is made; and if a deferred payment is made through a letter of credit, it is guaranteed to a seller just as if it were made immediately. The risk increases for a seller if the remitting bank is located in a risky country.

Acceptance
The payment type known as an acceptance is similar to a deferred payment. In this case, however, a “term” or “usance” draft is presented together to a stipulated bank along with the other required documents. Once the documents and draft are accepted, then the draft will be drawn on and payable at a future date as stipulated in the letter of credit. For example 30 days’ sight would mean payment will be made to the seller 30 days after “sight” (the remitting bank has looked at, reviewed and accepted) of the documents.

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title: Types of Payments/Types of Payments


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Types of Payments/Negotiation

Negotiation
In regard to letters of credit, when the documents are presented and reviewed by the bank, the process is referred to as negotiation of the documents. In accordance with UCP 600, a bank authorized to negotiate documents/drafts is authorized to give value for draft (s) and/or document(s), which means the letter of credit can stipulate that payment be made by the advising, issuing or confirming bank. For the purposes of the UCP, the interpretation is either “making immediate payment” or “undertaking an obligation to make payment” (on the due date).

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title: Types of Payments/Negotiation


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Types of Payments/Summary

Summary
Having completed this lesson, you should now understand the types of payments available for use in international transactions. Once agreed upon, the type of payment should be clearly stated to the customer to avoid confusion as most of the payment types work with many of the methods of payment. Clarifying this before the transaction is completed will allow for timely payment and may help both the buyer and seller avoid unnecessary banking costs.

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title: Types of Payments/Summary


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Types of Payments/Resources

Resources
Exporting from Start to Finance, Third Edition, L. Wells and K. Dulat. The Global Entrepreneur, James Foley, 2nd Edition, Jamric Press, 2004. International Chamber of Commerce – www.iccwbo.org ICC Resources – www.iccbooksusa.com

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title: Types of Payments/Resources


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Types of Payments/Activities

Activity
You are the exporter and have just shipped an order with a letter of credit. Using the following scenarios, determine when you will receive your funds and which bank will send them to you:

Scenario A
Invoice Date: January 15, 2007 Shipping Date: January 22, 2007 Type of LC: 60 Days after Invoice Date

Scenario B
Invoice Date: January 15, 2007 Shipping Date: January 22, 2007 Type of LC: 60 Days after Transport Date

Scenario C
Invoice Date: February 12, 2007 Shipping Date: February 12, 2007 Type of LC: at Sight

Scenario D
Invoice Date: March 19, 2007 Shipping Date: March 24, 2007 Type of LC: 90 days after negotiation by the Confirming Bank

Scenario E
Invoice Date: March 19, 2007 Shipping Date: March 24, 2007 Type of LC: 90 days after negotiation by the Issuing Bank

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title: Types of Payments/Activities


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Types of Payments/Assessment

Assessment
{Letters of credit promise the beneficiary that funds will always be transferred -immediately. +based on the agreed tenor of the l/c. -within 3 – 5 working days. -in a reasonable time frame.
 * type=""}

{When funds are transferred 60 days after sight without a draft, this is a(n) ___________ letter of credit. -acceptance -negotiation +deferred payment -sight
 * type=""}

{The different types of letters of credit allow the buyer and seller to be -risk-free. -restricted. -limited. +flexible.
 * type=""}

{If payment is to be made at negotiation, the funds are paid to the beneficiary by the +advising, issuing or confirming bank. -issuing bank only. -confirming bank only. -advising bank only.
 * type=""}

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title: Types of Payments/Assessment