Products

Financial institutions support trade with a variety of trade finance products – some focusing chiefly on risk mitigation and others on the actual financing requirements inherent to cash flow gaps in the underlying trade. The products required are typically determined by the stage of the trade cycle participants may find themselves in.

Trade finance products are typically categorized under two areas: Unfunded Trade Finance and Funded Trade Finance.

Unfunded Trade Finance products are focused on credit enhancement/support, such that the provider involved does not offer liquidity to the trade counterparts, but rather supports the transaction by guaranteeing the performance of the parties in their different roles. Funded Trade Finance Products are focused on the provision of funding/liquidity by a financial institution to the parties participating in the trade transaction.

In a trade transaction both Buyers and Sellers have it in their best interests to have as much control as possible over the transfer of title of the underlying goods and, naturally, over the proceeds of payment relating to those goods.

As such, trade finance products focused on risk mitigation help settle the conflicting needs of the parties (normally an exporter and an importer, as far as international trade is concerned). Where an exporter needs to mitigate the payment risk from the importer, it would be in its best interests to accelerate the payment from the importer. On the importer’s side, its aim is to mitigate the supply/performance risk of the exporter and thus receive the goods before it has to effect payment. In these cases, trade finance products effectively function as a mechanism whereby providers absorb the risks inherent to the trade (mostly payment and supply related risks), whilst also potentially providing the exporter with accelerated receivables and the importer with extended credit.

Non-structured unfunded trade finance products are simple trade finance tools focused on providing credit enhancement to participants involved in trade transactions. Considering the various risks associated with domestic and cross border trade, these tools/products provide additional comfort for the transacting parties.

Letters of Credit (LCs)

One of the products commonly used to achieve this goal is a Letter of Credit. A letter of credit is a contractual payment undertaking issued by a financial institution on behalf of a buyer of goods for the benefit of a seller, covering an amount as specified in the credit, conditional on the seller fulfilling the credit’s documentary requirements within a specific timeframe.

The primary aim of this instrument is to provide increased assurance to both the buyer and seller of the fulfilment of each party’s obligations in a commercial trade – namely the seller’s obligation to deliver the goods as agreed with the buyer, and the buyer’s obligation to pay for those goods within the specified timeframe.

Some variations to the main letter of credit include revolving, escalating, de-escalating, transferrable, back-to-back, as well as red and green clause letters of credit.

Standby Letters of Credit, Demand Guarantees and Bonds

These instruments can be classified as independent payment undertakings, i.e. undertakings issued by one part in support of another party’s obligations under and underlying agreement, where the issuing party’s obligations are independent of those of the supported party.

These instruments are typically required within a contractual framework, usually resulting in each party’s increased assurance of the other party’s fulfilment of its contractual obligations. In effect, a financial institution intervenes assuming the position of the party they are supporting, thereby replacing that party’s standing with their own, providing increased comfort to the contractual party benefiting from the undertaking.

The most common requirements for the issuance of these instruments arise from the need to support bids over projects or contracts, to guarantee the performance of contractual obligations and to ensure the protection of advance payments made under an agreement. Under Trade Finance terminology, the instruments issued by financial institutions to cover the aforementioned purposes are, respectively, bid, performance and advance payment bonds (although they can also be structured either as demand guarantees or stand-by letters of credit).

Credit Insurance

Firms engaging in both domestic and international trade are exposed to significant number of risks, many of which are not within the control of the supplier. In the event of protracted default, insolvency or bankruptcy, Credit Insurance may be offered by insurance underwriters (normally via an insurance broker) to protect sellers against non-payment from buyers. 

This risk management product, commonly referred to as Trade Credit Insurance increasingly focuses on simple (and all encompassing) non-payment triggers, which in international trade naturally include elements of political risk insurance. Political risk insurance is a product that insures the risk of non-payments due to political factors such as: political violence, sovereign payment default and the breach of letters of credit or similar on demand guarantees. 

Non-structured funded products are simple trade finance tools focused on providing funding/ liquidity to either the buyer or seller in the transaction (or both). In some cases, the seller will need funding in order to produce or ship the goods being exported. Concurrently, the buyer may also need funding in order to pay for the goods being purchased. The products below address this issue, allowing financial institutions to fund these transactions. Some products are focused on supporting sellers by accelerating cash flows from receivables generated  by sales (factoring, invoice discounting, supply chain finance, forfaiting), whilst others are focused on supporting buyers elongating their cash flow cycles by providing them with liquidity to settle their purchases while they wait to generate funds from their own onward sales (LC refinancing).

Factoring and Invoice Discounting Finance

These tools share the same end-result, i.e. the acceleration of a seller’s receivables under a commercial transaction, from their original due date in the future to the present. Both techniques utilize different methodologies, with a focus on the lender taking security from the repayment of the buyer’s debt on its original due date.

Factoring solutions offer the seller of a receivable a wider service than just the advance of funds to shorten its cash conversion cycle as the entity buying the receivable will also usually take on the responsibility of collecting the debt.

Invoice discounting solutions tend to focus on shortening a seller’s cash conversion cycle, as opposed to encompassing debt management and collection aspects. The degree of disclosure to the debtor under this type of facility varies, ranging from full disclosure to no-disclosure, depending on the level of comfort taken by the purchaser of the receivables over the nature and standing of the seller. In most cases, the greater the control the financing entity/purchaser of the receivables manages to attain over the process, the better the discounting conditions offered.

An invoice discounting facility without disclosure to the debtor will grant the seller of the receivables full confidentiality, and therefore avoid reputational hazards. In a no-disclosure situation the financing entity will endeavor to retain recourse to the seller should the debtor not pay its dues on time (i.e. the purchaser would still be entitled to recuperate its monies from the seller in case of non-payment by the original debtor).

Supply Chain Finance (SCF)

Supply Chain Finance has recently been defined as a much broader category of trade financing, encompassing all the financing opportunities across a supply chain. Notwithstanding, the product is still very much seen from a narrower perspective, where its key feature is that it is buyer/debtor driven. In such a case, a buyer approaches its financial provider for the establishment of a receivables discounting line for its suppliers to use and discount the invoices they issued to that buyer. This technique is sometimes called reverse factoring or payables finance(the latter our preferred term).

This is a very efficient way to increase a buyer’s negotiating power and market reach vis-a-vis its suppliers, allowing it to benefit from better credit terms and streamlined invoice payment procedures (supply chain finance tends to be made available through online platforms). It is also very beneficial to suppliers, as it allows them to shorten their receivables cycle and therefore reinvest their operational cash-flow at a faster pace. The advantages also tend to include financing in better terms for both parties, as suppliers don’t need to take out financing under their own credit lines and may benefit from their clients’ access to credit at lower rates, and buyers may get credit from their suppliers at a lower cost than that of taking out a loan.

Process:

  1. A Supply Chain Finance facility is entered by the buyer, financier and supplier
  2. Goods are shipped and sales invoice is raised on the buyer by the supplier
  3. Supplier submits invoice to financier’s supply chain finance platform
  4. Buyer approves the invoice on the financier’s supply chain finance platform
  5. The financier pays the supplier, excluding interest and fees.
  6. The financier debits the account of the buyer on the maturity of the invoice

Forfaiting

Forfaiting is a form of receivables purchase, consisting of the without recourse purchase of future payment obligations represented by financial instruments or payment obligations (normally in negotiable or transferable form), at a discount or at face value in return for a financing charge.

Typical payment instruments in Forfaiting include negotiable instruments such as:

  • Bills of exchange: An unconditional order in writing addressed by the drawer (exporter) to the drawee (importer) requiring the drawee to pay a sum of money to, or to the order of, a specified institution/person (payee) or the bearer on demand or a on a specified determinable future date.
  • Promissory notes: Issued by a buyer, such as an importer for example, promising to pay the seller at a future date – effectively like an IOU. The right to receive payment under a promissory note may be transferred by endorsement unless endorsement or transfer is expressly prohibited.

The main benefits of forfaiting include:

  1. Working capital optimization for buyer and supplier
  2. Potentially finance raised against a strong credit rating (either of buyer or financial institution providing security for the payment obligation) with lower implied cost of funding for the Supplier
  3. Assists suppliers in selling to countries where they have little local knowledge and open-account sales would not otherwise be possible
  4. Potentially improved payment and commercial terms for the supplier and buyer
  5. Finance and liquidity availability for suppliers with limited credit availability from traditional banking sources
  6. Supply chain stability
  7. Relieving Suppliers of administration and collection costs

LC Refinancing

The utility to importers  of post-shipment financing is centered around the duration of the importer’s cash conversion cycle, also including several other instruments and techniques, such as a goods in transit financing, warehouse financing and receivables financing from the importer’s perspective, whereby receivables are those generated by an end-buyer.

Refinancing letters of credit involves the financial institution issuing the letter of credit intervening to pay the seller on the buyer’s behalf, using money it has taken from a loan account opened in the buyer’s name. In principle, this gives the buyer a longer timeframe to sell the goods purchased under the letter of credit, while allowing them to keep up with its commitment to pay the seller within a shorter timeframe.

Structured Funded trade finance products are complex trade finance tools focused on the provision of funding and/or credit to participants in the trade transaction. These tools include pre-export finance, pre-payment finance, tolling, inventory finance, borrowing based facilities and asset-based lending amongst others.

Pre-Export Finance

Pre-export finance takes place when the borrower (seller) requires funding in order to produce and supply goods prior to delivery and shipment. Financial institutions advance the funds based on proven orders from buyers and an assessment of the performance risks related to the production and supply of the financed goods.

Commodity businesses are some of the largest users of pre-export financing, usually using the funds to finance large production operations. The borrower needs to ensure it has sufficient liquidity to maximize production, which is one of the key reasons exporters use pre-export financing.

Funds are provided directly from the lender to the borrower, with legal provisions that focus on the borrower being able to produce commodities and sell the product. Lenders will consider factors including production and delivery risk as the repayment of the loan is contingent on the production and sale of goods. Payment is made directly to the lender from the buyer, with the lender sending funds on to the seller once charges, interest and the original borrowed amount has been deducted. Payment risk is also an issue the lender will consider, in the event that the seller distributes the goods and the buyer fails to pay. Pre-export finance transactions are based on a strong buyer or additional payment security to support the firm orders and commercial contracts.

The lender will generally take security in:

  • Rights of assignment by the producer under an ‘offtake contract’
  • Charge over collection or segregated bank accounts that proceeds for a sale are paid into; and
  • Security over the goods or commodities

Third-party collateral management firms are often employed in Pre-export financing structures. This is to ensure that goods financed are properly stored, monitored and held to the order of the lender.

Pre-Payment Finance

The underlying rationale of a prepayment finance facility is similar to that of a pre-export finance facility, i.e. to allow an exporter to obtain sufficient funds in order to procure and store raw materials, undertake production and deliver finished goods to the buyer under an export contract.

The main difference lies in the fact that rather than the seller, the buyer is the actual borrower under the facility and uses the financing to prepay the seller. Repayment of the facility originates from money received under the onward sale of the imported goods by the buyer to another ultimate end-buyer.

This type of financing is widely used in the international trade markets, primarily by traders with a requirement to source goods to deliver to their end-buyers, seeking to empower their suppliers by financing their operations and thereby gaining access to the goods they require in more advantageous conditions. The key support elements that financial institutions look for when considering prepayment finance are the nature of the goods involved and the creditworthiness of the end-buyers. An assessment of the exporter’s track record and ability to deliver is also pertinent, considering the financing institution may retain performance risk on the exporter.

Tolling

A tolling facility adds to the concepts underlying pre-export and pre-payment facilities. In a tolling facility, the borrower is usually a trader or company that requires financing for the acquisition of raw materials, payment for the transformation of these raw materials into finished goods and delivery to an end buyer under an order or a contract.

The first leg of the financing can be seen as a pre-export or pre-payment finance, whereby the lender will finance the export of the raw materials in order to enable the trader to facilitate the fulfilment of their obligations. The raw materials are then delivered into a production facility/toller and more funds are disbursed by the lender for the settlement of the production/tolling fees. Finally, the finished goods are delivered to the end-buyer who makes the payment that settles the financing.

With the goods continuously evolving and being transported through various jurisdictions, a structuring challenge becomes apparent and will need to be addressed carefully. This is such that the notion of collateral is kept intact throughout the life of the facility, benefitting both the lending institution and the borrowing trader/company.

Inventory Finance

Inventory finance, also known as warehouse financing, aims at monetizing stocks held by the borrower, releasing cash-flow which can be reinvested in the operational cycle.

When establishing the degree of security associated with a potential inventory finance facility, financial institutions will assess the available legal instruments, allowing them to retain adequate security through the establishment of tight control mechanisms over the goods being financed (or even direct or indirect possession in some jurisdictions) and entitling them to sell the goods being financed in the open market should the borrower default, under the shortest timeframe possible, with the least amount of red tape. This assessment allows a lender to establish an acceptable ratio of financing vs goods given as collateral, against which the borrower will be able to draw on the facility on a revolving basis.

The repayment of an inventory finance facility arises from money received from the sale of the stored goods, and as such, the structure may be extended to include the use of trade receivables as collateral in addition to stocks.

Borrowing Base Facilities

Contrary to inventory finance, borrowing base facilities do not only rely on goods stored, but rather on an evolving pool of stocks, receivable and cash, including reserves of unextracted commodities (and respective production licenses and equipment).

A borrowing base is usually established using proved commodity reserves (if applicable), warehoused stocks of raw materials and ready-for-sale goods, goods in transit, goods sold (receivables) and cash. The amount made available to the borrower is a ratio of the total value of the collateral pool, with a different financing percentage applicable to each type of collateral, reflecting inherent risks.

As may be easily perceived, borrowing base facilities provide an encompassing technique that extends the monetization concept throughout the collateral pool, therefore enhancing the release of cash from the operational cycle.

Export & Agency Finance

Export Credit Agency (ECA) financing is a very relevant product used to assist importers in challenging jurisdictions, materializing through a number of incentives being availed to importers by export credit agencies linked to developed exporting countries.

The types of transactions usually supported by ECAs are capital intensive, including the importation of heavy machinery to be included in large scale projects in the importing country, offering long term financing maturities with attractive conditions. ECA support is usually provided via:

  • Government guarantees offered to financial institutions supporting exports
  • Financing facilities directly offered to importers
  • Insurance mechanisms offered to both exporters and financing entities under the underlying trade transaction with a view of enabling credit to the importer

What are the eligibility criteria for export finance?

  • Most ECAs have national content criteria and will only support exports that they deem beneficial to their economy and, if applicable, in accordance with the OECD Agreement. In practice, the exact criteria vary from country to country
  • ECAs finance a portion of home country content plus a varying amount of foreign content of the purchase order amount;
  • The project must be deemed to be creating enough national value;
  • The importer must be able to find alternative means of payment for at least 15% of the contract value, called the down-payment. Buyers can use equity or finance the down-payment, the latter on a subordinated basis to the ECA
  • Local parts of the contract may only be supported up to a 30% of eligible procurement.

Islamic Finance

Islamic Finance is the means by which individuals and companies in the Muslim world can conduct financial activity that complies with the principles of Sharia, or Islamic law. Islamic Finance also refers to the types of investments that are permissible under this form of law. Sharia is a religious law forming part of the Islamic tradition based on the teachings of the Qur’an and the traditions of the Prophet. 

Sharia’s key prohibitions are:

  • Lending money at unreasonably high rates of interest (Riba)
  • Uncertainty / the sale of what is not present (Gharar)
  • Gambling (Maisir)
  • Unethical Investments
  • Unjust Enrichment

Conventional financing is not Sharia compliant and so Islamic Finance seeks to replicate the economics and risk profile of a conventional financial instrument by using assets and services. A benchmark is set by using a conventional financial instrument, but Islamic Finance will differ largely in a structural way. One of the most notable differences in a Sharia compliant financing structure is that interest and price speculation are not permitted.

The main structures of Islamic Finance are:

  • Murabaha (Cost-plus financing)
  • Ljara (Leasing)
  • Mudaraba (Investment Capital)
  • Musharaka (Partnership)
  • Istisna’a (Construction)
  • Wakala (Agency)
  • Sukuk (Islamic Bonds)

Every transaction under Sharia will need to be approved from a Sharia perspective. Approval is provided by qualified scholars who typically have good knowledge of conventional financing. Most financial institutions who provide Islamic Finance have their own board of Sharia scholars.

Syndication

Syndication is financing provided by a group of lenders for a single borrower. Usually, syndication occurs when a borrower requires capital too large for an individual lender to provide or when the credit facility is not within the scope of the lender’s risk exposure.

The lead bank which is the bank that oversees the arrangement and administration of the syndication recruits the syndicate members and negotiates financing terms. The lead bank conducts necessary due diligence, thereafter an information memorandum is prepared. The information memorandum includes financial statements, company profile and directorship details of the borrower.

Syndications have become major source of corporate funds. Firms seek loans for a various business reasons that include capital for merger and acquisition and capital expenditure projects. These types of capital project can often require large amount of capital that typically exceed an individual lenders’ capacity. As a result, the prime motive of syndicated loan is to distribute the risk of a borrower’s payment default across multiple lenders. Usually, there is only one loan agreement for the entire syndicate.

Process

  1. An originator at Bank XXX analyses the capital requirements of a client;
  2. Originator receives documents from the client i.e. company profile along with financial data and credit score;
  3. The originator approaches different banks for participation in the syndication. Once each bank informs respective commitment- the bank with the largest exposure becomes the lead bank;
  4. The lead bank will stipulate the term sheet of the loan. The document will include details such as terms and conditions, repayment schedule and collateral;
  5. The loan documentation is circulated amongst the syndicate members for review;
  6. The Loan documentation is eventually executed by all parties and, where the loan is secured, the process of perfection immediately commences at the Stamp Duties Office; Lands Registry; Ship Registry; and Corporate Affairs Commission depending on the type of asset used as security;
  7. Upon execution of the documentation, the borrower has to fulfil the conditions stipulated in the loan agreement before any disbursement can be made on the loan;
  8. Often in syndications, bankers appoint a security trustee- the security trustees act as on the direction of syndicate lenders for security enforcement;
  9. In any syndication an individual entity cannot take enforcement action, it requires majority votes from other lenders.
Copy link
Powered by Social Snap