Trade finance in India 2018

Trade finance in India 2018

Trade finance in India 2018

Trade finance in India 2018 Click to launch

Trade finance in India 2018

Introduction to international trade 2 PwC Trade finance in India 2018 Introduction to international trade Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction • • International trade is the exchange of capital, goods and services across international borders or territories.

• • It allows both buyers and sellers to expand their markets for goods and services that otherwise may not be made available to them. • • All countries have different assets or strengths in terms of land, labour, capital, technology and natural resources. Hence, most countries usually focus on those products and services in which they possess a comparative or absolute advantage through specialisation. However, such specialisation may result in excess production capacity for certain goods and services and also result in an opportunity cost in terms of inadequate production of other goods and services.

• • It reduces dependency on the domestic market by expanding customers’ demand in other countries. • • It enhances economic growth and contributes significantly to the country’s gross domestic product. • • International trade presupposes the existence of a sufficient level of geopolitical peace and stability to facilitate smooth trade between nations. International trade

Trade finance in India 2018

Introduction to international trade 3 PwC Need for trade finance Trade finance in India 2018 Trade finance in India 2018 Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 1. The exporter ships the goods. Importer’s preference 2. The importer pays after goods are received. 1. The importer pays for the goods. Exporter’s preference 2. The exporter ships the goods. Importer Importer Importer Importer A B The trade dilemma • • International trade must work around a fundamental dilemma.

• • Imagine an importer and an exporter who would like to do business with one another. • • Due to the distance between the two, it is not possible to simultaneously hand over goods with one hand and accept payment with the other. • • The importer would prefer arrangement ‘A’, portrayed at the top of the adjacent figure, while the exporter’s preference, ‘B’, is shown at the bottom of the figure. International trade

Trade finance in India 2018

Introduction to international trade 4 PwC Need for trade finance Trade finance in India 2018 Trade finance in India 2018 Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade • • The fundamental dilemma of being unwilling to trust a stranger in a foreign land is solved by using a bank as an intermediary. A simplified view of such a structure is presented alongside. • • The importer obtains the bank’s promise to pay on its behalf, knowing that the exporter will trust the bank. The bank’s promise to pay is called a letter of credit.

• • The exporter ships the merchandise to the importer’s country. Title to the merchandise is given to the bank on a document called an order bill of lading. The exporter asks the bank to pay for the goods, and the bank does so. • • The bank, having paid for the goods, now passes title to the importer, whom the bank trusts. At that time or later, depending on their agreement, the importer reimburses the bank. Introduction to international trade Importer Bank Exporter Bank as an intermediary for import/export 1. The importer obtains the bank’s promise to pay on its behalf. 2. The bank promises the exporter it will pay on behalf of the importer. 4. The bank pays the exporter. 5. The bank ‘gives’ merchandise to the importer. 6. The importer pays the bank. 3. The exporter ships ‘to the bank’, trusting the bank’s promise. International trade

Trade finance in India 2018

Introduction to international trade 5 PwC Need for trade finance Trade finance in India 2018 Trade finance in India 2018 Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade • • Once the importer and exporter agree on terms, the seller usually prefers to maintain legal title to the goods until paid, or at least until assured of payment.

• • The buyer, however, will be reluctant to pay before receiving the goods, or at least before receiving title to them. • • Each wants assurance that the other party will complete its portion of the transaction. • • The letter of credit, sight draft and bill of lading are part of a system carefully constructed to determine who bears the financial loss if one of the parties defaults at any time. • • In international trade, foreign exchange risk arises from transaction exposure. • • If the transaction requires payment in the exporter’s currency, the importer carries the foreign exchange risk. If the transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk. • • Transaction exposure can be hedged; but in order to hedge, the exposed party must be certain that payment of a specified amount will be made on a particular date.

• • Most international trade involves a time lag during which funds are tied up while the merchandise is in transit. • • Once the risks of non-completion and exchange rate changes are disposed of, banks are willing to finance goods in transit. • • A bank can finance goods in transit, as well as goods held for sale, based on the key documents, without exposing itself to questions about the quality of the merchandise or other physical aspects of the shipment. Protection against risk of non-completion Protection against foreign exchange risk Financing the trade International trade Benefits of the system

Trade finance in India 2018

Introduction to international trade 6 PwC Trade finance methods Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Overview of trade finance methods Buyer’s credit Trade finance methods Pre-shipment credit Post-shipment credit Forfaiting and factoring Letter of credit

Trade finance in India 2018

Introduction to international trade 7 PwC Timeline and structure of international trade transactions Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Introduction to international trade • • In order to understand the risks associated with international trade transactions, it is helpful to understand the sequence of events. • • The two primary risks associated with an international trade transaction are currency risk and risk of non-completion. • • The risk of default on the part of the importer is present as soon as the financing period begins. Price quote request Export contract signed Goods are shipped Documents are accepted Goods are received Settlement of the transaction Negotiation Trade execution Documents are presented Financing period Time and events

Trade finance in India 2018

Introduction to international trade 8 PwC Timeline and structure of international trade transactions Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Introduction to international trade Understanding the trade finance needs of corporates Sale of finished goods Broad stages of the business value chain during the working capital cycle Trade finance needs Insurance protection provided by the Export Credit Guarantee Corporation of India Limited Trade finance plays two pivotal roles—providing working capital tied to and in support of international trade transactions and providing means of reducing payment risk.

Increased open account transactions Increased use in the Asia-Pacific region Increased proportion of US dollar funding Intense competition among banks Global trends in trade finance Conversion of raw materials into finished goods Procurement of raw materials Fund-based facility Buyer credit/supplier credit Cash credit/overdraft facility Cash credit/overdraft facility Pre-shipment credit in foreign currency (PCFC) Cash credit/overdraft facility Bill discounting/ factoring/for faiting Non-fund based facility Bank guarantee/ standby letters of credit (SBLCs) Foreign / inland letter of credit Foreign / inland letter of credit Bank guarantee/ SBLC Foreign/ inland letter of credit Bank guarantee/ SBLC

Trade finance in India 2018

Introduction to international trade 9 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade • • There are two types of clean payments: Open account and payment in advance. The payment in advance and open account schematics vary only in the order in which events take place.

• • Open account: The importer is trusted to pay the exporter after receipt of the goods. The exporter ships the goods and documents directly to the importer and waits for the importer to send payment. • • Payment in advance: An arrangement whereby the exporter is trusted to ship the goods after receiving payment from the importer. The importer sends payment directly to the exporter and waits for the exporter to send the goods and documents. Open account: • • Disadvantageous to the exporter since it assumes all the risks • • Advantageous to the importer since it does not take any risks; delays the outflow of cash resources Payment in advance: • • Advantageous to the exporter since it takes no risks and receives the payment in advance • • Disadvantageous to the importer since it assumes all the risks and incurs the opportunity cost of outflow of cash resources before receiving the goods • • ‘Clean payments’ are characterised by trust. Either the exporter sends the goods and trusts the importer to pay once the goods have been received, or the importer trusts the exporter to send the goods after payment is effected. • • In the case of clean payment transactions, all shipping documents, including title documents, are handled directly by the trading parties. The role of banks is limited to clearing funds as required.

What is a clean payment? Clean payments Basic facts and mechanics pertaining to clean payments Risk analysis under clean payment transactions

Trade finance in India 2018

Introduction to international trade 10 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade • • Documentary collection may be carried out in two ways: • • Documents against payment: Documents are released to the importer only against payment. It is also known as a ‘sight collection’ or ‘cash against documents’ (CAD).

• • Documents against acceptance: Documents are released to the importer only against acceptance of a draft/bill of exchange. It is also known as ‘term collection’. • • A method of payment used in international trade whereby the exporter entrusts the handling of commercial and often financial documents to banks and gives the banks instructions concerning the release of these documents to the importer. The banks involved do not provide any guarantee of payment. • • Collections are subject to the uniform rules for collections published by the International Chamber of Commerce (ICC) under Uniform Customs and Practice for Documentary Credits (UCP) 600 and International Standby Practices (ISP) 98.

Clean payments Basic facts of documentary collection What is documentary collection?

Introduction to international trade 11 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Flow of goods • • After the importer and the exporter have established a contract and agree on documentary collection as the method of payment, the exporter ships the goods. In documentary collection, the importer is known as the ‘drawee’ and the exporter, as the ‘drawer’. Flow of payment • • Payment is forwarded to the remitting bank for the exporter’s account. And the importer can now present the transport document to the carrier in exchange for the goods. Flow of documents • • After the goods are shipped, documents originating with the exporter (e.g. commercial invoice) and the transport company (e.g. bill of lading) are delivered to a bank, called the remitting bank in the collection process. • • The role of the remitting bank is to send these documents accompanied by a collection instruction giving complete and precise instructions to a bank in the importer’s country, referred to as the collecting/presenting bank in the collection process.

• • The collecting/presenting bank acts in accordance with the instructions given in the collection instruction and releases the documents to the importer against payment or acceptance, according to the remitting bank’s collection instructions. Mechanics pertaining to documentary collection Exporter/drawer Importer/drawee Remitting bank Presenting/ collecting bank 1 2 3 2 1 3 Legend: Flow of goods, documents and payment Flow of goods Flow of documents Flow of payment Payment instruments in international trade Documentary collection

Introduction to international trade 12 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Documents against payment (D/P) Advantages to exporter: • • Documents are not released to the importer until payment has been effected • • Less costly than a letter of credit Disadvantages to exporter: • • Risk of refusal of payment • • Commercial risk and country risk remain Advantages to importer: • • Ability to examine documents before authorising payment • • Unlike a letter of credit, a line of credit is not required, and fees are minimal Disadvantages to importer: • • In the case that transport documents carry title, cannot access goods until payment has been made Documents against acceptance (D/A) Advantages to exporter: • • Less costly than a letter of credit • • May provide formal/legal means to collect unpaid obligation Disadvantages to exporter: • • Risk of non-acceptance of documents • • Commercial risk and country risk remain • • Although bill of exchange/draft is accepted by the importer, there is no guarantee of payment by the banks involved • • Legal enforcement of unpaid obligation is costly and time- consuming Advantages to importer: • • Will receive goods before having to make payment Disadvantages to importer: • • Dishonouring an accepted draft is a legal liability and may ruin business reputation Risk analysis under documentary collection Payment instruments in international trade Documentary collection

Introduction to international trade 13 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade • • A letter of credit is a written undertaking by the importer’s bank (issuing bank) on behalf of its customer, the importer (applicant), promising to effect payment in favour of the exporter (beneficiary) up to a stated sum of money, within a prescribed time limit and against stipulated documents.

• • A key principle underlying letters of credit is that banks deal only in documents and not in goods. The decision to pay under a letter of credit will be based entirely on whether the documents presented to the bank appear, at face value, to be in accordance with the terms and conditions of the letter of credit. It would be prohibitive for banks to physically check whether all merchandise has been shipped exactly as per each letter of credit. • • The ICC publishes internationally agreed-upon rules, definitions and practices governing letters of credit, which are called UCP and referred to as UCP 600.

• • Letters of credit are either revocable or irrevocable: – A revocable letter of credit can be revoked without the consent of the exporter, meaning that it may be cancelled or changed up to the time the documents are presented. Revocable letters of credit are very rarely used. – An irrevocable letter of credit cannot be cancelled or amended without the consent of all parties, including the exporter. Unless otherwise stipulated, all letters of credit are irrevocable. • • Letters of credit may be settled either by sight or by acceptance: – If payment is to be made at the time that the documents are presented, this is referred to as a sight letter of credit. – If payment is to be made at a future fixed time from the presentation of documents, this is referred to as a term letter of credit.

What is a letter of credit? Basic facts and mechanics pertaining to letters of credit Payment instruments in international trade Letters of credit

Introduction to international trade 14 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Mechanics pertaining to documentary collection Issuance • • After the trading parties agree on a sale of goods where payment is made by a letter of credit, the importer requests that its bank (the issuing bank) issue a letter of credit in favour of the exporter (beneficiary). • • The issuing bank then sends the letter of credit to the advising bank. A request may be included for the advising bank to add its confirmation. The advising bank is usually located in the country where the exporter does business and may be the exporter’s bank, although it does not have to be. • • Next, the advising/confirming bank verifies the letter of credit for authenticity and sends it to the exporter.

Flow of goods • • Upon receipt of the letter of credit, the exporter reviews the letter of credit to ensure that it corresponds to the terms and conditions in the purchase and sales agreement; that the documents stipulated in the letter of credit can be produced; and that the terms and conditions of the letter of credit can be fulfilled. • • Assuming the exporter is in agreement with the above, it arranges for shipment of the goods. Flow of documents and payment • • After the goods are shipped, the exporter presents the documents specified in the letter of credit to the advising/confirming bank. • • Once the documents are checked and found to comply with the letter of credit (i.e. without discrepancies), the advising/confirming bank forwards these documents to the issuing bank. • • The drawing is negotiated, paid or accepted as the case may be.

• • In turn, the issuing bank examines the documents to ensure they comply with the letter of credit. If the documents are in order, the issuing bank will obtain payment from the importer for payment already made to the confirming bank. • • Documents are delivered to the importer to allow it to take possession of the goods. Contract negotiation Importer applies for letter of credit Advice/ confirmation of the letter of credit Exporter/ beneficiary Importer/ applicant Advising/ confirming bank Issuing bank 1 4 2 3 Request to advise and possibly confirm the letter of credit Goods Exporter/beneficiary Importer/applicant Flow of goods Flow of documents Flow of payment Exporter/ drawer Importer/drawee Issuing bank Advising/ confirming bank 2 3 4 5 6 7 1 Legend: Flow of goods documents and payment Payment instruments in international trade Letters of credit

Introduction to international trade 15 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Risk analysis for letters of credit Importer Advantages: • • The importer is assured that, for the exporter to be paid, all terms and conditions of the letter of credit must be met.

• • Ability to negotiate more favourable trade terms with the exporter when payment by letter of credit is offered. Disadvantages: • • A letter of credit ensures correct documents but not necessarily correct goods. • • Ties up the line of credit. Exporter Advantages: • • An undertaking from the issuing bank that the exporter will receive payment under the letter of credit provided that it meets all the terms and conditions of the letter. • • Shifts credit risk from the importer to the issuing bank. • • Not obligated to ship against a letter of credit that is not issued as agreed.

Disadvantages: • • Documents must be prepared in strict compliance with the requirements stipulated in the letter of credit. • • Non-compliance leaves the exporter exposed to risk of non-payment. Payment instruments in international trade Letters of credit

Introduction to international trade 16 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment methods in international trade Comparison of payment methods in international trade Method Time of payment Goods available to buyer Risk to exporter Risk to importer Prepayment Before shipment After payment None Relies completely on the exporter to ship the goods as per the order Letter of credit When shipment is made After payment Very little or none, depending on credit terms Assured shipment made, but relies on the exporter to ship goods described in documents Sight draft; documents against payment On presentation of draft to buyer After payment If draft unpaid, must dispose of goods Same as above (unless importer can inspect goods before payment) Time draft; documents against acceptance On maturity of drafts Before payment Relies on buyer to pay drafts Same as above Consignment At the time of resale by importer Before payment Allows importer to sell inventory before paying exporter None, improves cash flow of buyer Open account After shipment (as agreed) Before payment Relies completely on buyer to pay as agreed None Least risk to exporter Highest risk to importer Highest risk to exporter Least risk to importer

Introduction to international trade 17 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade Guarantees • • A guarantee is issued by a bank on behalf of its customer, the exporter, as financial assurance to the importer to be collected in the event that the exporter defaults on certain specified contractual obligations.

• • The bank that issues a guarantee will pay the named beneficiary the amount specified on presentation of a written demand as outlined in the guarantee. • • While there are standard guarantee formats, they can be tailored to meet specific contractual needs. • • Often, standby letters of credit are used instead of guarantees. Standby letters of credit work in much the same way as guarantees, offering financial assurance to the importer if the exporter defaults on agreed-upon contractual obligations. However, there are at least two important ways in which standby letters of credit differ from guarantees: – Standby letters of credit are governed by the ICC’s UCP, while guarantees are subject to the laws of the country of the issuing bank. The following guarantees are commonly requested in foreign contracts: • • Bid guarantee: An importer will often ask foreign contract bidders to post a bid guarantee as evidence of serious intent to supply the goods or services if selected. In the event that the selected supplier is unwilling or unable to carry out the contract, the importer can collect the amount of the bid guarantee.

• • Advance payment guarantee: An advance payment guarantee covers the amount of the down payment the exporter requests from the importer and provides the importer with some security that, if the exporter does not deliver under the terms of the contract, the amount of the down payment would be retrievable. • • Performance guarantee: A performance guarantee permits the importer to draw on the guarantee if the exporter fails to perform according to the terms of the contract. For example, in the event that the exporter is unable to complete the contract as agreed halfway through a project, the importer is compensated with the amount of the performance guarantee. What is a guarantee? Types of guarantees

Introduction to international trade 18 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade Guarantees • • During contract negotiations, the importer requests that the exporter provide a guarantee securing an aspect of the contract (e.g. bid, advance payment). The exporter (applicant) enlists its bank (issuing bank) to issue the guarantee in favour of the importer (beneficiary) for a specified amount and within a stated time frame.

• • In the event of default by the exporter, the importer would demand payment against the guarantee through the advising bank. • • A correspondent bank is a foreign bank with which the issuing bank has established a relationship where secure transactions may be processed. Mechanics of guarantees 1 3 2 Contract negotiation Issuing bank Importer/ beneficiary Exporter/ applicant Applies for a guarantee 4 Advice of the guarantee The guarantee is sent to a corresponden t bank of the issuing bank for advice to the importer. Advising bank

Introduction to international trade 19 PwC Making and receiving payments internationally Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade Guarantees/SBLCs For issuing bank • • Compliance checks on the parties and understanding the underlying purpose of the standby. • • Obtaining satisfactory documentation and reimbursement agreement from the obligor. Evaluating credit risk. • • Clear documentary conditions need to be mentioned to minimise the risk of conditions being misinterpreted by the beneficiary and possible rejection by the applicant in the event of a dispute under the underlying contract. For applicant • • As documents lack intrinsic value, additional documents may be required to support a demand certification, e.g. copy of unpaid invoices or transport documents or certification issued by an independent arbitrator or copy of court judgement. • • Effectiveness of standby is against clearly defined conditions, e.g. effectiveness of advance payment standby after receipt of the advance payment.

For beneficiary • • Evaluation of credit and cross-border risk on the issuing bank. • • Understanding the risk of automatic reduction or automatic termination against documents which the applicant can present directly to the issuing bank. • • Understanding documents and/or conditions that are required in order to draw, and avoiding documents which are issued and/or signed by the applicant. Potential risks/ challenges to consider

Introduction to international trade 20 PwC Buyer’s credit Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade Buyer’s credit • • Buyer’s credit is short-term credit given to an importer (buyer) from overseas lenders such as banks and other financial institutions for goods it is importing. Overseas banks usually lend credit to the importer (buyer) based on a letter of comfort (a bank guarantee) issued by the importer’s bank. For availing this service, the importer’s bank or buyer’s credit consultant charges a fee called an arrangement fee.

• • Buyer’s credit helps local importers gain access to cheaper foreign funds that may be closer to London Interbank Offer Rate (LIBOR) rates, as against local sources of funding which are more costly. • • It is regulated as per the RBI’s Master Circular on External Commercial Borrowing (ECB) and Trade Credit, 2014, which specifies norms for amount, maturity and ceiling charges. • • It is beneficial to both parties as the exporter gets paid on the respective due date, whereas the importer gets an extended date for making an import payment as per the cash flows.

• • The importer can deal with the exporter on sight basis, negotiate a better discount and use the buyer’s credit route to avail financing. • • The funding can be in any currency, depending on the terms of trade and availability of LIBOR. The currency of imports can be different from the funding currency, which enables importers to take a favourable view of a particular currency. • • The importer can use this financing for any form of trade—namely, open account, collections or letters of credit. • • Buyer’s credit involves cost such as interest (LIBOR plus bank spread), letter of credit issuing fees, hedging cost and withholding tax.

What is buyer’s credit? Basic facts and mechanics pertaining to buyer’s credit

Introduction to international trade 21 PwC Buyer’s credit Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Contacts Timeline and structure of international trade transactions Introduction to international trade Buyer’s credit The mechanics of buyer’s credit are depicted below: An importer imports goods using either a letter of credit, collections or an open account. 1 An importer approaches the issuing bank or arranges for a buyer’s credit quote. The issuing bank arranges for a an offer letter at the best possible rates from the funding bank.

2 3 The issuing bank makes the payment to the exporter and thus settles the liability of the importer towards the exporter. 5 On the due date, the importer either requests for the rollover of the buyer’s credit or recovers the funds from the importer and retires the liability of the importer towards the bank against the letter of undertaking. 6 The funding bank, on receipt of the letter of undertaking, credits the NOSTRO account of the issuing bank with the funds. 4

Introduction to international trade 22 PwC Pre- and post- shipment credit in foreign currency (PCFC) Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Payment instruments in international trade PCFC • • The applicant needs to arrange a ‘fund-based line of credit’ from an authorised dealer/bank.

• • To make the credit available to exporters at internationally competitive rates, the cost of the loan is quoted in LIBOR plus bank spread. • • A major cost/challenge for an Indian exporter will be rupee depreciation against the currency in which the loan is drawn. • • Interest is charged on credit up to 270 days at the rate decided by the bank within the ceiling rate arrived at on the basis of Benchmark Prime Lending Rate (BPLR), relevant for the entire tenor of the export credit under the respective category.

What is pre-shipment credit? Basic facts and mechanics pertaining to pre-shipment credit • • ‘Pre-shipment’ means any loan or advance granted or any other credit provided by a bank to an exporter for financing the purchase, processing, manufacturing or packing of goods prior to shipment, on the basis of a letter of credit opened in his favour or in favour of some other person, by an overseas buyer or a confirmed and irrevocable order for the export of goods from India or any other evidence of an order for export from India having been placed on the exporter or some other person, unless the depositing of export orders or a letter of credit with the bank has been waived.

Introduction to international trade 23 PwC Pre- and post- shipment credit in foreign currency (PCFC) Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade PCFC • • Post-shipment advance can mainly take the form of: (i) Export bills purchased/discounted/negotiated (ii) Advances against bills for collection (iii) Advances against duty drawback receivable from the government • • This type of credit is available for a maximum period of 365 days, depending upon the underlying bill and bank’s policy. What is post-shipment credit?

Basic facts and mechanics pertaining to buyer’s credit • • ‘Post-shipment credit’ means any loan or advance granted or any other credit provided by a bank to an exporter of goods/services from India from the date of extending credit after the shipment of goods/ rendering of services to the date of realisation of export proceeds as per the period of realisation prescribed by Foreign Exchange Department (FED), and includes any loan or advance granted to an exporter, in consideration of, or on the security of any duty drawback allowed by the government from time to time. As per the current instructions of FED, the period prescribed for realisation of export proceeds is 12 months from the date of shipment.

Introduction to international trade 24 PwC Pre- and post- shipment credit in foreign currency (PCFC) Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Forfaiting and factoring Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade RBI guideline for the pricing of PCFC 1 Pre-shipment credit (from the date of advance) (a) Up to 270 days (b) Against incentives receivable from the government covered by the Export Credit Guarantee Corporation of India (ECGC) guarantee up to 90 days 2. Post-shipment credit (from the date of advance) (a) On-demand bills for transit period (as specified by the Foreign Exchange Dealers’ Association of India [FEDAI]) (b) Usance bills (for total period comprising usance period of export bills, transit period as specified by the FEDAI and grace period, wherever applicable) (i) Up to 180 days (ii) Up to 365 days for exporters under the Gold Card Scheme (c) Against incentives receivable from the government (covered by the ECGC guarantee) up to 90 days (d) Against undrawn balances (up to 90 days) (e) Against retention money (for supplies portion only) payable within one year from the date of shipment (up to 90 days) Note: 1. Since these are ceiling rates, banks would be free to charge any rate below the ceiling rates. 2. Interest rates for the above-mentioned categories of export credit go beyond the tenors prescribed above and are deregulated. Banks are free to decide the rate of interest, keeping in view the BPLR and spread guidelines.

Introduction to international trade 25 PwC Forfaiting and factoring Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Forfaiting and factoring • • To make the exporters more competitive, this facility is available in major convertible currencies charged as part of a bank’s commitment fees plus bank spread over and above the respective currency’s LIBOR. • • Days of grace, added to the actual number of days until maturity for the purpose of covering the number of days normally experienced in the transfer of payment, are applicable to the country of risk.

• • Such transactions are normally done on a non-recourse basis with a marginal risk for the arranger/bank given that the final payment is generally guaranteed by the letter of credit from the importer’s bank. What is factoring and forfaiting? Basic facts and mechanics pertaining to factoring and forfaiting • • In normal course of business, the exporter is unable to clock the collection and reinvest in producing additional goods even after shipment to the importer due to long credit periods or the aging of invoices. This negatively impacts the exporter’s cash flow.

• • Factoring and forfaiting are two similar routes to finance accounts receivables of an exporter. They differ on the basis of the type of underlying consideration and the credit period given to the importer. The bank/arranger buys the accounts receivable for a margin. • • Factoring typically involves the purchase of an exporter’s accounts receivable with a short credit period and invoiced goods, whereas forfaiting is a term used for financing long-term credit periods ranging between six months and seven years for underlying securities being capital goods, commodities and high-value merchandise.

Introduction to international trade 26 PwC Forfaiting and factoring Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Case studies Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Differences Factoring Forfaiting Extent of finance (invoice value) 75–80% 100% Credit worthiness Bank does the credit rating in case of non-recourse factoring transactions.

The forfaiting bank relies on the creditability of the availing bank. Sales administration Day-to-day administration of sales No services are provided. Recourse With or without recourse Always without recourse Sales By turnover By bills Term Short term Medium term Forfaiting and factoring Credit extension Invoice sale The bank provides credit protection after doing a credit check of the importer/receiving a letter of credit. The exporter hands over invoices to the bank; the assignment is created at this stage. Cash advances The bank credits the exporter’s bank account as per the terms agreed on before receiving payment from the importer. Receivable collection The bank collects payment from the exporter (if the arranging bank is not a collection agent) and follows up on overdue invoices.

Remit collected funds Financial reporting The bank repays previous advances and remits the balance to the client (if the bank is a collection agent). The bank provides transaction reports and statements to the client.

Introduction to international trade 27 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 1. Outsourcing of preparation of documents by a large multinational to its bank 2. Use of letters of credit in commodity trading As with many companies, a large Asia-based subsidiary of a European electronics manufacturer was facing staffing pressures. The subsidiary found that it did not have the correct skill set among existing staff to prepare the full set of documents needed to support letters of credit. With the company preparing about 2,000 sets of documents a year, the proportion of errors resulted in a large number of discrepancies in the documents which the company presented to the bank. As a result, the company saw an adverse impact on its days sales outstanding (DSO) and decided to outsource this non-core activity to its bank. The bank had specialist teams responsible for originating and checking all such documents, and today the bank prepares the full set of documents for the company. The solution was implemented in a short time frame and to the company’s satisfaction, using dedicated resources at the bank. Not only did the bank improve efficiency by using its own expertise in the preparation of documents, it was also able to reduce the risk of discrepancies by simplifying the company’s own internal processes.

As a consequence, the company has effectively shortened its collection cycle, resulting in an improvement in the company’s DSO to three to four days. Moreover, when establishing the outsourced arrangement, the bank’s trade advisors also reviewed the company’s processes, leading to further operational savings and reduced staff costs. Thus, this move had both cost and revenue benefits. The company started by outsourcing trade documents prepared by at least one of its divisions to the bank. It is now considering opportunities to further expand this service. The trading of commodities is a global business, with goods constantly being shipped from one side of the world to the other and to all points in between. Typically, UK-based commodity traders will act as middlemen, sourcing goods from one country or region and selling them in another, adding value by providing logistics and other services to facilitate the transaction. Sales can often be to buyers in emerging, developing or economically challenging countries, where the risk of non-payment is a major concern for the seller. The value of individual commodity shipments can be relatively high (often million USD), and failure to collect the sale proceeds can have a serious effect on the seller’s own financial condition.

One way to mitigate this risk is for the seller to insist that the buyer arranges for its bank to issue a letter of credit in favour of the seller prior to the shipment of the goods. Payment under the letter of credit is conditional upon the seller presenting the required documents through its bank. These typically include, amongst others, bills of lading (or other title documents), invoice, certificate of origin, and certificate of weight/quality. This arrangement provides a degree of comfort to both parties. The seller can arrange for goods to be shipped, with the knowledge that they will be paid for provided that the appropriate documents are presented as required under the letter of credit; and the buyer can refuse payment if the documents presented do not conform to the requirements of the letter of credit. For example, the certificate of quality indicates that the goods are not of the correct specification.

Introduction to international trade 28 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 2. Use of letters of credit in commodity trading The trading of commodities is a global business, with goods constantly being shipped from one side of the world to the other and to all points in between. Typically, UK-based commodity traders will act as middlemen, sourcing goods from one country or region and selling them in another, adding value by providing logistics and other services to facilitate the transaction. Sales can often be to buyers in emerging, developing or economically challenging countries, where the risk of non-payment is a major concern for the seller. The value of individual commodity shipments can be relatively high (often million USD), and failure to collect the sale proceeds can have a serious effect on the seller’s own financial condition.

One way to mitigate this risk is for the seller to insist that the buyer arranges for its bank to issue a letter of credit in favour of the seller prior to the shipment of the goods. Payment under the letter of credit is conditional upon the seller presenting the required documents through its bank. These typically include, amongst others, bills of lading (or other title documents), invoice, certificate of origin, and certificate of weight/quality. This arrangement provides a degree of comfort to both parties. The seller can arrange for goods to be shipped, with the knowledge that they will be paid for provided that the appropriate documents are presented as required under the letter of credit; and the buyer can refuse payment if the documents presented do not conform to the requirements of the letter of credit. For example, the certificate of quality indicates that the goods are not of the correct specification.

However, it should be remembered that the letter of credit is a bank-to-bank instrument, and while it does provide comfort in respect of the buyer’s ability to pay (albeit with the support of the bank), it does not protect the seller in the event that the buyer’s bank is unable to make the required payment on the due date as a result of, for example, its own liquidity problems, or situations outside its control, such as the imposition of foreign exchange controls. Also, buyers increasingly require extended credit terms, such that they pay for the goods at some agreed future date (e.g. 60, 90 or 180 days from the date of shipment), which puts pressure on the seller’s cash flow and ability to do more business. By adding its ‘confirmation’ to the letter of credit, the seller’s bank agrees that, provided the correct documents are presented (the seller’s bank will check the documents before sending them overseas), it will pay funds to the seller on the due date in the event that the buyer’s bank is unable to do so, thereby effectively removing the bank and country risk factors for the seller. If the letter of credit allows for payment at an agreed future date, the seller’s bank may also agree to discount the proceeds—that is, advance funds to the seller (less an agreed discount) ahead of the actual due date, thereby improving the seller’s cash flow.

Introduction to international trade 29 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 3. ‘Letters of credit are too expensive’ This was what an Asian buyer from an Irish exporting company stated when he convinced the exporter to make a sale on open account terms. The Asian buyer obtained 60 days credit, which was to be calculated from the date of the invoice. The value of the order was 1,00,000 USD and the goods were dispatched and invoiced by the Irish exporter on 15 April 2006. The payment from Asia was due on 14 June 2006. The payment eventually arrived on21 August 2006, over two months late. The delay in payment cost the exporter 1,700 USD, as it resulted in his account being overdrawn by this amount for 68 days at 9% per annum. So, are letters of credit too expensive?

The Irish exporter could have insisted on receiving a confirmed letter of credit through Allied Irish Banks. The following costs would have applied at that time: Particulars Amount Confirmation fee 250 USD Acceptance commission (@ 1.5% pa for 60 days) 250 USD Negotiation/payment fee 150 USD Out of pocket expenses (estimate) 60 USD Total letter of credit cost 710 USD Interest cost as a result of late payment 1,700 USD Benefit of using letter of credit 990 USD The letter of credit seems expensive because the costs are very visible and linked to each transaction. The benefits, on the other hand, are intangible. What benefit would the confirmed letter of credit have provided to the exporter?

• • A guarantee of payment on the due date from Allied Irish Banks (provided the terms and conditions of the letter of credit were complied with). • • No risk of non-payment as a result of problems with the buyer or the Asian economy. • • A definitive date for the receipt of funds, particularly important for devising proper currency hedging strategies. • • The opportunity to receive the payment in advance of the due date through non-recourse discounting of the receivable. Conclusion Please note that this case has not accounted for the costs the Irish exporter incurred in chasing the debt with the Asian buyer. In addition, if the exporter had sold his foreign currency receivable on a forward basis to his bank for the original due date, they may have incurred a further cost in cancelling or rearranging the forward contract.

Letters of credit, although they appear to be expensive, do provide real and tangible benefits to companies. In this case, the Irish exporter only lost 1,700 USD. Of course, if the Asian buyer had not paid at all, they would have lost the whole 1,00,000 USD.

Introduction to international trade 30 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 4. Securitisation of receivables Large companies that generate a sufficient volume of receivables may be able to raise finance through securitisation. The following case study is an example of how this technique can be used. It also shows how the proceeds from a transaction can be used in a variety of ways.

Case study An international chemicals distribution group wanted to open a 250 million EUR funding facility by securitising trade receivables denominated in euros and dollars. The receivables were originated by the group’s operating subsidiaries in the US and a number of European countries. The group’s bank and two other banks arranged for the establishment of a special purpose vehicle (SPV) in Ireland. Using funds raised via the issue of A1/P1- rated commercial paper (CP) into the asset-backed commercial paper (ABCP) market, the SPV purchases the receivables directly from the company (indirectly in the case of Italy and the US). The structure is operated without recourse to the company, which receives funds at the cost of the CP issuance, plus a credit-related margin on any drawn funds. This facility has freed cash for the distribution company and allowed it to refinance some acquisition financing.

Introduction to international trade 31 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 5. Implementation of a cash and trade solution by the division of a major international retail company The regional division of a major international retail company wanted to improve the efficiency of its cash management structure, improve its working capital (via an extension to its days payable outstanding [DPO]) and strengthen its supply chain to reduce the risk of disruption. The solution involved the division centralising its treasury operations and establishing a true end-to-end payables solution, including a supply chain finance (SCF) programme. As part of this process, the company was able to automate a number of its cash and trade processes, including its accounts payable function. Central to the success of the SCF is the way the company has minimised its involvement in the accounts payable process. The company uploads all of its approved invoices (payables) automatically from its ERP system to its bank on a daily basis. Invoices relating to suppliers which participate in the SCF programme are filtered by the bank on receipt to its trade platform. Other invoices are forwarded directly to the bank’s cash management system. Once the invoices from suppliers in the SCF appear on the bank’s trade platform, suppliers have the option of selling them to the bank to accelerate cash receipt. If the supplier chooses a discounted payment, the bank pays it on a next-day basis. The bank then collects payment from the company’s cash management account on the invoice due date. If the supplier does not discount the invoice, payment information is uploaded to the bank’s cash management system. This then initiates payment from the company’s account to the supplier on the invoice due date. Invoices relating to suppliers not participating in the SCF programme are paid via the bank’s cash management system. From the company’s perspective, only one file is uploaded to the bank. The bank then manages the entire payables process, even for those suppliers participating in the SCF. This reduces the company’s workload and minimises the touchpoints between the bank and corporates.

The bank’s cash management system generates a series of reports back to the company, giving the latter visibility on all the flows it requires. Once the system has executed the payment run on behalf of the company, all payments are automatically reconciled, whether or not the supplier is part of the SCF programme. As a result of implementing the SCF programme, the company strengthened its relationships with its strategic suppliers, who were all able to participate. With the bank placing the credit risk on the company when financing its suppliers, the company was able to reduce the risk of supplier default. At the same time, this supply chain financing element allowed the division to mitigate the impact on suppliers from extending DPO by up to 90 days (thereby improving its working capital).

Finally, the automated solutions and the reduction in the number of bank relationships have given the regional treasury much greater visibility and control over the group’s regional operations.

Introduction to international trade 32 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade 6. Boosting sales with a customer financing programme To protect and grow its share of market, an industry-leading company asked its bank to develop a programme that would provide competitive financing for key customers. Designed to strengthen the company’s relationship with key customers who were having difficulty accessing credit to finance their purchases at reasonable costs, the programme was a defensive play against predatory competitors, offering extended financing. At the same time, the programme had the potential to grow market share by providing customers with more competitive financing terms than they could obtain on their own. At the heart of the programme was the company’s principal payment guarantee. The company understood that no bank would be able to undertake the credit risk of each of its customers worldwide, especially that of smaller, thinly capitalised companies that did not meet minimum bank lending standards. Therefore, to make the deal commercially viable, the company provided a corporate guarantee of its buyers’ obligations to the bank. The company identified the programme’s core participants, mostly large local or regional distributors that were typically under pressure from rising interest rates in their markets and, in some cases, having difficulty accessing financing at any price. Each participant was approached individually to participate in the programme. After the bank performed its necessary compliance checks, each buyer signed an individual agreement with it.

All of the company’s sales to these customers were on open account terms under a variety of tenors, ranging from 30 to 60 days. The programme was structured to offer additional terms of up to 180 days. The company is still paid on its standard terms of 30–60 days from invoice/onboard bill of lading date. The bank takes ownership of the receivables at this time and finances the buyers for the difference between the original and extended tenors. Both parties benefit from this arrangement.

Introduction to international trade 33 PwC Case studies Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Contacts Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade First, the company’s customers benefit from financing at very favourable rates compared to local rates. Second, the company benefits from no impact to its DSO and not having to carry the receivables on its balance sheet for extended periods. Instead, the receivables are carried as a contingent liability in the footnotes.

Furthermore, this form of financing does not qualify for a true sale opinion under existing accounting standards, but it does move the receivables off the balance sheet and into the notes. The company’s side guarantee may or may not be disclosed to buyers in the financing agreement they sign with the bank. However, in the event of non-payment by one of the buyers, the bank follows up directly with the buyer for payment, after notifying its customer of the delinquency. The bank and the company have developed a mutually agreeable arrangement for follow-up on late payments, including when the exercise of any drawing under the guarantee may occur. Late interest is billed to the buyers but it is also ultimately the company’s responsibility.

The structure took about three months to negotiate. Initially launched to support US customers, the programme was later expanded to Europe and the UK as it became clear it would benefit customers around the world, especially those in countries with very high interest rates. The programme currently operates this financing in two currencies—dollars and euros—though it can operate in more. The company has noted the goodwill the programme has engendered with its customers. Another unexpected benefit is that in paying the bank rather than the company, the customers appear to be more disciplined in making timely payment.

Introduction to international trade 34 PwC Contacts Trade finance in India 2018 Trade finance in India 2018 Need for trade finance Trade finance methods Making and receiving payments internationally Pre- and post-shipment credit in foreign currency (PCFC) Forfaiting and factoring Case studies Buyer’s credit Timeline and structure of international trade transactions Introduction to international trade Contact us Vivek Iyer Partner Financial Services – Risk Assurance Services vivek.iyer@pwc.com Mobile: +91 9167745318 Vernon Dcosta Director Financial Services – Risk Assurance Services vernon.dcosta@pwc.com Mobile: +91 9920651117 Ramkumar Subramanian Associate Director Financial Services – Risk Assurance Services ramkumar.subramanian@pwc.com Mobile: +91 9004644029 Dhruv Khandelwal Manager Financial Services – Risk Assurance Services dhruv.khandelwal@pwc.com Mobile: +91 9820589399 Rajeev Khare Manager Financial Services – Risk Assurance Services rajeev.khare@pwc.com Mobile: +91 9702942146

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