Trade Finance

With the boom of the Chinese economy over the past decade and Australia’s growing links with China and throughout Asia, more and more businesses are trading across international borders. Trade Finance covers a range of different financial facilities that can assist exporters and importers reduce the risk of trading with overseas parties and also provide working capital while waiting for payment of exported goods or when making a payment for imported goods.

There are 5 main methods of payment for Trade Finance transactions:

Prepayment on is where the importer pays the exporter for the goods prior to shipping. This form of payment carries the most risk for the importer and the least risk for the exporter for obvious reasons. The importer has no means of ensuring delivery or quality of the goods, and the exporter is happily paid before making any tangible commitment.

A Documentary Letter of Credit is a bank guarantee provided by the importer’s bank to the exporter guaranteeing payment for the shipped goods upon presentation of shipping documents (and meeting any required conditions) or at a future specified date. This payment arrangement shares the risk between the exporter and importer and is often used when they are still establishing a trade relationship. For the importer, there is some assurance that the goods are shipped prior to payment being made, and for the exporter, they are guaranteed payment provided they ship the goods and meet any agreed conditions.

Documentary Collection (at sight), aka “Documents against Payment”, is where payment is made by the importer upon sighting shipping documents. Goods are not released until payment is made. This method of payment shares the risk between the exporter and importer as the importer has some assurance that the goods have been shipped and the exporter has assurance that the goods will not be released without receiving payment (although no guarantee of payment).

Documentary Collection (term), aka “Documents against Acceptance”, is where the shipping documents and shipped goods are released to the importer upon endorsement of the bill of exchange (promise to pay at a future date). The risk of this type of transaction is greater for the exporter than the importer as the importer receives the goods only on a promise to pay at a later date. The exporter may not receive payment if there is a dispute or if the importer cannot afford to pay at the payment date.

Open Account transactions are when the importer pays the exporter upon receiving delivery of the goods. All of the risk lies with the exporter in this type of transaction as the goods are shipped with no method of guaranteeing payment. Approximately 80% of the world’s international trade transactions are conducted in this manner.

The more commonly used Trade Finance facilities include Trade Finance Loans and Documentary Letters of Credit.

Trade Finance Loans assist either the exporter or the importer fund their trade obligations and are specific to an underlying trade transaction that must be evidenced by the appropriate documentation. For example, an exporter may seek a Trade Loan to assist funding the production/acquisition and delivery of goods to a corresponding importer. This Trade Loan is then repaid once payment is received from the importer. Alternatively, an importer may seek a Trade Loan to assist with the payment for goods being imported pending arrival and sale of the goods to their local buyers. Trade Loans are often used to facilitate open account transactions.

Documentary Letters of Credit provide a level of comfort to both the exporter and importer. A description of how they work is detailed above. As an example; an importer would approach his bank for a Documentary Letter of Credit (“DLC”) facility to facilitate the importation of goods. Once an agreement to purchase goods is made between the exporter and the importer, the importer will request its bank to provide a DLC to the exporter guaranteeing payment of the goods (subject to delivery and certain conditions). The exporter will ship the goods through a carrier and receive a bill of lading from the carrier. The exporter then sends the bill of lading to the importer’s bank that makes payment upon receiving and meeting any agreed conditions. The bill of lading is then provided to the importer (to allow collection of goods) in exchange for payment from the importer.