INTERNATIONAL TRADE FINANCE International Trade Finance A Pragmatic Approach TARSEM SINGH BHOGAL ARUN KUMAR TRIVEDI © Tarsem Singh Bhogal and Arun Kumar Trivedi 2008 Softcover reprint of the hardcover 1st edition 2008 978-0-230-55378-1 All rights reserved.No reproduction,copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced,copied or transmitted saved without written permission or in accordance with the provisions of the Copyright,Designs and Patents Act 1988,or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency,90 Tottenham Court Road,London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published in 2008 by PALGRAVE MACMILLAN Houndmills,Basingstoke,Hampshire RG21 6XS and 175 Fifth Avenue,New York,N.Y.10010 Companies and representatives throughout the world. PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St.Martin’s Press,LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States,United Kingdom and other countries.Palgrave is a registered trademark in the European Union and other countries. ISBN 978-1-349-36360-5 ISBN 978-0-230-59432-6 (eBook) DOI 10.1057/9780230594326 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources.Logging,pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10 9 8 7 6 5 4 3 2 1 17 16 15 14 13 12 11 10 09 08 Contents List of Tables xii List of Figures xiii Preface xv About the Authors xvii Acknowledgements xviii Glossary xix 1 International Trade and Inherent Risks 1 Background of International Trade 1 Exporters’Risks 2 Importers’Risks 2 2 Services Offered by Commercial Banks 4 Finance for Exports 6 3 Methods of Trade 7 Cash on Delivery 7 Advance Payment 7 Open Account 8 Collections 8 Letters of Credit 8 Methods of Payment/Settlement of Account 9 v vi CONTENTS 4 Foreign Exchange Rates 11 Introduction 11 Foreign Currency Transactions 11 Bank’s Accounting System 11 Foreign Exchange Market 12 Exchange Rates Quotation 12 Spot Exchange Rates 13 Forward Exchange Rates 13 Fixed Forward Exchange Rates 13 Option Forward Exchange Rates 14 How Exchange Rates are Determined 14 Factors Influencing Exchange Rate 14 Forward Exchange Rates 15 Foreign Exchange Spot Transaction – Mechanism 15 Forward Exchange Contract 17 How the Forward Exchange Rate is Calculated 18 5 Bills of Exchange,Collections,Purchasing and Discounting 20 Definition of a Bill of Exchange 20 Clauses on Bills of Exchange 24 Types of Acceptances 26 Endorsement of Bills of Exchange 27 Collection of Bills 32 Mechanism – Sight Bill for Collection 34 Mechanism – Documentary Usance Bills for Collection 35 Bills Purchased 37 Bills Discounted 37 Mechanism – Bills Discounted 38 Bills Processing Cost (Indicatives) 38 6 Documentary Letters of Credit 40 Who Does What? 43 Advantages and Disadvantages of Letters of Credit 45 Letter of Credit – Mechanism 47 Letter of Credit Contracts and Regulations 48 Sale Contract 50 7 Letters of Credit – Types 52 Clean Letter of Credit 53 Documentary Letter of Credit 53 Circular or Traveller Letter of Credit 53 Revocable Letter of Credit 53 Irrevocable Letter of Credit 54 CONTENTS vii Irrevocable Confirmed Letter of Credit 56 Revolving Letter of Credit 57 Revolving Letter of Credit – Mechanism 58 Red Clause Letter of Credit 59 Red Clause Letter of Credit – Mechanism 60 Transferable Letter of Credit 62 Transferable Letter of Credit – Mechanism 62 Transferable Credit – Limitations 63 Procedure for Effecting Transfer of a Letter of Credit 66 Back-to-Back Letter of Credit 66 Back-to-Back Letter of Credit – Mechanism 69 Status of Issuing Bank of the Prime Letter of Credit 71 Credit Check on Letter of Credit Applicant 71 Third Country or Transit Letter of Credit 77 Deferred Payment Letter of Credit – Mechanics 79 Standby Letter of Credit 81 Standby Letter of Credit – Mechanism 82 Skeleton Letter of Credit 86 Omnibus Letter of Credit 86 Straight Letter of Credit 86 8 Methods of Payment Settlement 87 Payment L/C 87 Channels of Payment Settlement 87 Payment L/C – Bill on Issuing Bank 88 Mechanism of Settlement – Acceptance L/C 89 Method of Settlement – Usance Bill on Issuing Bank 90 Method of Settlement – Negotiation 92 Negotiation Under 3 months Usance L/C Bill on Issuing Bank 94 Negotiation of Documents Under Reserve 95 Negotiation of Documents Under Reserve 96 Advising/Confirming Bank – Procedural Aspect 97 9 Financial Load Variations – Eight Types of Letters of Credit 98 Payment Letter of Credit – Bill Drawn on Issuing Bank 98 Payment Letter of Credit–Bill Drawn on Confirming Bank 100 Deferred Payment Letter of Credit 101 Acceptance Letter of Credit – Bill Drawn on Issuing Bank 102 Acceptance Letter of Credit – Bill Drawn on Confirming Bank 103 Sight Negotiation Letter of Credit – Bill Drawn on Issuing Bank 104 Usance Negotiation Letter of Credit – Bill Drawn on Issuing Bank Paid at Maturity 105 viii CONTENTS Usance Negotiation Letter of Credit – Bill Drawn on Issuing Bank Reimbursement on Sight Basis 107 10 Incoterms 109 Background 109 Ex Works (......Named Place. “EXW”) 111 Free Carrier (......Named Place. “FCA”) 111 Free Alongside ship (...Named Port of Shipment. “FAS”) 112 Free on Board (...Named Port of Shipment. “FOB”) 112 Cost and Freight (..Named Port of Destination. “CFR”) 112 Cost,Insurance and Freight (..Named Port of Destination. “CIF”) 113 Carriage Paid to (...Named Place of Destination. “CPT”) 113 Carriage and Insurance Paid to (..Named Place of Destination. “CIP”) 114 Delivered at Frontier (...Named Place. “DAF”) 114 Delivered Ex Ship (...Named Port of Destination. “DES”) 114 Delivered Ex Quay (Duty Paid) (…Named Port of Destination. “DEQ”) 114 Delivered Duty Unpaid (Named Place of Destination “DDU”) 115 Delivered Duty Paid (...Named Place of Destination. “DDP”) 115 Cost Sharing between Sellers and Buyers – Incoterms 116 11 Documents in Foreign Trade – Significance 117 Genesis 117 Bill of Exchange 118 Invoice 119 Pro-forma Invoice 120 Bill of Lading 120 Types of Bills of Lading 122 Air Waybill 123 Certificate of Origin 124 Certificate of Inspection 124 Packing List 125 Post Parcel/Courier Receipt 125 Forwarding Agent’s Receipt 125 Rail,Road Consignment Notes/Truck and Carrier Receipt 125 Consular Invoice 125 Veterinary Certificate/Health Certificate 126 Non-negotiable Sea Waybill (UCP Article 21) 126 Multimodal Transport Document (UCP Article 19) 126 Combined Transport Document 127 FIATA Bill of Lading 127 Other Documents 127 CONTENTS ix 12 Negotiation of Documents 128 Meanings of Negotiation 128 Role of Advising and Confirming Banks 129 Role of Issuing Bank 129 Negotiation of Documents Under Reserve 130 Letter of Credit – Processing Cost (Indicatives) 131 13 Factoring and Forfaiting 132 Factoring:Genesis 132 Factoring and Cash Flow 132 Factoring and Legal Implications 133 Factoring Mechanism 133 Advantages of Factoring 134 Disadvantages of Factoring 134 Invoice Discounting 135 Advantages to Exporter 135 Export Factoring 136 Forfaiting:Genesis 137 Fixed Rate Export Finance 137 Forfaiting – Capital Goods Sale 137 Forfaiting – Secondary Markets 138 Risks in Export Finance 138 Advantages to the Exporter 139 Disadvantages to the Exporter 139 Requirements of a Forfaiter 139 Documents Required by the Forfaiter 140 Forfaiting Procedures in Practice 141 Mechanism of a Forfaiting Transaction 141 14 Electronic Documents (eUCP) 143 15 Scrutiny of Documents – Procedures 149 Buyer’s Responsibilities 150 Seller’s Responsibilities 150 Responsibilities of Other Parties (Banks) 150 The Issuing Bank 151 16 Common Irregularities in Documents 160 Compliance of Terms 160 17 Guarantees and International Bonds 164 Guarantees as Security 164 Distinction between Guarantees and Indemnities 166