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International Trade Finance A Pragmatic Approach Tarsem Singh Bhogal Arun Kumar Trivedi INTERNATIONAL TRADE FINANCE 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page i 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page ii TARSEM SINGH BHOGAL ARUN KUMAR TRIVEDI International Trade Finance A Pragmatic Approach 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page iii © Tarsem Singh Bhogal and Arun Kumar Trivedi 2008 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-13: 978–0–230–55378–1 hardback ISBN-10: 0–230–55378–8 hardback 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. 10987654321 17 16 15 14 13 12 11 10 09 08 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page iv 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 Contents 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page v 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 vi 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page vi 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 CONTENTS vii 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page vii 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 viii 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page viii 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 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page ix [...]... international inter-active developments Based on our learning experience and working as practitioners facilitating international trade, in our capacity as bankers, we have worked on a xv 9780230_553781_01_prexlii.qxd xvi 15-11-07 03:34 PM Page xvi PREFACE treatise in your hands International Trade Finance ‘A Pragmatic Approach’ In fact, we have been motivated to write this book in view of the urge from... practitioners to understand and grasp the type and nature of various documents in use in international trade and mechanism of settlement of payments thereof The book is organised into 21 chapters endeavouring to address key topics relating to the gamut of international trade, letter of credit mechanism, collection of bills, trade customs and practice and so on We do not pretend that all technical concerns... vis-à-vis trade customs and practice protecting the interest of the parties involved in international trade We have striven to present and explain transaction flow through diagrams easing the job of a learner enabling to understand and grasp the hard-core subject matter We sincerely believe that this book will be regarded as an essential tool for both the beginners and practitioners in international trade. .. this expansion as an outcome of globalisation and internationalisation, adding to multi-complexities to the players in the international trade In this spectrum, industry practitioners will solicit solace resorting to basics and learning the lesson of the laser How to focus rather than find a solution from the ponderance? So we did, encouraged by these international inter-active developments Based on... Taking as Security International Bonds/Bank Guarantees Parties Bank’s Role Format of Bank Guarantees/Bonds Categories of Bank Guarantees/Bonds Types of Bank Guarantees /International Bonds Retention or Maintenance Bonds Banking Facility Other Types of Bonds Precautions International Bonds/Guarantees – Precautions Time for Payment Arbitration Clause Issuing Bank Guarantees – Action Steps International Bonds... Inter-bank Payment System is a computerized funds transfer system for international dollar payments linking over 140 depository institutions with offices or subsidiaries in New York Funds transfers through CHIPS, operated by the New York Clearing House Association, account for over 90% of all international payments relating to international trade Final settlement occurs through adjustments in special account... Vice President and Chief Representative of IndusInd Bank, London He has been Head, Global Banking, IndusInd Bank He is a former faculty of International Banking, Foreign exchange and Foreign Trade at the National Institute of Bank Management, Pune Professional international banking experience includes Head Forex Treasury, Vysya Bank (now INGVysya and Chief (Treasury), State Bank of Patiala He is Fellow... of various books on the subjects viz International Banking, Treasury operations, Risk Management xvii 9780230_553781_01_prexlii.qxd 15-11-07 03:34 PM Page xviii Acknowledgements We are grateful to the following authorities for their permission to publish information in this book relating to their products and services As the systems and procedures of international trade change with improvements of information... example, by fingerprint matching, voice recognition or retinal scan BIS (Bank of International Settlements): The BIS is an international organisation which fosters co-operation among central banks and other agencies in pursuit of monetary and financial stability, its banking services are provided exclusively to central banks and international organisations BLUE CHIP: A term used to describe the ordinary... it more equitable and relevant for those who trade in the twenty-first century with Uniform Customs and Practice Looking in the retrospect we find that in 2005, the value of world merchandise exports rose by 13 per cent to $10.1 trillions and the value of world commercial services export by 11 per cent to $2.4 trillions The volume and value of international trade is a testimony to make us believe that . International Trade Finance A Pragmatic Approach Tarsem Singh Bhogal Arun Kumar Trivedi INTERNATIONAL TRADE FINANCE 9780230_553781_01_prexlii.qxd 15-11-07. 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. in international trade and mechanism of settlement of payments thereof. The book is organised into 21 chapters endeavouring to address key top- ics relating to the gamut of international trade,