A study on instruments of trade financing in vietnamese commercial banks

ABSTRACT The academic research analyzes some trade financing instruments’ processes and focuses on modern trade financing instruments like L/C for financing purpose, Forfaiting, Supply c

MASTER THESIS

A study on instruments of Trade financing in Vietnamese

commercial banks

Major: International Trade Policy and Law

SUPERVISOR : Asso Prof, Dr Nguyen Thu Thuy

Hanoi - 2016

Prof, Dr Nguyen Thu Thuy, for all of her remarks and guidance so that I can continue doing my research and complete this on time

I also would like to thank my friends working with me in trade financing field for their strong support Without them, the study would not be accomplished

Lastly, I would like to take this chance to express my deepest gratitude to my dear family, who always supports me no matter what happens for all the time I study I would like to sincerely thank my parents, for giving me unconditionally loving and encouraging me through my hardest time; my sister, for truly understanding and sympathizing with me I would never have finished this without you

ABSTRACT 1

CHAPTER 1: INTRODUCTION 2

1.1 Relevance of study 2

1.2 Research questions 5

1.3 Data and methodology 6

CHAPTER 2: THEORETICAL FRAMEWORK OF TRADE FINANCING INSTRUMENTS 8

2.1 Methods of settlement 8

2.2 Methods of secondary payment 14

2.3 Methods of finance for customers 16

2.4 Methods of finance for banks 27

CHAPTER 3: LEGAL FRAMEWORK OF TRADE FINANCING INSTRUMENTS 31

3.1 National law 31

3.1.1 General law 31

3.1.2 Specific law for each kind of trade financing instrument 32

3.2 International law 35

3.3 Relationship between national law and international law of trade financing instruments 38

3.4 Effect of law in trade financing instruments 39

CHAPTER 4: DEVELOPMENT AND IMPACT OF TRADE FINANCING INSTRUMENTS TO VIETNAMESE COMMERCIAL BANKS 43

4.1 Development of Trade financing instruments in Vietnamese commercial bank………… 43

4.1.1 Financing by issuing or confirming Letter of credit 43

4.1.2 Discount/negotiation 44

4.1.3 Guarantee/Standby L/C 46

4.1.4 Express discount 47

4.1.7 Internal L/C 58

4.1.8 Products for loaning purpose between banks 61

4.1.9 Factoring 62

4.1.10 Forfaiting 65

4.1.11 Supply chain 69

4.2 Impact of trade financing instruments to banking business 74

CHAPTER 5: ANALYSIS ON THE CURRENT SITUATION OF TRADE FINANCING INSTRUMENTS AND RECOMMENDATIONS FOR DEVELOPING TRADE FINANCING INSTRUMENTS IN VIETNAMESE COMMERCIAL BANKS 78

5.1 Analysis on the current situation of Trade financing instruments in Vietnamese commercial banks 78

5.2 Success and shortcomings of trade financing instruments in Vietnamese commercial banks 84

5.3 Recommendations for Vietnamese banks in developing trade financing instruments … 87

CHAPTER 6: CONCLUSION 93

REFERENCES 94

Agribank Vietnam Bank for Agriculture and Rural Development

BIDV Bank for Investment and Development of Vietnam

CDCS The Certificate for Documentary Credit Specialists

DOCDEX Documentary Instruments Dispute Resolution Expertise

Exim bank Vietnam Export Import Commercial Joint - Stock Bank

EPLC Early payment letter of credit

FMCG Fast moving consumer goods

GSM 102 Export Credit Guarantee Program 102

ICC International Chamber of Commerce

IFC International Finance Corporation

IFC International Finance Corporation

IMO International Maritime Organization

ISBP 745 International Standard Banking Practice for the Examination of

Documents under Documentary Credits 745

ISP 98 International Standby Practices 98

OCR Optical character recognition

SCF Supply chain finance

SWIFT Society for Worldwide Interbank Financial Telecommunication

TMA Transaction Matching Application

TPP Trans Pacific Partnership

TSU Trade Services Utility

UCP600 Uniform Customs and Practice for Documentary Credit 600

UPAS L/C Usance payable at sight letter of credit

URBPO 750 Uniform Rules for Bank Payment Obligations 750

URC522 Uniform rules for collection 522

URDG 758 Uniform Rules for Demand Guarantees 758

URF 800 ICC Uniform Rules for Forfaiting 800

URR725 Uniform rules for bank to bank reimbursement 725

USDA U.S Department of Agriculture

Vietcombank Joint Stock Commercial Bank for Foreign Trade of Vietnam

Vietinbank Vietnam Joint Stock Commercial Bank for Industry and Trade

VP bank Vietnam Prosperity Joint-Stock Commercial Bank

Figure 1 Bank payment obligation transaction flow 10

Figure 2 Documentary credit without confirmation of advising bank 13

Figure 3 Payment secured by a bank guarantee (or Standby letter of credit) 15

Figure 4 Close 3-corner Supply chain flow 21

Figure 5 Open 4-corner Supply chain flow 23

Figure 6 Basic forfaiting transaction 25

Figure 7 Comparison between methods of finance 26

Figure 8 UPAS L/C mechanism 54

Figure 9 Bank spending on block chain 71

Figure 10 Market adoption of BPO 72

Figure 11 The revenue potential from supply-chain 73

Figure 12 Non-interest income 76

Figure 13 Global trade finance revenue 78

Figure 14 Mix trade finance product 79

Figure 15 Trade-related revenues for banks 80

Figure 16 Techcombak’s volume of Trade finance instruments 82

ABSTRACT

The academic research analyzes some trade financing instruments’ processes and focuses on modern trade financing instruments like L/C for financing purpose, Forfaiting, Supply chain, which are developed in the world but limited in Vietnamese commercial banks In addition to bringing out the impact of trade financing products on business of Vietnamese commercial banks, the study also points out success and shortcomings of trade financing activities in Vietnamese banking business and proposes suggestions to increase trade finance in Vietnamese banking system

Moreover, this dissertation would like to mention all recent national laws and international rules for each product and also indicates their affect to trade financing processes in Vietnamese commercial banks So that, bankers can get a whole view

on a legal aspect of trade financing instruments

This paper will approach a different view with previous researches by deeply focusing on specific trade finance products and study with the scope in Vietnamese commercial banks like Vietcombank, Techcombank, MB, VP bank,… in comparison with international banks Thus, this paper would like to be a useful source for bankers, especially trade financing officers, RM to develop trade financing procedures as well as operate them efficiently

in comparison with import-export volume-159.9 million USD1

The developing trend of Vietnamese commercial banks in trade finance field

is diversification of products since it is an important factor that creates difference among banks Trade finance products do not stop at traditional way but more efficient way In tradition, to finance, banks can use their capital (namely negotiation of exporting documents or lending loan to customers for payment under L/C) or their credit to finance customers (like issuing L/C, Standby L/C or Guarantee) However, nowadays, banks offer more modern products like express negotiation which is based on normal negotiation but it is more efficient to help companies get money quickly Therefore, with a wide range of trade finance products, it is a hard job for banks to offer suitable products for their customers since enterprises only care about trading process and leave financing issues for banks

Moreover, the need of enterprises from banks is more complicated in the booming period of trade and enterprises are usually customers of different banks Hence, companies can compare trade financing instruments between banks As a result, it is a pressure for banks to continuously update information on new products

1 Vietcombank (2016), The first six-month business report in 2016

and develop its own instruments For example, UPAS L/C is so familiar to Vietnamese commercial banks thanks to its win-win mechanism (UPAS L/C is payable sight basis to the seller (beneficiary), while the payment settlement from the applicant (buyer) to the issuing bank will made at the end of usance term) However, although used in other countries long time ago (i.e Korea), at the time of

2011, UPAS L/C was an exclusive product of Techcombank It took almost five years for this kind of L/C become popular in Vietnamese commercial banks The same situation applied with Draft by back L/C which has same mechanism with UPAS L/C but the issuing bank has the role of reimbursement bank Till now, only Techcombank and MB offer this product Moreover, some products like Supply chain, Forfaiting have not been developed in Vietnam

Since Vietnamese legal structure is so complex with a lot of Circulars, Decisions, Official notices… which are revised or replaced in each period of time, it

is required that banks must update new rules governing their trade financing products So that, they are able to build up or update their procedures in compliance with new regulations

Researches on trade financing instruments are done in various ways from theoretical view and practical view For example, Mustafa (2010), Ahn & JaeBin (2011) and Grath (2013) provide all theories of trade finance There are some papers in a practical aspect like Henri (2013) indicating practical process in trade financing unit from the perspective of corporate banking employees or Sindberg (2011) and Oramah (2016) providing financing activities in international trade In the financial crisis, trade financing activities were researched increasingly like Rochet (2010), Chauffour & Malouche (2011), Chor & Manova (2012), all of which shown the fact that because of crisis, bank-intermediated trade finance fell in value significantly In addition, analyses on development of trade finance are also mentioned by many authors namely Clark (2014) and Garralda& Vasishtha (2015) Moreover, the importance of trade finance in trading activities is also proved in a variety of researches namely Wandhöfer (2012) and Prete & Federico (2014)

As to categorical aspect, ICC have annually issued ICC Global Survey on Trade finance to update new products and trade financing trend of the world in each period of time For example, ICC Global Survey on Trade finance 2016 gives a view of development of new technique like BPO from 2014 to 2015 and growth of new trade finance products like Forfaiting According to this report, the market uptake for the Bank Payment Obligation did not experience significant increase during the calendar year 2015, demand for BPO in 2015 following a similar trend in

2014 While nearly 80% reported no change in their use of this instrument, nearly 15% reported an increase2 Growth of Forfaiting in all regions has been observed, however, relative to 2014 Not mention to some researches on specific products like Frederic (2016) introducing supply chain management technologies and Surbhi (2016) analyzing the difference between Factoring and Forfaiting

Moreover, the development of trade finance field in Vietnamese banking system has been researched from time to time For instance, Doan Thi Nuong Nuong (2012) provides some solutions to develop trade finance in Vietnamese commercial banks and Pham Thi Thu Hang (2015) focuses on how to manage risks

in trade finance field In the newest research, Nguyen Thi Ha (2015) indicates development of trade finance in Vietnamese commercial bank with analysis on some modern trade finance products like UPAS L/C, Draft buy back L/C, Trade loan and L/C Refinancing

With a wide range of previous researches, bankers can get a lot of information

on trade finance field especially trade finance instruments However, not mention to the fact that all previous researches do not provide mechanism of trade finance products in practical view, like all products, trade finance instruments are updated

in an increasing pace Therefore, the previous researches do not contain sufficient updated data for readers Because of the gap and the fact that the current trend to develop trade financing section of banks is diversifying products, this dissertation -

“ A study on instruments of Trade financing in Vietnamese commercial banks” is written

2 ICC (2016), Global Survey on Trade finance 2016

This paper would like to provide bankers, in view of a trade finance officer, detailed process of new trade financing instruments like L/C for financing purpose, Forfaiting, Supply chain With this information, the research would like to be a useful source for bankers to develop trade financing procedures as well as operate them efficiently

In legal aspect, although Vietnamese legal framework is quite complex, there

is no previous research analyzing national laws and international rules governing each trade financing instruments Therefore, this dissertation would like to mention all recent national laws and international rules for each product and also approach their affect to trade financing process in banks Thus, trade financing officers can have a whole view on legal regulations which govern and guide trade financing activities

Moreover, unlike other researches which only analyze development of trade finance field as a whole, the paper will get a close look on the impact of trade financing instruments to commercial banks’ business and aim to give recommendations to develop trade financing products in Vietnamese banking systems With that purpose, the paper will indicate newest information of benefits which trade financing instruments create, limitation of some trade financing procedures in different banks

 What are the recommendations for Vietnamese commercial banks in developing their trade finance instruments?

1.3 Data and methodology

The author used the following methods to answer four research questions:

a) Statistic method: data collected from annual report of some commercial banks, data of finance institutions and corporations like ICC…

b) Investigation method: Investigate trade finance activities in some Vietnamese commercial banks and foreign banks

c) Comparison and collective method: collect information from related researches, compare status of trade finance in commercial banks and collect the results to find out the solutions

The scope of study is in Vietnamese commercial banks like Vietcombank, Techcombank, MB… which represent big four state-owned banks, foreign-shareholder banks and big corporation banks respectively, in comparison with international banks and focus on trade financing sector The dissertation is studied with data from the period of 2010-2016 and will give suggestions till the period of

2025 in which Vietnamese banking system is predicted to pass difficulty and grow steadily

With a view to addressing these problems, the research will be divided into six main sections Firstly, Chapter 1 will be Introduction giving an overview on the study Following Chapter 2 will be Theoretical framework of trade financing instruments, showing mechanisms of trade financing instruments Chapter 3 will be Legal framework of trade financing instruments, providing update regulations for trade financing instruments and effect of them Furthermore, Chapter 4 is Development and impact of Trade financing instruments to Vietnamese commercial banks, aiming to provide a practical view of each product in Vietnamese commercial banks in comparison with that of foreign ones Chapter 5 Analysis on the current situation of trade financing instruments and recommendations for developing trade financing instruments in Vietnamese commercial banks will point

out current situations and some recommendations for developing trade financing products in Vietnamese banking system Finally, Conclusions will be drawn and recommendation for further research will be presented in the last Chapter 6, along with the limitations of this study

CHAPTER 2: THEORETICAL FRAMEWORK OF TRADE FINANCING INSTRUMENTS

2.1 Methods of settlement

Each kind of trade financing instruments is based on basic payment terms The five basic terms of payment are Open account, Documentary collection, BPO, L/C and Payment in advance

 Open account

In an open account transaction, a seller will dispatch goods to a buyer and send documents (shipping documents and/or customs documents) asking for payment or agreement to pay on a specified date Once goods have been dispatched,

a seller will lose all control over payment, and is reliant on the trustworthiness and creditworthiness of a buyer to pay Therefore, this kind of payment is only a convenient method of payment if a buyer is well established, has a long and favorable payment record

Open account terms may be offered with use of one or more of trade financing techniques namely Guarantee/Standby L/C, Factoring, Forfaiting and Supply chain

to reduce risks and provide advance payment for exporters

 Documentary collection:

In a documentary collection, a seller will ship or dispatch goods However, instead of sending documents directly to a buyer, it will send them via a banking system for payment or acceptance by a buyer

URC 522 (ICC, 1995) sub-article 2 (a) defines a collection as being: handling

by banks of documents in accordance with instructions received, in order to:

(I) obtain payment and / or acceptance, or

(II) deliver documents against payment and / or against acceptance, or

(III) deliver documents on other terms and conditions

More commonly, collections are described as being ‘D/P’ - documents release against payment, ‘D/A’ - documents release against acceptance, with payment due

at a future date or ‘D/OT’ - documents release against other terms and conditions namely promissory notes, trust receipts, letters of under taking to pay,…

Enterprises can get finance from this kind of payment method like negotiation for exporters and a loan for importers to effect payment In D/A transactions, exporters may require Guarantee/Standby L/C to reduce risks of non payment at maturity from importers

 Bank payment obligation:

URBPO 750, article 3 defines that BPO (bank payment obligation) is an irrevocable undertaking given by one bank (Obligor bank) to another bank (Recipient bank) that payment will be made on a specified date after a successful electronic matching of data

BPO is a new tool for international trade finance It will be located somewhere between open account and letter of credit Based on standardized messaging and advanced transaction matching, this new instrument will accelerate financial supply chain

The process flow of a basic BPO transaction is illustrated in Figure 1 below

Figure 1 Bank payment obligation transaction flow 3

(1) The buyer and the seller agreed on BPO as a payment term on the sales contract

(2) The buyer provides minimum data from the sales contract and conditions

of BPO to the obligator bank which will inform the recipient bank

(3) The recipient bank advises the seller BPO conditions The seller confirms the data and sends its acceptance of BPO conditions to the recipient bank If both buyer's and seller's data are matched on the Transaction Matching Application (TMA), the baseline is established At that moment, an irrevocable undertaking of the obligor bank is issued Then, both buyer and seller will be receiving a matching report from their banks

An example of a TMA is the SWIFTNet Trade Services Utility (TSU) which is

a centralized matching and workflow engine The obligor bank and the recipient bank communicate in a BPO transaction by a set of ISO 20022 messages-Trade services management (TSMT) Communication systems for BPO are operated by Society for Worldwide Interbank Financial Telecommunication SWIFT)

3 Mark Ford (2014), First German-Japan BPO processed, DCInsight Vol.19

(4) The seller ships the goods as agreed on the sales contract

(5) The seller presents shipment data and invoice data to its bank (the recipient bank), which submits them to Transaction Matching Application for matching

(6) The buyer receives a match report from its bank (the obligor bank) The buyer is invited to accept any mismatches if any

(7) The recipient bank informs the seller about the successful dataset match

(8) The seller sends trade documents directly to the buyer The buyer will clear goods from the customs with these documents

(9) On the due date, the obligor bank debits the proceeds from the buyer's account to effect payment for the recipient bank

It is noticeable that, unlike an LC, where the seller in the underlying trade transaction is the beneficiary, the party entitled to payment under a BPO is the recipient bank (the seller's bank) This is because a BPO creates a bank-to-bank payment obligation, not a bank-to-customer obligation Therefore, a BPO offers assurance of payment, risk mitigation for all parties, and is possibly used as collateral for finance In addition, the obligor and recipient banks need separate agreed documents with their customers in respect of a BPO since the actual parties

of this payment method are the seller and the buyer

 Letter of credit:

The definition of letter of credit, offered in UCP 600, article 2, is a short and definitive statement: “Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank

to honor a complying presentation”

The structure of a basic documentary credit transaction is highlighted in Figure 2

(1) The contract is agreed between the buyer (‘applicant’) and the seller (‘beneficiary’) indicating a documentary credit as the method of settlement

(2) The applicant applies to its bank for the issuance of a documentary credit, usually by completing the bank’s standard application form

(3) Subject to a credit facility being in place and the bank agreeing to the terms and conditions that have been stated in the application form, the bank issues the documentary credit and advises it through a bank in the country of the beneficiary, known as the ‘advising bank’

(4) The advising bank issues its advice of the documentary credit and sends it

(7) Because the advising bank has not added its confirmation to the credit, it may or may not examine the documents prior to sending them to the issuing bank It

is also under no obligation to honor or negotiate the beneficiary’s documents We will assume that the advising/nominated bank has not examined the documents

(8) The issuing bank determines that the documents comply and arranges to debit the applicant’s account for the value of the drawing In return, the documents are handed over to the applicant so that it may take control of the goods At the same time, the issuing bank reimburses the advising/nominated bank

(9) The advising/nominated bank, upon receipt of the proceeds from the issuing bank, effects settlement to the beneficiary in the manner requested

This is a basis flow of L/C transaction There may involve a confirmation bank which like the issuing bank gives its irrevocable undertaking and a reimbursing bank which is the third party to effect payment

Letter of credit can be used for almost trade finance activities because of its efficient features which are presentation of documents to prove transactions,

independent parties like the issuing bank/the confirming bank giving irrevocable undertaking, or the nominated bank/the reimbursing bank effecting payment

Figure 2 Documentary credit without confirmation of advising bank 4

 Payment in advance:

With this method of payment, the buyer pays the money in advance Once the seller is in receipt of the funds, it arranges for the goods to be shipped or dispatched From the seller’s point of view, receiving payment in advance of the shipment is an

4 Gary Collyer (2015), Guide to Documentary Credits, 5th edition, ifs University College

ideal situation, as it appears to eliminate all risks associated with payment

non-However, from the buyer’s point of view, payment in advance carries the greatest risk, as it is wholly dependent on the seller shipping the correct goods

in accordance with the contract In addition, payment in advance can create flow problems for the buyer, as it has to wait to receive the goods Therefore, the buyer usually required bank guarantee or stand-by L/C to reduce risks

cash-2.2 Methods of secondary payment

In case another primary payment mechanism does not work, a party of contract will get reimbursement from a third independent party by a Guarantee or Standby letter of credit Guarantee and Standby L/C have very similar characteristics but they work in different mechanisms with particular uniform rules for each kind Standby L/C has its rules as ISP 98 - International Standby Practices, ICC Publication No 590 and the rules of Guarantees is the Uniform Rules for Demand Guarantees, ICC publication No 758

As per URDG 758, article 2 “ Guarantee means any signed undertaking, however named or described, providing for payment on presentation of a complying demand” ISP98 rules (1998) includes reference to Standby letters of credit in the following terms: Irrevocable-Rule 1.06b says: ‘‘Because a Standby is irrevocable,

an issuer’s obligations under a Standby cannot be amended or cancelled except

as provided in the Standby or as consented to by the person against whom the amendment or cancellation is asserted’’ For the purpose of demonstrating this transaction, Figure 3 uses a bank guarantee as an example, but the process could equally applies to a Standby letter of credit

Figure 3 Payment secured by a bank guarantee (or Standby letter of credit) 5

(1) The contract is agreed between the buyer and seller, indicating open

account terms or a documentary collection as the method of settlement, supported

by a bank guarantee

(2) The buyer applies to its bank for the issuance of a bank guarantee, usually

by completing the bank’s standard application form

(3) Subject to a credit facility being in place, and the bank agreeing to the terms and conditions that have been stated in the application form, the bank issues the guarantee and advises it through a bank in the country in which the beneficiary

is located, known as the ‘advising bank’

(4) The advising bank issues its advice of the guarantee and sends it to the beneficiary

(5) The beneficiary, if in agreement with the terms and conditions of the guarantee, arranges shipment of the goods Having shipped the goods, the

5 Gary Collyer (2015), Guide to Documentary Credits, 5th edition, ifs University College

beneficiary issues, collates and presents its documents directly to the buyer (open account terms) or to the remitting bank (if documentary collection terms) for sending to the collecting bank

(6) If the open account transaction, or the documentary collection, is honored, the guarantee is not utilized If there is a payment default by the buyer, the seller issues a demand in accordance with the requirements of the guarantee and presents

it to the advising bank

(7) The advising bank sends the demand to the issuing bank

(8) The issuing bank determines that the demand complies and arranges to debit the applicant’s account for the value of the drawing In return, the demand is handed over to the applicant At the same time, the issuing bank reimburses the advising bank

(9) The advising bank, upon receipt of the proceeds from the issuing bank, effects settlement to the beneficiary in the manner requested

The two instruments are not only used to finance enterprises by banks’ credit but also used in connection with other kind of instruments For instance, some banks required a Guarantee or Standby L/C issued by reputed financial institutions before providing reimbursement under UPAS L/C or Trade loan/Refinancing

2.3 Methods of finance for customers

 Negotiation/Discount

Discount is a method that banks will effect payment of drafts or documents at

a certain amount (i.e 90% of invoice value) in advance and customers in return pay back banks a principal amount plus interest From that mechanism, discount can be used in a wide range of trade financing transactions namely documentary collection, letter of credit…

In letter of credit terminology, negotiation term is used instead of discount term UCP 600, article 2, defines “negotiation” as “Negotiation means the purchase

by the nominated bank of drafts (drawn on a bank other than the nominated bank)

and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank”

The structure of a basic discount transaction is described as below steps:

(1) The contract is agreed between the buyer and the seller indicating shipment

of goods and a payment activity

(2) The seller arranges shipment of the goods

(3) Having shipped the goods, the seller issues, collates and presents documents stipulated in the contract and presents the application for discount and documents to its bank

(4) The bank reviews the application and the documents as per their policy then agrees or disagrees the discount offer

(5) When agreeing to discount, the bank pays the seller a percentage of invoice value

(6) The bank sends the documents to the buyer or the buyer’s bank and claims for value of goods

(7) The bank receives payment from overseas party and off balance the amount with the seller

(8) If The bank does not receive payment at maturity, it will recourse the seller (in discount with recourse) or it will claim reimbursement from the buyer or buyer’s bank (in discount without recourse)

As mentioned above, discount with recourse and discount without recourse are two kinds of discount In discount with recourse, the client is legally responsible for repayment of the funds and the finance will be shown in the client’s balance sheet

as a liability In discount without recourse, the client is not legally responsible for repayment of the funds; banks have agreed to look to someone other than the client for repayment (i.e buyers or buyer’s bank) and the finance will not appear on the

client’s balance sheet as a liability provided that the client’s auditors are in agreement

Discount without recourse has higher risks for banks because it is easier for banks to get repayment from their customers than from overseas parties So that, to get discount without recourse , there are requirement of higher interest and more conditions like documents must be under L/C transactions, documents must be accepted by issuing banks or confirming bank and credit line of issuing banks and confirming banks and country risks must be complied with banks’ policy The requirement on overseas parties are difficult to get since they are changeable and hard to analyze by banks However, if banks are confirming banks under L/C transactions, they must negotiate complying documents without recourse (as stipulated in sub-article 8 (a) (ii) UCP 600) That is to say, the confirming bank is exposed to risk of non-reimbursement from the issuing bank for whatever reasons

 Factoring

A factoring service is similar to discount except that the whole of administration and credit control of the sales ledger are taken over by a factoring company For this reason, the provision of this facility must be known to the buyer The seller and the factoring company will need to agree precisely what services are required and will be offered by the factor Factoring is short-terms financing which

is usually not applicable to a small invoice because of the high charges will be applied for the factoring administration

The standard step by step invoice factoring process is as follows:

(1) A company (seller) sells goods or services to one of its customers (buyer)

as per the agreed terms and conditions

(2) The seller ships goods, prepares documents and contacts his bank for factoring service

(3) The bank verifies the transaction and the background of the buyer

(4) After receipt of acceptance from the bank, the seller presents to the bank shipping documents including invoice, which usually has an instruction for the buyer to pay the value of the invoice directly to the bank

(5) The bank advances cash to the seller and sends documents to the buyer for payment The percentage of advance given usually ranges between 80% to 90% of the invoice value and the balance is kept as a reserve payment and a part of it as its fee that is charged for convenience The percentage of advance may depend on upon the credit comfort that the bank has on the buyer after it does the credit appraisal of the buyer

(6) The bank administrates the claim and on the due date, the buyer will make payment directly to the bank

(7) Upon receipt of the payments from the buyer, the bank releases the balance cash after deducting the factoring fee The factoring fee is usually the processing fee and interest charge based on the amount of invoice and number of days till the amount is received

In case where the payment is not made by the customer to the factoring company, two possibilities exist:

 If the factoring, when it was agreed upon, was “with recourse” to the seller, the seller will have to bear the credit loss by paying to the bank

 If the factoring was with “non-recourse” to the seller feature, the bank shall bear the credit risk and loss thereon

Factoring is not the same thing as “invoice discounting” Factoring is very specifically the actual true sale of receivables, whereas invoice discounting is a loan whereby the account receivable (AR) assets are used as collateral Moreover, Factoring service is applied mostly in open account technique since Factoring transaction provides not only advance payment but also administration of payment schedule

 Supply chain finance

In a typical supply chain finance arrangement, a creditworthy buyer allows its suppliers to access their invoices on an internet platform and obtain a formal confirmation that the invoice has been approved Having the formal confirmation will enable banks to make an immediate advance to the seller, knowing that the invoice has been agreed and hence payment will be forthcoming The advance will

be charged at a lower rate of interest, based on the creditworthiness of the buyer

There are two models of supply chain which are close 3-corner and open corner Close 3-corner model is traditional one which involves only one party like buyer’s bank while Open 4-corner model involves buyer’ bank and seller’s bank Open 4-corner is used with BPO technique The following process is a basic flow of

4-a Close 3-corner model supply ch4-ain tr4-ans4-action

(1) A company (seller) sells goods or services to one of its customers (buyer)

as per the agreed terms and conditions

(2) The seller ships goods, prepares documents, provides data of shipment to the buyer’s bank The transmission of data is made through Supply chain finance platform (SFC) of banks

(3) The bank informs the data received to the buyer

(4) The buyer informs acceptance of the data

(5) + (6) The seller sends documents to the buyer and requests the bank for advance payment

(7) The bank advances cash to the seller and charge early payment interest At maturity, the buyer will effect payment for the bank

Figure 4 Close 3-corner Supply chain flow 6

As per Figure 4, It seems that this kind of supply chain is similar with factoring of which the purpose is to finance the supplier’s receivables by a factor so that the supplier can cash in the money immediately for what he sold (minus the interest that is deducted by the factor to finance the advance of payment) However, the difference is the ordering party and technology involved In factoring the ordering party is the supplier while in supply chain, the ordering party is the buyer Moreover, in this kind of transaction, the seller’s bank can access the data on an internet platform and obtain a formal confirmation that the invoice has been approved since it is also a party in the process

Since supply chain is initiated by the buyer in order help finance the supplier’s receivables, it is easier, and at a lower rate than factoring However, there are some disadvantages for sellers:

6

David Frederick Ross (2016), Introduction to Supply Chain Management Technologies, 2nd edition, CRC Press

 Sellers need to connect to various SCF portals operated by the buyers’ banks portals if they enter contract with several buyers

 Buyers’ banks face new supplier on- boarding and KYC challenges leading to much higher costs than ever before because sellers may not be their customer

 SCF services are often limited to approved payables finance where suppliers often need purchase order finance

 Bank- or vendor-specific formats increase costs for all and limit opportunity for automation

Therefore, this kind of model is still rare today and banks incline to use Open 4-corner which is created by BPO mechanism in stead Open 4-corner or two-bank interoperable model is illustrated in Figure 5 below

The supply chain service will begin at the step of BPO when the successful dataset match occurs When the recipient bank gets the acceptance of the obligor bank for the data, it will, as request of the seller, advances cash to the seller

In this model, the seller’s bank will be a party providing supply chain services and the supply chain finance platform is SWIFTNet Trade Services Utility (TSU)

of SWIFT with ISO 20022 messages So that, there are many advantages for the seller:

 The seller can get services from their own bank

 The seller’s bank takes risk on the buyer’s bank not on buyer - no need for KYC between the buyer and the seller’s bank

 The buyer’s bank commits to pay the seller’s bank on due date - no need for KYC between the buyer’s bank and the seller

 No supplier on-boarding is needed as banks only deal with their respective customers

 BPO uses ISO 20022 messages which are end-to-end automation by all

Figure 5 Open 4-corner Supply chain flow 7

 Forfaiting

Forfaiting means the sale by the seller (exporter) and the purchase by the buyer (forfaitor) of the payment claim on a without recourse basis, in other words, forfaiting is discounting of trade-related receivables secured with negotiable instruments such as bills of exchange, promissory notes or deferred payment letter

of credit In the U.S., forfaiting is known as "structured trade finance"

It has been developed to provide medium-term finance (up to ten years) at fixed interest rates for construction projects or the sale of capital goods Today, its use has been extended to include shorter terms (but more than six months) and for a wider range of sales The seller, holding a series of drafts accepted by the buyer or a

7 David Frederick Ross (2016), Introduction to Supply Chain Management Technologies, 2nd edition,

CRC Press

bank, or promissory notes issued by the buyer, can discount these on a ‘without recourse’ basis with a forfaiter Unless the acceptor of a draft or drawer of the promissory note is of undoubted international credit standing, a guarantee of the buyer’s obligations will be required by forfaiter providing the facility Always

“without recourse” and can be traded in secondary market are two main different features that forfaiting have in comparison with factoring

The basis forfaiting transaction is described in Figure 6 below

(1) The forfaiter and the exporter agreed upon a Forfaiting Agreement

(2) The exporter and the importer entered a sales

(3) Shipment is initiated by the exporter

(4) The importer obtains a guarantee from his bank

(5) The importer sent the guarantee to the exporter

(6) The exporter gives documents to the forfaiter

(7) The forfaiter controls the documents and pays for them as indicated on the Forfaiting Agreement

(8) The forfaiter presents documents for payment at maturity date

(9) + (10) The importer or its bank effects payment at maturity date

Figure 6 Basic forfaiting transaction 8

Since the payment of banks is without recourse in Forfaiting transactions, unless the acceptor of a draft or drawer of the promissory note is of undoubted international credit standing, a guarantee of the buyer’s obligations will be required

by the bank or forfaiter providing the facility This can be in the form of:

 a Standby letter of credit issued on the buyer’s behalf;

 a bank guarantee;

 an ‘aval’ placed on the draft or promissory note

Forfaiting facilities are arranged in advance and a commitment letter is drawn up Once the drafts or promissory notes have been discounted for the seller and they have been paid, the forfaiter can either hold the drafts or promissory notes

8 Sandeep Singh (2010), Risk Management in Factoring and Forfaiting

until maturity and collect payment from the drawer, or it can sell the drafts or promissory notes on the ‘secondary market’ The ultimate holder will then present the drafts or promissory notes at maturity to the accepting party and collect payment

 Comparison between methods of finance

As described above, there are four main methods of finance which are Discount/negotiation, Factoring, Forfaiting and Supply chain Some similarity and difference between them will be illustrated in Figure 7

Figure 7 Comparison between methods of finance

Advance payment for seller

Credit facility Yes-a loan No-a purchase No-a purchase No-a purchase

Bank effects

payment

Seller’s bank Seller’s bank Seller’s bank

- Buyer’s bank with close 3-corner model

- Seller’s bank with open 4-corner model

Administration of

With recourse and

Without recourse Both Both

Only without recourse Both

Length of time Short-term Short-term Long-term Short-term

Methods of payment Collection,

L/C

Collection, Open account Not limited

- Open account with close 3-corner model

- BPO with open corner model

4-From this Figure, only one feature that all methods of finance have in common

is advance payment for sellers With different features, each method will provide sellers in compliance with each underling transaction and sellers’ need For example, if the seller needs a long-term finance, he can required forfaiting method

If the seller needs administration of ledger service, banks can offer factoring method Moreover, if the seller only wants advance payment with collections or L/C

in a basis way, he may require discount/negotiation method If the underling transaction involves high technology with transmission of data, banks can offer supply chain method which will help purchase process to run fast and efficient

2.4 Methods of finance for banks

 Reimbursement finance

In many cases an issuing bank will nominate another bank to reimburse a nominated bank that has honored or negotiated a presentation made under its documentary credit Such a bank is known as a ‘reimbursing bank’ Reimbursement finance is act that the reimbursing bank allows the issuing bank or the confirming bank repays it at a fixed future date while it effects payment for claiming bank earlier

This kind of instrument is used mostly in UPAS L/C It required a finance agreement between the issuing bank and the reimbursing bank before the transaction begins This agreement has a limited facility for whole financing package The process of Reimbursement finance is described as the following:

(1) Before issuing a UPAS L/C, the issuing bank contacts the reimbursing bank for acceptance of the deal The issuing bank must provide the reimbursing bank the amount of L/C, the information of underlining transaction like the beneficiary, the applicant, the goods, and the tenor of L/C

(2) After assuring about the facility, the AML of transaction, the reimbursing bank sends an acceptance with an offered interest

(3) The issuing bank agrees with the reimbursing bank’s offer and issue UPAS L/C and then sends a copy of L/C to the reimbursing bank

(4) When the documents of the beneficiary approved by the issuing bank, the issuing bank will send a reimbursement authorization to the reimbursing bank requesting payment for the claiming bank (the beneficiary’s bank) and sends an acceptance to the claiming bank authorizing the claiming bank to send a reimbursement claim to the reimbursing bank to obtain payment

(5) After receipt of the reimbursement authorization and the reimbursement claim, the reimbursing bank effects payment to the claiming bank and informs the issuing bank accordingly

(6) At maturity, the reimbursing bank will debit the account of the issuing bank or the issuing bank will effect payment to the reimbursing bank The payment includes a principal amount plus interest

This kind of finance may replace confirming service which involves a complicated process and escalation clauses in L/C since confirming is irrevocable payment undertaking of banks In this case, The reimbursing bank only acts as a third party effecting payment for the beneficiary without financing the issuing bank, which will also make the beneficiary comfortable about payment The reimbursing bank will, on behalf of the issuing bank, effects payment for the beneficiary and then debits the issuing bank’s account accordingly

 Trade loan

Originally, Trade loan is a product which enables companies to obtain current financing for trade transactions, both before and after delivery They are flexible, short-term borrowing facilities, linked to specific import or export transactions They are available for firms regardless of the method they use to trade, whether open account, collections or documentary credit basis Trade loans work as fully revolving credit facilities, which help fund a business between the time it has to pay for the purchased goods, and the time when the firm receives the funds from the sale of those goods

However, nowadays, Trade loan method is used by banks to get finance in foreign currency with the following process:

(1) The borrowing bank contacts the lending bank for a loan and provides the amount, tenor and interest

(2) The lending bank checks the loan and sends the borrowing bank requirement for a list of underlining transactions and a form of request Underlining transactions may be collection or letter of credit method

(3) The lending bank approves the list of underlining transactions provided by the borrowing bank

(4) Upon receipt of acceptance of the lending bank, the borrowing bank sends

an authenticated swift message to the lending bank requiring the loan The message must be in form requested by the lending bank

(5) The lending bank remits the proceed to the borrowing bank and informs the maturity date, interest and payment instruction

(6) The borrowing bank records the loan and pays at maturity

In trade loan transactions, the borrowing bank will use its collections or L/C(s)

as assets to get a loan Collections or L/C(s) are finance services of the borrowing bank for its customers and that seems to be the need of the borrowing bank for a loan However, after getting the loan, the issuing bank may use it for other activity rather than financing the underlining transactions

 Refinancing

A refinance occurs when a business or person revises a payment schedule for repaying debt Mechanically, the old loan is paid off and replaced with a new loan offering different terms When a company refinances, it typically extends the maturity date Companies or individuals get refinancing loans may have to pay a penalty or fee

Generally thinking, Refinancing takes place when the issuing bank is not provided with reimbursement funds from the applicant, at time of settlement The issuing bank is still obliged to pay the beneficiary, but in this case, allows the applicant to pay at a later fixed date, at an agreed interest rate This is either

recognized as a loan from the issuing bank to the applicant, or an authorized overdraft This arrangement can take place by prior arrangement between the applicant and issuing bank or initiated in the event of applicant's payment default

However, like Trade loan, some banks have used Refinancing to get source of foreign currency with the following steps:

(1) When the issuing receives at sight complying documents or when the issuing bank accepts documents, it sends copy of L/C, documents and acceptance (if any) to the refinancing bank to request refinancing In this step, the issuing bank provides the value date of payment and maturity of the loan which it would like to get

(2) After scrutinizing the file, the refinancing bank provides the issuing bank acceptance, form of official request and interest rate of the loan

(3) The issuing bank officially sends an authenticated swift message to request refinancing The request must contain the net amount (claimed amount less all charges of the issuing bank), the beneficiary bank and payment instruction, value date, maturity date, interest

(4) On value date, the refinancing bank will effect payment to the beneficiary bank and inform the issuing bank accordingly

(5) At the maturity, the issuing bank will pay the refinancing bank the principal amount plus interest

There is difference between trade loan and refinancing In trade loan transactions, there are a lot of underling transactions like collections or L/C(s) while Refinancing is for one L/C transaction and the lending bank will only effect a loan

by paying for a drawing amount under L/C However, like Trade loan, in Refinancing transactions, when the borrowing bank gets money from the applicant without using it to pay the beneficiary (the lending bank will effect the payment), the borrowing bank will use the money for other activities rather than finance the

applicant to pay under L/C

CHAPTER 3: LEGAL FRAMEWORK OF TRADE FINANCING INSTRUMENTS

Each financing activity of bank is subject to both local law and international law, which will provide guidance for banks when building up trade finance instruments Moreover, these laws can effect the development of trade finance instruments significantly The chapter will provide updated laws and analyze their affects to trade finance products

3.1 National law

3.1.1 General law

 Law No 47/2010/QH12 dated June 29, 2010 of the National Assembly

on Credit Institutions This law was effective on 01/01/2011 and regulates organization, business activity of Credit Institutions

 Decree No 59/2009/ND-CP dated July 16, 2009, of the Government on organization and operation of commercial banks This decree was effective

on 15/09/2009 and regulates business activities of commercial banks

 Ordinance No 28/2005/PL-UBTVQH11 dated December 21, 2005 of the Standing Committee of the National Assembly on foreign exchange control This ordinance was effective on 01/06/2006 and regulates foreign exchange

of organizations or individuals in Vietnam

 Some circular regulates loans for enterprises in foreign currency as following:

 Circular No 24/2015/TT-NHNN dated December 8, 2015 of the State Bank of Vietnam on foreign currency loans granted to residents by credit institutions and branches of foreign banks

 Circular No Circular 31/2016/TT-NHNN dated November 17, 2016

of State Bank of Vietnam supplementing NHNN dated December 8, 2015 of the State Bank of Vietnam on

Circular24/2015/TT-foreign currency loans granted to residents by credit institutions and branches of foreign banks

According to these Circulars, Credit Institutions are allowed to give loans in foreign currency for companies with the purpose of payment for importing materials and will get the amount of foreign currency from manufacturing or trading However, enterprises, getting loans for manufacturing to export, can only get short-term loans in foreign currency and have to sell all foreign currency to banks when they get from importers and this activity is only allowed to December 31, 2017

 Some decrees regulates loans for investment and export activities with specific portfolio as following:

 Decree No 75/2011/ND-CP dated August 30, 2011 of the Government on state investment credit and export credit

 Decree No 54/2013/ND-CP dated May 22, 2013 of the Government supplementing the Decree No 75/2011/ND-CP dated August 30, 2011

of the Government on state investment credit and export credit

 Decree No 133/2013/ND-CP dated October 17, 2013 of the Government on amending and supplementing the Decree No 54/2013/ND-CP dated May 22, 2013 and on supplementing the Government’s Decree No 75/2011/ND-CP dated August 30, 2013 on State’s investment credit and export credit

These decrees regulate conditions which exporters or investors must meet and also provide maximum time for a loan of exporters or investor These Decrees provide guidance for credit divisions when approving a loan in trade financing process

3.1.2 Specific law for each kind of trade financing instrument

 Law for L/C

State bank of Vietnam only has two decisions regulating L/C directly namely Decision No 711/2001/QD-NHNN dated May 25, 2001 of the State Bank of

Vietnam promulgating the Regulation on the opening of letter of credit for importing goods with deferred payment and Decision No 1233/2001/QD-NHNN of September 26, 2001, on the amendment of Article 15 of the regulation on opening

of deferred letter of credit for goods import issued in conjunction with the Decision

No 711/2001/QD-NHNN dated 25 May, 2001 However, these two decisions have been revoked as per Circular 25/2012/TT-NHNN dated September 06, 2012

However, there are some laws for L/C although they are not direct In accordance with these Decrees, banks can provide payment services which includes L/C:

 Decree No 101/2012/ND-CP dated November 22, 2012 of the Government non-cash payments

 Decree No 80/2016/ND-CP dated July 01, 2016 of the Government mending Government's Decree No 101/2012/ND-CP dated November 22, 2012 on non-cash payments

 Circular No 46/2014/TT-NHNN dated 31/12/2014 guiding non-cash payments This Circular replaces Decision No 226/2002/QD-NHNN dated March

26, 2002 of the State Bank of Vietnam promulgating the Regulation on activities of payment via payment service-providing organizations

The regulations only focus on allowing financial institutions like banks to operate non-cash payment service for their customers with requirement of documents which are evidence of legal activities Therefore, they prove that banks can provide trade financing services for customers

 Law for discount/negotiation

 Circular No 04/2013/TT-NHNN dated March 1, 2013 of the State Bank of Vietnam providing the discount of negotiable instruments and other valuable papers

by credit institutions and foreign bank branches for clients

 Circular No 21/2016/TT-NHNN dated June 30, 2016 of the State Bank of Vietnam on amending a number of Articles of the Circular No 04/2013/TT-NHNN