Trade finance in India 2018

Transcription

1 in India 2018

2 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign International Introduction International is the exchange of capital, goods services across borders or territories. It allows both buyers sellers to exp their markets for goods services that otherwise may not be made available to them. All countries have different assets or strengths in terms of l, labour, capital, technology natural resources. Hence, most countries usually focus on those products services in which they possess a comparative or absolute advantage through specialisation. However, such specialisation may result in excess production capacity for certain goods services also result in an opportunity cost in terms of inadequate production of other goods services. It reduces dependency on the domestic market by exping customers dem in other countries. It enhances economic growth contributes significantly to the country s gross domestic product. International presupposes the existence of a sufficient level of geopolitical peace stability to facilitate smooth between nations. 2 PwC in India 2018

3 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign International The dilemma A 1. The exporter ships the goods. Importer Importer s preference 2. The importer pays after goods are received. Importer International must work around a fundamental dilemma. Imagine an importer an exporter who would like to do business with one another. Due to the distance between the two, it is not possible to simultaneously h over goods with one h accept payment with the other. B Importer 1. The importer pays for the goods. Exporter s preference Importer 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. 2. The exporter ships the goods. 3 PwC in India 2018

4 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign International Introduction Bank as an intermediary to for import/export Importer 5. The bank gives merchise to the importer. 6. The importer pays the bank. 1. The importer obtains the bank s promise to pay on its behalf. Bank 4. The bank pays the exporter. 3. The exporter ships to the bank, trusting the bank s promise. 2. The bank promises the exporter it will pay on behalf of the importer. Exporter The fundamental dilemma of being unwilling to trust a stranger in a foreign l 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. The exporter ships the merchise to the importer s country. Title to the merchise is given to the bank on a document called an order bill of lading. The exporter asks the bank to pay for the goods, 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. 4 PwC in India 2018

5 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign International Benefits of the system Protection against risk of non-completion Once the importer 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, sight draft 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. Protection against foreign exchange risk In, 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. Financing the Most involves a time lag during which funds are tied up while the merchise is in transit. Once the risks of non-completion exchange rate changes are disposed of, banks are willing to goods in transit. A bank can 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 merchise or other physical aspects of the shipment. 5 PwC in India 2018

6 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Overview of Pre-shipment Letter of Post-shipment 6 PwC in India 2018

7 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Time events Price quote request Export contract signed Goods are shipped Documents are accepted Goods are received Settlement of the transaction Negotiation execution Documents are presented Financing period In order to underst the risks associated with, it is helpful to underst the sequence of events. The two primary risks associated with an transaction are currency risk risk of non-completion. The risk of default on the part of the importer is present as soon as the financing period begins. 7 PwC in India 2018

8 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Understing the needs of corporates Procurement of raw materials Broad stages of the business value chain during the working capital cycle Conversion of raw materials into finished goods Sale of finished goods Increased open account needs Fund-based facility Non-fund based facility Buyer /supplier Bank guarantee/ stby letters of (SBLCs) Cash /overdraft facility Foreign / inl letter of Pre-shipment in foreign currency (PCFC) Bank guarantee/ SBLC Cash /overdraft facility Foreign / inl letter of Bill discounting/ /for faiting Bank guarantee/ SBLC Insurance protection provided by the Export Credit Guarantee Corporation of India Limited Cash /overdraft facility Foreign/ inl letter of plays two pivotal roles providing working capital tied to in support of providing means of reducing payment risk. Global trends in Increased use in the Asia-Pacific region Increased proportion of US dollar funding Intense competition among banks 8 PwC in India 2018

9 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Clean payments What is a clean payment? Clean payments are characterised by trust. Either the exporter sends the goods 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, all shipping documents, including title documents, are hled directly by the trading parties. The role of banks is limited to clearing funds as required. Basic facts mechanics pertaining to clean payments There are two types of clean payments: Open account payment in advance. The payment in advance 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 documents directly to the importer 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 waits for the exporter to send the goods documents. Risk analysis under clean payment 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 receives the payment in advance Disadvantageous to the importer since it assumes all the risks incurs the opportunity cost of outflow of cash resources before receiving the goods 9 PwC in India 2018

10 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Clean payments What is documentary collection? A method of payment used in whereby the exporter entrusts the hling of commercial often financial documents to banks 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 Practice for Documentary Credits (UCP) 600 International Stby Practices (ISP) 98. Basic facts of documentary collection 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. 10 PwC in India 2018

11 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Documentary collection Mechanics pertaining to documentary collection Flow of goods After the importer the exporter have established a contract agree on documentary collection as the method of payment, the exporter ships the goods. In documentary collection, the importer is known as the drawee the exporter, as the drawer. Flow of documents After the goods are shipped, documents originating with the exporter (e.g. commercial invoice) 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 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 releases the documents to the importer against payment or acceptance, according to the remitting bank s collection instructions. 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. Legend: Flow of goods, documents payment Exporter/drawer 1 Remitting bank Flow of goods Flow of documents Flow of payment Importer/drawee Presenting/ collecting bank 11 PwC in India 2018

12 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Documentary collection Risk analysis under documentary collection 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 Disadvantages to exporter: Risk of refusal of payment Commercial risk country risk remain Advantages to importer: Ability to examine documents before authorising payment Unlike a letter of, a line of is not required, 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 May provide formal/legal means to collect unpaid obligation Disadvantages to exporter: Risk of non-acceptance of documents Commercial risk 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 timeconsuming Advantages to importer: Will receive goods before having to make payment Disadvantages to importer: Dishonouring an accepted draft is a legal liability may ruin business reputation 12 PwC in India 2018

13 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Letters of What is a letter of? Basic facts mechanics pertaining to letters of A letter of 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 against stipulated documents. A key principle underlying letters of is that banks deal only in documents not in goods. The decision to pay under a letter of will be based entirely on whether the documents presented to the bank appear, at face value, to be in accordance with the terms conditions of the letter of. It would be prohibitive for banks to physically check whether all merchise has been shipped exactly as per each letter of. The ICC publishes ly agreed-upon rules, definitions practices governing letters of, which are called UCP referred to as UCP 600. Letters of are either revocable or irrevocable: A revocable letter of 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 are very rarely used. An irrevocable letter of cannot be cancelled or amended without the consent of all parties, including the exporter. Unless otherwise stipulated, all letters of are irrevocable. Letters of 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. 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. 13 PwC in India 2018

14 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Letters of Mechanics pertaining to documentary collection 14 PwC Issuance After the trading parties agree on a sale of goods where payment is made by a letter of, the importer requests that its bank (the issuing bank) issue a letter of in favour of the exporter (beneficiary). The issuing bank then sends the letter of 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 may be the exporter s bank, although it does not have to be. Next, the advising/confirming bank verifies the letter of for authenticity sends it to the exporter. Exporter/ beneficiary 1 Contract negotiation Importer/ applicant 4 Advice/ confirmation of the letter of Importer applies for letter of 2 Advising/ confirming bank 3 Request to advise possibly confirm the letter of Issuing bank Flow of goods Upon receipt of the letter of, the exporter reviews the letter of to ensure that it corresponds to the terms conditions in the purchase sales agreement; that the documents stipulated in the letter of can be produced; that the terms conditions of the letter of can be fulfilled. Assuming the exporter is in agreement with the above, it arranges for shipment of the goods. Flow of documents payment After the goods are shipped, the exporter presents the documents specified in the letter of to the advising/confirming bank. Once the documents are checked found to comply with the letter of (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. 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. Exporter/beneficiary Exporter/ 2 Advising/ drawer confirming bank Goods Importer/drawee Issuing bank 7 Legend: Flow of goods documents payment Importer/applicant Flow of goods Flow of documents Flow of payment in India 2018

15 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Letters of Risk analysis for letters of Importer Advantages: The importer is assured that, for the exporter to be paid, all terms conditions of the letter of must be met. Ability to negotiate more favourable terms with the exporter when payment by letter of is offered. Disadvantages: A letter of ensures correct documents but not necessarily correct goods. Ties up the line of. Exporter Advantages: An undertaking from the issuing bank that the exporter will receive payment under the letter of provided that it meets all the terms conditions of the letter. Shifts risk from the importer to the issuing bank. Not obligated to ship against a letter of that is not issued as agreed. Disadvantages: Documents must be prepared in strict compliance with the requirements stipulated in the letter of. Non-compliance leaves the exporter exposed to risk of non-payment. 15 PwC in India 2018

16 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment in Comparison of payment in 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 When shipment is made After payment Very little or none, depending on terms Sight draft; documents against payment Time draft; documents against acceptance Consignment Open account On presentation of draft to buyer After payment If draft unpaid, must dispose of goods On maturity of drafts Before payment Relies on buyer to pay drafts At the time of resale by importer After shipment (as agreed) Before payment Before payment Allows importer to sell inventory before paying exporter Relies completely on buyer to pay as agreed Assured shipment made, but relies on the exporter to ship goods described in documents Same as above (unless importer can inspect goods before payment) Same as above None, improves cash flow of buyer None Least risk to exporter Highest risk to exporter Highest risk to importer Least risk to importer 16 PwC in India 2018

17 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Guarantees What is a guarantee? Types of 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 dem as outlined in the guarantee. While there are stard guarantee formats, they can be tailored to meet specific contractual needs. Often, stby letters of are used instead of guarantees. Stby letters of 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 stby letters of differ from guarantees: Stby letters of 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 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. 17 PwC in India 2018

18 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Guarantees Mechanics of 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 within a stated time frame. In the event of default by the exporter, the importer would dem payment against the guarantee through the advising bank. Exporter/ applicant 1 Contract negotiation 2 Applies for a guarantee 3 The guarantee is sent to a corresponden t bank of the issuing bank for advice to the importer. Issuing bank A correspondent bank is a foreign bank with which the issuing bank has established a relationship where secure may be processed. Importer/ beneficiary Advice of the guarantee 4 Advising bank 18 PwC in India 2018

19 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in Guarantees/SBLCs Potential risks/ challenges to consider For issuing bank Compliance checks on the parties understing the underlying purpose of the stby. Obtaining satisfactory documentation reimbursement agreement from the obligor. Evaluating risk. Clear documentary conditions need to be mentioned to minimise the risk of conditions being misinterpreted by the beneficiary 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 dem certification, e.g. copy of unpaid invoices or transport documents or certification issued by an independent arbitrator or copy of court judgement. Effectiveness of stby is against clearly defined conditions, e.g. effectiveness of advance payment stby after receipt of the advance payment. For beneficiary Evaluation of cross-border risk on the issuing bank. Understing the risk of automatic reduction or automatic termination against documents which the applicant can present directly to the issuing bank. Understing documents /or conditions that are required in order to draw, avoiding documents which are issued /or signed by the applicant. 19 PwC in India 2018

20 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Payment instruments in What is buyer s? Basic facts mechanics pertaining to buyer s is short-term given to an importer (buyer) from overseas lenders such as banks other financial institutions for goods it is importing. Overseas banks usually lend 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 consultant charges a fee called an arrangement fee. 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) Credit, 2014, which specifies norms for amount, maturity 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 use the buyer s route to avail financing. The funding can be in any currency, depending on the terms of 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 namely, open account, collections or letters of. involves cost such as interest (LIBOR plus bank spread), letter of issuing fees, hedging cost withholding tax. 20 PwC in India 2018

21 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign The mechanics of buyer s are depicted below: 1 An importer imports goods using either a letter of, collections or an open account. 6 On the due date, the importer either requests for the rollover of the buyer s or recovers the funds from the importer retires the liability of the importer towards the bank against the letter of undertaking. 2 An importer approaches the issuing bank or arranges for a buyer s quote. 5 The issuing bank makes the payment to the exporter thus settles the liability of the importer towards the exporter. 4 The funding bank, on receipt of the letter of undertaking, s the NOSTRO account of the issuing bank with the funds. 3 The issuing bank arranges for a an offer letter at the best possible rates from the funding bank. 21 PwC in India 2018

22 in India 2018 Timeline structure of Making ly Pre- postshipment in foreign currency (PCFC) Payment instruments in PCFC What is pre-shipment? Basic facts mechanics pertaining to pre-shipment Pre-shipment means any loan or advance granted or any other 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 opened in his favour or in favour of some other person, by an overseas buyer or a confirmed 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 with the bank has been waived. The applicant needs to arrange a fund-based line of from an authorised dealer/bank. To make the available to exporters at ly 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 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 under the respective category. 22 PwC in India 2018

23 in India 2018 Timeline structure of Making ly Pre- postshipment in foreign currency (PCFC) PCFC What is post-shipment? Post-shipment means any loan or advance granted or any other provided by a bank to an exporter of goods/services from India from the date of extending 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), 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. Basic facts mechanics pertaining to buyer s 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 is available for a maximum period of 365 days, depending upon the underlying bill bank s policy. 23 PwC in India 2018

24 in India 2018 Timeline structure of Making ly Pre- postshipment in foreign currency (PCFC) RBI guideline for the pricing of PCFC 1 Pre-shipment (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 (from the date of advance) (a) On-dem 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 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 go beyond the tenors prescribed above are deregulated. Banks are free to decide the rate of interest, keeping in view the BPLR spread guidelines. 24 PwC in India 2018

25 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign What is forfaiting? In normal course of business, the exporter is unable to clock the collection reinvest in producing additional goods even after shipment to the importer due to long periods or the aging of invoices. This negatively impacts the exporter s cash flow. Factoring forfaiting are two similar routes to accounts receivables of an exporter. They differ on the basis of the type of underlying consideration the 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 period invoiced goods, whereas forfaiting is a term used for financing long-term periods ranging between six months seven years for underlying securities being capital goods, commodities high-value merchise. Basic facts mechanics pertaining to forfaiting 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 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 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 from the importer s bank. 25 PwC in India 2018

26 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Differences Factoring Extent of (invoice value) 75 80% 100% Credit worthiness Bank does the rating in case of non-recourse. The forfaiting bank relies on the ability 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 Credit extension Invoice sale Cash advances Receivable collection Remit collected funds Financial reporting The bank provides protection after doing a check of the importer/receiving a letter of. The exporter hs over invoices to the bank; the assignment is created at this stage. The bank s the exporter s bank account as per the terms agreed on before receiving payment from the importer. The bank collects payment from the exporter (if the arranging bank is not a collection agent) follows up on overdue invoices. The bank repays previous advances remits the balance to the client (if the bank is a collection agent). The bank provides transaction reports statements to the client. 26 PwC in India 2018

27 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 1. Outsourcing of preparation of documents by a large multinational to its bank 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. 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 outsting (DSO) decided to outsource this non-core activity to its bank. The bank had specialist teams responsible for originating checking all such documents, today the bank prepares the full set of documents for the company. The solution was implemented in a short time frame 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 advisors also reviewed the company s processes, leading to further operational savings reduced staff costs. Thus, this move had both cost revenue benefits. The company started by outsourcing documents prepared by at least one of its divisions to the bank. It is now considering opportunities to further exp this service. 2. Use of letters of 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 to all points in between. Typically, UK-based commodity rs will act as middlemen, sourcing goods from one country or region selling them in another, adding value by providing logistics 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), 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 in favour of the seller prior to the shipment of the goods. Payment under the letter of 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, 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 ; the buyer can refuse payment if the documents presented do not conform to the requirements of the letter of. For example, the certificate of quality indicates that the goods are not of the correct specification. 27 PwC in India 2018

28 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 2. Use of letters of 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 to all points in between. Typically, UK-based commodity rs will act as middlemen, sourcing goods from one country or region selling them in another, adding value by providing logistics 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), 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 in favour of the seller prior to the shipment of the goods. Payment under the letter of 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, 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 ; the buyer can refuse payment if the documents presented do not conform to the requirements of the letter of. 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 is a bank-to-bank instrument, 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 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 ability to do more business. By adding its confirmation to the letter of, 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 country risk factors for the seller. If the letter of 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. 28 PwC in India 2018

29 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 3. Letters of 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, which was to be calculated from the date of the invoice. The value of the order was 1,00,000 USD the goods were dispatched invoiced by the Irish exporter on 15 April The payment from Asia was due on 14 June 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 too expensive? The Irish exporter could have insisted on receiving a confirmed letter of through Allied Irish Banks. The following costs would have applied at that time: Particulars Confirmation fee Acceptance commission (@ 1.5% pa for 60 days) Negotiation/payment fee Out of pocket expenses (estimate) Total letter of cost Interest cost as a result of late payment Benefit of using letter of Amount 250 USD 250 USD 150 USD 60 USD 710 USD 1,700 USD 990 USD What benefit would the confirmed letter of have provided to the exporter? A guarantee of payment on the due date from Allied Irish Banks (provided the terms conditions of the letter of 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, although they appear to be expensive, do provide real 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. The letter of seems expensive because the costs are very visible linked to each transaction. The benefits, on the other h, are intangible. 29 PwC in India 2018

30 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 4. Securitisation of receivables Large companies that generate a sufficient volume of receivables may be able to raise 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. study An chemicals distribution group wanted to open a 250 million EUR funding facility by securitising receivables denominated in euros dollars. The receivables were originated by the group s operating subsidiaries in the US a number of European countries. The group s bank two other banks arranged for the establishment of a special purpose vehicle (SPV) in Irel. 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 the US). The structure is operated without recourse to the company, which receives funds at the cost of the CP issuance, plus a -related margin on any drawn funds. This facility has freed cash for the distribution company allowed it to re some acquisition financing. 30 PwC in India 2018

31 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 5. Implementation of a cash solution by the division of a major retail company The regional division of a major retail company wanted to improve the efficiency of its cash management structure, improve its working capital (via an extension to its days payable outsting [DPO]) strengthen its supply chain to reduce the risk of disruption. The solution involved the division centralising its treasury operations establishing a true end-to-end payables solution, including a supply chain (SCF) programme. As part of this process, the company was able to automate a number of its cash 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 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 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 minimises the touchpoints between the bank 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 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 the reduction in the number of bank relationships have given the regional treasury much greater visibility control over the group s regional operations. 31 PwC in India 2018

32 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 6. Boosting sales with a customer financing programme To protect 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 to 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 risk of each of its customers worldwide, especially that of smaller, thinly capitalised companies that did not meet minimum bank lending stards. 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, 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 stard terms of days from invoice/onboard bill of lading date. The bank takes ownership of the receivables at this time s the buyers for the difference between the original extended tenors. Both parties benefit from this arrangement. 32 PwC in India 2018

33 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign 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 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 stards, but it does move the receivables off the balance sheet 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 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 exped to Europe 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 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. 33 PwC in India 2018

34 in India 2018 Timeline structure of Making ly Pre- post-shipment in foreign Contact us Vivek Iyer Partner Financial Services Risk Assurance Services Mobile: Vernon Dcosta Director Financial Services Risk Assurance Services Mobile: Ramkumar Subramanian Associate Director Financial Services Risk Assurance Services Mobile: Rajeev Khare Manager Financial Services Risk Assurance Services Mobile: Dhruv Khelwal Manager Financial Services Risk Assurance Services Mobile: PwC in India 2018

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