A Comprehensive Guide to Structured Trade Finance

Posted by Liamh Smith on December 16th, 2020

Structured Trade Finance is  an alternative to conventional lending. It is common practice among  countries engaging in cross border transactions. 

It essentially empowers producers, processors and traders. Structured Trade Finance has 3 major components:

1.Working Capital Finance

2.Warehouse Finance

3.Pre-export Finance 

Why is Structured Trade Finance so important?

It adds strength to the trade. It is used when trade is between countries and has to go through different jurisdictions. It plays a decisive role in managing the payment time, procurement strategy and diversifying funding.

Structured Trade Finance provides a solid infrastructure to trade. It evaluates both parties, specifically the borrower’s strength and the lender’s credibility. It serves as an authorized transaction platform. 

The primary objective is to boost international trade. The other reason is that the strength of a borrower is not evaluated as it would be for a normal loan. 

The transaction does not reflect the balance sheet. It helps importers to be on good terms with exporters. Despite having many advantages, there are other aspects to consider:

A third-party, usually a bank, will facilitate  the transaction between the buyer and the seller.  ('Escrow’ )

Businesses must have the facilities to stay relevant and compete with foreign players. There must be reasonable and business-friendly sales terms. Trust is vital. It gives traders confidence and is an essential part of effective trade. 

Structured Trade Finance involves important financing methods to make cross-border trade more secure and business-friendly. 

Escrow services are most commonly used by exporters, importers and traders to address core trade issues. The preliminary goal of Escrow services is to provide a solution that works for all. Cross-border trade will flourish in a stable environment and a robust and secure infrastructure.

Escrow mitigates the risk involved in trading. It provides appropriate payment processes. Escrow services ensure payments are made and goods are delivered. It verifies the transaction and authorizes the trade. 

International trade is fraught with risks;  mainly payments.  Structured Trade Finance, allied with Escrow services accelerate the trade process in two ways:

1.Importers receive goods as agreed

2.Exporters receive payment as agreed

Each party will have their own concerns. Structured Trade Finance is a mutually beneficial method that works for both. 

It involves:

Cash in advance

This is the safest way to eliminate credit risk. A seller receives payment before delivery. In international trade, online transfer and credit card payments are the most common means of transaction. Technology has boosted it even further. It is particularly popular in escrow services.

Needless to say, this is the most attractive option for sellers. Goods are not released unless payment is being made. For sellers who insist on these payment terms are open to losing buyers to competitors who may offer more attractive payment terms. 

Pros:

Payment in advance

Rules out the risk of non-payment

Secure transfer of money 

Cons:

Risk of losing customers due to onerous payment terms

Letters of credit

Letters of credit are an affirmation by the bank on behalf of a buyer. They guarantee timely payment to a seller, when the goods are delivered. ILC’s  build trust and makes the transaction more secure. 

LCs are issued based on the importer’s credit. An importer must pay the bank a fee to obtain an LC.  It gives the creditworthiness to the buyer. 

It gives an importer a great deal of security as everything is documented and evidenced. It brings transparency in trade. Both  parties have  assurance of payment and receipt of goods. 

Pros:

Payment is made when the goods are shipped

Mitigates risks and ensures payment

Cons:

Can be a time-consuming process

Can be more expensive than other payment methods

Documentary collections

A Documentary Collection (‘DC’ ) is a transaction between the importer’s and exporter’s bank. The exporter’s bank sends documents to the importer’s bank containing the payment terms. 

Funds are transferred to the exporter’s account through the exchange of documents known as a draft. It is precise, with clear payment and goods details.

Pros:

The Bank ensures payment is on time

It is a simple and straightforward process

Cons:

Payment is not guaranteed

Documents must be valid

Open account

This is a transaction in which goods are shipped and delivered before the payment is made. The time frame is typically from 30 to 90 days. It is the most preferred option for an importer. However, an exporter may have issues and less confidence in the trade. 

The Open Account transaction method has boosted international trade and created healthy competition. 

Pros:

Creates healthy competition in the market

Builds a long term trade relationship

Cons:

Greater risk of non-payment

Expensive and may involve additional costs managing associated risk

Consignment

This is similar to the open account method. It favours importers. It is a contractual agreement where payment is not received until a foreign distributor sells goods to an importer.

It can be a risky option for exporters. It is a concern where goods are received, managed and sold by a third-party distributor, without payment being guaranteed. 

Pros:

Enhances competitiveness 

Faster delivery

Eliminates the cost of storage and inventory

Cons:

Payments are not insured

Costs associated with managing risk

There is no perfect system of international transactions. Risk must be minimised. However, Escrow agreements are not always flawless and can have loopholes. 

Exporters must choose the best Structured Trade Finance method for their requirements.