THE MECHANICS OF

INTERNATIONAL TRADE

FINANCE

MODULE 1

Trade Finance Overview

Graham Bull

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CONTENTS

Structure of This Course ................................................................................................................ 3

1. WHAT IS TRADE FINANCE? ............................................................................................... 5

2. UNDERSTANDING THE TERMS OF TRADE .......................................................................... 8

3. THE USE OF INCOTERMS ................................................................................................... 9

3.1 Free Alongside Ship (FAS) ............................................................................................ 9

3.2 Free on Board (FOB) .................................................................................................... 9

3.3 Cost and Freight (CFR)............................................................................................... 10

3.4 Cost, Insurance and Freight (CIF) ............................................................................... 11

3.5 CIF Liner Terms ........................................................................................................ 12

4. TYPES OF COMMERCIAL DOCUMENTATION ..................................................................... 13

4.1 Bill of Lading ............................................................................................................. 13

4.2 A Charterparty Bill of Lading ....................................................................................... 15

4.3 Air Waybill ................................................................................................................ 15

4.4 Road Consignment Note or Truck Receipt ..................................................................... 15

4.5 Bills of Exchange, Waybills and Control Over Goods ....................................................... 16

4.6 Commercial Documents ............................................................................................. 16

4.6.1 Pro-forma Invoice .......................................................................................... 16

4.6.2 Commercial Invoice ........................................................................................ 16

4.6.3 Certified Invoice ............................................................................................. 17

4.7 Consular Invoice ....................................................................................................... 17

4.8 Other Commercial Documents..................................................................................... 17

4.9 Insurance Document ................................................................................................. 17

4.10 Documents Required by Government Departments or Agencies ....................................... 18

5. TYPES OF FINANCIAL DOCUMENTATION ......................................................................... 20

5.1 Bill of Exchange ........................................................................................................ 20

5.2 Promissory Note ........................................................................................................ 21

5.3 Bill of Exchange (Example) ......................................................................................... 21

6. SUMMARY AND CONCLUSIONS ........................................................................................ 22

6.1 The Next Module ....................................................................................................... 22

6.2 What Now? ............................................................................................................... 22

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STRUCTURE OF THIS COURSE

The intention of this programme is to adopt a “building block” approach.

Module 1

In this module, starting at the lowest level, we will consider the composition of international trade

contracts and the documentary evidence that might be generated. Through an understanding of the

terms of trade, we will assess the possibility of the bank taking title and control over the goods

themselves.

Module 2

In Module 2 we move on to consider activity in geographical areas where the buyer and their country are

considered to be economically strong. The use of the open account and documentary collection systems

will be investigated, together with the financing opportunities that might arise.

Module 3

Many exporters might be unwilling to take buyer and country risk, and would look to mitigate their risk

where possible. Module 3 covers the use of the documentary credit for this purpose, and here we will

assess the credit risk associated with the bank providing support to an importer.

Module 4

Module 4 moves on to consider more complex documentary credit structures, particularly associated with

the role of a middleman or trader. Risk factors and facility composition around the back-to-back and

transferable products will be assessed in detail.

Module 5

Module 2 will have shown us that open account and documentary collection systems do not guarantee

that the buyer and their country can and will pay. Module 5 will investigate the roles of the credit

insurance and factoring companies in mitigating these risks, thus facilitating a structured lending

approach.

Module 6

Exporters are often required to support their contracts with bank guarantees or standby letters of credit.

Risk assessment in providing bid, performance and advance payment guarantees is addressed in Module

6, together with consideration of ancillary financial support mechanisms.

Module 7

Module 7 takes us beyond the concepts covered in previous modules, by looking at the highly specialised

world of commodity finance. Particular emphasis is placed on using the underlying goods as a form of

security, and warehousing financing techniques are considered in some detail.

Module 8

Pre-export financing is in high demand in the current market, and involves many of the concepts covered

in previous modules. Module 8 brings this all together, and considers individual transactional finance (red

and green clause credits) together with “big picture” country-based deals.

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Module 9

Barter was one of the earliest forms of trade activity, and is now bracketed with more modern (and

complex) structures under the general heading of countertrade. The final module, Module 9, considers

potential solutions to challenging problems, often utilising a combination of the features discussed in

previous modules.

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1. WHAT IS TRADE FINANCE?

For hundreds of years, exporting has been seen as a key element for the generation of hard currency,

and for every exporter you must have an importer in another country, each or both of which might need

financial support. In the early days of international trade, the transportation of goods could be a lengthy

(and dangerous) process, and transactions were mostly settled in cash prior to the release of the cargo.

Slowly, systems were developed to facilitate trade, and we still use one of those early products, namely

the documentary letter of credit (described in Module 3).

Over the years, a wide variety of processes were developed, mostly reliant upon the use of the postal

system, and although fairly useful they could be very time consuming and sometimes inefficient. The

advent of electronic capabilities has streamlined most processes, and it is now possible to communicate

rapidly in an authenticated manner, thus giving certainty to the flows of information, documentation and

payment.

The various trade products currently in use are described in this distance learning programme – their

popularity and usage are often heavily influenced by worldwide economic situations. In times of relative

peace and stability, exporters might be inclined to trade in a fairly unstructured manner, believing that

their buyers have the ability to pay, and not being unduly concerned about the buyer’s country risk (open

account and documentary collections). During phases of worldwide instability and unrest, an exporter is

more likely to be cautious and would then elect to use stronger products which help the mitigation of

payment risk (e.g. documentary credits).

With the benefit of hindsight, it is possible to see the ebb and flow of trade product usage, mostly

influenced by world market conditions.

Within the banking community, the phrase “trade finance” can have a variety of meanings. For many, it

is used to describe all elements of trade related business, whether it be domestic or international, and

sometimes is used to cover both the operational and credit related aspects.

However, nearly every bank around the world has the ability to process the products that will be

described in later modules, some can do so more professionally than others, and some can handle

greater volumes of business. For the sake of clarity, I would prefer to call this purely the delivery of

trade services, an operational activity.

For many people, a good trade finance bank must have the ability to deliver a quality trade service, but

must also have the desire to understand a customer’s needs and aspirations, with a view to formulating

appropriate financial solutions. To achieve this, it would be necessary to understand the following:

How are the goods bought and sold?

What type of goods?

Where do they come from? Where are they going to?

Who is the supplier? Who is the end buyer?

How are the goods transported?

Where are the goods kept?

Can the bank obtain and retain title and control?

Can the bank obtain control over the cash flow?

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The main aim would be firstly to understand the customer’s trade cycle, and then consider the financial

support that might be necessary.

In essence, trade finance can be described as the provision of bank credit facilities to meet a company’s

borrowing needs in relation to their international trade activities. The traditional analysis of the balance

sheet would give us a view on the company’s financial status, but would generate very little information

regarding their trading activity, and thus make it difficult to formulate meaningful facilities.

Trade finance techniques can be used to bridge the funding gap between any credit provided in terms

of trade (negotiated by the exporter and importer) and the need to fund stock and debtors. Historically,

within many banks, this funding gap has been financed by overdraft facilities. Furthermore, it is fully

acknowledged that in many instances traditional “domestic” working capital finance continues to offer a

perfectly adequate solution to customers involved in international trade. However, a major advantage of

trade finance products and techniques is the additional comfort which a bank can gain through

transactional control.

In the trade finance environment, it is possible to break trade related business into its constituent parts

and thereby gain a better view of potential areas of risk. Structured loans can be used in place of

overdrafts, which whilst very flexible are also open-ended from a risk perspective. Trade finance

structured loans typically have rolling limits and maturity dates set to coincide with the borrower’s cash

flow generated by the sale of goods.

Trade finance structures, therefore, offer a bank considerable advantages:

Use of trade finance instruments (for example, documentary collections, documentary credits as

described in later modules) enables the bank to exercise transactional control and mitigate risks.

Credit facilities are more closely matched to the customer’s transactional requirements and trade

cycle. Unlike conventional overdrafts, moneys borrowed cannot be easily diverted into supporting

general working capital or indeed financing losses.

Repayment is more closely linked to the sale of underlying goods. Any delay in repayment gives an

early warning of liquidity problems.

Structured facilities increase the quality of account information for the bank which, therefore,

improves their ability to monitor risk.

In certain circumstances, the bank will have a prior security interest in the goods financed, enabling

the bank to sell the underlying goods.

The increased levels of comfort which the bank can acquire through trade finance techniques has a

positive effect on their willingness to make credit facilities available to their customers involved in

international trade. Thus, the use of trade finance products by a bank offers a number of advantages for

their customers:

The bank may be prepared to make trade finance facilities available even if the customer’s normal

credit facilities are fully extended or the customer’s balance sheet does not support the level of limits

requested.

Specific facilities for individual transactions enable the customer to evaluate the profitability of

individual transactions, including financial costs.

For the customer with a strong credit standing and balance sheet, the bank may be prepared to offer

a lower margin than on a conventional overdraft in recognition of the superior transactional control

and improved risk profile.

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Basic Trade Cycle

1. Exporter and importer sign a contract.

2. Exporter ships goods to importer.

3. Exporter raises documentary evidence and remits via the banking system (or directly to importer if

open account trade).

4. Importer makes payment on due date via the banking system (or directly to exporter if open

account trade).

Exporter Contract (1) Importer

Goods (2)

Documents (3) Funds (4)

Exporter’s bank Documents (3) Importer’s bank

Funds (4)

Documents (3) Funds (4)

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2. UNDERSTANDING THE TERMS OF TRADE

The method of payment is generally agreed by the exporter and the importer at the time the sales

contract is negotiated. Importers and exporters have naturally opposing views of risk in international

trade. A payment structure which is totally satisfactory for an importer invariably involves a high

element of risk for the exporter and vice versa. It is possible to consider this situation as a risk ladder

on which the risks for the importer gradually increase as you go higher, whilst the corresponding risk for

the exporter gradually decreases.

Risk Ladder

The method of payment used will usually depend on:

The negotiations between the exporter and importer before the sales contract is signed. An importer

who is very keen to obtain goods from a particular source (perhaps due to quality or price) may have

little choice other than to accept the exporter’s request for a certain type of payment method.

The commercial practice in the countries involved. For example, open account trading is normal

practice for trade within the EU and North America. On the other hand, for trade between the EU and

Asian countries, documentary credits are widely used.

When negotiating the method of payment, the exporter/importer should bear in mind that their decision

on this matter will affect not only the risk of payment/non-payment but also the alternative trade

financing structures available. The principal trade financing instruments and techniques are described in

detail in later modules.

High risk

Exporter

Low risk

Low risk

Importer

High risk

Open account

Documents against

acceptance

Unconfirmed

documentary credit

Confirmed documentary

credit

Cash in advance

Documents against

payment

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3. THE USE OF INCOTERMS

Who pays what, and who is responsible for arranging transport, must be agreed when an export contract

of sale is signed. There are various ways in which responsibilities and costs can be shared, and these are

described by certain shipping terms, for which internationally-accepted abbreviations have been

designated by the International Chamber of Commerce (ICC). These are known as INCOTERMS, the

most recent update being 2010.

There are several shipping terms in use and you will be expected to know some of them. The most

common ones are explained here.

3.1 Free Alongside Ship (FAS)

The seller must arrange to:

• deliver the goods alongside the ship at the port of loading named in the contract; and

• pay all the charges up to delivery of the goods alongside ship, including freight and insurance charges

to that point.

The buyer is responsible for:

• choosing the carrier to transport the goods abroad and paying the cost of freight from the port of

shipment, including the cost of loading the goods on board ship, if loading costs are separate from

freight charges;

• arranging insurance and paying insurance from this point; and

• arranging and paying for any export licence or export taxes.

The point of delivery of the goods from the seller to the buyer is alongside the ship.

For example, “FAS Southampton” for the export of some goods by a UK firm to an overseas buyer would

mean that the exporter must:

• deliver the goods free alongside ship at Southampton; and

• pay all the costs, including freight and insurance, to bring the goods alongside the ship at

Southampton.

The overseas buyer must nominate the carrier(s) to take the goods from Southampton to their

destination and:

• pay freight from Southampton;

• pay export charges (if any);

• pay for loading the goods on board ship (if separate from freight charges); and

• pay for insurance of the goods from their time/point of delivery at Southampton.

3.2 Free on Board (FOB)

FOB means that the buyer does not have to pay for transporting or insuring the goods from the place

where they are originally dispatched up to the point when they are taken on board ship. The costs up to

this point are borne by the seller/exporter. The place of delivery is the ship’s rail.

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The seller/exporter must:

pay for transportation to the named port of shipment (e.g. “FOB Adelaide” would mean that an

Australian supplier would be responsible for sending goods for shipment on board at Adelaide, and to

pay costs up to that point). The costs borne by the seller include freight and insurance charges to

that point;

provide and pay for the export licence (if applicable);

pay export taxes (if any);

deliver the goods on board the ship or airline flight etc that the buyer has specified;

pay for the cost of loading the goods on board ship, if loading costs are separate from freight charges;

provide a “clean on board” receipt. Clean on board means that the shipper acknowledges that the

goods have been taken on board in good condition, i.e. with no damage; and

notify the buyer without delay that the goods have been loaded on board.

The buyer must:

nominate the carrier to transport the goods. For example, if the shipping terms for an export

consignment from the Netherlands are FOB Rotterdam, it is the buyer who specifies the ship;

give the seller the details of the ship and sailing time, or the airline, flight number and flight date etc;

pay for carriage from this point (i.e. freight from that point, including costs of unloading at the place

of destination); and

arrange and pay for insurance of the goods from this point.

The shipping term FOA might be used for free on board at a named airport, e.g. FOA Schiphol Airport

would mean free on board an aircraft at Schiphol Airport.

3.3 Cost and Freight (CFR)

With cost and freight, the supplier/seller must nominate the carrier to ship the goods abroad, arrange the

contract of carriage, pay freight charges and, in these respects, CFR differs from FOB.

The seller must:

nominate the carrier and so make the contract of carriage (e.g. book space on an aircraft);

pay for transportation of the goods to the place of shipment and insure the goods up to this point;

provide and pay for the export licence (if applicable);

pay export taxes (if any);

deliver the goods on board;

pay for the cost of loading the goods, if the loading charge is separate from the freight charge;

provide the buyer with a clean on board bill of lading;

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pay the cost of freight charges to the named port of destination. For example, “CFR Rotterdam”

would mean that the UK exporter must pay freight charges for delivery to the port of Rotterdam; and

send to the buyer advice of the carrier (shipping company or airline etc), the shipment date and, in

the case of shipments by air, the flight number.

Although the supplier pays the freight charges to the port of destination, the place of delivery of the

goods is the ship’s rail when the goods are taken on board. When they are on board, they are the

responsibility of the buyer.

With CFR, the supplier is paying freight charges for goods that have already been delivered to the buyer.

The buyer must:

pay for the insurance of the goods from the time they are taken on board. The risk of loss or damage

to the goods is borne entirely by the buyer;

pay for unloading costs at the port of destination, if these costs are separate from the freight charges

(unless the shipping terms are “CFR landed”, in which case the seller pays for the unloading costs as

well as freight);

pay for any import licence required;

accept delivery of the goods, when the appropriate documents have been presented to him (e.g. bill of

lading, invoice etc). This obligation is important because the supplier does not want the buyer to

refuse the goods after they have been shipped to the buyer’s country, the seller already having paid

freight charges to get them there; and

arrange and pay for transportation and insurance from the port of destination to their final destination

in the buyer’s country.

3.4 Cost, Insurance and Freight (CIF)

Cost, insurance and freight is similar to CFR, with the exception that it is the seller, not the buyer, who

must arrange and pay for the insurance of the goods to the port of destination.

(Note: remember that CIF means “cost, insurance and freight”. As mentioned earlier, some students

think wrongly that the “C” stands for carriage.)

The obligations of the seller are, therefore, the same as for CFR, except that additionally the seller must:

arrange for insurance of the goods from the port of shipment to the port of destination. The amount

of insurance cover must usually be the CIF value of the goods plus 10%;

pay the insurance premium; and

provide the buyer with the insurance policy or certificate.

With CIF, the place of delivery by the seller is still the ship’s rail when the goods are taken on board so

that the insurance taken out by the seller will be in favour of the buyer in the event of loss or damage etc

to the goods during shipment.

The buyer’s obligations are the same as for CFR, with the exception that he does not have to pay for the

insurance of the goods between the port of shipment and the port of destination.

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The terms of shipment might, therefore, be “CIF Hong Kong” meaning that the exporter undertakes to

pay for the freight charges and insurance of the goods to the port of destination, which is Hong Kong.

If terms for an import of goods from Taiwan are “CIF Dutch port”, this means that the exporter in Taiwan

can deliver the goods to any Dutch port. The Dutch importer would obviously be well advised to have the

port of delivery specified to avoid unnecessary transport costs in the Netherlands.

Similarly, “CIF Dutch airport” would mean that an overseas supplier can send the goods to any airport in

the Netherlands with CIF terms applied. The supplier would then send advice of the airline, flight number

and flight date to the Dutch importer or the Dutch importer’s agent.

It may be useful to be aware that the terms FAS, FOB, CFR and CIF are mainly concerned with who

arranges and pays for:

• freight for the transport of the goods from a port of loading in the exporter’s country to the port of

destination in the buyer’s country;

• insurance for this part of the journey; and

• other costs, such as export licences or export taxes etc.

3.5 CIF Liner Terms

“CIF liner terms” refer to the shipment of goods aboard a liner, i.e. a scheduled regular sailing rather

than a ship specially appointed to make the particular shipment.

Since the ship will be on a scheduled sailing, it might have several ports of call and so goods might not

be shipped directly from the port of shipment to the port of destination, but instead be taken to one or

more intermediate ports of call en route. The shipping company will issue a timetable of its sailings and

will reserve berths at all the ports on its route, for loading and unloading cargo.

Liner terms are the terms and conditions of the shipping company for sailings on the particular route. As

you might imagine, liner terms must differ in some way from the terms for direct shipments on specially

hired (unscheduled) cargo vessels.

When goods are carried on a scheduled sailing and the shipping terms are CIF, CIF liner terms will apply.

The advantages of sending goods on a scheduled sailing rather than an unscheduled sailing are that:

• the cost of freight is less; and

• the seller and buyer can plan the dates of shipment and delivery more exactly because the ships sail

to a timetable.

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4. TYPES OF COMMERCIAL DOCUMENTATION

There are many documents which are used for one purpose or another in foreign trade. They can be

categorised under the following general headings:

• Transport documents (bill of lading, air waybill or combined transport bill of lading etc). A transport

document is a document that indicates loading on board or dispatch or taking in charge. Its functions

are to provide evidence of a contract of carriage, evidence of receipt of the goods (by the carrier) and,

in some cases, they are also documents of title, giving the holder of the documents title to the

possession of the goods.

• Commercial documents: the most important of these is the invoice.

• Insurance documents.

• Official documents required by government regulations.

• Financial documents, e.g. the bill of exchange or the promissory note.

4.1 Bill of Lading

A maritime or marine bill of lading is a transport document for goods shipped by sea.

In spite of the considerable growth of container transport, the marine bill of lading is still the most

common transport document for exporting to Africa, Asia and the Middle East (particularly when payment

by the overseas buyer for the goods is arranged through the banking system).

A bill of lading has three separate functions.

It is evidence of a contract of carriage between the shipping company and either the exporter or the

foreign buyer, to transport the goods by sea (as detailed in the bill of lading).

It is a receipt for the goods taken on board ship, and provides some details about the condition of

goods received.

- A clean bill of lading is one which does not have any statement by the shipping company that there

is some defect in the goods or their packaging.

- A foul or dirty bill of lading is one which may carry a statement that the goods received or their

packaging is damaged (in a specified way).

- A received for shipment bill of lading merely confirms that the shipping company has the goods in

its custody for shipment. This type of bill of lading is commonly used for goods packed into

containers at the exporter’s factory or at an inland depot and then driven on board ship.

The shipping company endorses the received for shipment bill of lading to confirm that it has taken

custody of the containers. You might also come across the term “container bill of lading”.

A bill of lading, once signed by the exporter, is also a document of title, which means that the holder

of the bill of lading has the right to possess the goods.

Indeed, the goods will only be released by the shipping company at the port of destination to someone

(the buyer’s representative) who presents a signed original of the bill of lading.

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The document of “title” aspect of a bill of lading is also very important for the payment arrangements, i.e.

the procedures whereby the buyer pays the exporter for the goods. A bill of lading is usually made out in

sets of two, three or even more originals, all signed and any one of them giving them the holder title to

the goods.

When a bank handles a bill of lading it must, therefore, be sure to check that is has a full set of the

signed originals, because only a full set ensures complete control over the right to gain possession of the

goods.

A bill of lading is prepared by the exporter (or a freight forwarding agent) and then given to the shipping

company for completion. The shipping company acknowledges receipt, and adds any statement about

damaged goods or packaging where necessary.

If the goods are undamaged, the shipping company will issue a clean bill of lading. The shipping

company’s terms and conditions of carriage, however, are printed on the back of the bill of lading.

A firm of freight forwarders might use its own “house” bill of lading.

When the shipping company returns these signed originals, they can now perform their three functions

of:

evidence of contract;

receipt for the goods; and

document of title.

Title to the goods can be transferred by the sender, using a (marine) bill of lading, in one of three ways:

• Issuing a bill of lading to order and endorsing them in blank. The title to the goods can be obtained

by anyone presenting a signed original copy of the bill of lading.

• Issuing the bill of lading to the order of the named buyer or bank abroad.

• Issuing the bill of lading to the order of the named buyer, but arranging for the bill of lading to be

presented to the buyer through the international banking system.

Since the bill of lading will be despatched to the buyer, perhaps through the banking system, usually long

before the goods arrive at their destination, evidence that the goods are in fact on the way might be

provided by the wording “shipped” or “since shipped” on the bill.

A bill of lading must show clearly that the conditions of shipment between buyer and seller have been

met, with regard to arrangements for dividing responsibilities for carriage and insurance.

For example, if the terms are:

“FAS Liverpool” – the bill of lading would indicate that goods had been received at Liverpool for

putting on board ship.

“FOB Bristol” – the bill of lading would indicate that the goods had been loaded on board ship, and the

port of loading on the bill would be Bristol.

“CFR Adelaide” – would show that the goods had been loaded on board ship, with a destination of

Adelaide. A statement “freight paid” would also be included for the benefit of the overseas consignee.

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“CIF Mombasa” – would show that the goods had been loaded on board ship, with a destination of

Mombasa. A statement “freight paid” would be included. The shipper is not concerned with insurance

for the goods, and evidence of insurance would not be included on the bill of lading, as it would be

provided by the certificate of insurance, or the insurance policy.

4.2 A Charterparty Bill of Lading

When a company or person charters (hires) a vessel from its owner, there may be some spare cargo

space on board. An exporter might arrange with the hirer to ship his goods on the chartered vessel,

using up some of this spare space. The contract of carriage is, therefore, between the exporter and the

hirer of the vessel, not the shipowner. The bill of lading issued for the journey will state “subject to

charterparty” and the contract of carriage is subject to the contract for the hire of the vessel.

A charterparty bill of lading will usually be unacceptable to banks holding documentary credits.

4.3 Air Waybill

(Also called an air consignment note or air freight note.)

An air waybill is a waybill for goods transported by air. Like a sea waybill, it is a contract of carriage and

a receipt by the airline for goods received into custody, and it is not a document of title.

The airline will hand the goods to the consignee at the airport of destination without the consignee having

to present an original copy of the waybill.

Goods can be despatched by air very quickly, and this raises a problem for the exporter who wishes to

obtain payment before giving control of the goods to the foreign buyer. To get round this problem, an

exporter (or his bank) might consign the goods to a correspondent bank (or to the order of this bank) in

the country of destination, subject to that bank’s consent. The correspondent bank would then only

release the goods or documents as instructed.

4.4 Road Consignment Note or Truck Receipt

A truck receipt or a road consignment note is a receipt issued by a carrier for goods that are to be

transported by road. The note also specifies the name and address of the sender and the consignee, the

place of delivery and the place and date of taking in charge by the carrier. The note acts as both a

receipt and a delivery note.

A Convention Merchandises Routiers (CMR) consignment note is an internationally-approved transport

document for the carriage of goods by road through European countries that are party to the CMR. A

CMR note is evidence that the goods are being transported subject to the terms of the CMR. (CMR,

translated loosely into English, is “Convention on the Contract for International Carriage of Goods by

Road”.)

A road consignment note, even a CMR note, is non-negotiable and so is not a document of title. The

goods will be delivered to the consignee named in the note at the place of delivery given in the note.

The option of using either a bill of lading or using a waybill should focus attention on the function of the

bill of lading as a document of title, whereas a waybill is not a document of title.

The advantage to an importer of an air waybill, a sea waybill or road consignment note is that they are

non-negotiable, and indicate to the shipping company or carrier the name (and address) of the consignee

to whom the goods should be delivered. They do not constitute title to the goods, and so the consignee

does not have to present and surrender an original copy of a bill of lading in order to take possession of

the goods.

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In contrast, when the goods arrive at their destination before a bill of lading, the importer is not able to

take charge of the goods, but must wait for the documentation to come into his possession.

The advantages to an importer of a waybill, over a bill of lading, are conversely disadvantages to an

exporter. Since a waybill is not a document of title, the exporter does not have the ability to control the

possession of the goods after their shipment. The risk of non-payment by importers, who nevertheless

take delivery of the goods is, therefore, greater and this is a risk that exporters might have to learn to

live with. Ideally, of course, there should be complete trust between the exporter and the buyer so that

the risk involved is minimal, even when waybills are used.

4.5 Bills of Exchange, Waybills and Control Over Goods

An exporter may not wish to relinquish title to the goods to the buyer until the buyer has paid for the

goods, or accepted a bill of exchange for the price of the goods.

With a bill of lading, as we shall see, this problem can be overcome by making sure that the buyer

doesn’t receive the bill of lading, and so doesn’t obtain title to the goods until he has paid or accepted a

bill of exchange.

With a waybill, this isn’t possible because the waybill isn’t a document of title. So what can the exporter

do to prevent the buyer getting hold of the goods before the exporter would wish? The way round this

problem is for the exporter to ask his bank for help. The bank can then ask a correspondent bank in the

country of destination to agree for the goods to be consigned to or to the order of the bank. The bank

will then have control over the goods and should not release them to the buyer until the buyer has paid

for them or accepted a bill of exchange for them.

4.6 Commercial Documents

The main commercial documents are invoices. There are three main types of invoice.

4.6.1 Pro-forma Invoice

This is a price quotation by an exporter to a potential overseas buyer. There has been no agreement to

buy and sell goods at this stage. A pro-forma invoice has several uses:

• The overseas buyer might need to present a pro-forma invoice to the government authorities in his

country in order to obtain an import licence or the foreign exchange to pay for the goods.

• It serves as a price quotation, and might include the terms of sale. If the buyer accepts the

quotation, there is a firm contract of sale. The commercial invoice sent later should replicate the pro-

forma invoice.

• In the same way, it can be used to tender for an export contract.

• It is used when the exporter requires cash with order. When the buyer makes a payment in

accordance with the pro-forma invoice, the exporter will despatch the goods and a receipt.

4.6.2 Commercial Invoice

This is the demand for payment for goods sold. Amongst the information shown in the invoice will be:

• description of goods, quantity, unit price and total sales price;

• the terms of delivery (e.g. CIF or FOB); and

• the terms of payment (e.g. 60 days after date of invoice).

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4.6.3 Certified Invoice

A certified invoice is a commercial invoice.

This also includes a statement by the exporter about the condition of the goods sent, or their country of

origin. Some form of statement might be provided at the request of the buyer or for the benefit of

customs authorities of the buyer’s country.

4.7 Consular Invoice

This is a commercial invoice which is prepared on a form printed in the exporter’s country by the

consulate of the buyer’s country, and is then stamped by the consulate. The purpose of a consular

invoice is to help the government of the buyer’s country to control imports into the country (e.g. to

prevent “dumping” of goods). A consular invoice will be used for exports to any country which requires

their use.

4.8 Other Commercial Documents

Other commercial documents you should take note of are:

• A weight note is a document issued by the exporter or a third party declaring the weight of the

goods in the consignment (this declared weight must tally with the weight declared on the transport

document and shown on the invoice).

• A packing list and specification for use by customs authorities.

• A supplier’s quality inspection certificate is a signed declaration by the exporter that the goods

have been inspected before despatch and are of a quality in accordance with the contract of sale.

The buyer can ask an independent checker to look at the quantity of the goods before despatch. This

independent person would then issue a third-party quality inspection certificate.

The third-party certificate of inspection is a document that might be of particular value to the buyer

because it provides independent evidence to the buyer that the goods have been shipped by the supplier

in good condition and according to specification.

The buyer might insist on such a certificate being provided – and arrange for a third party to make the

inspection – as a pre-condition for paying for the goods in situations where the buyer must pay before

even being allowed to see the goods.

4.9 Insurance Document

There are three basic types of insurance document:

• A letter of insurance or cover note is issued by an insurance broker to provide notice that steps

are being taken to issue an insurance policy or certificate.

• A certificate of insurance shows the value and details of the shipment, and the risks covered (in an

abbreviated form). It is signed by the exporter and the insurance company. Only a certificate of

insurance is required when the insurance policy of the exporting company provides “open cover” for

the whole of its export trade.

When an exporter takes out open cover with Lloyd’s or an insurance company for the whole of its

export trade, a certificate of insurance for each individual shipment will be prepared by the exporter

on a certificate provided (and pre-signed) by the insurance company.

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In the UK and many other countries, an insured person cannot take legal action against an insurer

where the only evidence of a contract of insurance is a certificate of insurance. The legal proof of a

contract is provided by the insurance policy itself.

• An insurance policy gives full details of the risks covered, and it is evidence of a contract of

insurance. A policy which provides open cover will not specify the details of any particular shipment.

Insurance cover is often provided on the basis of “Institute Cargo Clauses” provided by the Institute of

London Underwriters. These clauses list the risks covered and are referred to as A, B or C Institute Cargo

Clauses.

The Institute’s policies and clauses were changed in 1982, and a widely used type of policy is an “all

risks” policy. An “all risks” policy does not have an “all risks” clause, but instead a “Clause A” which

begins “This insurance covers all risks of loss or of damage to the subject matter insured except as

provided in Clauses 4, 5, 6 and 7 below”.

An “all risks” policy (or Clause A) does not provide insurance against “all” risks, and the main risks it

covers are:

• perils of the sea, i.e. accidental loss or damage caused by sinking, collision, seawater, heavy weather

or stranding;

• jettison, i.e. loss caused by a decision of the master of the ship to throw goods overboard so as to

lighten the vessel in an emergency;

• fire, including smoke damage;

• thieves, i.e. the forcible theft of goods rather than pilferage by the crew; and

• damage in loading, transhipment or discharge.

The policy will not cover losses or damage from strikes, riots or civil commotions, and war or capture and

seizure of the vessel (in war or by piracy). These risks must be insured separately by payment of an

additional premium.

An all risks policy also provides cover against “contributions to general average”. This is an odd-sounding

term, which requires some explanation. “Average” in insurance means partial loss or damage, so that

“general average” refers to partial loss or damage to the general cargo of the ship as a whole, caused by

action of the ship’s master (in time of danger) to save the entire ship. The loss must then be shared

amongst all the parties in proportion to their interests, whether or not their own goods are damaged.

All cargo insurance policies cover the risk that the insured might have to make a contribution to the

general average loss, provided that the cause of loss was a risk covered by the insured’s policy. For

example, if some of the ship’s cargo is damaged by the water used to put out a fire, and an insured

person whose goods are unharmed is expected to contribute to the general average, then the policy will

cover the insured person for this payment.

4.10 Documents Required by Government Departments or Agencies

Some documents in international trade are provided to satisfy the legal or procedural requirements of the

government of the country of export or import or transit. The following list gives examples and is not

comprehensive:

• A certificate of origin might be required by the importing country’s authorities as evidence of the

country from which the goods originated. This may be necessary, for example, if an exporter wishes

to claim a preferential level of import duty.

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• A certificate of health, quality or inspection might also be required by the importing country’s

authorities.

• A blacklist certificate provides evidence that the goods did not originate in (and were not

transported through) a blacklisted country, i.e. a country with which the importing country has

stopped normal trading relations.

Exports to countries in the EU are subject to EU regulations. The EU is founded on the “free

circulation” of goods between member countries.

• The Community Transit (CT) system provides forms which give entitlement to duty-free import of

goods, and for preferential tariffs for exports to countries of the European Free Trade Association

(EFTA).

• The EU’s Common Agricultural Policy requires a declaration prior to shipment of agricultural goods

to be exported.

When goods are carried abroad outside countries governed by EU regulations (and the CT system), but

between member countries of the Customs Convention, customs formalities at border posts will be

reduced if the goods are transported in customs-approved sealed containers. This is known as the TIR

Carnet system (and no doubt you have seen trucks marked TIR on the roads transporting such

containers). TIR Carnets are issued in the UK by the Road Haulage Association and the Freight Transport

Association.

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5. TYPES OF FINANCIAL DOCUMENTATION

In international trade, there are two main financial documents which provide for payment by the buyer:

• after a period of credit; but

• establishing a clear legal undertaking by the buyer to make the payment.

These are the bill of exchange and the promissory note.

5.1 Bill of Exchange

A bill of exchange may be defined as:

• an unconditional order in writing;

• addressed by one person (the drawer);

• to another (the drawee);

• signed by the person giving it (the drawer);

• requiring the person to whom it is addressed (the drawee);

• to pay;

• on demand, or at a fixed or determinable future time;

• a sum certain in money;

• to, or to the order of, a specified person, or to bearer.

When a term bill is addressed to the drawee, the drawee should sign the bill on receipt to indicate his

acceptance of the order. After acceptance, the drawee becomes known as the “acceptor”. A bill might be

drawn in any currency, depending on the terms of sale between the exporter and the foreign buyer.

Sometimes, the exporter might draw two bills of exchange on the foreign buyer, for the same shipment

of goods. This is to provide “insurance” against the loss in transit of one of the bills:

• one of the two bills will read “Pay this first (bill) of exchange, second of the same tenor and date

unpaid”;

• the second bill will read “Pay this second (bill) of exchange, first of the same tenor and date unpaid”.

If only one bill is to be drawn, it is referred to as sole.

Bills of exchange can be divided into two types:

• A sight bill, which means that payment is due immediately on sight of the bill, i.e. “at sight”.

• A term bill (also known as a tenor or usance bill) which allows the drawee a period of credit before

payment. A bill might state the term for payment to be, say, “45 days sight” which means that

payment must be made 45 days after sight of the bill (and associated documents). This period before

maturity of the bill is referred to as the tenor of the bill. Alternatively, a bill might be payable one,

two or three months etc after the date of shipment. The bill would then state “At 60 days” date, pay

this first bill of exchange and the bill would be payable 60 days after the date of the bill.

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Bills of exchange can also be divided into:

• trade bills – which are drawn on and accepted by a commercial firm;

• bank bills – drawn on and accepted by a bank. Such bills carry very little risk if the bank is first class

and so can be discounted at the finest rate, i.e. at the lowest rate of discount; and

• accommodation bills – are used by banks to provide accommodation finance to some companies.

5.2 Promissory Note

A promissory note achieves the same objective, but is originated by the buyer, and is addressed to the

seller. The buyer promises, in a legally binding fashion, that they intend to effect payment of a certain

amount on a determinable date in the future. There is no need for the seller to acknowledge the

instrument. In today’s short term trade market, this instrument is rarely used.

5.3 Bill of Exchange (Example)

If, under the terms of a contract, ABC Ltd had agreed to offer their customer XYZ 90 days credit terms,

for the delivery of a cargo worth USD 100,000.00, then the financial instrument might be raised by ABC

and addressed to XYZ as follows:

London, 31 July 2012

At 90 days from date of shipment (31 July 2012) please pay this sole bill of exchange for the sum of US

Dollars 100,000.00 (US Dollars One hundred thousand only) to our order. Covering shipment of 1,000

ladies dresses as per contract number 123/12.

To:

XYZ ABC Ltd

Main Street High Street

Miami London

USA UK

ABC would be described as the drawer of the bill, XYZ would be the drawee, and could ultimately become

the acceptor. Once the bill has been accepted by XYZ, they become legally bound to pay at maturity.

Their failure to pay on the due date would be an act of default, and the bill of exchange could be used as

evidence of debt in a court of law.

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6. SUMMARY AND CONCLUSIONS

Hopefully you have found Module 1 useful.

In the short term trade finance arena it is important to understand the thought process that both buyers

and sellers adopt when formulating their contracts. There are many decisions for them to make, with

particular regard to the mode of transport, the selection of INCOTERMS, and last but not least the

intended method of payment.

For a financing bank, it is very difficult to offer meaningful support without understanding the terms and

conditions of related contracts:

• The bank can only obtain/retain title and control over cargoes if they move by sea. All other modes of

transport do not generate documents of title.

• The choice of INCOTERM can have a significant impact on the size of facility requirement, and

associated risk factors. Who pays the insurance premium? Who pays the freight charges?

• The intended method of payment will drive the type of trade product that needs to be utilised. It

identifies the level of risk that both exporter and importer are willing to take, and clarifies for the bank

the type of support that might be necessary.

In an ideal world, banks and their customers would discuss financing needs prior to the contract being

signed, but this often does not happen. In many transactions, where the contract has already been

signed, the bank’s “solution” will be restricted to the underlying contractual terms and conditions.

6.1 The Next Module

In Module 2, we will study different styles of trade (and their financial impact) in so-called “low risk

areas”:

• the mechanics of the open account system;

• the mechanics of the documentary collections system;

• associated risk factors; and

• possible financial structures.

Where an exporter is reasonably confident that their buyer can and will pay, and that the buyer’s country

can and will pay, they may elect to use relatively simple processes, thus avoiding significant bank

charges. Many of these trade flows would still need to be financed, and Module 2 investigates possible

solutions.

6.2 What Now?

It’s time to test what you have learned. If you are not already online, you need to log in and undertake

the module test. It will be found listed below this module on the website.

If you get a question wrong, don’t worry. You simply need to go back to this module and revise the

section before trying again. The questions will be in a different order, and the answer options may be

rearranged as well, so keep this in mind. You can have as many attempts as you need to pass the test.