international trade finance and risk hedging_n

8/7/2019 International trade Finance and Risk Hedging_n

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International trade Finance and RiskHedging. ..Continued..

By Group 3Sanjay Bhati - 105Vishram Desai - 113Amit Goenka - 118Alekh Jain - 122Anita Kavadia - 127Varun Talwar - 154

Yogita Waman - 158


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RISKS

International trade is characteristically costlier in terms of domestic trade.

C ommercial risk A bank's lack of ability to honor its responsibilitiesA buyer's failure pertaining to payment due to financial

limitationsA seller's inability to provide the required quantity or quality of goods

E conomic risksRisk of concession in economic control

Risk of insolvency of the buyerRisk of non-acceptanceRisk of protracted default i.e. the failure of the buyer to pay off the due amount after six months of the due dateRisk of E xchange rate


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Currency Management:Understanding currency fluctuationsInvoicing currency Forward contractRepatriationEE FC


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Exchange Earners Foreign Currency (EEFC)account is foreign currency-denominated account maintainedwith banks dealing with foreign exchanges.

The Reserve Bank of India introduced this scheme in 1992.

enable exporters and professionals to retain their foreignexchange receipts in banks without converting it into the localcurrency.

Any person residing in India who receives inward remittancesin foreign currency or a company with foreign currency earnings can open EE FC account.

account expressed in foreign currency and maintained with anauthorised dealer (a bank dealing in foreign exchange) inIndia


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Th e necessityIndian exports have surged over the last decade.

As a result of this, the volume of inward remittances has alsoincreased significantly.

To shield the firms engaged in regular export and import fromthe exchange rate fluctuations RBI has allowed parking of foreign currency by exporters in EE FC a/c.

As per F EM A Foreign E xchange M anagement Act, Only anauthorised person [generally an authorised banker] can dealin foreign currency transaction


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Benefits

credit 100 per cent of their foreign exchange earnings to theaccount.

convert foreign exchange into Rupees and vice versa.

M inimize transaction cost.

N atural Hedge.

International draft facility


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FactsAll categories of foreign exchange earners, such as individuals,companies, etc. who are resident in India, may open EE FC accounts.

form of a current account. N o interest is payable on EE FC accounts.

One can credit up to 100 per cent of his/ her foreign exchangeearnings, subject to permissible credits and debits.

a unit located in a S EZ can open a Foreign C urrency Account withan AD in India subject to certain conditions. S EZ Developers canopen EE FC Accounts.

C heque facility is available for operation of the EE FC account.

no restriction on withdrawal in Rupees of funds held. However, theamount withdrawn in Rupees shall NOT be eligible for conversioninto foreign currency and for re-credit to the account.


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a zero-balance account like normal current accounts.

EE FC account balances can be hedged. The balances in theaccount sold forward by the account holders has to remainearmarked for delivery. However, the contracts can be rolledover.


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Permissible credits

Inward remittance through normal banking channels, other thanremittances received on account of foreign currency loanor investment received from abroador received for meeting specific obligations by the account holder;

P ayments received in foreign exchange by a 100 per cent E xport Oriented

Unit or a unit in(a) E xport P rocessing Z one or(b) Software Technology P ark or(c) E lectronic Hardware Technology P ark for supply of goods to

similar such units or to a unit in Domestic Tariff Area;

P ayments received in foreign exchange by a unit in the Domestic Tariff Areafor supply of goods to a unit in the S EZ ;

P ayment received by an exporter from an account maintained with an ADfor the purpose of counter trade.


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Permissible creditsAdvance remittance received by an exporter towards export of goods or services;P ayment received for export of goods and services from India, out of fundsrepresenting repayment of State C redit in U.S. Dollar held in the account of Bank for Foreign E conomic Affairs, M oscow, with an AD in India;

Professional earnings including directors fees, consultancy fees, lecture fees,honorarium and similar other earnings received by a professional by rendering

services in his individual capacity;

Re-credit of unutilized foreign currency earlier withdrawn from the account;

Amount representing repayment by the account holder's importer customer, of loan/advances granted, to the exporter holding such account; and

The disinvestment proceeds received by the resident account holder onconversion of shares held by him to ADRs/GDRs under the SponsoredADR/GDR Scheme approved by the FI P B of the Government of India.


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Permissible debits:Payment outside India towards a permissible current account transaction and capital

account transaction [in accordance to the FEMA Regulations, 2000].

Payment in foreign exchange towards cost of goods purchased from a 100 percentExport Oriented Unit or a Unit in

(a) Export Processing Zone or(b) Software Technology Park or(c) Electronic Hardware Technology Park

payment of customs duty in accordance with the provisions of the Foreign TradePolicy of the Central Government for the time being in force.

Trade related loans/advances, extended by an exporter holding such account to hisimporter customer outside India, subject to compliance with the Foreign ExchangeManagement (Borrowing and Lending in Foreign Exchange) Regulations, 2000.

Payment in foreign exchange to a person resident in India for supply of goods/services including payments for airfare and hotel expenditure.


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Th e controversyDiscontinue EE FC:

The promotion facility not fitwith the rate of growth of E xports (29%, Budget 2011).

Keeps foreign currency blockedin a/c.

Interest bearing A/ C:

offer interest onEE

FC

a/c.

2007-2008, Govt. paid interest@ LIBOUR + 0.25 to +0.50 bps.

Discontinue EE FC:

The promotion facility not fitwith the rate of growth of E xports (29%, Budget 2011).

Keeps foreign currency blockedin a/c.

Interest bearing A/ C:

offer interest onEE

FC

a/c.

2007-2008, Govt. paid interest@ LIBOUR + 0.25 to +0.50 bps.


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Indian Scenario Kalyana Sundaram C ommittee recommendedintroduction of factoring in 1989.Banking Regulation Act, 1949, was amended in 1991 forBanks setting up factoring services.SBI first Bank to set up its Factoring Subsidiary-

SBI Factors Ltd., (April, 1991)

Renamed as SBI Global Factors Ltd. from 23/03/2010


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C oncepto Factoring is the Sale of Book Debts by a firm

(C lient) to a financial institution (Factor) on theunderstanding that the Factor will pay for theBook Debts as and when they are collected or on aguaranteed payment date.

o N ormally, the Factor makes a part payment(usually up to 80%) immediately after the debtsare purchased thereby providing immediateliquidity to the C lient.


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The Parties

Supplier or Seller (Client)Buyer or Debtor (Customer)Financial Intermediary (Factor)

Process Flow

Business opportunity

CUSTOMERCLIENT

FACTOR

Collection process

Assignment acknowledgment

FactoringAgreement

Invoice

assignment

Payment Invoicesettlement


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Mec h anismC lient concludes a credit sale with a customer.C lient sells the customers account to the Factor.The C lient (Seller) prepares invoice with a notation thatdebt due on account of this invoice is assigned to andmust be paid to the Factor (Financial Intermediary).The C lient (Seller) submits invoice copy with Delivery C hallan showing receipt of goods by buyer, to the Factor.The Factor, after scrutiny of these papers, allowspayment (usually upto 80%-90% of invoice value).

The balance is retained as Retention M oney ( M argin M oney).x Also called Factor Reserve.


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Mec h anism Contd..Till the payment of bills, Factor maintains the customersaccount , follows up for payment and sends regularstatements to the C lient.

C ustomer remits the amount due to the Factor.

Once the invoice is honoured by the buyer on due date,the Retention M oney is credited to the C lientsAccount.


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Factor Verification` Factor ensures that the following conditions met to give

full effect to factoring arrangements

` Invoice, bills or other documents drawn by the sellershould contain a clause that these payments arising outof transaction might be factored

` Seller should confirm in writing to the factor that allthe payments arising out of these bills are free fromany encumbrances, charge lien, pledge, hypothecation

or mortgage or right of set-off or counter claim .


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Factor Verification` Seller should execute a deed of assignment in favor of

the factor to enable him to recover the payment at thetime or after default

` Seller should confirm that all conditions to sell-buy contract between him and the buyer have beencomplied with and the transactions complete .

` Seller should procure a letter of waiver from a bank infavor of factor in case the bank has a charge over theassets sold to buyer and the sale proceeds are to bedeposited in the account of the bank


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Tw o-Factor System of FactoringThere are usually four parties to a cross-borderfactoring transactions

E xporter (client)Importer (customer)E xport FactorImport Factor

Two factor system results in two separate but inter-linked agreements

Between exporter and export factorBetween export factor import factorP rocess Flow


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Tw o-Factor System of Factoring

Import factor provides a link between exportfactor and the importer.

He also underwritesC ustomer trade credit risks,C ollects receivables

Transfers funds to the export factor in thecurrency of the invoice

E liminating the need for opening a letter of credit (L C ) by the importer


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Ex porter Importer

Country A Country B

Ex port Factor Import Factor

Goods and invoices I

Copy Invoice II

Prepayments III

Copy Invoices IV

Statements V

PaymentVI

Payments VII

Payment of Commission VIII


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Tw o-Factor System of Factoring

E xporter informs the export factor about the export of goods to a particular import-client domiciled in a specifiedcountry.E xport factor writes to import factor (domiciled in thecountry of the importer) enquiring about the credit-worthiness, reputation and so on of the importer

On getting satisfactory information from the import factor,exporter delivers the goods to the importer and the relevantinvoices, bills of lading and other supporting documents aredelivered to the export factor.

E xport receivables on a non-recourse basis are factored.


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Tw o-Factor System of FactoringE xport factor does credit checking, sales ledgering andcollection to the import factor

Import factor collects the payment from the importer andeffects payments to the export factor onassignment/maturity/collection as per the terms of assignment in the currency of the invoice

Finally, the export factor makes payment to the exporterupon assignment or maturity or collection depending uponthe factoring agreement between them


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C h arges

Finance / Interest charge :

Interest is higher than rate of interest charged on WorkingC apital Finance by Banks.

P rocessing fees / C ommission :

A flat percentage of total value of invoices factored rangesbetween 0.50% to 1.50%. C ommission is collected up-front.

Service/Handling charges : Ranges between 0.1-0.2%.


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Types Of FactoringRecourse

Factor purchasesReceivables on thecondition that lossarising on accountof non-recovery willbe borne by theC lient. Credit Risk is withthe C lient.Factor does notparticipate in thecredit sanctionprocess.

N on-Recourse

Factor purchases

Receivables on thecondition that theFactor has norecourse to theC lient, if the debtturns out to be non-recoverable.

Credit risk is withthe Factor.

Higher commissionis charged.Factor participatesin credit sanctionprocess andapproves creditlimit given by theC lient to theC ustomer.

Advance

Factor makes

advance payment tothe C lient. Commission andInterest charges asapplicable ischarged.

M aturity

Factor does not

make any advancepayment to theC lient. Pays onguaranteedpayment date or oncollection of Receivables.Guaranteed

payment date isusually fixed takinginto accountprevious collectionexperience of theC lient. N ominalC ommission ischarged.


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RegulationsFactoring transactions in India are governed by the following Acts :-

a) Indian C ontract Actb) Sale of Goods Actc) Transfer of P roperty Actd) Banking Regulation Act.e) Foreign E xchange Regulation Act.

Absence of a consolidated regulatory framework.N ot covered under Debts Recovery Tribunal Act (DRTAct).


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P ropositions A h ead

A new bill to regulate factoring business andamend the Stamp Act, 1899.Stamp duty exemption for sale of accountsreceivablesAs of now only banks are exempt from paying

stamp duty on receivables , P ure factoringcompanies have to pay the duty, which differsfrom state to state.


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P ROS & CONSImproves the cash flow.By offloading the sales accounting andadministration, the management can focus on corecompetence.The reduction in overheads brought about by thefactors administration of the sales ledger and theimproved cash flows contribute towards cost

savings.Factoring could prove to be costlier compared to in-house management of receivablesFactoring is perceived as an expensive form of financing and also as finance of the last resort.


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ForfaitingForfaiting is the discounting of international tradereceivable on a 100% "without recourse" basis.

It is a form of suppliers credit involving the sale orpurchase of receivables falling due at some futuredate.The exporter is responsible for the validity of his orderand execution thereof, but once documentation hasbeen delivered and accepted and discounting is done,there is absolutely no recourse to the E xporter, withthe exception of an underlying fraudulent transaction.Forfaiting effectively transforms a credit sale into acash sale.


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ForfaitingTraditionally, Forfaiting is fixed interest rate andmedium term (3-5 years) financing.It can however, be structured on a floating rateinterest basis as well as for longer periods up to10 years or for shorter periods down to 90 days.Forfaiting is generally suitable for high valueexports like heavy machinery, capital goods,consumer durable, vehicles, bulk commodities,consultancy and construction contracts andproject exports.


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C h aracteristics of Forfaiting100% financing without recourse to the seller of theobligation.

Importer's obligation is normally supported by alocal bank guarantee or aval .The debt is typically evidenced by Letter of credit,Bills of E xchange, P romissory N otes. C redit periodscan range from 90 days to 10 years

Amounts financed to be upwards of USD 2,50,000/-C ontract in any of the world's major convertiblecurrencies can be financed.Finance to be either on a fixed (market norm) orfloating rate basis


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Steps in Forfaiting

In pursuance of a commercial contract between an exporter

and importer, the exporter sells and delivers the goods tothe importer on a deferred payment basis.

Importer draws a series of promissory notes in favour of theexporter for payment including interest charge.

The promissory notes/bills are guaranteed by a bank whichmay not necessarily be the importers bank.

The guarantee by the bank is referred to as an AVALdefined as an endorsement by a bank guaranteeingpayment by the buyer (importer)


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Steps in ForfaitingE xporter enters into a fortaiting arrangement with aforfaiter usually a reputed bank including exporters bank.

E xporter sells the availed notes/bills to the bank (forfaiter)at a discount without recourse .

The agreement provides for the basic terms of thearrangement such as

x cost of forfaiting,x

margin to cover risk,x commitment charges,x days of grace,x fee to compensate the forfaiter for loss of interest due to

transfer and payment delays, period of forfaiting contractx installment of repayment, usually bi-annual instalment,x rate of interest and so on.


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Steps in ForfaitingThe rate of interest or discount depends upon

x terms of the note/bill,x

currency in which it is determined,x credit rating of the Av alling bank,x country risk of the importer etc

Forfaiter may hold these notes/bills till maturity for

payment by the importers bank.Alternatively, he can securitize them and sell theshort-term paper in the secondary market as high-yielding unsecured paper


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B ill Discounting Factoring

Advances are made against thebills.Bills discounted may berediscounted several timesbefore the maturity.

The drawer undertakes theresponsibility of collecting thebills and remitting theproceeds to financing agency Just a P rovision of financeagainst billsBill discounting is always withrecourse.Bill financing is individualtransaction oriented.In Balance Sheet

Trade debts are purchased by assignment.Debts purchased for factoringcannot be rediscounted, they can only be refinanced.Factor undertakes to collectthe bills of the clientIn addition to the provision of finance, Factor renders allservices like maintenance of sales ledger, advisory, services.Factoring may be with or

without recourse.Several invoices in batches areprocessed.Off balance sheet


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F A CTORING FORF A ITING

Service of Sale Transaction

Upto 80% financedimmediately

With or Without Recourse

Sales Administration done

Short Term

C harge C reation asAssignment

Individual Sale Transaction

Upto 100% financedimmediately

Without Recourse

Sales Administration not done

M edium Term

C harge C reation asAssignment


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E xternal C ommercial Borrowings ( EC B) refer to commercial

loans in the form of

bank loans, buyers credit, suppliers credit, securitized instruments (e.g. floating rate notes and fixedrate bonds, non-convertible, optionally convertible orpartially convertible preference shares)

Foreign C urrency C onvertible Bonds (F CC Bs)

availed of from non-resident lenders with a minimum averagematurity of 3 years.


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A utomatic Route

App ro v al Route

Eligible B orrowers

Recognized L enders

A mount and Maturity

A ll In cost CeilingsEnd Use

EC B can be accessed under two routes :


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Automatic R outeE L IGI B L E B ORROWERS RECOGNISED L ENDERS

A MOUNT A ND M A TURITY

C orporate registered except financialintermediaries are eligible.

N GOs engaged in micro financeactivities -subject to certain conditions.

Internationally recognised sources-international banks, multilateralfinancial institutions example.Foreign equity holder as recognized

lender Requirements

up to USD 500 million per borro w er per financial year w ould be permitted forRupee expenditure and / or foreign currency expenditure. Hotel, h ospital andsoft w are- USD 100 mn

up to USD 20 million or equivalent can be availedw

ith

minimum average maturityof t h ree years.above USD 20 million and up to USD 500 million or equivalent w it h minimum

average maturity of five years.Up to 5 million NGO engaged in micro finance activitiesECB up to USD 20 million can h ave call/put option provided t h e minimum average

maturity of 3 years is complied before exercising call/put option .


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END USES PERMITTED

for investment in real sector - industrial sector including S ME ,

infrastructure sector and specified service sectors namely hotel,hospital, software in India.

Overseas direct investment in Joint Ventures (JV)/ Wholly OwnedSubsidiaries

first stage acquisition of shares in disinvestment process and also in themandatory second stage offer to the public.

For lending to self-help groups or for micro-credit or for bonafide microfinance activity .

P ayment for Spectrum Allocation

Infrastructure Finance C ompanies up to 50 per cent of their ownedfunds, for on-lending to the infrastructure sector as defined under theEC B policy.


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END USES NOT P ERMITT ED

For on-lending or investment in capital market or acquiring a

company (or a part thereof) in India by a corporate.

for real estate sector.

for working capital, general corporate purpose and repaymentof existing Rupee loans


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App roval R outeE L IGI B L E B ORROWERS RECOGNISED L ENDERS

A MOUNT A ND M A TURITY

Infrastructure Finance companies.

Banks & FI in restructuring packages-Steel & textile.

NBF

Cs/ S

PVs/ S

EZdevelopers forinfrstructure.

C orporate - F CC B.

Internationally recognised sources-international banks , capital market,EC A.

Foreign equity holder as recognized

lender Requirements (25% of paidup capital, debt : equity ratio 4 :1 )

additional amount of USD 250 million with average maturity of more than 10 years.


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Conditions for CONVE RSI ON OF EC B INTO EQU ITY

Activity of the company is covered under the Automatic Route forForeign Direct Investment or Government (FI P B) approval forforeign equity participation has been obtained.

The foreign equity holding after such conversion of debt into equity is within the sectoral cap, if any,

P ricing of shares is as per the pricing guidelines issued underFEM A, 1999 in the case of listed/ unlisted companies.

C onversion of EC B may be reported to the Reserve Bank

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Concept of All in Cost Ceilings in bot h t h eroutes

All-in-cost includes rate of interest, other fees and expenses inforeign currency except commitment fee, pre-payment fee, andfees payable in Indian Rupees

A ll in Cost in res p ect of both the routes

Average M aturity P eriod All-in- C ost ceilings over 6 M onths LIBOR

Three years and up to five years 300 bps

M ore than five years and up to sevenyears 500 bps

The requirement of minimum a v erage maturity p eriod of se v en years for EC B more thanUSD 100 million for Ru p ee ca p ital ex p enditure by the borrowers in the infrastructuresector has been dis p ensed with.


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T R ADE CR EDIT S

credits extended for imports directly by the overseassupplier, bank and financial institution for maturityof less than three years.

Supplier credit is a credit facility arranged at the instance of the supplier to enable the buyer to procure the goods on creditterms.

Suppliers credit represents credit sales by supplier on thebasis of accepted bills or promissory notes.

E xporters ( overseas sellers) supply goods to Indian buyers ondeferred payment terms on long term or short term basis.


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Short term E .g. LC with a usance of 6 months.

Long term deferred terms spread over number of years. E .g.Airbus Industry sells air craft to Air India on deferred termsbasis.

E xtent of credit 100%.

Interest LIBOR related

Security L C /BG

Trade credit less than3 years to be approved Ads for amountUP to US $ 20 M per import transaction.

* For non capital goods , it is one year.


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EC A (E xport C redit Agency) in overseas market offer credit toIndian importers .

On supply of goods to importer, EC A disburses, supplier getsthe proceeds

E ncourages exports for the country.

EX IM bank extends such loans to importers from African andsouth American countries to encourage exports from India .current all-in-cost ceilings :

Maturity p eriod A ll-in-cost ceilings o v er 6months L I B OR*

Up to one year 200 basis points

M ore than one year but less thanthree years


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Thank You

international trade finance and risk hedging_n

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