International Trade Finance

Countertrading and Forfaiting

Part 1 - Countertrade

Countertrade means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. A monetary valuation can however be used in counter trade for accounting purposes.

There are five main variants of countertrade:

I Barter II Compensation III Switch Trading IV Counterpurchase V Offset

Barter
Barter is a method of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money. Barter usually replaces money as the method of exchange in times of monetary crisis, such as when the currency may be either unstable. The principal exports are paid for with goods or services supplied from the importing market. A single contract covers both flows, in its simplest form involves no cash. In Bartered goods can range from meat to iron tablets, mineral water, furniture or olive-oil.

Compensation

Compensation is like barter. But, the exporter agrees to accept payment in goods (instead of cash) from the importer and who must then sell those goods in order to generate foreign exchange to pay his own sale. Usually, the goods or services purchased by the original seller are surplus to his requirements and must be onsold to a third party.

Forward purchase In compensation there is Forward purchase involved. Forward purchase is a variation of compensation where the buyers goods are delivered before the main transaction in order to generate the foreign exchange needed by the buyer to pay for the goods he wishes to purchase. In order to protect both sides against the risk of non delivery, an escrow account is usually delivered. An escrow account is a bank account in hard currency opened as joint between the importer and the exporter.

Partial Compensation Partial Compensation involves payment partly in goods and partly in cash.

Switch trading
Switch trading involving a bilateral trade agreement is used to reduce or clear an imbalance on bilateral clearing account. What is Bilateral trade or clearing trade? It is trade exclusively between two countries without using hard currency. (Hard currency is defined by be precious metals for example gold, diamonds or paper currencies of some developed who countries have earned recognition as hard currencies at various times, including the United States dollars, Euro, Swiss franc, British pound sterling). Bilateral trade agreements often aim to keep trade deficits at minimum by keeping a clearing account where deficit would accumulate.

Switch trading (cont.)

As already stated, Switch Trading takes place usually between two countries that do not have hard currency and are usually short of foreign exchange. A switch dealer offers to purchase the imbalance in hard currency at a discount on the clearing currency unit. The switch dealer has to find a third party willing to purchase these goods and to pay for them in hard currency. He will charge commission plus the discount needed.

Counterpurchase
Counterpurchase is the sale of goods and services to one company in other country by a company that promises to make a future purchase of a specific product from the same company in that country. It is essentially a trading technique, involving entirely separate financial flows, with two separate contracts but with a clear reciprocal obligation which must be fulfilled. - The first contract is the original sales contract, outlining the terms in which an initial buyer purchases from an initial seller. - The second contract, a parallel contract, outlines the terms in which the original seller agrees to buy unrelated goods from the original buyer. Basically this is a contractually enforced relationship between two parties who agree, at some point, to provide business for one another.

Offset
Offset is an agreement that a company will make a hardcurrency purchase of an unspecified product from that nation in the future. It is an agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials (BuyBack) from the buyer of the finished product, or the assembly (BuyBack) of such product in the buyer nation. Buyback agreement usually involves capital equipment sale whereby the seller agrees to purchase a portion of the end product. The buyers objective may be to get back part of his foreign exchange expenditure, to develop his export market or ensure an income stream which will be used to amortize the original investment.

Advantages of Countertrade:
Advantages of the Buyer/Importer: Foreign exchange can be conserved and better managed. It can be used as a mean of bypassing restrictive trade agreements among exporting and importing countries. An importer (often a developed country) may be able to take advantage of the sellers excess capacity to impose offset requirements. Disadvantages of the Buyer/Importer: The buyer/importer will often end up paying a higher price as the seller is paying extra cost such as commission on third parties.

Advantages&Disdvantages of Countertrade:
Advantages of the Seller/Exporter: The exporter is gaining access to a market which would otherwise have been closed to them. In a counterpurchase or parallel trading deal, the export side of the transaction can be covered by export credit insurance provided cover is available for the importer in question. Disadvantages of the Seller/Exporter: The seller usually ends up with goods or services which are of no use to it where he will be obliged to sell at lower price to a third party. The seller may end up with goods which are overpriced, imperfect in quality and do not have obvious market appeal.

Advantages&Disdvantages of Countertrade:
Mutual Advantages: Markets are opened up on both sides that otherwise would have never existed. Countertrade provides a way of boosting trade between countries with non-convertible currencies. Mutual Disdvantages: Countertrade involves lengthy negotiations. Documentation is complicated, weighty and expensive. The seller may end up with goods which are overpriced, imperfect in quality and do not have obvious market appeal.

Part 2 - Forfaiting

 Forfaiting In trade finance, forfaiting involves the purchasing of receivables from exporters. Receivables may refer to the amount due from individuals and companies. Receivables are claims that are expected to be collected in cash. The forfaiter takes on all risks involved with the receivables. The forfaiting operation is a transaction-based operation (involving Exporters) involving the sale of one of the firm's transactions. Factoring is also a financial transaction involving the purchase of financial assets, but Factoring involves the sale any portion of a firm's Receivables.

The characteristics of a forfaiting transaction are:

Credit is extended to the exporter for a period ranging between 180 days to seven years. Minimum bill size is normally US$ 250,000, although $500,000 is preferred. The payment is normally receivable in any major convertible currency. A letter of credit or a guarantee is made by a bank, usually in the importer's country. The contract can be for either goods or for services. At its simplest the receivables should be evidenced by a promissory note, a bill of exchange, a deferred-payment letter of credit, or a letter of guarantee.

Three elements relate to the pricing of a forfaiting transaction:

Discount rate - the interest element, usually quoted as a margin over LIBOR. (LIBOR is the interest rate that the banks charge each other for loans usually in Eurodollars. The LIBOR is officially fixed once a day by a small group of large London banks.) 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, applicable to the country of risk. Commitment fee - applied from the date the forfaiter is committed to undertake the financing, until the date of discounting.

Advantages of Forfaiting:
1) Advantages of the Exporter: - He gets immediate cash for his goods or services. - Documentation is quick and straight forward. - Not worrying of debt collection - Clearing his balance sheet of a liability. - Free from credit risk on the importer - Free of any country risk - He can offer facilities to a buyer who appears to be creditworthy but cannot get cover from an export credit agency.

Advantages of Forfaiting(cont.)
2) Advantages of the Importer: - Credit can be obtained from a forfeiter when other doors have been closed. - He obtains fixed rate finance and knows exactly how much this is going to cost. - He is offered considerable flexibility in the choice of currencies, maturity and grace period.

Advantages of Forfaiting(cont.)
3) Advantages for the forfeiter:

- Its liquidity is not restricted as there is a strong secondary market. Liquidity is the ability to convert an asset to cash quickly. It is safer to invest in liquid assets than illiquid ones because it is easier for an investor to get his/her money out of the investment. -The return on fixed rate forfait paper are generally higher than on floating rate loans for the same risk and maturity.

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