International trade Finance and Risk

Hedging. …..Continued…..

By Group 3
Sanjay Bhati - 105
Vishram Desai - 113
Amit Goenka - 118
Alekh Jain - 122
Anita Kavadia - 127
Varun Talwar - 154
Yogita Waman - 158
RISKS
• International trade is characteristically costlier in terms of
domestic trade.
• Commercial risk 
▫ A bank's lack of ability to honor its responsibilities
▫ A buyer's failure pertaining to payment due to financial limitations
▫ A seller's inability to provide the required quantity or quality of goods

• Economic risks
▫ Risk of concession in economic control
▫ Risk of insolvency of the buyer
▫ Risk of non-acceptance
▫ Risk of protracted default i.e. the failure of the buyer to pay off the
due amount after six months of the due date
▫ Risk of Exchange rate
Currency Management:

▫ Understanding currency fluctuations

▫ Invoicing currency
▫ Forward contract
▫ Repatriation
▫ EEFC
• Exchange Earners’ Foreign Currency (EEFC)
account is foreign currency-denominated account maintained with
banks dealing with foreign exchanges.

• The Reserve Bank of India introduced this scheme in 1992.

• enable exporters and professionals to retain their foreign exchange

receipts in banks without converting it into the local currency.

• Any person residing in India who receives inward remittances in

foreign currency or a company with foreign currency earnings can
open EEFC account.

• account expressed in foreign currency and maintained with an

authorised dealer (a bank dealing in foreign exchange) in India
The necessity
• Indian exports have surged over the last decade.

• As a result of this, the volume of inward remittances has also

increased significantly.

• To shield the firms engaged in regular export and import from

the exchange rate fluctuations RBI has allowed parking of
foreign currency by exporters in EEFC a/c.

• As per FEMA Foreign Exchange Management Act, Only an

authorised person [generally an authorised banker] can deal
in foreign currency transaction
Benefits
• credit 100 per cent of their foreign exchange earnings to the
account.

• convert foreign exchange into Rupees and vice versa.

• Minimize transaction cost.

• Natural Hedge.

• International draft facility

Facts
• All categories of foreign exchange earners, such as individuals, companies,
etc. who are resident in India, may open EEFC accounts.

• form of a current account. No interest is payable on EEFC accounts.

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

• a unit located in a SEZ can open a Foreign Currency Account with an AD in

India subject to certain conditions. SEZ Developers can open EEFC
Accounts.

• Cheque facility is available for operation of the EEFC account.

• no restriction on withdrawal in Rupees of funds held. However, the

amount withdrawn in Rupees shall NOT be eligible for conversion into
foreign currency and for re-credit to the account.
• a zero-balance account like normal current accounts.

• EEFC account balances can be hedged. The balances in the

account sold forward by the account holders has to remain
earmarked for delivery.   However, the contracts can be rolled
over.
Permissible credits

•Inward remittance through normal banking channels, other than

▫ remittances received on account of foreign currency loan
▫ or investment received from abroad
▫ or received for meeting specific obligations by the account holder;

•Payments received in foreign exchange by a 100 per cent Export Oriented Unit or a unit
in
(a) Export Processing Zone or
(b) Software Technology Park or
(c) Electronic Hardware Technology Park for supply of goods to
similar such units  or to a unit in Domestic Tariff Area;

•Payments received in foreign exchange by a unit in the Domestic Tariff Area for supply of
goods to a unit in the SEZ;

• Payment received by an exporter from an account maintained with an AD for the

purpose of counter trade.
Permissible credits
• Advance remittance received by an exporter towards export of goods or services;

• Payment received for export of goods and services from India, out of funds
representing repayment of State Credit in U.S. Dollar held in the account of
Bank for Foreign Economic Affairs, Moscow, 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 on

conversion of shares held by him to ADRs/GDRs under the Sponsored
ADR/GDR Scheme approved by the FIPB of the Government of India.
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 percent
Export 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 Trade
Policy of the Central Government for the time being in force.

• Trade related loans/advances, extended by an exporter holding such account to his

importer customer outside India, subject to compliance with the Foreign Exchange
Management (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.
The controversy
Discontinue EEFC: Interest bearing A/C:

• The promotion facility not fit • offer interest on EEFC a/c.

with the rate of growth of
Exports (29%, Budget 2011).

• Keeps foreign currency • 2007-2008, Govt. paid interest

blocked in a/c. @ LIBOUR + 0.25 to +0.50
bps.
Factoring & Forfaiting
Indian Scenario
• “Kalyana Sundaram Committee” recommended
introduction of factoring in 1989.
• Banking Regulation Act, 1949, was amended in 1991 for
Banks 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
Concept
o Factoring is the Sale of Book Debts by a firm
(Client) to a financial institution (Factor) on the
understanding that the Factor will pay for the
Book Debts as and when they are collected or on a
guaranteed payment date.

o Normally, the Factor makes a part payment

(usually up to 80%) immediately after the debts
are purchased thereby providing immediate
liquidity to the Client.
 Business opportunity

CLIENT CUSTOMER

Factoring Assignment
Agreement acknowledgment

Invoice
assignment Collection process

Invoice Payment
settlement FACTOR

The Parties
Supplier or Seller (Client)
Buyer or Debtor (Customer)
Financial Intermediary (Factor)
Process Flow
Mechanism
• Client concludes a credit sale with a customer.
• Client sells the customer’s account to the Factor.
• The Client (Seller) prepares invoice with a notation that
debt due on account of this invoice is assigned to and
must be paid to the Factor (Financial Intermediary).
• The Client (Seller) submits invoice copy with Delivery
Challan showing receipt of goods by buyer, to the Factor.
• The Factor, after scrutiny of these papers, allows
payment (usually upto 80%-90% of invoice value).
▫ The balance is retained as Retention Money (Margin Money).
 Also called Factor Reserve.
Mechanism Contd..
• Till the payment of bills, Factor maintains the customer’s
account , follows up for payment and sends regular
statements to the Client.

• Customer remits the amount due to the Factor.

• Once the invoice is honoured by the buyer on due date,

the “Retention Money” is credited to the Client’s
Account.
Factor Verification
 Factor ensures that the following conditions met to give
full effect to factoring arrangements

 Invoice, bills or other documents drawn by the seller

should contain a clause that these payments arising out
of transaction might be factored

 Seller should confirm in writing to the factor that all

the payments arising out of these bills are free from
any encumbrances, charge lien, pledge, hypothecation
or mortgage or right of set-off or counter claim.
Factor Verification
 Seller should execute a deed of assignment in favor of the
factor to enable him to recover the payment at the time or
after default

 Seller should confirm that all conditions to sell-buy contract

between him and the buyer have been complied with and the
transactions complete.

 Seller should procure a letter of waiver from a bank in favor of

factor in case the bank has a charge over the assets sold to
buyer and the sale proceeds are to be deposited in the account
of the bank
Two-Factor System of Factoring
• There are usually four parties to a cross-border
factoring transactions
▫ Exporter (client)
▫ Importer (customer)
▫ Export Factor
▫ Import Factor
• Two factor system results in two separate but inter-
linked agreements
▫ Between exporter and export factor
▫ Between export factor import factor
▫ Process Flow
Two-Factor System of Factoring
• Import factor provides a link between export
factor and the importer.

• He also underwrites
▫ Customer trade credit risks,
▫ Collects receivables
▫ Transfers funds to the export factor in the
currency of the invoice

• Eliminating the need for opening a letter of

credit (LC) by the importer
 Country A Country B
Goods and invoices –I
Exporter Importer

Copy Invoice II Payment

VI

Prepayments III
Statements V

Export Factor Copy Invoices IV Import Factor

Payments VII

Payment of Commission VIII

Two-Factor System of Factoring
▫ Exporter informs the export factor about the export of goods to a
particular import-client domiciled in a specified country.

▫ Export factor writes to import factor (domiciled in the country 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 relevant
invoices, bills of lading and other supporting documents are
delivered to the export factor.

▫ Export receivables on a non-recourse basis are factored.

Two-Factor System of Factoring
▫ Export factor does credit checking, sales ledgering and
collection to the import factor

▫ Import factor collects the payment from the importer and

effects payments to the export factor on
assignment/maturity/collection as per the terms of
assignment in the currency of the invoice

▫ Finally, the export factor makes payment to the exporter

upon assignment or maturity or collection depending upon
the factoring agreement between them
Charges

Finance / Interest charge :

• Interest is higher than rate of interest charged on Working
Capital Finance by Banks.

Processing fees / Commission :

• A flat percentage of total value of invoices factored ranges
between 0.50% to 1.50%.Commission is collected up-front.
Service/Handling charges : Ranges between 0.1-
0.2%.
Types Of Factoring
Recourse Non-Recourse Advance Maturity

• Factor purchases • Factor purchases • Factor makes • Factor does not

Receivables on the Receivables on the advance payment make any advance
condition that loss condition that the to the Client. payment to the
arising on account Factor has no • Commission and Client.
of non-recovery will recourse to the Interest charges as • Pays on
be borne by the Client, if the debt applicable is guaranteed
Client. turns out to be non- charged. payment date or on
• Credit Risk is with recoverable. collection of
the Client. • Credit risk is with Receivables.
• Factor does not the Factor. • Guaranteed
participate in the • Higher commission payment date is
credit sanction is charged. usually fixed taking
process. • Factor participates into account
in credit sanction previous collection
process and experience of the
approves credit Client.
limit given by the • Nominal
Client to the Commission is
Customer. charged.
Regulations
• Factoring transactions in India are governed by
the following Acts:-
a) Indian Contract Act
b) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.
e) Foreign Exchange Regulation Act.
• Absence of a consolidated regulatory framework.
▫ Not covered under Debts Recovery Tribunal Act (DRT
Act).
Propositions Ahead
• A new bill to regulate factoring business and
amend the Stamp Act, 1899.
• Stamp duty exemption for sale of accounts
receivables
• As of now only banks are exempt from paying
stamp duty on receivables , Pure factoring
companies have to pay the duty, which differs
from state to state.
PROS & CONS
• Improves the cash flow.
• By offloading the sales accounting and administration,
the management can focus on core competence.
• The reduction in overheads brought about by the
factor’s administration of the sales ledger and the
improved cash flows contribute towards cost savings.
• Factoring could prove to be costlier compared to in-
house management of receivables
• Factoring is perceived as an expensive form of
financing and also as finance of the last resort.
Forfaiting
• Forfaiting is the discounting of international trade
receivable on a 100% "without recourse" basis.
• It is a form of suppliers credit involving the sale or
purchase of receivables falling due at some future date.
• The exporter is responsible for the validity of his order
and execution thereof, but once documentation has been
delivered and accepted and discounting is done, there is
absolutely no recourse to the Exporter, with the
exception of an underlying fraudulent transaction.
• Forfaiting effectively transforms a credit sale into a cash
sale.
Forfaiting
• Traditionally, Forfaiting is fixed interest rate and
medium term (3-5 years) financing.
• It can however, be structured on a floating rate
interest basis as well as for longer periods up to 10
years or for shorter periods down to 90 days.
• Forfaiting is generally suitable for high value
exports like heavy machinery, capital goods,
consumer durable, vehicles, bulk commodities,
consultancy and construction contracts and
project exports.
Characteristics of Forfaiting
• 100% financing without recourse to the seller of the
obligation.
• Importer's obligation is normally supported by a local bank
guarantee or aval.
• The debt is typically evidenced by Letter of credit, Bills of
Exchange, Promissory Notes. Credit periods can range from
90 days to 10 years
• Amounts financed to be upwards of USD 2,50,000/-
• Contract in any of the world's major convertible currencies
can be financed.
• Finance to be either on a fixed (market norm) or floating rate
basis
Steps in Forfaiting
▫ In pursuance of a commercial contract between an exporter and importer,
the exporter sells and delivers the goods to the importer on a deferred
payment basis.

▫ Importer draws a series of promissory notes in favour of the exporter for

payment including interest charge.

▫ The promissory notes/bills are guaranteed by a bank which may not

necessarily be the importer’s bank.

▫ The guarantee by the bank is referred to as an AVAL defined as an

endorsement by a bank guaranteeing payment by the buyer (importer)
Steps in Forfaiting
▫ Exporter enters into a fortaiting arrangement with a forfaiter usually a
reputed bank including exporter’s bank.

▫ Exporter sells the availed notes/bills to the bank (forfaiter) at a

discount without recourse.

▫ The agreement provides for the basic terms of the arrangement such as
 cost of forfaiting,
 margin to cover risk,
 commitment charges,
 days of grace,
 fee to compensate the forfaiter for loss of interest due to transfer and
payment delays, period of forfaiting contract
 installment of repayment, usually bi-annual instalment,
 rate of interest and so on.
Steps in Forfaiting
▫ The rate of interest or discount depends upon
 terms of the note/bill,
 currency in which it is determined,
 credit rating of the Avalling bank,
 country risk of the importer etc

▫ Forfaiter may hold these notes/bills till maturity for

payment by the importer’s bank.

▫ Alternatively, he can securitize them and sell the short-

term paper in the secondary market as high-yielding
unsecured paper
Bill Discounting
• Advances are made against the
bills.
• Bills discounted may be
rediscounted several times before
the maturity.
• The drawer undertakes the
responsibility of collecting the
bills and remitting the proceeds
to financing agency
• Just a Provision of finance
against bills
• Bill discounting is always with
recourse.
• Bill financing is individual
transaction oriented.
• In Balance Sheet’
Factoring
• Trade debts are purchased by
assignment.
• Debts purchased for factoring
cannot be rediscounted, they can
only be refinanced.
• Factor undertakes to collect the
bills of the client
• In addition to the provision of
finance, Factor renders all
services like maintenance of sales
ledger, advisory, services.
• Factoring may be with or without
recourse.
• Several invoices in batches are
processed.
• ‘Off balance sheet’
FACTORING FORFAITING

• Service of Sale Transaction • Individual Sale Transaction

• Upto 80% financed • Upto 100% financed

immediately immediately

• With or Without Recourse • Without Recourse

• Sales Administration done • Sales Administration not done

• Short Term • Medium Term

• Charge Creation as • Charge Creation as

Assignment Assignment
External Commercial Borrowing
• External Commercial Borrowings (ECB) refer to commercial
loans in the form of

▫ bank loans,
▫ buyers’ credit,
▫ suppliers’ credit,
▫ securitized instruments (e.g. floating rate notes and fixed
rate bonds, non-convertible, optionally convertible or
partially convertible preference shares)
▫ Foreign Currency Convertible Bonds (FCCBs)

availed of from non-resident lenders with a minimum average

maturity of 3 years.
ECB can be accessed under two routes:

• Eligible Borrowers

• Recognized Lenders
Automatic Route
• Amount and Maturity

Approval Route • All In cost Ceilings

• End Use
 42

Automatic Route
ELIGIBLE BORROWERS RECOGNISED LENDERS
•Corporate registered except financial •Internationally recognised sources-
intermediaries are eligible. international banks, multilateral
financial institutions example.
•NGOs engaged in micro finance •Foreign equity holder as recognized
activities -subject to certain conditions. lender – Requirements

AMOUNT AND MATURITY

•up to USD 500 million per borrower per financial year would be permitted for Rupee
expenditure and / or foreign currency expenditure. Hotel, hospital and software-
USD 100 mn
•up to USD 20 million or equivalent can be availed with minimum average maturity
of three years.
•above USD 20 million and up to USD 500 million or equivalent with minimum
average maturity of five years.
•Up to 5 million –NGO engaged in micro finance activities
•ECB up to USD 20 million can have call/put option provided the minimum average
maturity of 3 years is complied before exercising call/put option .
END USES PERMITTED

• for investment in real sector - industrial sector including SME,

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

• Overseas direct investment in Joint Ventures (JV)/ Wholly Owned

Subsidiaries

• first stage acquisition of shares in disinvestment process and also in the

mandatory second stage offer to the public.

• For lending to self-help groups or for micro-credit or for bonafide micro

finance activity .

• Payment for Spectrum Allocation

• Infrastructure Finance Companies up to 50 per cent of their owned funds,

for on-lending to the infrastructure sector as defined under the ECB
policy.
END USES NOT PERMITTED

• 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 repayment

of existing Rupee loans
 45

Approval Route
ELIGIBLE BORROWERS RECOGNISED LENDERS
•Infrastructure Finance companies. •Internationally recognised sources-
international banks , capital market,
•Banks & FI in restructuring packages- ECA.
Steel & textile.
•Foreign equity holder as recognized
•NBFCs/ SPVs/ SEZ developers for lender – Requirements (25% of paid
infrstructure. up capital, debt : equity ratio 4:1 )

•Corporate - FCCB.

AMOUNT AND MATURITY

•additional amount of USD 250 million with average maturity of more than 10 years.
Conditions for CONVERSION OF ECB INTO EQUITY

• Activity of the company is covered under the Automatic Route for

Foreign Direct Investment or Government (FIPB) approval for
foreign equity participation has been obtained.

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

• Pricing of shares is as per the pricing guidelines issued under FEMA,

1999 in the case of listed/ unlisted companies.

• Conversion of ECB may be reported to the Reserve Bank

 47

Concept of ‘All in Cost Ceilings’ in both the routes

All-in-cost includes rate of interest, other fees and expenses in

foreign currency except commitment fee, pre-payment fee, and
fees payable in Indian Rupees
All in Cost in respect of both the routes

Average Maturity Period All-in-Cost ceilings over 6 Months LIBOR

Three years and up to five years

300 bps

More than five years and up to seven

years 500 bps

The requirement of minimum average maturity period of seven years for ECB more than
USD 100 million for Rupee capital expenditure by the borrowers in the infrastructure
sector has been dispensed with.
TRADE CREDITS
• credits extended for imports directly by the overseas
supplier, bank and financial institution for maturity
of 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 credit
terms.

• Supplier’s credit represents credit sales by supplier on the

basis of accepted bills or promissory notes.

• Exporters ( overseas sellers) supply goods to Indian buyers on

deferred payment terms on long term or short term basis.
• 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 terms
basis.

• Extent of credit – 100%.

• Interest – LIBOR related

• Security – LC/BG

• Trade credit – less than3 years to be approved Ads for amount

UP to US $ 20 M per import transaction.

* For non capital goods , it is one year.

• ECA (Export Credit Agency) in overseas market offer credit to
Indian importers .

• On supply of goods to importer, ECA disburses, supplier gets

the proceeds

• Encourages exports for the country.

• EXIM bank extends such loans to importers from African and

south American countries to encourage exports from India.
• current all-in-cost ceilings :

Maturity period All-in-cost ceilings over 6

months LIBOR*
Up to one year 200 basis points

More than one year but less than

three  years
Thank You