The UCP 600 (“Uniform Customs & Practice for Documentary Credits”) is the official publication issued by the ICC (International Chamber of Commerce) for trade finance governance.

It is a body of rules on the issuance and use of a letter of credit and applies to 175 countries.

The aim has been to standardise a set of rules aimed to benefit all parties during a trade finance transaction – for that reason, it is designed by industry experts rather than through legislation.

The UCP was originally created in 1933 and has been revised repeatedly by the ICC, with the most recent UCP 600 coming into force on 1 July 2007. Read more →

Export finance specifically refers to the financing mechanisms used by exporters in cross-border transactions.

The term trade finance is an umbrella term that includes export finance, as well as other financing mechanisms like import financing and can even be used for domestic transactions.

Often, this will cover invoice finance, purchase order finance, off-balance sheet lending, letters of credit, and similar funding instruments.

Trade finance is generally not well known in the market but many practitioners regard it as a way of financing trade through the use of a lender’s funds. Read more →

Trade finance includes the following:

• Bonds and guarantees
• Lending facilities
• Issuing letters of credit (LCs)
• Export factoring (companies receive funds against invoices or accounts receivable)
• Forfaiting (purchasing the receivables or traded goods from an exporter)
• Receivables financing, invoice factoring, and invoice discounting
• Export credits (to reduce risks to funders when providing trade or supply chain finance)
• Insurance (during delivery and shipping, also covers currency risk and exposure)
• Supply chain finance
• Foreign exchange and currency products

Cash advances

As the least risky product for the seller, a cash advance requires payment to the exporter or seller before the goods or services have been shipped.

Cash advances are very common with lower value orders, and help provide exporters (sellers) with the upfront cash needed to ship the goods and no risk of late or no payment.

Letters of credit (LCs)

Letters of credit (LCs), also known as documentary credits, are financial, legally binding instruments, issued by banks or specialist trade finance institutions that pay the exporter on behalf of the buyer if the terms specified in the LC are fulfilled.

An LC requires an importer and an exporter, with an issuing bank and a confirming (or advising) bank.

The financiers and their creditworthiness are crucial for this type of trade finance: it is called credit enhancement – the issuing and confirming bank replaces the guarantee of payment from the importer and exporter.

In this section, and in most cases, we may consider the importer as the buyer and the exporter as the seller.

See a worked example here of how trade finance can be used to finance the purchasing of frozen fish from a supplier, to be sold on to end customers:

Documentary collection

Documentary collections differ from a Letter of Credit (read our blog post on the differences between DCs and LCs).

In the case of DC, the exporter will request payment by presenting its shipping and collection documents to its remitting bank.

The remitting bank then forwards these documents to the importer’s bank, which then pays the exporters bank, which will credit those funds to the exporter.

Open accounts

An open account is a transaction where the importer pays the exporter 30 – 90+ days after the goods have arrived from the exporter.

This is advantageous to the importer but carries substantial risk for the exporter – it often occurs if the relationship and trust between the two parties are strong.

Open accounts help increase competitiveness in export markets, and buyers often push for exporters and sellers to trade on open account terms.

As a result, exporters may seek export finance to fund working capital while waiting for the payment.

Retail and commercial banks

Some commercial banks have specialised trade finance divisions that offer facilities to businesses.

Commercial banks represent the majority share of financial institutions globally, although they range in size from small and niche banks to large multinational banks.

Alternative finance and non-bank funders

There are many types of financial institutions that do not use public deposits as a funding resource.

Funding sources include crowdfunded (pooled) investment, private investment, and public market sourced capital.

Read more here.

1. Application

The initial ‘credit’ application drives the process when applying for credit.

Lenders will often ask for information on current assets or collateral that the business owns, including debt and overdrafts, and assets that the company or directors own (such as property, equipment, or invoices).

2. Evaluating the application

The evaluation process will normally involve some kind of credit scoring process, taking into account any vulnerabilities such as the market the business is entering, the probability of default, and even the integrity and quality of management.

3. Negotiation

Eligible SMEs applying for trade finance can negotiate terms with lenders.

An SME’s aim with a lender is to secure finance on the most favourable terms and price.

Some of the terms that can be negotiated can include fees, fixed charges, and interest rates.

4. The approval process and documentation of a loan

Typically, the account officer who initially deals with the applicant and collects all of the documentation will do an initial credit and risk analysis.

This then goes to a specific committee or the next level of credit authority for approval.

If the loan is agreed upon (on a preliminary basis) it goes to the legal team to ensure that collateral can be secured/ protected and to mitigate any risks in the case of default.

Read our full ‘trade finance application process’ here.

From the bank’s perspective, as the regulation burden (i.e., Basel III) has become heavier, SMEs often don’t fulfil certain criteria for banks to justify lending.

As lending money has an associated transaction cost, it is more costly to assess and monitor loans to a smaller, riskier company where profit is less certain, relative to a larger, more profitable, and stable business.

Banks will often ask for the following from any company when filling out an application for any type of business finance:

• Audited financial statements
• Full business plans
• Financial forecasts
• Credit reports
• Details and references of the directors
• Information on assets and liabilities

As well as the cost of lending to SMEs being less profitable for banks, there is a much higher default risk and a greater chance of bankruptcies with SMEs in comparison to larger firms.

The other challenge banks have in lending to SMEs is the lack of security and collateral an SME can provide.

SMEs also face challenges in accessing finance from banks.

In a recent survey by the British Business Bank, 46% of SMEs were looking to grow in the next 6 months, yet awareness of types of finance available and finding sources of finance (especially after being rejected from a bank) are major concerns amongst SMEs.

The perceived high cost of borrowing, lengthy procedures for securing a loan and also the amount of paperwork and documentation required are often off-putting and cumbersome to SMEs.