The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

Negotiable trade documents

Companies can arrange finance by negotiating
trade documents, such as bills of exchange,
promissory notes and other instruments. As
long as the document is negotiable, the holder
of the document can use it to raise finance
without notifying the issuer.
This is a relatively straightforward financing
technique that the holder of the document can
arrange quickly, as long as it can find a party
prepared to accept it. Under a negotiation,
the previous holder of the document transfers
all rights (including future payments) relating
to that document to the new holder. The new
holder is entitled to seek payment from the
issuer of the document under the same terms
as it was originally drawn.

How it works

There are two main forms of negotiable trade
documents.

ƒ Promissory note.
This is a promise by the issuer (maker)
of the note to pay a specified sum to the
bearer or named payee on a set date or
on demand. A promissory note is originally
a two-party transaction.

ƒ Bill of exchange.
Also known as a draft, this is a three-party
transaction. There is an instruction from
one party (the drawer) to another party
(the drawee, the drawer’s customer or a
bank) to pay a specified sum to the drawer
or a third party (the bearer or named
payee) on a set date or on demand. The
drawee must ‘accept’ the bill before they
become liable under it (and may then be
referred to as the acceptor).

As long as the document is negotiable, the
holder (bearer) can use it to raise funds by
transferring its rights to a third party. The
original beneficiary forgoes any right to
claim the funds promised in the document.
In return, the third party will pay the original
holder the face value of the instrument, less
a discount to recognise the time value of
money, and a margin representing the cost of
funds and the credit rating of the drawee.
The method of negotiation varies
according to the nature of the document.

If the document is a bearer instrument

(‘pay the bearer’), the holder can transfer

the document to the third party (a bank

or another company) simply by giving the

document to the third party. If the document

is an order instrument (‘pay a named entity’),

the holder can transfer the document to the

third party by endorsing (signing) and then

giving the document to the third party.

Once an instrument has been negotiated,

the entity to which the instrument has been

transferred (the lender) becomes the payee.

The new payee is then entitled to seek

payment from the drawee/acceptor of the

note or bill under the same terms as enjoyed

by the original beneficiary.

Advantages

There are a number of advantages for

a company seeking to raise finance by

negotiating trade documents.

Drawer

(Seller)

DDDrawerrawer

(S(Seellerller))

Drawee

(Acceptor)))

rrr

DDraDrawweeee

((AcAcceptoceptorr

BuyBuyBuyBuyBuyBuyBuyBuyByyyyyyereerereer

BankBkBaBanknk

(^4 5)
6
goods / service

2

1

3

1. Drawer writes bill of exchange on
   drawee (a bank or a drawer’s customer)
   and sends it to the drawee


2. Drawee accepts the bill (becomes the
   acceptor) and sends the bill back to the
   drawer


3. Drawer sends the accepted bill to a
   bank for discounting


4. Bank pays drawer the bill’s face value
   less a discount


5. On the due date, the bank presents the
   bill to the acceptor


6. The acceptor pays the bank the face
   value of the bill

Transfer of documents

Payment

A discounted bill of exchange