The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

balances held in an escrow account,
subject to the agreement between the
three parties.
ƒ As long as the initial agreement permits,
an escrow account can be used to
manage a series of ongoing transactions
between the same buyer and seller.
ƒ The initial escrow agreement can be
used to establish a long-term trading
relationship between two unknown parties.
Escrow accounts can be used to manage
online transactions, for example.
ƒ Sellers can send goods or perform a
service, knowing that funds have been
deposited in the escrow account by the
buyer.
ƒ Buyers can refuse to permit the bank to
release payment if the received goods are
wrong, faulty or substandard.

Disadvantages

As with any technique, there are some
disadvantages.
ƒ Escrow accounts can be difficult to set
up quickly.
ƒ The arrangement is only as secure as the
third-party provider. Both buyer and seller
should evaluate the credit risk of the bank
(or other provider) before entering into an
escrow arrangement.
ƒ The agreement can give rise to cash flow
problems. Some banks may only pay
interest on balances held in an escrow
account for a specified period of time,

for example a month. During this period,

neither the buyer nor the seller has access

to that cash, and no compensatory interest

is being earned by either party. This

additional cost should be included when

evaluating the potential benefits of an

escrow agreement.

ƒ Residual counterparty risk remains.

Although the escrow arrangement

reduces the counterparty risk, events

outside the arrangement can occur that

result in loss to one or other party. For

example, the buyer may be delayed in

authorising the release of payment, or

may refuse to pay at all, adding cost

to the seller. On the other hand, the

buyer may discover problems with the

consignment after the release of the

cash.

ƒ Escrow arrangements offer no protection

against damage in transit. Both parties

will want to arrange transit insurance to

protect against the consequential loss in

the event of the goods being damaged

in transit.

Evaluation

Escrow agreements provide both parties with

the opportunity to reduce the risk of loss as

a result of counterparty failure. They are best

suited where the two parties are unknown to

each other. As the two parties get to know

each other, reliance on the escrow agreement

can be ended.