The Role of Trade Finance in Working Capitalthe world. One benefit of these agencies
is they use the same methodology when
conducting credit checks (although there can
be differences in the information available
from country to country). There are also
national credit check agencies in a number
of countries, which only provide information
on domestic entities. Companies trading
internationally may find these agencies
do not provide coverage for the most risky
counterparties, as a result of a lack of
geographical coverage.
Although the coverage is better than for
credit ratings, credit check agencies cannot
provide cover in every location or for every
counterparty. They may also not cover
recently established potential counterparties
(although there may be access to information
on a new entity’s directors, for example).
Although they are probably quite effective
as indicators of short-term payment track
records, and are a good place to start,
companies should not rely solely on credit
check reports when evaluating a counterparty.
Outsource credit support
A third alternative for companies is effectively
to outsource counterparty risk advice. This
applies when companies choose to factor
their invoices, as they hand over control of
their sales management process to a third
party. Specialists in factoring companies can
identify trends among a company’s existing
customers, and highlight potentially weakening
credits. (In the case of invoice discounting, the
company’s sales management process will be
scrutinised by the invoice discounter, which
may also provide advice on the management
of customers.)
References from a customer’s bank can
be sought with the customer’s assistance.
However, these tend to be very vague, using
statements such as ‘We believe this customer
is good for GBP 50,000’, which do not convey
much useful information.
In all three cases, the information provided
from external sources will only be an indication
of any weakening of credit. The treasurer and
other officers will still need to perform their
own credit checks on these counterparties.
Most importantly, though, the company
should always maintain a dialogue between
all its current and prospective counterparties.
Any suggestion of a weakening credit
should trigger a follow-up conversation with
the counterparty as soon as possible, and
certainly before another contract is agreed.Action to manage counterparty risk
Having identified where the company is
exposed to counterparty risk, the treasurer
will want to evaluate the risk before assessing
what to do.
Essentially, any risk is a combination
of the loss to the company if a particular
event occurs and the likelihood of the event
occurring. For counterparty risk it can be
relatively straightforward to identify the direct
cost of a failure. However, it may be more
difficult to assess indirect costs, especially if
an event affects a company’s reputation. For
example, if a company sells into a foreign
company via an import agent who sells goods
on to the retailer, any failure of the import
agent may result in the goods being delayed
in delivery to the retailer or the final customer.
This may affect future sales, although the
impact will be very difficult to quantify.
If a treasurer identifies a problem with a
current or potential counterparty, it has four
alternative courses of action to follow.
Continue trading.
All transactions involve a degree of risk.
As long as the treasurer assesses the
risk of counterparty failure as tolerable
(perhaps on the basis that the impact
of a counterparty failure would not
result in the failure of the company), it
may be appropriate to continue without
implementing any particular changes.
The company may try to negotiate better
payment terms by, for example, moving
from open account terms to using letters
of credit, although this is clearly subject
to negotiation as well as the availability of
facilities on the buyer side.
Cease or reduce trading.
On the other hand, the treasurer may
consider the potential impact of a
counterparty failure to be too great, given
the likely reward. In these circumstances,
if the terms of the transaction cannot be
renegotiated, the company might be better