The Treasurer’s Guide to Trade Finance

The Role of Trade Finance in Working Capital

Enhancing sales

When a company is seeking to demonstrate

its creditworthiness to become a supplier

to another company, bank support can be

critical. Bank support can come in two main

forms: first, bonds and guarantees to support

an exporter, especially when tendering for

participation in large-scale contracts, and

second, more general support for exporters

when their credit is being evaluated by a

potential customer.

The use of bonds and guarantees

For larger, typically infrastructure, projects,

companies may be required to provide

bonds as part of their tender. These

effectively work to guarantee that a company

will commit to a project if it is awarded

the contract. A bank would provide a

bond (against an indemnity signed by the

company) to the organisation running the

tender. Under the terms of the bond, the

bank must make a payment of a pre-agreed

percentage of the contract in the event that

the company withdraws after the contract

is awarded. This would cover the cost, for

example, of retendering for a project.

For long-term projects, once awarded the

contract, contractors often have to arrange

performance guarantees. A performance

guarantee is a commitment from a bank

(again against an indemnity signed by the

contractor) to make a payment in the event

that the contractor has not performed a

particular activity by a particular date. A

contractor may have to arrange a series of

performance bonds to cover each stage of a

particular construction contract.

Case study

The use of bank guarantees when tendering for

infrastructure contracts

Companies engaged in infrastructure projects are usually asked to give bank

guarantees at various stages during the tender process.

The buyer may want an initial bank
guarantee for, say, 5–10% of the tender
value of the contract. If the company
then wins the tender, the buyer may
then require a bank-issued performance
guarantee. This performance guarantee
provides reassurance to the buyer of
the financial capability of the supplier,
and the ability to call on the issuer of the
guarantee for an agreed percentage of
the contract in the event that the company
fails to perform or otherwise withdraws
from the contract.

These instruments are critical to the
infrastructure business. They offer

longer-term guarantees which reflect the

nature of the risks. They are also essential

to companies tendering for business.

Holding a bank guarantee is seen by

the awarders of contracts as evidence

of a potential contractor’s ability to raise

finance, and its seriousness in pursuing

the tender.

Bonds and guarantees are used

in both domestic and international

transactions. Obtaining a bank’s

backing is an important part of proving

creditworthiness, which is critical to

longer-term contracts where alternative

suppliers may be difficult to identify.