A Reference Guide to Trade Finance Techniques Prepayment finance.
Another technique to provide funds to a
supplier is prepayment finance. As the
name suggests, this is a credit facility
which is linked to a sales or export
contract. Borrowers will want to avoid
committing to a contract that exposes
them to liability under the structure.
Limited recourse financing.
Exporters/sellers may seek to arrange
limited recourse financing, which
establishes the terms under which
the lender can seek repayment. From
the borrower’s perspective it reduces
their liability such that, in the event of
default, the borrower is only liable for any
debts up to the limit established in the
agreement. Because the borrower will not
be liable for the full repayment, limited
(or non-) recourse financing can be
expensive, with interest charges based
on the borrower’s creditworthiness.
Advantages
As with any structured product, a
structured trade transaction can be
designed to meet the party’s objective,
whether this is to improve cash flow,
reduce risk or support customers and/or
suppliers. Even if the primary objective is
not to enhance sales, managing risk at a
more accurate price will usually result in
lower costs being carried along the supply
chain. This is particularly likely where the
financing is arranged off the strongest
credit in the supply chain.
Financing can be put in place to meet the
specific funding gap, in contrast to general
working capital financing, which may be
underutilised at times.
Depending on the structure used,
this form of finance can support an
international supply chain. Where this
includes suppliers and/or customers, it will
strengthen the relationships between the
various parties, building trust over time.
This is particularly likely where participants
share information about, for example, the
status of approved invoices.
Such structures free participants to use other
assets to secure other borrowing.Disadvantages
The strength of a structured trade
finance transaction is usually dependent
on the credit rating of one entity in
the supply chain. Although such
agreements typically strengthen the
supply chain, all participants retain a
residual risk against that counterparty.
The biggest risk to the supply chain is
that the finance provider will decide to
withdraw financing facilities or reduce its
exposure to the counterparty.
Where the finance provider has recourse
to the strongest credit in the supply chain,
this entity will usually have to report a
contingent liability.
These structures can take a significant
amount of time to agree, and may
include significant set-up costs in terms
of both legal and administrative fees and
management time.Evaluation
Structured trade finance solutions can
be tailored to meet almost any set of
circumstances. They are best when entities
along the supply chain find it difficult to
access finance at a reasonable cost.
This applies particularly to international
transactions, where the liquidity of the loan
markets in different countries varies quite
significantly. However, it is just as applicable
for a company seeking to strengthen its
domestic supply chain.