The Treasurer’s Guide to Trade Finance

Chapter 7 Trade financing techniques

Trade-related escrow

An escrow account is used when a buyer

and a seller both want to protect themselves

against counterparty risk. In the case of the

buyer, an escrow account allows the company

to protect itself against the risk that it pays for

substandard goods. In the case of the seller,

an escrow account provides the company

with a guarantee of payment. The bank at

which the escrow account is established acts

as the intermediary between the two parties,

minimising the risk of loss to both.

Escrow accounts are most commonly

used in new trading relationships where two

parties are not well known to each other

and third-party credit assessments are not

readily available.

How it works

An escrow account can be established by

either party, which then asks the counterparty

to transact through that account. The

two parties will then enter into an escrow

agreement with the bank (or other provider)

that will set out the terms and conditions

under which the bank will release cash (or

deposited documents) to the seller. When

the bank receives cash from the buyer it will

advise the seller. The seller will then send the

goods or perform the service under the terms

of the contract. On receipt of advice from the

buyer that the seller has met the conditions

of the transaction, the bank will then release

the cash or documents to the seller. The

documents needed by the bank will be listed

in the escrow agreement and may include a

delivery note, proof of acceptance and/or an

inspection certificate.

The bank will charge an initial fee for

arranging the escrow account and further

fees for every release of payment under the

agreement. Such fees will vary according to

the sums released and the complexity of the

conditions which have to be met for release

to be made.

Advantages

There are a number of advantages to the use

of escrow accounts.

ƒ Terms and conditions can be negotiated

to suit buyer and seller. Both parties can

require specific terms designed to protect

their interests.

ƒ The third-party intermediary reduces credit

risk for both parties. As long as the third

party (usually a bank or other specialist

provider) is trusted by both parties, the

escrow account minimises the risk of loss

for both buyer and seller.

ƒ Buyers can continue to earn interest on

Case study

An escrow account used by a Malaysian rubber producer

selling into Europe

After the escrow arrangement and the

contract are agreed, a German client

prepays the funds into the escrow

account. The exporter ships the goods

to the German warehouse and sends

its bill of lading to the bank managing

the escrow account. On receipt of the

bill of lading, the bank releases it to the

German company, which then takes

control of the goods. At the same time

the bank forwards the funds in escrow to

the Malaysian exporter. In the event of

non-delivery of the bill of lading, according

to the terms of the contract, the funds in

escrow would be returned to the German

importer.