Case 1 - Trade Finance
- A company exporting small gifts has been established in Hong Kong for three years. Its operating capital mainly came from trading on credit terms with suppliers and secured property overdraft. Since inception, the global economy remained sluggish and orders from buyers were unstable, causing the company to operate at a loss for three consecutive years.
- To improve the company's performance, the management decided to appoint a designer to develop a series of products in its own brand. Consequently, a large US department store believed that these new products would be well received by the market and placed a large order, requesting a credit term of 90 days and a designated supplier for manufacturing.
- The company negotiated with the designated supplier immediately to request a credit terms of over 90 days so as to maintain adequate cashflow. However, the designated supplier refused to offer any credit terms as they had no trading experience with the company and the products were new. Therefore, the company turned to banks for financing. But it was rejected as its property devaluated and could not be used for re-financing, and the company did not have other collaterals.
- Since the company was not able to get sufficient funds to settle the payment to the supplier, it had to give up the large order and lost a good opportunity for the company to get out of the red.
Problems faced by the small gifts company
- The company required adequate funds for advance payment to the supplier for manufacturing the goods.
- The overseas buyer requested credit terms. The company needed to wait for a period of time before collecting the payment.
- The company had no other collateral available for bank financing.
- The small gifts exporter may consider using the ECIC’s insurance policy and extending it to the bank by a Letter of Authority to obtain the necessary export finance as the insurance policies issued by the ECIC are generally accepted by the banking community as collateral for the discounting of export bills. The ECIC provides exporters with insurance protection against non-payment risks arising from commercial and political events. Policyholders can obtain claim payment of up to 90% of the credit limit in case of buyer insolvency, default, failure or refusal to take delivery of goods, or country risk situations. With written consent from the bank, exporters can authorise the ECIC to pay directly to the nominated bank all claims which may become payable under the Policy. Thereafter, the bank will receive a copy of all credit limits and correspondences associated with the insured risks under the Policy. Banks obtained insurance protection are more ready to offer trade finance to the exporters.
Types of Letter of Authority
- Exporters can choose from three types of Letter of Authority (LA): “Whole Policy”, “Specific Countries” and “Specific Buyers” according to their actual needs. Generally speaking, a “LA-Whole Policy” is suitable for exporters who wish to accord the protection to one single bank. However, if the exporters receive facilities from more than one bank and prefer to arrange its claims to be paid to more than one bank on the basis of shipments to specific buyers or countries, “LA-Specific Buyers” or “LA-Specific Countries” will be appropriate. At any one period of time, protection for a particular buyer or country can be accorded to one bank only.
- Interested exporters should first obtain the appropriate LA forms in triplicate from the ECIC. After completing the relevant sections and sending the whole set to the nominated bank for its signature and chops, the completed set should be returned to the ECIC for signature. Finally, the ECIC will send one copy of the LA to the exporter and the bank respectively. After the authorisation is in force, exporters just need to follow the usual procedures for declaring their shipments via EC-link. Both the exporter and the bank will be notified.
Case 2 - Risk Protection
- Mr. Chan’s company was established in Hong Kong and engaged in export trading. In the early years, the company actively explored overseas markets. Owing to unfamiliarity with the new buyers, Mr. Chan often made business trips to understand their operating conditions, in order to decide whether to accept their orders and trade on credit terms.
- To minimise non-payment risks, Mr. Chan insisted trading on payment in advance or L/C terms with most of the overseas buyers. Credit terms would only be offered to the large and well-established buyers.
- Mr. Chan once conducted business negotiation with a creditworthy overseas company. Orders were obtained successfully and he offered a credit term of 90 days. Yet, the purchase orders were placed by a subsidiary of the overseas company. The difference in the buyer’s name drew Mr. Chan’s attention, but he thought that this minor variation was not important. Everything was normal at the beginning stage of the transactions. But later on, Mr. Chan encountered a sudden payment delay and so he negotiated with the parent company. However, the parent company refused to settle the payment for its subsidiary. The amount involved worth over HK$1 million.
Problems Faced by Mr. Chan
- Mr. Chan needed to visit the overseas buyers personally to understand their operating condition, which took longer time and extra expenses, causing an increase in operating costs. Moreover, those visits could not guarantee true understandings of the financial status of the buyers.
- Recently, the buyer-driven market was filled with keen competition. If Mr. Chan insisted trading on L/C terms, he had to consider the costs and complex operating procedures involved, which might lead to the loss of business opportunities due to inflexibility in the payment terms.
- Mr. Chan had not obtained a legally enforceable contract of sale. He had not verified whether the contractual party was the same as the trading party before signing the contract. Not until the non-payment happened, he realised that the contractual party was the buyer group’s subsidiary. Since the subsidiary was a separate legal entity which bore its own liability in the operating process, Mr. Chan lost more than HK$1 million eventually.
- Mr. Chan can obtain buyers’ information through ECIC’s risk assessment and monitoring services as references when selecting appropriate payment terms for the buyers. The ECIC monitors buyers’ financial status, collects payment experience from policyholders and reviews country risks regularly.
- Insurance protections provided by the ECIC cover all short-term contracts concluded on credit terms including Documents Against Payment (DP), Documents Against Acceptance (DA) and Open Account (OA) of periods up to 180 days. Medium and long term contracts for credit periods of 5 years or above are also offered. The maximum percentage of indemnity is 90%. Mr. Chan may make use of the ECIC's credit insurance cover to offer credit terms to his overseas buyers to seize orders and expand customer base. Apart from traditional markets like the US and Europe, more and more exporters are interested in exploring emerging markets such as Asia, Latin America and Africa. The ECIC constantly provides economic information, for example, bankruptcy news, claims statistics and market information. The ECIC also organises seminars to share underwriting experience with the policyholders so that they can have an in-depth understanding of their target markets.
- A slight variation in the name of a company can represent another separate legal entity and each member of the group is a single legal entity. The ECIC suggests the policyholders to ensure that the buyer name is identical to the one on the contract of sales. For the above case, Mr. Chan can use the ECIC’s policy to cover his buyer for risk protection, and will be assisted by the ECIC staff in obtaining buyers’ background and related information.