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TRADE AND PROJECT FINANCE IN EMERGING MARKETS

idh ha el Rowe

Published by Euromoney Publications PLC Nestor House, Playhouse Yard EC4V 5EX Reprinted February 1999 Copyright Q Michael Rowe Reprinted 1999 MICHAEL ROWE asserts and gives notice of his right under Section 77 of the Copyright, Designs and Patents Act 1988 to be identified as the author of this book.

All rights reserved. This publication is not included in the CLA Licence. No part of this book may be reproduced or used in any form (graphic, electronic or mechanical, including photocopying, recording, taping or information storage and retrieval systems) without permission by the publisher Euromoney Publications PLC believes that the sources of information upon which the book is based are reliable and has made every effort to ensure the complete accuracy of the text. However, neither Euromoney, the author, nor any contributor can accept any legal responsibility whatsoever for consequences that may arise from errors or omissions or any opinions or advice given. It is not a substitute for detailed local advice on a specific transaction.

Edited at Euromoney by Beverley Lester Sub editor Charles Kerr Typeset by Data Layout Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham,Wiltshire

Contents
Acknowledgements About the author Foreword xi xii xiii

Part 1 - Overview
Chapter 1 Emerging markets and business
Definitions, trends, regional trading blocs, privatisation and deregulation, adapting to local conditions, joint ventures, regulations,

Profiting from government regulations 1. Investing in Asia -regulations 2. Investing in Eastern Europe -Belarus and Latvia 3. The World Trade Organization and Gatt.

Appendices

Chapter 2 -

Financing techniques in brief


Open account trading , negotiable instruments, documentary collections, documentary credits, factoring, export credits, forfaiting, leasing, project financing, Build Own Operate Transfer (BOOT), raising credits in the capital markets, countertrade,

Islamic banking Financing foreign trade in Morocco Structured borrowing in South Africa : bank study Trade finance services in Chile -bank example

Chapter 3 -

Managing business payments


Credit management, ueasuly management, exchange risks -definition, hedging techniques, securities for payment and performance - guarantees, standby letters of credit, reservation of title, bills of lading, trust receipts. The world of options - some expressions Trade and investment regulations in the Philippines

25

Part 2 - Payment methods and short-term credit


Chapter 4 Negotiable instruments
Definitions, uses, legal framework, formal requirements, UN convention, bills of exchange, cheques and promissory notes, avals and guarantees, rights of recourse and exclusion of recourse, holder in due course, dishonour, international nature.

Corporate table Bills of exchange and promissory notes - UN convention.

Appendix:

Chapter 5 -

Documentary collections
Definitions, uses, charges, security, parties, stages, types of payment, collection order details, presentation and payment. Collection order checklist

45

Chapter 6 -

Documentary credits - general


Definitions, where used, applications, main features, security, nomenclature, costs, legal framework, fraud, blocking payment, developments, trends and automation. Case study: exporting to the CIS Case study: personal comment

53

Chapter 7 -

Documentary credits - procedures


Irrevocable and revocable credits, sight credits, acceptance credits, deferred payment credits, negotiation credits , red clause credits, revolving credits, transferable credits, back-to-back credits, assignment of proceeds, buyer and seller agreement, credit issuance, transmission of credit, advice of beneficiary, checking the credit, credit amendments, presentation of documents, irregular documents, back-to-back reimbursement particular documents, Latin American bankers' acceptances Pre-shipment inspection Appendices : 1. Uniform customs and practice 2. Transport documents 3. Trade terms.

63

Chapter 8 -

Factoring
Definitions, origins, application, types of factoring, with and without finance, with and without recourse, full service factoring, bulk or agency factoring, disclosed and undisclosed factoring, export-import factoring, hedging, risk assessments, master agreement,

Factoring in Turkey Factoring in Morocco Case study - UK export factoring

Part 3 - Medium- and long-term financing techniques


Chapter 9 Forfaiting - general
Definitions, uses, operation, size of deals, advantages, emerging markets, secondaxy trading Forfaiting- what the term means How fortaiting developed

91

Chapter 10 - Forfaiting- procedures


Preliminary action, providing details of proposed transaction to forfaiter, risk analysis, firm commitment, documentation required by forfaiter, instalment payments, no acceleration, UN convention, currencies used, forms of receivable accepted for forfaiting, guarantees and avals, costs.

97

Chapter 11 - Leasing
Definitions, development, uses, finance and operating leases, sale and leaseback. lease receivables discounting, multi-investor situation, domestic and cross-border leases, categories of leasing companies, advantages, concluding leasing a-pements, legal framework and contract drafting

101

Hungarian real estate leasing Leasing in Morocco Costs and structure - an example

Appendices : 1. 2. Cross-border aircraft leasing Leasing in Turkey.

Chapter 12 - Project financing - general


Definitions, uses, characteristics, basic structures, advantages and disadvantages, bank concerns, risks and insurance, lending terms, advisers, lawyers, developments.

111

Mexican roll road Indonesian power station Russian pipeline Pakistan power Project financing and Finnish Guarantee Board

Chapter 13 - Project financing - procedures


Sponsors, lenders, experts, lawyers, Feasibility studies, rights of recourse, loan instalments, project agreements, credit risks, construction risks, market risks, financial risks, political risks, regulatory and legislative issues, dispute settlements, security over project assets, letters of comfort, take-or-pay and throughput agreements, tolling agreements.

119

Sticking points Arbitration

Appendix:

Chapter 14 - Boot operations


Definitions, uses, basic structures, regulations, initiating a BOOT project, contract networks, negotiating with governments, key issues in negotiating agreements, agreements between consortium members, forming the project company, lender's requirements, a,mements with contractors.

127

Some key terms Power in Oman BOOT in eastern Europe

Chapter 1.5 - Interview


BOOT power station - protecting the utility's interests. Interview with Dr Tony Wheeler, Sudies Manager with Ewbank Preece Ltd.

BOT in the Philippines

Part 4 - Countertrade
Chapter 16 - Countertrade - general
Definitions, increasing use, involvement of banks, risk factors, attitude of international organisations and governments, nature of countertrade techniques, barter, compensation agreements, counterpurchase, buyback, advance compensation, offset, switch trading, cooperation agreements, bilateral agreements, clearing accounts, international trading certificates, warehouse receipts, escrow accounts, evidence account Growing applications of countertrade Counterpurchase and buyback

Chapter 17 - Countertrade - management and legal issues


Organising for countertrade :- countertrade strategies, linkage, trading houses, banks, insurance. Legal issues:- Government regulation and contract negotiation, contract structures, framework agreements, effect of default, crediting counterpurchaser, content of agreements, effect of agreements, conaact gap filling.

Compensation deals -case study

Appendices :
1. Offset in Saudi Arabia 2. Countertrade in Indonesia.

Part 5 - Guarantees
Chapter 18 - Guarantees - general
Definitions, uses, advantages, guarantees of suppliers' obligations, tender bonds, performance bonds, advance payment bonds, retention money bonds, maintenance, payment guarantees covering the buyer's obligation, letters of indemnity, customs guarantees, loan guarantees, guarantees in respect of legal proceedings, equipment bonds, transportation bonds, structures, demand guarantees, accessory guarantees, operation of demand guarantees, legal acceptance of demand guarantees, blocking payment. international practice, standby letters of credit. costs. Demand guarantees in Turkey - two cases Appendix: International rules for guarantees.

Chapter 19 - Guarantees - procedures


Contract negotiation, form and contents, reference to underlying contract, guarantee amount, entry into force, expiry, call mechanism, counter guarantee and insurance, ICC rules, working capital, issuing the guarantee, calling the guarantee, blocking payment

Guarantees and documentary credits -case study

Part 6 - Official support for export and project finance


Export credits procedures Development banks

Chapter 20 - Export credits procedures - general


Definitions, Ex-Im banks, credit guarantees agencies, involvement of commercial banks, exports and foreign investments, commercial assessment criteria, risk assessment procedures, information services, private sector insurers, action by OECD, action by European Union, Beme Union, terms of cover, commercial risk, political risk, private sector buyers, public sector buyers, pre-shipment

187

cover and post-shipment cover, cover for exporters and financing banks, specific and comprehensive policies, percentage covered.

E x ~ o rcredits t for Lithuanian ~urchasers

I
193

Chapter 21 - Export credits in emerging markets - country examples


Hungary. Czech Republic, Poland, Slovakia, Romania, Malaysia, Singapore, Sri Lanka, Argentina, Jamaica, Zimbabwe, Cyprus, Israel.

Chapter 22 - Export credit systems in OECD countries -some country examples 201
Japan, Australia, the United States, Canada, the Netherlands, United Kingdom, Germany, France, Italy, Belgium, Austria, Sweden, Finland. OPIC guarantees -case studies

Chapter 23 - Development banks - general


Definitions, business opportunities, objectives, structures, trends, privatisation and private sector financing, ,mwth in export transactions, new approaches, community involvement, role of women in development, financing small businesses, environment. Co-financing Development finance in India

21 1

Chapter 24 - Development banks - the World Bank Group


Structure of World bank, component organisations, evolving role, International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), International Centre for Settlement of Investment disputes (ICSID). Appendices:
1. MIGA guarantees -case studies 2. IFC case studies 3. Wodd Bank speak - a glossary.

215

Chapter 25 - Regional development banks


Asian Development Bank,Inter-American Development Bank,The Multilateral Investment fund. Inter-American Investment Corporation (IIC), Andean Development Corporation, Caribbean Development Bank, Islamic Development Bank, Arab Monetary Fund, Arab Fund for Economic and Social Development, OPEC Fund for International Development, Arab Investment

225

Company, Arab Petroleum Investments Corporation, Arab Gulf Program for United Nations Development Organisation, African Development Bank, East African Development Bank, La SociCtt Internationale pour les Investissements et le Wv6loppernent en Afrique, Arab Bank for Development in Africa, the West African Development Bank, Fosidec, Ecobank, European Bank for Reconstruction and Development, European Investment Bank, European Investment Fund, European Development Fund. Sao Paulo commuter train system Developing projects in Africa Co-financing trade.

Appendices :
1. Borrowing from the Inter-American Development Bank. 2. Asian Development Bank - financing private enterprise.

Part 7 - Conclusion
Chapter 26 - Conclusion
Some useful addresses

Bibliography

Acknowledgements
One of the things that most helped me in writing this book was the readiness of people in different parts of the world to send me documents and supply information on a wide diversity of relevant topics. This enabled me to cite examples and gain an impression of daily practice that would not otherwise have been possible. Many of the organisations that responded to my requests for information are mentioned by name in different parts of the book. This applies particularly to all the export credit agencies and hanks whose activities are referred to later. Among the banks that helped me in this way are:- Bahrain Islamic Bank (and the chief executive of that Bank, Mr Abdul Latif Janahi), Dresdner Bank, F i t National Bank, Commerzbank, Creditanstalt, Banco Centroamericano de Integraci6n Econ6mica, Bangko Sentral Ng Pilipinas, Lloyds Bank Group, Vilniaus Bankas, Belvnesheconom Bank, Banco Continental, CentroBank, Bank Leumi, Banestado (Banco del Estado de Chile), CrCdit Suisse, Banco Santander, DBS Bank, Banco de A. Edwards, UBS (Union Bank of Switzerland), Central Bank of Cyprus, Hongkong Bank, the Bank of East Asia Ltd, the World Bank ,goup, BMCE, The Asian Development Bank, Inter-American Development Bank, European Investment Bank, Bradesco, ANZ and Standard Chartered. Export credits organisations and insurers that provided information include the following :MECIB, MEHIB, EGAP, KUKE, SPE, Compania Argentina de Seguros de Crkdito a la Exportacidn SA, SCECI, Credsure, ECIS, ECICS, National Export-Import Bank Ltd (Jamaica), Israel Foreign Trade Risks Insurance Corporation Ltd, MITI, JTIO, EFIC, US Ex-Im Bank, OPIC, EDC, NCM, ECGO, HERMES, COFACE, SACE, Medio Credito Centrale, Ducroire, Ostreichische Kontrolbank, EKN, FGB, Trade Indemnity (UK) and ERG (Switzerland). The Organisation for Economic Cooperation and Development (OECD) in Paris and the United Nations Commission for International Trade Law (UNCITRAL) in Vienna were both sources of valuable information. INSEAD - an international business school based at Fontainebleau in France - generously provided me with access to its library facilities and amanged for me to meet members of its academic staff. Clifford Chance - an international commercial law firm with roots in London - provided me with documentation in several areas including project finance, leasing, offset and forfaiting. Martin Arnison of Londonbased lawyers Trowers & Hamlins generously allowed me to use material he had prepared on BOOT operations in connection with seminar presentations. Dr Tony Wheeler of Mott Ewbank Preece, Brighton, was also a valuable source of information on power projects and BOOT operations. Volkan Icier of T. Emlak Bankasi, Turkey, was particularly generous with his time in preparing and sending me details of several documentary credit and guarantee case studies. Canadian trade consultant Michael Doyle also furnished useful data on documentary credits. Other sources include Albert Stocker of European Capital London, who provided documentation on BOOT operations, and Leaseurope Brussels, who provided me with documentation on leasing. The International Chamber of Commerce, Paris, kindly showered me with complimentary copies of its international business rules and guides, and also gave me access to the records of its 1995 New Delhi business opportunities conference on the theme Dynamic Asia. Other sources of documentation include Socikt.6 G n i r a l e de Surveillance (SGS) Geneva, the International Union of Credit and Investment Insurers (the Berne Union), the Latvian Privatization Agency and the Industrial Credit and Investment Corporation of India (ICICI). Mr Gerald T West of MIGA (Multilateral Investment Guarantees Agency) kindly sent me several of his own articles as well as documentation on MIGA.

About the author


Michael Rowe is a British lawyer and writer, living in France, who specialises in international business and financial writing. He qualified as a solicitor in England in 1969, and holds the degrees of Bachelor of Laws (London University - London School of Economics 1966), and Master of Laws in European Legal Studies (Exeter University, 1976). From 1976 to 1986 Michael Rowe served as legal anache to the International Chamber of Commerce in Paris, France, with responsibilities in the areas of banking, trade law, commercial arbitration and telecommunications policy. He also has experience in private and corporate legal practice in the United Kingdom. Michael Rowe's previous books include Letters of Credit, (Euromoney, 1985), Electronic Trade Payments, (IBC, 1987). Guarantees, (Euromoney, 1987) and Countertrade, (Eurornoney, 1989). He is COauthor (with F Eisemann and C Bontoux) of Le Cridit Documentaire dans le Commerce Exterieur (Editions Jupiter, Paris, 1985). Among the journals for which he writes are the Inrenational Herald Tribune (Paris), EuroProperry, The European, Banking Technology (London) and MBA Newsletter (New York).

Foreword
Typically, international trade involves a seller in one country providing goods or services to a buyer in another. Projects carry this process one stage further, since the supplier goes to the customer's country and carries out work or installations there. Arranging payment and providing credit for such deals brings into play a host of different techniques. These range from the swapping of shipping documents for money, to interlinked structures under which the supplier operates the facility it has built, and the operation is underpinned by promises from governments, users and syndicated project loans. The changing needs and growing power of emerging markets around the world are adding yet more dimensions to these business and financial relationships. Asia, Latin America, eastern Europe, the Middle East and Africa present a kaleidoscopic variety of business, cultural and political practice, levels of economic achievement or development, belief, hope and opportunity. Yet at the heart of this profusion lies in each case at least one common factor : a seller concerned to be paid and a customer expecting to receive goods, works or services. In an ideal world the first would like the money before he or she delivers, the second would prefer to receive delivery before he or she pays. Essentially this book looks at ways in which this problem may be dealt with in the baffling complexity of the marketplace. Some of these centre on means to secure payment and delivery. Others provide ways of granting credit to the buyer or seller in the most effective way. Several more aim at generating funds by requiring the seller to undertake matching purchase obligations or to operate a completed project. At first glance, nothing could seem further removed from the raging conflicts, fine words, and often cynical calculations of world politics than say, the mechanics of a letter of credit or the lawyers' unpunctuated small print in a syndicated loan agreement. Yet every day, countless deals employing these structures lend concrete expression to the vast movements that are carving out a new global context for business, finance and political argument. These deals include the international trend towards deregulation and privatisation, the opening up of central and eastern Europe, and the rise of East Asia and the Pacific as an economic powerhouse. In years gone by world trade flows used to follow the well-established routes between the industrialised west and the developing countries. Today deals between the newly industrialised and emerging markets are becoming ever more significant whilst the most successful newly industrialised countries have become formidable competitors for global business in many sectors. Also, in line with this increase in business involving emerging markets, there is an ever growing demand for financing techniques that move the emphasis away from traditional country and transfer risks towards the customers' production capabilities. This is boosting a trend trowards more sophisticated and structured financing packages that divide the risks of non-payment in new ways between the financing bank and the supplier. (Bankers often use the expression "structured finance" to mean procedures that knit together several different techniques.) Against the above background most of the procedures described in this book are global in reach. This means that they can be used in deals between emerging markets and also the older industrialised economies of the west. There is nothing inflexible or obligatory about these structures. They are creatures of business and banking practice. Accordingly, parties making use of them are free to negotiate the terms they require according to individual need, local conditions and bargaining power.

PART 1
OVERVIEW

Chapter 1

Emerging markets and business

Introduction
The term "emerging market" covers a huge variety of contrasting country situations in all the inhabited continents of the globe. These range from the greed and unpredictability of Russia to the relentless social engineering of tidy Singapore. For instance, in the Middle East and beyond, the passions and energies unleashed by Islamic revival are also fostering the growth of alternative financing techniques for business. These lay emphasis on sharing risks and profit, rejecting the concept of fixed returns. At the same time the emergence of South Africa as a democratic state seems to give a new perspective to a continent that is often left out of account in business calculations. In much of Latin America, the elected inheritors of the zenerals and colonels battle with the often Byzantine remains of protectionist regulations, and the corruption that surrounds them. China stmggles to reconcile market forces with political control and India struggles with its bureaucracy and lawyers. In Europe the emerging marketeers of the former Eastern bloc countries sometimes hesitate, sometimes push forward with their reforms, but continue to look westwards to a sceptical and frequently timorous European Union. Meanwhile, across East Asia the powerful family networks of overseas Chinese that pull many of the region's business strings are busily welding new strategic alliances with western companies and other global players.
~ ~

Trading blocs
It would be difficult to find a single consistent philosophy that unites this diverse and far-flung collection of nations and regions. There are nonetheless several international trends of great significance for trans-national business and finance. One of these is a move towards greater private sector participation in public works and utilities and the lifting of restraints on the provision of financial services. Another is the strengthening of regional trading blocs. At the beginning of the 19th century, the great Latin American liberator, Sim6n Bolivar, dreamed of - and fought for - a united Southern American continent that would stretch from Mexico to Cape Horn. A more recent statesman - Charles de Gaulle, one-time President of France - entertained similar visions of a Europe reaching from the Atlantic to the Urals. Today the forces that are giving practical shape to some of these ideas derive more of their strength from economic interest than from idealism. The most institutionally advanced of the regional groupings is the 15 member European Union (EU). Bedecked with some of the trappings - though little of the power - of a nation state, the EU often resembles the antics of a bad-tempered working party. Nevertheless member states have managed to agree on the creation of a single internal market and the Union's further objectives include deeper integration. The Americas boast several regional common markets including Mercosur, the Andean Pact, the so-called "Group of Three", and the North American Free Trade Agreement (NAFTA). Regional development banks provide additional financial backing to these attempts at integration. In the Asia-Pacific region, the formal

structures for cooperation such as the ASEAN group, are generally less important than the economic and business dynamic that is pushing the region forwards. Regional groupings also exist or have been talked about in Africa and the Middle East. The big question for business people is whether further development of such blocs will make it easier to do business inside each regional grouping, and whether by the same token trading between the blocs is likely to become less attractive. This question is posed in particularly acute form by the proponents of the theory that the world is dividing into three basic economic zones - America, Europe and Asia. This simple calculation is complicated among other things by the recent hardening of the GATT multilateral trading rules and the creation of the World Trade Organisation (WTO). Neat regional calculations can also be blown asunder when political, social and racial tensions boil over.

Privatisation and deregulation


Some 20 or 30 years ago developing countries were eager to increase production, prosperity and economic independence through central planning and public sector borrowing. Then came the various debt crises, oil shocks, and a turnaround in political philosophies in many western countries. Now the emphasis in emerging markets is on creating a business climate that will attract foreign capital and equity investment. This includes opening up the public sector to private capital and reducing restrictions on cross-frontier capital flows. These moves are encouraging the development of complex projects and project financing structures, such as BOT arrangements, that are discussed later in this book. They are also leading to a greater emphasis on the role of multilateral and regional lending institutions as catalysts for attracting diverse forms of equity and loan capital from a variety of sources.

Local conditions
At one level, business is business anywhere in the world. The structures used to package trade and major project finance deals are the same in Bolivia, Bucharest or Beijing. Also, rapidly developing countries keen to attract business and eastern European states adapting their regulations to the market system, are all drawing up legislation that gives express recognition to the same forms of business and financing instruments. However, at quite a different level markets and business remain intensely local. One very simple example is the frequently quoted difference in negotiating techniques between Western and Chinese business people. The Westerners generally expect to resolve individual issues as they arise, while the Chinese often prefer to make all decisions at the end. Similarly, in many countries the painfully argued and exhaustively drafted written contract, may be regarded more as an expression of an intention to cooperate to mutual benefit, than as a strict set of rules to be. obeyed to the last letter. Undue diligence in taking contract disputes rapidly to litigation or arbitration is also unlikely to enhance future business prospects in parts of the world where negotiation is the accepted procedure. Furthermore, in many parts of the world, whatever the regulations say - or perhaps even more significantly omit to say - it may often be vital for foreign business people to discuss major investment and development plans in advance with key goverment officials. Handled in the right way, such preparation can often avoid many future obstacles and obstructions. Among many others a number of Latin American countries provide good examples of this. In many instances joint ventures provide the vehicle whereby companies from different countries can operate a partnership in local or regional markets. Business people with experience of this type of arrange-

ment typically stress the fundamental importance of ensuring that staff consider that their prime loyalty lies towards the joint venture company rather than to one or other of its parents. If not, conflict and indecision frequently arises. One way of avoiding the problem may be to recruit key staff from outside the business relationship rather than by delegating managers from the partner companies.

Regulations
In many developing countries around the world, governments still apply detailed regulations that can overturn international deals if attention is not paid to them in advance. For example exchange control rules and importlexport licensing can frustrate the intentions of the trading partners Parties to contracts in these instances need first to check carefully what the rules are and what permissions may have to be obtained. Once a contract is signed it may be too late for one party to excuse non-performance to the other by saying that a necessary authorisation was refused. A clause making the contract conditional on the required permissions being obtained can help in these circumstances. A particular difficulty can arise in the case of countries only recently opened to the international market economy. For example, when banks issue letters of credit to underwrite payment on a customer's import, they are supposed to pay out if documents presented by the exporter are in order. If the local bank is new to the practice it may sometimes block payment merely because its customer - the importer - has become unhappy about the deal. For instance, banks acting for Turkish exporters have reported the difficulty on a number of cases involving Turkish exports to parties in CIS countries. In the short term sellers can do little other than insist on a separate payment undertaking from a bank in their own country. In the longer term concerted business pressure through bodies such as the International Chamber of Commerce may help. Agreeing on the optimum payment and financing structures for a prospective deal can constitute a major element in ensuring success. Whilst no amount of clever financial engineering can replace adequate knowledge of local markets and of the other party to a deal, credit terms and structured payment vehicles can help to win business and provide security for payment and performance. Subsequent chapters examine some of the main devices available for this purpose.

Profiting from government regulations


In some cases, restrictive regulations can provide opportunities for new business. One instance is the strong emphasis in many developing Asian countries on the use of documentary credits as a means of monitoring foreign trade. This means that some US and European corporations that regularly buy their supplies in Asia have to pay commissions to banks in both the importing and exporting country simply in order to comply with official requirements and practices. Banks with global networks and both eyes open to potential profit have found one solution to this problem by offering to issue the necessary letter of credit direct from a subsidiary in the exporting country. The importer in the US or Europe gives credit opening instructions to the overseas issuing bank using a PC and telecommunicationslink. One example of this approach is provided by the USbased Core States Bank which runs an operation in Hong Kong.

Appendices

1.

Investing in Asia - regulations

2.

Investing in eastern Europe:Belarus and Latvia

3.

The World Trade Organization and GATT

Appendix 1:

Investing in Asia - regulations

Asia has become a leading region for attracting international business investment, and governments in the region have taken many steps to attract foreign investors by making regulations less onerous and improving market access. Direct investment involves a foreign company establishing a permanent presence and carrying out activities in the local market. Asian countries generally still impose a range of authorisation procedures and resmctions though most have eased their rules considerably over recent years. In China for example, foreign companies and joint ventures require a business licence. These are issued more readily for export oriented businesses and high tech undertakings. Most foreign investments take the form of an equity joint venture. The joint venture law also now permits the incorporation of special holding companies for joint ventures, often referred to as "umbrella companies". Indonesia has largely deregulated foreign investment so far as formal permissions are concerned, though in practice the government still takes a very close interest. In Korea foreign investors are free to start their own subsidiaries or to participate in Korean companies. Restrictions apply to public interest sectors and undertakings with potential dangers for population or the local environment. Malaysia generally encourages private investment and foreign initiative under its new development policy, though special permits are still required for some larger investments. India retains a general licensing structure for direct foreign investments, though approvals are now given with little difficulty for joint ventures with up to 51% foreign shareholding. As part of its transition to a market economy, Vietnam has adopted liberal investment laws. Foreign investments require approval by the Committee for Cooperation and Investment (SCCI). Most forms of corporate structure are permitted though market access for foreigners can still prove difficult because of various restrictions and approval procedures. Most countries in the region offer a variety of tax breaks to encourage foreign direct investments or to favour particular regions or sectors. For example, Thailand offers a tax exemption for a period of three to eight years for specified investment projects. Korea provides tax incentives for specific technology linked operations, whilst Thailand has favourable tax rules for the devlopment of transport systems. Another example is China's special economic zones, open coastal cities and high-tech industrial development zones. Most countries in the region also offer tax advantages for exports. High import duties still exist in most of the region's countries as a result of national policies aimed at export-oriented growth. Various exemptions exist for imports made by exporting companies and in some instances distinctions are also made between businesses that manufacture locally and those that trade but do not manufacture. Generally, in line with international agreements under GATT there is a movement towards the reduction of import tariffs and similar restrictions. Regionally, the ASEAN countries have committed themselves to creating a free trade area with near zero tariffs by the year 2003. Particular concerns often voiced by foreign business investors in the region are the difficulties experienced in pursuing and enforcing legal proceedings and the protection of industrial property rights. The position varies from one country to another and business people acknowledge that overall improvements are being made. Singapore, for instance operates particularly reliable court procedures; in some cases it may be possible to make use of Singapore legal procedures for cases involving other countries in the region. The above was compiled using information provided by the International Chamber of Commerce in connection with its Dynamic Asia conference organised in New Delhi, India on March 27 and 28 1995 which included a presentation on foreign investment and development by Veit Miiller Hillebrand, Executive ChairmanIPresident of Henkel Asia Pacific.

Appendix 2:
Belarus

Investing in eastern Europe - two country examples

The north eastern european Republic of Belarus is one of the democracies that emerged from the break-up of the Soviet Union. It has a total population of 10.3 million people of whom some 1.7 million live in the capital, Minsk. Over 60 % of the republic's GDP is based on industrial output and there are more than 1,400 large enterprises in operation employing in total around 1.5 million people. Belarus has established a two-tier banking system comprising a central bank (National Bank of the Republic of Belarus) and a network of over 40 commercial banks. One of these, Belvnesheconombank (Bank for Foreign Economic Affairs) occupies a dominant position in handling hard currency transactions. It was established in 1991 on the foundations of the Belarussian branch of the USSR Vnesheconombank. One of the priorities for Belarus as it moves towards a market economy is to attract foreign capital, to hasten the development of trade and to introduce new technology and appropriate management principles. The biggest conversion task and one giving rise to a large range of possible investment opportunities lies in the need to find new uses for the vast military industrial complex. In pursuit of its efforts to attract foreign investment, the government has set up a comprehensive legislative framework aimed at providing guarantees to foreign investors. These include guarantees against expropriation and illegal actions of state authorities, unrestricted repatriation of profits of foreign investors, and nondiscriminatory conditions. Moreover, in case legislative changes worsen the position for investors, the legal conditons that applied at the time a given investment was made, continue to be applied for the following five years. In addition, investors participating in joint ventures with a share of more than 30% are able to export all products without licence and to retain all foreign exchange proceeds minus taxes. Such investors are exempt from profits tax for three years after the profit is declared, including the first year's profit. The basic rate of tax on profits is 30%. A reduced rate of 15% applies to enterprises with low profits. The maximum rate of income tax is 30%.

Latvia
Situated on the Baltic sea, immediately to the north of Belarus and Lithuania, the modem Republic of Latvia also came into being as the result of the break-up of the Soviet Union. Its capital is Riga. Latvia has concluded an agreement on free trade and trade related issues with the European Union. It has also adopted a revised customs and tariff law abolishing most export tariffs. The corporate tax rate has been progressively reduced to 25% for all enterprises. Latvia is also pursuing a comprehensive privatisation programme. The law on the privatisation of state and municipal property came into effect in April 1994 and the Latvian privatisation agency was established to cany the programme through. hivatisation is being effected by a variety of means including public offering of shares, international tender, sale of the state equity shares of companies, and state enterprise privatisation projects. In addition, legislation is being put into place to remove restrictions on the foreign ownership of real estate.

Appendix 3:

WTO and GATT

The Geneva-based World Trade Organization (WTO) is the body responsible for administering the worldwide inter-governmental rules on international trade. The first version of these rules - known as GATT (General Agreement on Tariffs and Trade) - was established by member governments in 1947 and came into force in 1948. The WTO, which started operating on January 1 1995, provides a stronger institutional structure for policing and enforcing the GATT rules than previously existed. The basic aim of the rules is to boost international trade by obtaining worldwide inter-governmentalagreement on the lowering of tariffs, the removal of non-tariff barriers and the elimination of discriminatory treatment between counmes. This last concept is generally referred to as the "most favoured nation clause". The rules also call for equal treatment of imports and domestic goods in the internal market (national treatment). The GATT rules have been renegotiated several times since 1947. The latest version known as GATT 1994 entered into effect on January 1 1995. Previously the GATT rules applied only to trade in goods. The latest version extends the provisions to other major areas such as trade in services, intellectual property rights, and investment measures. In the above context, the WTO brings together most of the world's governments. It provides conciliation procedures between members. Panels of independent experts are established to examine disputes in the light of WTO rules and provide decisions. Governments are expected to respect such decisions, but if they do not, then diplomatic pressure provides the only enforcement procedure. The WTO also acts as a management consultant for world trade. Its economists follow developments in the world economy and - as is the way of economists - issue various studies. The secretariat assists developing countries in the implementation of the latest 1994 revision of GA'IT rules through its Development Division and the Technical Cooperation and Training Division. The WTO is also responsible for overseeing the pro,pssive removal of anomalous restrictions that were a feature of previous GATT rules. Of particular interest to many developing countries is the dismantling of export restraints on textiles and clothing. Rules relating to trade in agriculture are to be reformed and grey area trade measures - so-called voluntary export restraints - are to be phased out. The WTO's activities involve a global market in trade and services currently estimated to be worth around US$Strillion a year. The sponsors of the new trade rules calculate that the further freeing of trade under the new GATT rules will bring substantial benefits. They believe that global trade growth will be as much as a quarter higher by the year 2005 than it would have been otherwise, and that by that year world income will rise by over US$500billion annually.

Chapter 2:
Introduction

Financing techniques in brief

The first chapter of this book looked brieftly at the overall situation for business and finance in emerging markets. This chapter looks concisely at some of the main individual procedures that may be used to effect payment and extend credit on international business transactions. The chapter therefore serves as an introduction to the more detailed treatments contained in subsequent sections. In the descriptions set out below, emphasis is given to the uses of the procedures described in the emerging markets context. At the same time the techniques are global in concept and application, and in many cases they can be found in other situations as well.

Payment techniques and short-term credit


Open account trading
An exporter ships goods to the importer and sends an invoice for settlement at an agreed date or at the end of an agreed period. One example would be payment at the end of the month following the month of shipment. The buyer makes payment by methods such as international bank transfer or cheque. This procedure is most used on deals between parties in western European countries in situations where the two companies concerned know each other well and have a long-established trading relationship. So far open account trading terms have been used in a much more limited manner in deals between or with emerging markets. However, in some cases exporters are starting to use open account trading terms as a means of clinching a deal with parties in countries where more traditionally documentary credit terms (see below) might have been insisted on. Emerging countries such as Vietnam, where there is particularly keen competition between western and regional suppliers provide such examples. The advantage of open account trading is that it is simple to administer and involves few banking fees or other costs. On the other hand, it affords the seller no security for payment other than the creditworthiness and good faith of the buyer. The system is particularly attractive to buyers since it gives them the opportunity to examine the goods before making payment. This is an opportunity that can be exploited in various ways, some more honourable than others. In the above situation a supplier from the same region as the importer may have the advantage over a more distant competitor of being able to use more informal know-how and judgement in assessing whether he can take the risk of granting unsecured credit. In the case of exporters operating from distant bases, larger companies that have established comprehensive credit management structures, and that have good access to sources of commercial information, are likely to be better placed than small exporting firms to sell on unsecured terms. Apart from commercial considerations, exporting on open account terms is sometimes difficult or impracticable for regulatory reasons. This is particularly the case in a number of developing countries that require the use of documentary credits for imports. This acts as a supervisory measure since banks issuing import letters of credit can easily be required to report these to the government depamnent responsible for ,panting exchange control authorisations.
11

PAYMENT A N D SHORT-TERM CREDIT MECHANISMS

ACCEPTANCE OF A DRAFT

OF SHIPPING DOCUMENTS

UNDERTAKING BY BUYER OF DISCOUNTING DRAFT OR NOTE

II

1I

DOCUMENTS TO COLLECTGOODS
.NO BANK UNDERTAKING TO PAY

OBTAINS AN INDEPENDENT BANK PAYMENT UNDERTAKING

SELLER CAN OBTAIN IMMEDIATE DISCOUNTED PAYMENT OR PAYMENT ON RECEIVABLES

O PAYMENT WITHOUT SHIPPING

PAYMENT MAY B E WITH OR WITHOUT

Negotiable instruments
Written undertakings to pay, such as bills of exchange (also known as drafts), and promissory notes, are a frequent feature of export and project dealings all around the world. They are employed both as a means of extending credit - usually on a short term basis - to the buyer, and as a device to provide the seller with a negotiable security for payment. For example, an exporter in an East Asian country contracts to ship machine parts to a Middle Eastern buyer. Payment is to take place at sixty days from date of shipment. The seller dispatches the goods and sends to the buyer the shipment documents together with a bill of exchange drawn on the importer which is made payable to the exporter at the end of the 60-day period. The exporter signs the draft as the drawer. The document orders the drawee (the importer) to pay the agreed sum at the stipulated date. The importer accepts the order by endorsing it on the back and returning it to the exporter. This acceptance constitutes an unconditional payment undertaking by the acceptor (the importer) who is thereby obliged to pay the instrument at maturity quite independently of its obligations under the underlying export import contract. Also, the rights of the exporter are fully negotiable and can be transferred to a third party by endorsing and handing over the document. This means that it is possible for the exporter to obtain an immediate cash payment before the maturity date by discounting the instrument to a bank or other third party. The above practice is commonly employed in foreign trade deals, and is a particularly frequent practice on sales between countries in eastern Asia. The discounting of bills is an important activity for many banks in that region that offer trade financing services. The banking service offered may be described as trade bills or acceptance bills discounting, for example.

Drafts are the type of negotiable instrument most frequently encountered in international trade deals. Promissory notes can also be used. These have a similar effect, but they are drawn up and signed by the person undertaking the obligation to pay. They are a promise to pay by one party to another rather than an order to pay moving in the opposite direction. Cheques are also negotiable instruments. Unlike bills of exchange, cheques can be drawn only on a bank and they have to be made payable at sight - that is immediately they are presented. This means that they cannot be used in the same way to grant short-term credit. In addition to being used on their own as the main payment vehicle on a trade deal, negotiable instruments such as bills of exchange can also often be found as one element of more complex payments and financing structures. For example, such diverse vehicles as documentary credits and collections, forfaiting deals and project financing arrangements, often incorporate them as a negotiable security and payment device.

Documentary collections
The seller ships the goods to the buyer in the importing country. Simultaneously, pre-arranged shipping documents are sent to the seller's bank. These documents are likely to include bills of lading, commercial invoices, cargo insurance policies and certificates of inspection. The bank then forwards them to a correspondent bank in the importer's country. The latter undertakes to hand the documents to the buyer only if the buyer pays the sales price. Under this procedure the banks channel the documents but they do not give any payment undertaking themselves. Accordingly this device offers less security than a documentary credit (see below) but in return, the costs are lower. This system nonetheless gives the exporter a measure of security for payment. In the best of situations the buyer will not be able to obtain possession of the goods and clear them through customs unless he can present the shipping documents that are sent through the banking system by the seller. However, the full security of this device applies only if the transport document is a negotiable bill of lading (see further below) andlor if the goods are assigned to the bank presenting the documents in the importing country. If the seller has agreed to supply the goods on short term credit terms he can stipulate that the documents are to be handed over against the buyer's acceptance of a bill of exchange or signature of a promissory note. If he wishes, the exporter can then discount the bill or note with a third party in return for an immediate cash payment. Documentary collections fell out of favour some years ago, particularly for short haul journeys where the goods typically anive at destination quicker than the documents. However, there is now renewed interest in some cases in using documentary collections, as an alternative to documentary credits, for long distance exports involving developing country buyers. This might be suitable for a case where the seller does not require the more expensive security of an independent bank payment undertaking, but that some control over the timing of payment through the banking system is still required.

Documentary credits
These are one of the most frequently used payment devices on international trade deals, particularly for long distance exports involving developing countries. The system provides the exporter with a certainty of payment from an independent bank The buyer on the other hand, knows that payment will not be made unless the seller presents documentary evidence concerning the goods and their shipment. The arrangement is made as follows: the seller and the buyer agree that payment is to be effected on documentary credit terms. The buyer then instructs its own bank to issue the credit in favour of the seller via the seller's bank. The seller's bank sends the documentary credit details to the seller (the credit beneficiary).

SOME FINANCING TECHNIQUES


EXPORT CREDITS FORFAlTlNG LEASING PROJECTFINANCING

AND LONG TERM FINANCE AND GUARANTEES FOR EXPORTERS, IMPORTERS, BANKS AND INVESTMENT

NON RECOURSE FINANCING BY DISCOUNTING RECEIVABLES

BUYER LEASES THE IMPORTED GOODS ON A LONG-TERM LEASE MEDIUM TERM FINANCING OFFERED BY SPECIALIST LEASING COMPANIES AND SUBSIDIARIES OF BANKS AND MANUFACTURERS RENTAL PAYMENTS MAY BE TAX DEDUCTIBLE FOR TAX PURPOSES

LARGE PROJECTS LONG TERM FINANCING OF PROJECTOWNER BANKS ARE REIMBURSED FROM INCOME GENERATED BY COMPLETED PROJECT RECOURSE AGAINST BORROWER AND NON-PROJECT ASSETS EXCLUDED OR LIMITED

MEDIUM TERM MOST USED FOR CAPITAL

SUPPORTED BY GOVERNMENT EXPORT PROGRAMMES

If so requested by the seller, the seller's bank may also add its own confirmation to the credit. This gives the seller an additional independent undertaking of payment from a bank in its own country. The credit contains an irrevocable undertaking by the buyer's bank and the seller's bank if any, to pay the seller on presentation of specified documents relating to the goods and their shipment. The beneficiary of an irrevocable documentary credit enjoys maximum protection against commercial risk since it is assured that its own bank will pay it even if the buyer defaults or is unable to meet its payment obligation. If the credit is confirmed by a bank in the seller's country, the seller also obtains protection against transfer risks since the confirming bank is obliged to pay even if the buyer's bank is unable to transfer funds out of the country. A central concept in documentiuy credit practice is the idea that banks' payment undertakings depend only on the timely presentation of the stipulated documents. Accordingly the buyer cannot prevent the banks from paying if it believes the goods are defective but the documents are in order. Conversely, a seller that has shipped perfect merchandise will not be able to insist on being paid by its bank even if only one of the documents does not comply with the description in the credit. Documentary credits can be used to effect immediate payment on shipment and also to grant short-term credit -typically up to 180 days - to the buyer. In the latter even&the credit may contain a deferred payment provision under which the bank undertakes to pay on the agreed future date. Alternatively, and more usually, the bank undertakes to accept and therefore to pay on maturity a bill of exchange drawn up by the exporter. Since such a bill cames the acceptance of a bank, it will be possible for the exporter to discount it at any time before maturity on favourable terms. Documentary credits may be used not only for export of goods but also services and other longer-tern financing operations. For example forfaiting operations (see below), and individual payments under long term projects such as construction deals

Factoring
Factoring companies buy trade debts at a discount and manage client corporations' collection procedures. Such arrangements are most often suitable for medium sized organisations selling a compact product line to a wide spread of trade customers. Export factoring is dominated by a small number of large networks whose members tend to be bank-owned.

Medium- and long-term finance


Export credits
Many countries around the world have set up export credit support schemes which encourage their home companies to sell abroad by providing interest rate subsidies and guarantees. Nowadays such schemes extend to productive investments abroad as well as to simple cross-frontier sales. In some cases, an official export-import bank (Exim bank) directly provides loans to exporters and their foreign buyers as well as issuing insurance or guarantees against commercial and political risks. In other cases the lending is carried out by normal commercial banks with the benefit of government subsidies and guarantees. In these cases, an official export credit guarantee agency or company provides insurance against payment default and political risks such as expropriation or non-transferability of funds to exporters and lending banks. In some countries private sector insurers are also active in the commercially profitable end of this market. Such systems provide an important way of financing many sales from industrialised countries to the third world. This is especially so where the weak state of the buying country's economy might otherwise render access to funding problematical, or make it difficult to obtain a confirmed documentary credit. They also increasingly offer a means whereby countries with emerging markets are able to boost their own exports to other parts of the world. Most of the rich industrialised countries belong to the Paris-based Oganisation for Economic Cooperation and Development (OECD). Nearly all of rhese adhere with greater or lesser enthusiasm to the OECD's guidelines on export credits and guarantees, sometimes referred to as "the OECD consensus". These seek to reduce the subsidy element in rich countries' export finance provisions and to concentrate the subsidy element on the poorest developing countries. Many large projects involving emerging markets bring in a variety of partners from different countries. Accordingly, it is increasingly common for national Ex-Im banks and guarantee agencies to cooperate with one another in Funding such projects. Typically, commercial banks from different countries plus multilateral and regional development agencies are also involved. (The role of development banks is discussed in chapters 23-25.)

Forfaiting
This device has a number of applications. Its single greatest use is for the medium-term financing of exports of capital goods and equipment where official export credit support is not available. It provides a flexible means whereby a bank or other institution in the seller's country can extend credit to the buyer backed by the guarantee of a bank in the buyer's own country. In outline the scheme works as follows. Seller and buyer agree the terms of their sale including the granting of medium-term credit to the buyer - for example, a period of five years with quarterly repayments.

At the same time the exporter checks with the forfaiter - a bank or specialist institution in its own country that finance will he available for the deal. The buyer accepts a series of drafts or signs a set of promissory notes corresponding to the instalment dates for repayment of the agreed credit. These bills or notes are guaranteed by the importer's bank . This takes the form either of a separate guarantee or of a special endorsement on the bill or note, known as an aval. The exporter presents these documents to the forfaiter, which buys them from the exporter for an immediate discounted cash payment. The discounted sum received by the seller corresponds to the sales price agreed with the buyer. The difference between that amount and the total for which the bills or notes have been drawn up corresponds to the interest payment to be made by the buyer in return for being granted credit terms. The forfaiter makes his profit on the deal out of the difference between the discount price paid and the total sums payable to him under the promissory notes. He can either hold on to the notes and present them for payment on the maturity dates, or he can sell them in the secondary markets that exist for trading in such instruments. An essential element of forfaiting is that the forfaiter buys the documents from the exporter without recourse to the latter. This means that the forfaiter and not the exporter bears the loss if the buyer and the guaranteeing bank default, or if for any reason funds cannot be transferred out of the importing country. Also, the seller will have obtained a commitment from the forfaiter before concluding its deal with the buyer. Accordingly, the seller obtains a similar type of bank undertaking to that obtainable under a confirmed irrevocable documentary credit, but in a situation where longer term credit is being granted to the buyer. The major advantage of this system for the importer is that it gives him access on favourable terms to financing originating in the seller's country. This can also be a vital marketing argument for the supplier before the deal is concluded. The guarantee afforded by the bank in the importer's country gives rise to costs and commissions that have to be paid by the importer, but in return he is able to borrow at a lower rate. In addition, the importer's acceptance of drafts or promissory notes may not encumber its balance sheet to the same extent as a traditional loan would.

Leasing
When used as a financing instrument, this is often referred to as finance or capital leasing to distinguish i t from ordinary or operational leasing. It provides a form of long-term finance under which the importer pays rental fees to hire the goods and have the right to use them, but, initially at least, does not become the owner. The lessor - the party owning the goods and receiving the rent - may be the exporter. More often it is a specialist leasing company or bank that buys the goods from the exporter and leases them to the importer as an investment. Frequently the buyer obtains an option to buy the merchandise at the end of the term. Leasing arrangements are often employed to finance the acquisition of capital goods and equipment such as telecommunications equipment, contractors' plant, oil exploration and extraction machinery, multi-modal transport containers, aircraft and commercial premises. The use of finance leasing is growing among developing counmes. Such countries may make use of the technique for both domestic and foreign transactions. Costs may be higher on leasing structures than on traditional loans, but this drawback is compensated by a number of advantages. Generally rental payments are fully tax-deductible, and leasing finance may be technically less burdensome on the importer's balance sheet than a straight loan would be.

Project financing
This is an arrangement that can be used on large projects such as toll road and rail building, construction of airports. and the building of other works and utilities that will generate income when they are completed. The basic idea is that the lenders look to these future income streams as the sole or principal means of repaying their loans and agree to exclude or limit rights of recourse to the borrowers personally. Typically such projects involve syndicated lending by banks in several different countries and a multiplicity of parties including contractors, suppliers, prospective users and government authorities. In return for excluding or limiting rights of recourse, lenders will usually want various forms of security over the project assets, and the future revenue streams, together with undertakings concerning the future operation of the completed facility. Because of the large stakes and multiplicity of interests involved, project financing deals are particularly difficult to negotiate. (The same can be said of BOOT schemes referred to below). In the context of many developing markets, project financing has the particular attraction of at least partially isolating a viable project from more general concerns about country risk, and thus facilitating access to foreign financing. It also protects the assets of the borrowers other than those contained in the project itself, in the event of failure.

Build own operate transfer (BOOT)


This is a variation within project financing that has been growing more popular over recent years, particularly in the context of privatisation in many emerging markets. A government or government agency concludes a contract with a private sector (usually foreign ) supplier to build a revenue earning facility such as a power station, waterworks or toll road. It is agreed that the contractor (supplier) will operate the completed facility for a specified number of years and take the income earned from the operation during that period. The period is calculated so that the income generated will pay the contractors' costs and profits. At the end of the period the facility is transferred to the government or agency that will thereafter be responsible for its operation. As part of the structure, the contractor itself may be obtaining bank finance on project financing terms. Multilateral lending institutions and national export credits authorities are likely to be present in large numbers in both project financing and BOOT deals. The basic formula is subject to a number of variants. Because of the large number of parties and complexity of legal structures needed to set up this type of arrangement it is probable that there have been more failed negotiations than completed arran,oements.

Raising credit in the capital markets


Large companies in particular, can use the pool of funds provided by the international money markets (the Euromarkets) to raise finance for trade and project operations. This method permits such companies to bypass banks and borrow direct from investors. Banks will be involved in organising the debt issues. The technique in practice is likely to be used to finance part rather than the whole of a large project.

Countertrade
As a matter of principle, countertrade tends to be frowned on by supporters of the open market principle on the basis that it may distort the free play of competition. In practice, it has become an important way of doing business with many developing countries whose foreign debt problems and lack of foreign currency resources make it difficult for them to import goods and services in any other way. Countertrade may also provide a means whereby a developing country can sell its own goods and services on foreign markets that it could not easily reach by other methods. This applies particularly to non-traditional exports for which the exporting country is not well known on international markets. A typical example is where a developing country is trying to diversify from commodity and raw material exports to manufactured goods or value-added food products. The expression "countertrade" covers a host of different individual practices. The basic idea is that an importer agrees to conclude a deal only if the exporter will undertake a compensating import in return. In general, an exporter might agree to a countertrade if this is the only way to conclude a sale or open up a new market, and there is a likelihood that the countertrade product can be sold at a profit. There are various forms of countertrade and terminology and practice may differ. Subject to this, the following are some of the main categories : Countemurchase. The seller undertakes to buy goods from the buyer or from a company nominated by the buyer. Alternatively, it agrees to arrange for their purchase by a third party. The value of the counterpurchased goods is an a,md percentage of the goods originally exported. Buv-back. Under such a scheme a seller of equipment agrees to buy output produced by that equipment. The arrangement is used, for example, in long- and medium-term projects such as supply of rumkey factories and mining materials. In the US buy-backs are often known as direct compensation agreements. Strictly speaking this expression refers to an arrangement whereby a seller agrees to accept part of the price for its product in money and the balance in goods or services. It is also used more loosely to cover counterpurchase and buy-back schemes. Advance cornoensation. The exporter buys the required counterpurchase products before it has exported its own goods. . Goods andlor services are exchanged against other goods andlor services of equivalent value and no money changes hands between buyer and seller. Offset. This technique is most often practised by governments in connection with militaty and major civil procurement contracts. The basic idea is to make the agreement to buy conditional on the supplier's acceptance of offsening obligations such as local content requirementsand transfers of technology to the importing country.

TRADE FINANCE IN ASIA:- EXAMPLE O F CHARGES


THE FOLLOWING ARE EXTRACTS FROM THE TARIFFS PUBLISHED BY DBS BANK. THE BANK IS BASED I N SINGAPORE AND IT OPERATES THROUGHOUT THE ASIA-PACIFIC REGION. THE CHARGES ARE GIVEN BY WAY OF INDICATION ONLY, AND ARE SUBJECTTOCHANGE. ON ISSUANCE OF DOCUMENTARY CREDIT COMMISSION O N ADVISING A DOCUMENTARY CREDIT NEGOTIATION/HANDLING COMMISSION ON AN EXPORT LIC CONFIRMATION COMMISSION ON A DOCUMENTARY CREDIT (INDICATIVE) COLLECTION OF INWARD (IMPORT) BILLS COMMISSION DOCUMENTARY COLLECTIONS COLLECTION OF OUTWARD (EXPORT) BILLS COMMISSION

I /. I :**-

1.8% P.M. (MIN 1.4% FLAT, BUT NOT LESS THAN S$50.00) BORROWER - S$25,00. NON-BORROWER - S$40.00. BORROWER - 118% FLAT (MIN. S$40.00) NON-BORROWER - 118% FLAT (MIN. S$60.00) 118% PM (MIN. 114% BUT NOT LESS THAN 5$60.00)

II *-

1 . 1

BORROWER - l/8% FLAT ( M N S$50.00) NON-BORROWER - 118% FLAT (MIN. S$60.00) BORROWER - 118% FLAT (MIN. S$40.00) MAX. S$200.00 NON-BORROWER: 118% FLAT (MIN. S$60.00)

*-

Bank strategies
Banks involved in emerging market trade and project financing adopt a wide variety of different strategies for delivering services to customers, based on the above techniques. Some are developing a global policy that emphasizes the latest project financing vehicles for multinational corporate customers. Others aim at providing comprehensive support for local exporters. Bradesco - a Brazilian bank - constitutes one example. Agricultural exports still account for a large proportion of that country's foreign sales. One important aspect of Bradesco's activities is providing agricultural producers with pre-export finance in US dollars prior to the harvest season. The bank is also an active player on the money markets in both the United States and Europe. Standard Chartered bank is a London-based institution with a strong leaning towards trade-related activities. In common with many others, it is busily developing trade and project financing vehicles that mix together several different techniques. This approach is sometimes referred to as structured financing. One case involved the financing of a telecommunications project in Malaysia. Standard Chartered arranged a syndicated commercial bank loan combined with an export credit guaranteed by the ECGD agency in Britain. This was made particularly attractive to the borrower through structuring of a fixed rate loan denominated in Malaysian ringgits. Another example is provided by ANZ group, which is present in Europe, Asia and the United States. The group has taken a strategic decision to target its trade and project financing activities on the booming Asian markets and to concentrate on a range of operations in which it can offer particular skills. For instance, ANZ has been building up its expertise on project financing and BOOT deals. This is in part a response to the growing need for commercial funding following reduction in support under many national export credit guarantee schemes. On short-term export finance, ANZ aims at offering tailored solutions for a relatively limited number of large deals, rather than catering for the mass market in financing smaller general exports. ANZ has also launched an Islamic banking activity, using funds invested largely by Mid-Eastem institutions. Trade finance has been the dominant activity of this operation to date, since investors have tended to

look for short maturities. This is now being extended however, so that in some cases maturities of up to four or five years can be covered. Faced with this wide choice, buyers and sellers can make the task of raising finance easier by finding out in advance what sort of area and operations different banks specialise in. It also pays to keep up to date with banks' current appetites for particular markets and products since this fluctuates in line with available resources and changing market conditions.

Islamic banking
Islamic banking -which is based on the concept of sharing profits and risks rather than charging and paying interest - is playing a growing role in financing trade and development projects. Banks operating on this principle have established a significant presence in Asia, Africa and Europe. According to some estimates, the total funds available to the Islamic banking system worldwide, could be as much as $80billion. The Qur'anic prohibition of usury -taken to encompass all forms of interest - provides one of the basic religious cornerstones of this system. At the same time, the prohibition reflects a positive belief that the best economic and social results are obtained through a dynamic interaction of capital, with human thought and effort. Islamic scholars and bankers argue that banking systems inspired by this principle, encourage balanced spending to the good of the community and discourage the unproductive hoarding of wealth and the short-term profit mentality. Against this background, economic woes such as inflation and the debt burden on developing countries, are ascribed in part to distortions caused by more traditional financial systems of the west. Islamic banking institutions based in the Middle East and Asia include Bahrain Islamic Bank, DM1 in Saudi Arabia, Kuwait Finance House and Bank Islam Malaysia Berhad (BIMB). The Jeddah-based Islamic Development Bank (IDB) provides trade and project finance for development purposes. In addition, several western banking institutions have set up departments or divisions that provide trade and project finance according to Islamic principles. Examples are Standard Chartered Bank, Kleinwort Benson and Citibank. Western companies doing business with Muslim countries provide the major focus of their activities. A growing range of instruments cater for the need of Islamic banks and their customers. One particular concern is to devise procedures that can ensure sufficient liquidity in the context of Islamic financing rules. Several of these instruments are based on sales structures. For instance a device called morabaha is particularly appropriate for trade deals. Under this procedure, the bank buys the goods from the exporter and sells them to the importer at a marked-up price. The bank thus makes its profit out of the difference between the two prices. A further procedure is a factoring structure known as Bai A1 Esrisna. Often this is combined with morabaha as a means to boost manufacturing activity in Islamic countries. Production by the seller is financed on a Bai Al Estisna basis, with the purchaser benefitting from a morabaha facility. In addition a technique known as the A1 sulam sale is sometimes employed to finance farmers during the crop growing season. A further risk and profit sharing technique known as Islamic modaraba allows for funding of projects on a participatory basis. Also, Islamic banks in areas such as the Gulf States have devised a number of investment products in which customers can participate in profits and losses. These include deposit accounts, savings accounts, investment deposits for periods ranging from a month to a year, and short- and medium-term investment certificates of deposit, or bonds. Options products and equity funds vehicles are also available.

Financing foreign trade in Morocco


Over recent years, Morocco has abandoned its old system of credit corsets under which bank lending was restricted to specific Limits for particular sectors. At the same time, the authorities continue to regulate business access to funding for foreign trade purposes. In addition, companies in Morocco can benefit from funding provided by a number of multilateral and regional institutions. There are several specific avenues open to Moroccan parties seeking funding for export or import operations. Sgecial regulated systems provide exporters with both pre-shipment and post-shipment financing prior to being paid by the importer. Many of the rules are laid down in central bank circulars. Discretionary rates of interest apply. The amount available to an exporter under the pre-shipment scheme is limited to 10% of the company's preceding year export turnover. When goods have been shipped, the exporter can obtain similar discretionary financing for up to 100% of the sum payable to him by the foreign importer. The period of the loan to the exporter is restricted to 45 days maximum for cash payment sales and 195 days maximum for cases where short-term credit has been granted to the buyer. The above provisions relate to situations in which the Moroccan bank is lending to the exporting company in dirhams, the local currency. Since a change in the regulations in 1986, Moroccan exporters can also obtain funding in foreign currencies in relation to their foreign sales in those currencies. These are provided through specific credit lines opened by Moroccan banks with their correspondents in other countries. This provision is of great practical importance since it permits Moroccan parties to use techniques such as factoring and forfaiting in an international context. It also allows Moroccan exporters the possibility of obtaining financing on more favourable terms when foreign denominated funds are cheaper than dirhams. In addition to the above provisions relating specifically to export sales Moroccan companies involved in exports can also make use of government supported loan schemes for specific sectors such as small- and medium-sized enterprises (SMEs) and young entrepreneurs. They may also be able to benefit from targetted loans and credit lines made available by multilateral lenders such as the World Bank, the European Investment Bank, the International Finance Corporation and the African Development Bank. A further example is provided by the United States Agency for International Development (USAID) which has set up a guarantee fund to facilitate access by SMEs to bank loans. Additionally, a number of Moroccan companies in which French businesses hold a share of the equity, can benefit de DCveloppement under a Francofrom a specific line of credit granted by the Caisse Fran~aise Moroccan partnership agreement.

Structured borrowing in South Africa: Bank study


In common with many other banks, First National Bank of Johannesburg, South Africa, offers large corporate customers multi-optional credit lines. They can be used for a wide variety of purposes including international sales and project commitments. Examples of such facilities include the following: Bullet or single repayment facility. A borrowing arrangement is put in place whereby the capital amount is borrowed for a specific period and is repaid in one amount on a fixed future date. Interest on the instrument or insuuments utilised to fund the arrangement is serviced by the borrower as and when it is incurred. The rate of interest applicable may be fixed or variable.
Fixed maturity variable repayment facility. The capital amount of the facility is drawn down and the repayment structure is calculated to service interest and to repay the borrowing over the fixed period of the arrangement. Interest is of a fluctuating nature. Fixed repayment variable maturity facility. The capital amount of the facility is drawn down and a fixed repayment structure based on an agreed rate of interest is formalised. Changes to the rate of interest applicable to the instrument or instruments utilised to fund the facility will not alter the fixed repayment structure. Such rate changes will either bring fonvard or extend the final repayment date of the facility.

Fixed interest rate facility. Fixed interest rate borrowing facilities can be arranged for any period up to 10 years. Depending on market conditions this period can be extended up to 15 years.

Trade finance services in Chile: Bank example


The Banco del Estado de Chile, a public sector bank, provides a range of payment and financing services to exporters and importers. In outline these are as follows:

Export services
Financing credits granted by Chilean exporters to foreign buyers. This service is available to exporters holding credit documentation avalised by foreign banks. The interest rate is between 0.75% and 2.25% over cost of funds. Pre-shipment credits. These are available to exporters for up to 180 days. The interest rate is between 0.75% and 2.25% over cost of funds. Post-shipment credits. These are available to exporters for a period that cannot exceed the maximum credit period authorised by the Bank of Chile. The interest rate is between 0.75% and 2.25% over cost of funds. Financing letters of credit for Chilean exports to ALADI member countries. This service is available to foreign banks eligible to use the inter-bank clearing arrangement that operates between ALADI members. Up to 90% of the value of the letter of credit can be financed for a maximum period of 180 days. Medium-term credits for sales of capital goods to ALADI member countries. This service provides relevant exporters with non-recourse discounting of bills of exchange and promissory notes drawn under confirmed letters of credit or under collection operations in cases where the bill or note is avalised by the foreign bank. Maturities from one to five years can be covered at interest rates of between 2.5% and 4.0% over financing cost. Guarantees for non-traditional exports. Under the terms of Chilean legislation (Law No 18.645) exporters of goods qualifying as non-traditional exports can benefit from a guarantee of up to 50% of the credit terms that they grant to the foreign buyer. This guarantee can be extended for periods of up to one year at a commission of 1% p.a.

Import services
The bank offers special import financing facilities to Chilean buyers under a series of individual agreements with foreign banks and exporting countries. These include agreements concerning imports of capital goods and grain from the United States, and imports from Switzerland and Sweden. The bank has also concluded several import financing agreements with Spanish banks. In addition, the Banco del Estado de Chile also operates a general import financing scheme using its own funds, and applicable for credit periods of up to 360 days. A separate scheme provides foreign currency credits for up to five years on capital goods imports. Guarantees and avals are also available in respect of undertakings given by Chilean companies to foreign parties.

Chapter 3:
l ntroduction

Managing business payments

Trade and project financing involves essential flows of funds into and out of the selling and buying companies concerned. The techniques outlined in chapter 2, provide means whereby funds may be transferred and credit extended through hanks and other intermediaries. In addition, companies can take various steps themselves to manage and secure these flows of funds in the best possible way. Some of them are described briefly below.

Credit management
Over recent years many large corporations have established credit management departments or similar functions. They can operate both with respect to domestic and foreign sales. The basic purpose of credit management is to ensure that credit is granted only to suitable customers on appropriate terms and that invoices are paid on time. Calculations suggest that as much as 40% of a company's current capital may be tied up in outstanding receivables and that interest losses resulting from late payment often exceed many times over the sums lost on irrecoverable bad debts. Against this background, the credit manager will seek to obtain, and keep up to date comprehensive information on the creditworthiness of current and potential customers. This can be achieved both through informal contacts and from sources such as credit rating agencies, banks and other suppliers. The credit manager may also establish credit limits for each customer in much the same way as a bank applies loan ceilings to its clients, on the basis of their capacity to repay. Finally, a well run credit management department establishes machinery for monitoring invoice maturity dates and taking appropriate recovery action when these are not met. Businesses have always had to take decisions on the credit terms that they will offer to customers and undertake steps for recovery if payment is not made. Credit management as a distinct discipline, together with all the appropriate jargon and credit managers' conferences that now go with it, was first created in the US. Europe followed later and more hesitantly. Some important aspects of credit management - particularly collecting precise corporate information and figures -remain problematical in many developing markets.

Treasury management
Treasury management (or cash management) may be considered the counterpart of credit management. Essentially it is the art or science of handling the company's cash and other liquid resources so as to obtain maximum return at minimum cost. Treasury managers shop around for lines of credit to finance current working capital requirements at the most attractive rates; try to invest surplus short term liquidity at the best yields and to ensure that funds are not allowed to be under-utilised until the very moment needed to discharge a liability. Suppliers - including and perhaps especially exporters - sometimes gain the impression that the main

essence of the treasury manager's art lies in never paying any invoice until at least three overdue reminders have been sent out. This tendency becomes more noticeable when interest rates rise and recession bites. This is where credit management comes in.

Exchange risks
Many of the risks to be found in foreign deals are the same in nature as those present in domestic operations, but with additional risks. One special feature that is different is that of the exchange risk arising from the use of foreign currencies. The issue arises for any party involved in a payment or loan denominated in a different currency from its own.

EXCHANGE RISKS:- SOME HEDGING DEVICES


MATCHING NETTING LEADINC 4 N D LAC
RECEIVABLES A N D PAYABLES INVOICED I N SAME CURRENCY PAYMENTS ARE NETTED WITHIN A GROUP OF COMPANIES ARE BROUGHT FORWARD OF RATE TRENDS

7
I

FORWARD F U N D CURRENCY TRANSACTIONS CURRENCY FUTURES

SALE OR PURCHASE OF CURRENCY FOR DELIVERY AT A FUTURE DATE

AGREEMENT T O BUY OR SELL CURRENCIES AT A FUTURE DATE

CURRENl SWAPS EXCHANGE RISK INSURANCE

EXCHANGE BETWEEN COMPANIES OF RECEIVABLES OR PAYABLES I N DIFFERENT CURRENCIES INSURANCE POLICY AGAINST ADVERSE EXCHANGE MOVEMENTS

Generally speaking, companies operating internationally face several kinds of currency risks. All of these are heightened at moments of volatility in exchange rates. The three main risks may be summarised as follows: Transaction exposure. This is the risk of a cash loss resulting from exchange rate fluctuations during the period between the time when prices are agreed and the time when payment is made or received. Translation exposure (also known as accounting or balance sheet exposure). This arises when a company has assets and liabilities and profit and loss accounts denominated in a foreign currency. The exposure arises because these accounts have to be revalued periodically in terms of the company's home country (reporting) currency.

Economic exposure. Essentially this is the risk that a company's costs may be increased or its competitive position eroded by adverse movements in rates of exchange between its home currency and those of its foreign trading currencies. For example, if a company's home currency is devalued, the cost of essential imported raw materials or parts may rise. In another instance, an exporter that invoices in its home currency may be put at risk of losing to competitors when the national currencies of competing suppliers in other countries are devalued. Various hedging techniques are available for companies that wish to protect themselves against such risks. Some of these. such as matching, multilateral netting, leading and lagging and currency clauses are agreed directly between companies doing business with one another. Others, such as forward currency transactions, futures, options. swaps and insurance, generally involve a financial intermediary such as a bank or insurer. Companies may gain as well as lose from exchange rate movements, depending on the direction in which rates move. Thus hedging removes or diminishes an opportunity for gain as well as an exposure to loss. Widely used techniques for managing exchange rate risks include the following: Matching. This is the technique whereby a company seeks to balance its receivables and payables in the same currencies. Multilateral or intra-company netting. This technique is applicable to large groups of companies that have subsidiary companies in several different countries. The group can set up a netting system for its subsidiaries so that payments due between companies in the group are thrown into a common pool and settlement is effected on the basis of the net balances rather than on each individual item. Each group company receives or pays one net amount in its own base currency from or to a group clearing centre. The clearing centre then trades these amounts in the foreign exchange market. Leading and lagging. This practice aims at accelerating or delaying payments to independent or associated companies when it is calculated that the currencies involved are likely to appreciate or depreciate. Various restrictions apply to the exercise of this technique including limitations imposed by contractual payment terms and the vigilance of tax authorities in the case of dealings between associated companies. Invoicing or currency clauses. Depending on its bargaining position and any applicable exchange control regulations, a supplier may be able to negotiate a contractual clause giving it the ability to invoice in a specified currency or a selection of currencies. This can also include a unit of account such as the IMF's Special Drawing Rights (SDR) or the EU's Ecu which are made up of baskets of currencies. A further approach is to include a clause in the contract stipulating a maximum band of fluctuation between the currency of payment and the supplier's currency. Forward fund currency transactions. This is a very commonly used technique whereby a company sells or buys one currency against another for delivery at or by a future date. The price is determined at the date of the contract. Currency futures. These consist of contracts to buy or sell currencies at a future date with the price fixed at the time of the deal. Thus, unlike the forward currency transaction, the sale or purchase does not take place until the specified future date. Futures contracts can be traded in the futures market. Currency options. Currency options give the option holder the right to buy or sell a specified foreign currency at an agreed price at a future date. He is free to exercise the option or not as he wishes. Currency swaps. This is a device whereby one company with a right to receive or an obligation to make a payment in one currency swaps it with another company having a corresponding right or obligation in a

different currency. The procedure is most often applied to long term loans or investments and banks generally act as intermediaries.
8 Exchange risk insurance. This is offered in relation to overseas transactions by a number of official export

credit guarantee agencies and other insurers.

Securities for payment and performance


The granting of guarantees and securities of various kinds is a vital element of many business deals. This is even more important in international trade and project transactions that may involve many parties at great distance from, and sometimes with very little knowledge of, one another. Many of the payment and financing vehicles outlined in chapter 2, contain their own security devices. In addition, specific securities for payment and performance include the following details listed below.

SECURITIES FOR PAYMENT A N D PERFORMANCE


hi7 PERFORMANCE U\DERTAKCCS

I I

9 9 : : ;
SECURITY OVFK ASSETS
7

I II

LADING

NEGOTIABLE WRITTEN UNDERTAKINGS TO PAY A SUM OF


UNTIL PAYMENT MADE

Guarantees
A guarantee is an undertaking by one party to cany out z second party's obligation to a third party in the case of default. For example, a parent company may underwrite its subsidiary's undertakings by issuing its own guarantee or letter of comfort. In other instances, companies and governments ordering international construction works and other projects routinely require the contractors to provide bank guarantees in respect of tender bids, due performance of the contract and repayment of advances made in the event of later default in performance. These are nearly always provided in the form of a demand instrument under which the guarantee beneficiary (the buyer) can require the bank providing the guarantee to pay a specified sum of money on simple demand

under conditions where the guarantee becomes operable. Banks can also issue guarantees against a buyer's failure to pay the price, though this practice is less common in international business. The more usual course is for the exporter to obtain insurance against non-payment from its national export credit guarantee authority or to negotiate for payment on documentary credit terms. Insurance issued by export credit guarantee agencies is different in principle from a bank guarantee. Insurance is obtained by and at the cost of the party to whom performance is due or whose interest is to be protected. Bank guarantees on the other hand, are issued by and at the expense of the party that is to carry out the performance or make the payment. At the same time insurance companies as well as banks can provide guarantees. However, banks, insurance companies prefer guarantees under which direct proof of default is required before performance of the guarantee can be demanded. Also, insurance company guarantees typically include an option for the insurer to take over performance of the contract as an alternative to paying a sum of money. Because of the more extensive obligations involved, they tend to be more expensive than bank guarantees and are much less commonly encountered in internatonal business practice.

Standby letters of credit


In the United States banks are usually not empowered to issue guarantees. Instead, they provide so-called standby letters of credit which operate in the same way as demand guarantees. Standby letters of credit adopt the same basic structure as documentary credits. They are used in a wide variety of financial transactions in the United States and can also increasingly be encountered in other countries.

Reservation of title (or property)


Ownership of goods in export sales commonly passes from the seller to the buyer when the goods are dispatched by the seller. This applies whether or not payment has been made at that point. However, if the export contract includes an appropriate reservation of title clause, the seller remains owner until it has been paid in full. This allows the seller to take the goods back in case of default. Under some legal systems, the exporter can also claim priority rights over the goads or their proceeds of sale against other creditors of the buyer, particularly in cases of insolvency.

Bills of lading
When goods are loaded on board ship or taken in charge by the carrier, the ship's master issues a document called the bill of lading (EL). This sets out the terms of the contract of carriage and acts as a receipt for the goods. It also constitutes a negotiable document of title to the goods. This means that the seller or buyer holding the B L can transfer ownership of the goods while they are afloat by endorsing the BL. The carrier then has to deliver the goods to the new holder of the bill of lading. The E L can also be endorsed to a financing bank in order to pledge the goods to the bank as security for its loan. In this case the carrier is not entitled to hand over the goods to the buyer unless the bank consents. Generally, negotiable B L s are issued only in the case of maritime transport. However, some multi-modal transport operators (MTOs) also issue negotiable documents for transport operations where the goods will be carried by several different modes of transport. Rail, road and air transport documents are issued only in nonnegotiable form with the goods consigned direct to a named consignee. Usually this will be the buyer unless the goods are consigned to a bank.

Uniform Commercial Code, Article 3 (US)


--

Uniform Law on Bills of Exchange and Promissory Notes, 1932 (Geneva Convention) The term 'bill of exchange' in the language of the instrument; an unconditional order to pay a determinate sum of money; the name of the drawee; the time of payment (or if not indicated the bill is payable at sight); place of payment; name of the person to whom or to whose order the bill is to be paid: date and place of issue; signature of the drawer.

Bills of Exchange Act (1 8822 as amended

(UK)
Unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand o r at a iixed or determinable future time a sum certaln in money to or to the order of a specified person, or to bearer.

Formal requirements

In wr~ting; signed by drawer; unconditional order to pay a sum certain in money; payable on demand or at a definite tlme; payable to order or to bearer.

How negotiated

By endorsement and delivery By endorsement, even i f the bill is not expressly drawn to if made out to order; by order. If the bill expressly delivery alone for a bearer indicates that it is not drawn instrument. to order, it cannot be negotiated, but can only be assigned (an assignee can receive no better right to the instrument than the assignor has to convey).
By acceptance.

By endorsement and delivery if made out to order; by delivery alone for a bearer instrument.

How does the drawee become bound by the bill? Guaranteeing payment

By acceptance.

By acceptance

A party can indicate on the bill that he will pay if the primary party liable dishonours it.

Payment may be guaranteed by an 'aval'on the bill itself or on an 'ailonge'(a separate piece of paper). A simple signature on the face of the bill, if not that of the drawer, i s assumed to be an 'aval'.

The Act does not specifically refer to guarantees, but parties frequently guarantee payment by signature on the back of the bill. The Act provides that where a person signs a bill otherwise than as drawer or acceptor he thereby incurs the liabilities of an endorser to a holder in due course. Normally, notice must be given to each drawer and endorser. Protest is required only for foreign bills.

Procedure on dishonour (nonpayment or nonacceptance]

Notice of dishonour is required to charge the drawer and endorsees. Protest is necessary only if the draft appears to be drawn or payable outside the United States.

Formal protest required. In addition the holder must give notice to his endorsee and to the drawer.

Uniform Commercial Code, Article 3

L"J)
Types of endorsement Special - i n favour of a particular endorsee; or general in blank. The latter makes the draft payable to bearer. It can then be negotiated by delivery.

Uniform Law on Bills of Exchange and Promissoy Notes, 1932 (Geneva Convention) Special or in blank. To show title the possessor of the bill has to establish that he received it through an uninterrupted series of endorsements. Accordingly an endorsement in blank does not turn the instrument into a bearer bill. An endorsement 'to bearer' is regarded as equivalent to an endorsement in blank. Drawer may release h~mself from guaranteeing acceptance but not fram guaranteeing payment. Yes

Bills of Exchange Act (1882), as amended !UK) Special - in favour of a particular endorsee; or general in blank. The latter makes the drait payable to bearer. It can then be negotiated by delivery.

Can drawer exclude rights of recourse against himself?

yes

Yes

Can an endorser exclude recourse against himself? Protection of holder against defects in title

Yes

YB

A holder in due course is entitled to look to prior parties for payment despite defects in title. A holder in due course is one who takes the draft for value in good faith and without notice of defects in the title. Other holders can obtain no better title than the transferor.

Persons sued on a bill cannot set up against the holder defences founded on their personal relations with the drawer or with previous holders, unless the holder, in acquiring the bill, has knowingly acted to the detriment of the debtor. There is no requirement for the holder to have given value. A forged or otherwise ineffective signature does not bind the person whose signature it is or purports to be, but the obligations of the other persons who signed it are nonetheless valid.

A holder in due course is entitled to look to prior parties for payment despite defects in title. A holder in due course is one who takes the draft for value in good faith and without notice of defects in the title. Other holders can obtain no better title than the transferor.

Effect of fraud

Holders, including holders in due course, cannot normally enforce the instrument against a party whose signature was forged or is otherwise ineffmive.

Where a signature 1s forged or is otherwise of no legal effect a subsequent holder in due course has no rights against those who were parties to the bill prior to the ineffective signature.

Trust receipts
A bank finances operations by an importer and takes security interest in the goods being purchased. It releases the goods to the importer before reimbursement of its loan in return for signalwe of a trust receipt by the importer. Under the terms of this document the importer acknowledges that it holds the merchandise in trust for the bank pending reimbursement of the loan. This device is common in England and some other jurisdictions with similar common law legal systems.

The world of options - some expressions


STRIKE PRICE. The price at which an option may be exercised.

PUT OPTION. When an underlying currency is being sold against a base currency.

CALL OPTION. When an underlying currency is being bought against a base currency.
AT THE MONEY. An option where the strike price is equal to the current spot rate for the currency concerned.
IN THE MONEY. An option whose strike price is more favourable than the spot rate for the currency concerned. OUT OF THE MONEY. An option whose strike price is less favourable than the spot rate for the currency concerned. (Information extracted from Lloyd's Bank (Foreign Exchange) Brochure).

I
I

Trade and investment regulations in the Philippines


Freedom to move money and assets in and out of a country is a vital issue on trade deals and projects involving emerging markets. In common with many other countries, the Philippines has liberalised its rules over recent years. The country's central bank - the Bangko Sentral NG Pilipinas (BSP) - plays a key role in administering the foreign trade and investment rules in that country. A brief outline is set out below.

Payments on exports from the Philippines


Most exports have to be billed in a major foreign currency included on a list prescribed by the authorities. Sales to ASEAN countries can be paid for in Philippine pesos. The buyer and seller can agree on payment according to a wide choice of modes ranging from prepayment to open account. The exporter obtains payment by means of a procedure known as export negotiation. This involves the presentaton of a bill of exchange and shipping documents to an authorised agent bank (AAB) in the Philippines. This may be either a local commercial bank (KB) or an offshore banking unit (OBU). Authorised agent banks have to report export negotiations and export payments to the BSP on a daily basis within two banking days after the transaction date. Exporters can convert foreign currency payments received into pesos or retain or deposit them in foreign currency accounts in the Philippines or abroad.

Imports into the Philippines


Goods and commodities may be imported freely unless they figure on the lists of regulated or prohibited commodities. There are four permitted modes of settlement. These are letter of credit (Itc), documents against payment (dp), documents asainst acceptance (da) and open account (ola) arrangements and direct remittance. Payments may be funded by foreign exchange purchased from an authorised agent bank, from foreign currency deposit accounts, or from outside the banking system. The Philippines operates a comprehensive import supervision scheme (CISS). This involves preshipment inspection of all goods valued at US$500 or above on a free-on-board [FOB] basis. The scheme is operated by the Geneva-based SociMC GknCrale de Surveillance.

Foreign investments in the Philippines


Foreign investments have to be registered with the central bank if the foreign exchange needed to service the repatriation of capital and the remittance of dividends, profits and earnings is to be sourced from the banking system. The regulations divide foreign investments into three categories: 1. Direct foreign equity investments in Philippine firms or enterprises. 2. Investments in government securities and/or securities listed on the Philippine stock exchange. 3. Investments in money market instruments andlor bank deposits. Investments in the last two categories above may be registered directly with the central bank or with the investor's designated custodian bank. Full and immediate repatriation of capital and remittance of dividends,.profits and earnings abroad can be made without prior approval on all categories of duly registered foreign investments.

PART 2

PAYMENT METHODS AND SHORT-TERM CREDIT

Chapter 4:
Introduction

Negotiable instruments

Negotiable instruments provide a means whereby a payment undertaking can be detached from any underlying commercial or financial contract and issued in the form of an independent document that can be transferred from one party to another. Cheques , bills of exchange (also known as drafts) and promissory notes provide the main examples of such negotiable instruments. The payment undertaking contained in such documents can also be guaranteed by a third party such as a bank. In business jargon, sums due from a debtor to a creditor including amounts receivable on negotiable instruments are commonly referred to as receivables. When they are evidenced in the form of a negotiable instrument, such receivables become a more liquid asset than, for example, a simple payment undertaking under an expodimport contract. This is because the document containing the payment promise can be more easily traded for an immediate cash payment and as a result there are active markets for discounting commercial paper of this type in most countries. The reason for this is that the buyer of a negotiable instrument knows that it will not be concerned with any disputes regarding the underlying commercial contract and that by following a simple legal procedure involving endorsement and handing over of the document, good title will be obtained to the amounts receivable. Moreover, in cases where a first class bank for example has guaranteed payment, the buyer of the negotiable instrument at the same time obtains the independent security afforded by that guarantee. Negotiable instruments first developed from merchant practice in Europe many hundreds of years ago. One of the purposes of the great trade fairs that used to be held in major European trading cities in the Middle Ages, was to allow merchants to meet and settle their outstanding payment obligations. Today, instruments such as drafts and promissoty notes, play an important procedural role in many international trade and project financing operations. In this context they allow parties to obtain additional security for payments to be made in the future, and ease the way to trading receivables for immediate cash payments. This latter helps to improve the cashflow of trading companies and gives banks and other financial intermediaries a means to maximise flexibility and liquidity in their portfolio management. Bills of exchange or promissory notes are sometimes used on their own as the means of payment between exporter and importer. In addition, they are also widely employed as one element in structured financing operations such as documentary credits, syndicated loan agreements and forfaiting deals.

Legal framework
Negotiable instruments and the rights of parties to them are governed by detailed legislation in most countries. This varies from one country to another though a set of international conventions drawn up in Geneva in the 1930s provide a common mould for a large number of European systems. England applies its own legislative rules which have influenced other countries whose systems are based on English legal principles. These two sources provide the two main families of rules on negotiable instmments. (See box to this chapter for a summary of the main provisions). In addition, the United Nations Commission on International Trade Law (UNCITRAL) has drawn up a model law for international negotiable instruments. It is summarised in the appendix to this chapter.

Because of the very detailed and formalistic nature of legislation on negotiable instruments and the differences between the main systems, the entire outcome of a deal may be radically influenced simply by the law applicable to the bill of exchange or other instrument concerned. One case decided in England well over 100 years ago illustrates this point well. It also demonsuates that despite rapid changes in the business climate and practices, some basic issues retain their validity over time. A bill of exchange was drawn in England and payable in Spain. It was dishonoured by non-acceptance in the latter country. No notice of dishonour was given. This was required by English legislation but not by Spanish law. The English Court of Appeal held that Spanish law applied to the issue. Accordingly the court decided that the endorser of the bill in England was liable on it. He would not have been liable under English law because of the failure to give the notice of dishonour prescribed by English rules (Horn v. Rouquette (1878) 3 QBD 514).

Formal requirements
Negotiable instruments have special legal effects which concern the rights and obligations of third parties as well as the people who originally drew up the instrument. For this reason, documents have to conform to strict formal requirements in order to be legally accepted as true negotiable instruments. These requirements are laid down in national legislation and in the applicable international conventions. One characteristic example is to be found in the 1988 United Nations convention on international bills of exchange and international promissory notes. Article 3 of that convention provides as follows:

1. A bill of exchange is a written instrument which: (a) contains an unconditional order whereby the drawer directs the drawee to pay a definite sum of money to the payee or to his order; (b) is payable on demand or at a definite time; (c) is dated; (d) is signed by the drawer. 2. A promissory note is a written instrument which: (a) contains an unconditional promise whereby the maker undertakes to pay a definite sum of money to the payee or to his order ; (b) is payable on demand or at a definite time: (c) is dated; (d) is signed by the maker.

Bills of exchange
Under a bill of exchange, the drawer writes out and signs the bill instructing the drawee - a bank for example - to pay a specified sum of money either to a third pany or to the drawer (the payee). The bill may either call for payment on presentation (a sight draft) or on a specified future date or event (a tenor or usance draft). The payment order must be unconditional. A tenor draft may be presented to the drawee for acceptance. The drawee accepts the draft by signing on the back. Acceptance constitutes an unconditional undertaking to pay the draft on maturity. The payee and subsequent holders can negotiate (discount) the bill. This means that they sell their rights in

the bill to a third party who then becomes the holder. In return for making an immediate cash payment, the party buying the bill pays a discounted amount which is less than the face value of the bill. This difference between the cash sum paid and the full amount payable on the bill at a later date represents the buyer's interest charge, opportunity costs, and assumption of risk. Drafts are normally made payable to a particular party and if so are transferred by endorsement and delivery. (The latter is the legal term for the physical handing over of the document.) However, they can also be made payable to bearer - that is the party duly holding the bill at any particular time. In this event the endorsement does not name the bearer and the bill is transferred by delivery alone.

BILL O F EXCHANGE

PROMISSORY NOTE

PAYEE

A
>

3
W

P
L"

+ t,

2
DRAWEVACCEPTOR

s 8

MAKER

Cheques and promissory notes


The legal structure of a cheque is similar to that of a bill of exchange. However, unlike a bill of exchange, a cheque must be drawn on a bank and it can be made payable only at sight. A promissory note also has most of the same features as the bill of exchange. The essential difference is that it is not an order to another party to pay but a direct promise of payment by the person who signs the note (the maker). In the same way as the bill of exchange, it must be drawn up in unconditional terms.

Avals and guarantees


In some countries a bank or other party can guarantee payment of a draft or promissory note by giving its aval. By si,ping the note in this way on the back, the bank or other organisation commits itself unconditionally to pay should the maker or drawee default. The practice is well established by legislation in most European countries, in particular those that have adopted the Geneva Conventions, but there is no precise equivalent in English law. The benefit of an aval is transferred automatically when the note is negotiated. Accordingly, the use of an aval is a particularly convenient way of dealing with commercial paper underwritten by banks in the secondary markets. Separate bank guarantees are also sometimes given. These have to be transferred separately, however, and additional procedures may be involved in checking that the bank issuing the guarantee has drawn it up in assignable form and in notifying that bank of any transfers.

Recourse
A draft or promissory note that is traded in the secondary markets may pass through the hands of several holders and other parties including the drawer and a bank that gives an aval. When multiple parties are involved in this way, it may be of vital importance for the ultimate holder to trace the chain of responsibility - that is to know who he can turn to in case of default by the party primarily liable on the instrument. The following case illustrates briefly some of the main principles involved in this situation. An exporter is being paid by documentary credit. He draws a draft which is accepted by the accepting bank nominated in the credit. He then discounts it with his own bank which in turn endorses it to another institution. The accepting bank is bound to pay on maturity. The party holding the bill of exchange at maturity can also have recourse against previous holders all the way back to the drawer. Each person in the chain can cfaim against previous holders and the drawer if the draft is not honoured, whether or not it has been accepted. A party negotiating a draft thus acquires a right of recourse in case of dishonour against the party endorsing the draft to him and previous endorsers. The mere drawing up of a bill of exchange does not oblige the drawee to pay it though. He becomes bound by the draft only if he accepts it. Refusal to pay or accept may constitute breach of an agreement with the drawer, however. For example, a bank on which the draft is drawn may have issued or confirmed a letter of credit including an undertaking to accept drafts. Similarly an exporter and an importer conclude a sales deal under which the seller agrees to afford thirty day payment terms to the buyer. In return the latter undertakes to accept the seller's usance draft when the goods are shipped. Also, under some national legal systems, a purchaser of an unaccepted draft may automatically be assigned the right to sue the drawee for any debt to which the draft refers. French law for example starts from the presumption that the drawee owes money to the drawer. The right to collect this debt, called the provision, is automatically assigned at the same time as the draft itself. Therefore, if the money is owed by the drawee to the drawer, the holder can insist on payment even from a drawee who has not accepted the bill. However, the holder has to show that the debt exists. Unless the daft has been accepted he can have no better right to payment than the original creditor - that is the drawer of the draft. French law is relatively unusual in this respect. Under most other systems no such presumption is made and rights against the drawee arise only when the instrument is accepted.

Excluding recourse
As mentioned above, the drawer of a bill of exchange and all subsequent endorsers become liable to pay the bill if the drawee defaults. However, the very essence of some trade and project financing procedures is that the financing - which may be evidenced by drafts or other receivables - takes place without recourse. For example, a documentary credit is made available by acceptance of drafts drawn on the issuing or confirming bank. That bank specifically undertakes not to exercise any rights of recourse under the drafts since such action would be contary to the basic nature of the bank's credit undertaking. A similar issue arises in the case of folfaiting operations in which the forfaiter discounts bills drawn on the importer by the exporter. In practice, in such cases, the exporter endorses the bills to the financing institution "without recourse". However, under the Geneva Convention system the drawer is not allowed to exclude his liability for non-payment by the drawee and can exclude only liability for non-acceptance. The logic of this is that the drawer of a draft is by the very nature of drawing up such an instrument undertaking that payment will be made. On the other hand, even under the Geneva Convention system, subsequent holders can exclude liability for both non-acceptance and non-payment. Moreover, the problem is avoided where a promissory note rather

than a bill of exchange is used since the person drawing the note up in the first place is the debtor. In addition, banks that offer non-recourse financing will give an undertaking not to exercise their theoretical right of recourse against the drawer of a bill. The problem does not arise in English law which allows the drawer to exclude liability for both non-payment and non-acceptance.

Holder in due course


A vital concept in the context of enforcing payment under negotiable instruments is that of the holder in due course. As mentioned above, such instruments are legally separate from any underlying deal. Holders acquire their right to claim payment from endorsement and delivery of the instrument. Their rights are not generally affected by disputes on the rights and wrongs of any commercial contract which led to the instrument's being granted. To benefit fully from this protection the holder must be a holder in due course. This means that the holder must have taken the instrument in good faith without notice of any defect in its title. Under English law, for instance, the holder is fully protected only if, in addition, valuable consideration was given- normally money payment - for the instrument. French law insists that a draft or promissory note must have been issued for a valid purpose ("cause"). However, court decisions in France have established that lack of such a "cause" does not prejudice the rights of a holder in good faith. Suppose a thief steals a bill of exchange and forges an endorsement on it. English law says that the drawer and endorsers prior to the forged endorsement are no longer liable to subsequent holders. Later endorsers can still be liable to subsequent holders. Many other legal systems including those covered by the Geneva conventions consider that the chain of title is not broken by the forgery provided that the subsequent holder takes without notice of the theft.

Dishonour
Furthermore, all legal systems lay down precise formalities to be observed in case of dishonour (nonpayment). English law provides for notice to be given to all parties affected. Many other countries lay down a procedure called protest. Where this applies, the fact of non-payment has to be offically established and stamped on the instrument by a public notary.

International nature
When an instrument involves parties in different countries, different laws may be applicable to each step. For example, the English Bills of Exchange Act provides that formal validity is governed by the law of the place where the bill was issued, and validity of acceptance and endorsement by the laws of the place where the agreements to accept or endorse were made. The due date of payment under English law is determined by the law of the place of payment, and the rules applicable to notice and dishonour are those in force where these events occur. European legal frameworks applicable to them were later exported to many other parts of the world through subsequent waves of trading and colonisation. Thus the basic principles established for instance, in the Geneva Conventions and English legislation, can be found today reflected in the legal provisions of emerging markets around the world. In addition, the recent UN convention now offers a unified solution for international transactions.

Appendix:

- UN Convention

Bills of exchange and promissory notes

The United Nations Convention on International Bills of Exchange and International Promissory Notes (the convention) was adopted by the UN General Assembly in December 1988. It represents more than 15 years of work by the United Nations Commission on International Trade Law (UNCITRAL). The convention sets out a comprehensive set of rules for drafts and promissory notes used on international deals. It applies only if its provisions are incorporated by reference in the relevant instrument. Also, even then the rules cannot apply unless the bill or note is connected with countries that have ratified the convention. Detailed provisions set out how this connection may be established. The text of the convention reflects a deliberate policy to preserve wherever possible the rules on which the main existing national systems are based. Particular attention was paid in this respect to systems deriving from one of the two main families of legal rules in this area - namely the Geneva Conventions and English law. At the same time, the convention introduces a number of novel provisions aimed at situations where the existing systems provide conflicting solutions. It also attempts to handle the evolving requirements of commercial needs and banking and financial market practices. The convention does not replace existing national legislation. Furthermore, it has no application to instruments involving a single country. Rather it provides a separate comprehensive system for optional use in international cases. The convention is divided into nine chapters as follows :Chapter I - sphere of application and form of instruments Chapter 2 - definitions, general provisions and formal requirements Chapter 3 - transfer Chapter 4 - rights and liabilities Chapter 5 - presentation, dishonour and recourse Chapter 6 - discharge of liability Chapter 7 - lost instruments Chapter 8 - limitation (prescription) Chapter 9 - final provisions concerning acceptance and denunciation by member states.

Holders
When dealing with the rights of the holder of an instrument and the limitation of those rights by the claims and defences of others, the drafters of the convention had to choose between the radically different approaches of the civil and common law systems. The solution chosen was a pragmatic two-tier system that distinguishes between what the convention calls a protected holder and a mere holder. The rights of the former are freed from the claims and defences of other people to a greater extent than are the rights vested in an ordinary holder. This is a compromise between the two systems. For instance under the convention, a person is not prevented from becoming a holder by the fact that the instmment was obtained in circumstances involving incapacity or fraud, duress or mistake, even though these can give rise to a claim or defence on the instrument. Also, a person who is in possession of an instrument its an endorsee or under an endorsement in blank, can be awarded full protected holder status provided that there appears to be an unintermpted series of endorsements. This applies even if any endorsement appearing on the instrument was forged or signed by an agent without authority.

Representations
In addition, unless otherwise agreed, a person who transfers an instrument by endorsement and delivery or by delivery alone, thereby makes a number of representations conceming the quality of the instrument and indicates that he is not aware of any fact that could impair the right of the transferee to payment. The representations as to quality consist of a warranty that the instrument does not bear any forged or unauthorised signature and has not been materially altered.

Guarantees and avals


In addition, the convention includes provisions conceming procedures whereby third parties such as a bank, may guarantee the primary payment obligation. These recognise both the aval that is common to many European legal systems, and the independent guarantee procedure that is more relied on under English law. Under the convention, the promise given by an aval is more unconditional in nature than is a separate guarantee. At the same time, when the guarantor is a bank or other financial institution, it is deemed to have granted an aval rather than the weaker form of guarantee if it merely signs without expressly indicating which form of guarantee it is undertaking to give.

Excluding recourse
Furthermore, the convention contains a rule aimed at facilitating without recourse, financing such as forfaiting operations. Under this rule the drawer of a bill of exchange may exclude or limit its own liability for both acceptance and payment by an express stipulation on the bill - for example by drawing up the instnment "without recourse". This stipulation becomes effective only if another party is or becomes liable on the bill.

Interest and exchange rates


The convention contains a number of provisions that allow for additional flexibility in the context of modem commercial and financial practice. For example, it expressly permits instruments to bear interest at a variable rate without loss of negotiability, and it also allows reference to a rate of foreign exchange outside the instrument in calculating the amount payable. This could be a particular bank exchange rate for example.

lnstalrnents and acceleration causes


The convention also allows instruments to be made payable by instalments at successive dates. Such instruments may also contain an acceleration clause. This is a stipulation that upon default in payment of any instrument the entire unpaid balance becomes immediately due. This provision could also be helpful in situations such as forfaiting where the buyer agrees to repay by instalments, with each instalment evidenced by a tenor or usance draft or promissory note. Under existing systems, a separate bill or note has to be issued for each instalment, and since each such instrument is legally independent of all the others the holder's rights to sue for payment in case of default are limited to the particular instrument on which default occurs.

Currency units
Further, the convention also creates a regime under which instruments may be made payable in units of value other than the official currencies of nation states. This is accomplished by defining the terms "money" and "cu~~ency" to include monetary units of account established by inter-governmental institutions or agreement

between states. Examples are the Special Drawing Right (SDR) of the International Monetary Fund, the European Currency Unit (ECU) and the Unit of Account of the Preferential Trade Area for Eastern and Southern African States (UAPTA). The convention also contains a new rule providing for the selection of a different currency of payment in cases where the monetary unit of account in which an instrument is payable is not transferable between the person liable to pay the instrument and the person receiving the payment. When bills or promissory notes are drawn up in a currency different from that of the place at which payment under the instrument is to be made, disputes often arise if the person making the payment attempts to do so in his local currency. Such controversies are typically connected with exchange rate fluctuations. In an attempt to minimise conflict on this point, the convention includes an express provision that unless otherwise indicated, payment must he made in the currency in which the instrument is drawn up. Most often this will be the currency of the country in which the payee or its bank is established.

Electronic signatures
The convention additionally attempts to adapt the law to new technology by providing that the word "signature" includes not only a handwritten signature but also a facsimile or an equivalent authentication effected by any other means.

Lost instruments
In addition, new rules are provided concerning lost instruments. In particular, a p a y from whom payment of a lost instrument is claimed, may require the party claiming payment to give security in order to indemnify it for any loss that it may suffer by reason of the subsequent payment of the lost instrument.

Protest
In many jurisdictions - common law ones in particular - highly precise rules apply concerning the necessity of making a formal protest in case a negotiable instrument is dishonoured. The Geneva Convention on the other hand is lacking in regulation on this point. The UN convention aims at a compromise between these two by including protest rules that are less formalistic than those generally applicable in common law jurisdictions. The convention provides that unless an instrument stipulates that protest must be made, such protest may be replaced by a declaration. This is written on the instrument and signed and dated by the drawee, the acceptor or the maker. In the case of an instrument domiciled with a named party for payment by that party, the declaration must be to the effect that acceptance or payment has been refused. The period normally allowed to make protest under the convention is four business days.

Prescription
In addition, the convention provides a single period of prescription or limitation of actions. It is set at four years for almost all actions arising on an instrument under the convention. The only exception is that where a party pays an instrument on which another was primarily liable, the party's action for reimbursement (recourse) is barred after one year.

Chapter 5:
Introduction

Documentary collections

Documentary collections provide a means of payment whereby the exporter can ensure that the buyer should not be able to take possession of the goods until the buyer has paid or given a negotiable payment undertaking. In return for this payment or payment undertaking, the importer receives documents allowing possession of the goods. The system is appropriate to cases in which the seller is unwilling to provide the merchandise on open account terms but does not need a bank undertaking such as a documentary credit. When a documentary collection procedure is agreed between buyer and seller, the exporter ships the goods and sends the supporting documentation covering the shipment through the banking system to a bank in the importer's country. Such papers characteristically include the bill of lading or other transport document, cargo insurance policies, inspection certificates and certificates of origin. The buyer needs these documents to obtain possession of the goods and clear them through customs. In cases where immediate payment has been agreed on, the banks are instructed to release the documents against payment by the importer. In other cases the banks are instructed to release the goods against the acceptance or signature by the importer of a bill of exchange or promissory note payable at the agreed date for payment. Under this system banks handle the same sort of documents that they process in documentary credit operations. However, in this instance the banks give no payment undertakings. Their essential role is to forward the documents and to ensure that they are not released to the buyer unless the appropriate payment is made or the agreed payment undertaking obtained. Some of the main international rules and practices applicable to such operations have been codified by the International Chamber of Commerce (ICC). These are published in the form of the Uniform Rules for Collections (URC) and banks in countries across the world incorporate them by reference in collection transactions. The latest version of the URC was drawn up in 1995.

Uses
The documentary collection procedure can be used as a means to effect payment on exporidimport transactions in all parts of the world. Recently its use has been increasing in deals involving sales by parties in industrialised countries, to companies in developing countries. This applies in particular to a number of situations in which sellers previously insisted on documentary credit terms. The reasons for this include an increasing readiness on the part of western sellers to accept greater risk in order to conclude deals and the growing sophistication of companies in many emerging markets. Characteristically the main banking charges are the following: commission for the delivery of the documents against acceptance or payment; commission for the collection of the amount payable under the bill of exchange or promissory note on maturity; and

commission for the release of the goods when the documents are addressed to a bank in the buyer's country or to a forwarding agent and the documents are to be held at the bank's disposal. At least two banks will be involved. These are the exporter's bank (the remitting bank) and a bank in the buyer's country (the collecting bank). Both of these will charge commissions. In some cases the transaction may also involve further charges and expenses. Examples are actions taken to protest the dishonour of a bill, the return of documents in the case of refusal, and postage plus related expenses. In a documentary collection the exporter cannot be sure at the time of the dispatch of the goods that the buyer will pay the sum owed. Accordingly this form of settlement is most appropriate if conditions such as the following are met: the exporter has no doubt about the buyer's willingness and ability to pay. This situation may arise particularly if there is a long-standing good business relationship between the exporter and the importer; the political, economic and legal environment in the importing country is generally believed to be a stable one; and the buyer's country has placed no restrictions such as exchange controls on imports, or if it has, then all the necessary authorisations have been issued. The procedure does not give the exporter the same payment security as a documentary credit. However, it is cheaper and more flexible. Also, it relieves the exporter of a large part of the administrative work connected with the collection of documents. In addition, major banks have established worldwide networks of contacts from which the exporter benefits when arranging a collection operation.

Parties to documentary collections


In the simplest case there are four parties to a documentary collection operation. These are as follows : The exporter. In the context of a documentary collection operation, the exporter is referred to as the principal, since it is the party on whose behalf the banks carry out the collection. The remitting bank. This is the bank instructed by the exporter that sends the documents for collection to a bank in the importer's country. The presenting bank. This is the collecting bank in the importer's country which presents the documents to the importer. The importer. Sometimes a further intermediary bank is involved in hnsmitting documents andlor payment between the remitting bank and the presenting bank. The URC refer to this additional intermediary bank as the collecting bank.

Stages of a collection operation


In general terms a documentary collection operation involves three main phases. In the first of these the buyer and seller agree that payment will be made on documentary collection terms. They determine how

payment is to be effected and what documents are to be presented. In some cases the seller sets these terms out in a standard form offer which becomes effective when accepted by the importer. In other instances they are negotiated between the parties. It is particularly important that all the main terms and conditions on which papers are to be collected are agreed between buyer and seller at this stage. Payment delays or a refusal to take up documents are likely to occur at a later stage, if there is any lack of clarity on issues, such as the timing of payment, or the documents to be submitted, showing that the goods have been shipped. It should be noted that the role of the banks is limited to checking thatthe documents listed in the collection order have been submitted and presenting them to the buyer. They have no obligation to examine the contents of the documents or to decide whether they are in accordance with the underlying sales terms. The second stage takes place when the export contract has been concluded. At this stage the exporter assembles all the necessary documents such as the invoice, bill of lading, insurance certificate, certificate of origin and so on. They are then sent to the exporter's bank (the remitting bank) together with the collection order. The remitting bank then sends the documents together with the necessary instructions to the bank that is to cany out the collection (the presenting bank). In stage three, the presenting bank informs the buyer of the amval of the documents and notifies it of the terms on which these documents will be released. The buyer makes payment (or accepts a bill of exchange, or signs a promissory note) and in return receives the documents. The presenting bank then transfers the collected amount to the remitting bank which credits it to the exporter's account.

Types of payment
There are two main categories of payment - documents against payment (DP) and documents against acceptance (DIA). In the D P situation the presenting bank is authorised to release the documents to the importer. Where payment is to be made on documents against acceptance terms, the presenting bank releases the documents to the importer against his or her acceptance of a bill of exchange. It is also possible to stipulate that the buyer should sign a promissory note, though in practice bills of exchange are more common. Characteristically, payment terms of between 30 to 180 days after sight are agreed between the exporter and the importer, and the appropriate period is stipulated in the bill of exchange. Alternatively, a fixed future date may be stipulated. Under a DIA arrangement the importer gains possession of the goods before making payment. If they are sold immediately the proceeds can be used to pay the bill of exchange. The importer thus obtains a period of credit and is relieved of the need to arrange short term inventory financing. When the goods have been released, the exporter's only security is the bill of exchange accepted by the importer. While waiting for the bill to mature, the exporter accordingly bears the risk of non-payment. In some instances the seller may be able to arrange for the importer to have the bill guaranteed by the collecting bank or by another banking institution. This may take the form of an aval or independent guarantee depending on applicable law and practice. In either event the seller reduces its own risk. This will improve the ability to discount the bill, get it accepted as security for a bank advance, or sell it to a forfaiter. In addition to the above two payment techniques, a third alternative known as acceptance with documents against payment is also sometimes encountered. This procedure is used mainly by some East Asian companies and banks. Under this variation, the exporter gives instructions that on presentation of the documents the importer is required to accept a bill of exchange maturing at a later date - for example 60 days after sight. However, the exporter also stipulates that the documents may not be released to the importer until the bill has been paid. Pending payment the goods are to be kept in a warehouse. This technique provides the buyer with a short-term credit period during which it may, for example, seek buyers for the goods. At the same time it gives the exporter the security of knowing that the goods will not be handed over until they have been paid for.

SELLER

REMllTlNG BANK

1 31
COLLECTING BANK

' : ~ ~ ~ ~ $ ~ $ %
BILL OF LADING COMMERCIAL INVOICE BlLL OF EXCHANGE

BUYER

Collection order details


Banks that regularly handle documentary collections, maintain a supply of their own standard collection order forms for customers. These may be based on the model forms drawn up by the ICC to accompany its Uniform Rules for Collections. The following points figure among the many items to which the exporter should pay careful attention when completing the collection order for its bank. Full and accurate address of the buyer should be given. Failure to do so may lead to serious delays in the payment procedure.

The seller should indicate whether documents are to be released against payment or against acceptance. If no such stipulation is made the presenting bank will not release the documents unless full payment is received.
In order to ensure that the operation proceeds smoothly, the exporter should be satisfied that the documents being presented will comply with all the relevant laws and regulations in the buyer's country. In case of doubt enquiry may be made at the relevant country's consulate.

In addition, the document details need to be consistent. For example, packing marks and numbers should be the same on all relevant documents as should the ports of loading and discharge and the name of the carrying vessel.

In cases where a negotiable marine bill of lading is to be presented, the document acts as a certificate of title and the goods can be released only to the regular holder of the bill. Accordingly, problems can arise in particular, if in such instance the goods are consigned to the order of the importer and the importer fails to take up the documents and endorse the bill of lading. Consequently, it would not be possible to dispose of the goods. This problem is avoided if the exporter endorses the bill in blank - that is without naming a specific holder. If goods are dispatched by air, post, road or truck directly to the importer's address, they will be handed over to the importer regardless of whether or not the sales price has been paid or a bill of exchange accepted. This is because documents of this type are not negotiable documents of title and the canier is authorised to hand the goods over to the person named as consignee. To avoid this problem, the exporter may be able to address the goods to the presenting bank or to another collecting bank involved in the operation. However, in such cases the consent of the bank in question must first be obtained. If the collecting bank has expressly agreed to the goods being dispatched to its address, its sole obligation in the event of non-payment or non-acceptance by the importer is to give immediate notification to the remitting bank. The warehousing, sale or return of the goods is then the responsibility of the exporter or its representative in the country of destination. If the collecting bank offers additional assistance the costs will be for the exporter. If the exporter knows the identity of the importer's bank or wishes a particular bank to be entrusted with the collection, it should state the exact name and address of this bank in the collection order. In the absence of instructions from the exporter the remitting bank will entrust the collection to a correspondent bank of its own choice in the importer's country. Generally speaking the bank's only obligation is to choose a presenting bank with reasonable care and pass on the correct instructions. If payment is on D/P terms, the seller will provide a bill of exchange drawn on the buyer and payable to the seller. Depending on the insauctions contained in the collection order, the presenting bank will return the accepted bill to the remitting bank for delivery to the exporter or retain it in safekeeping until maturity. In the absence of instructions to the contrary the remitting bank will debit its own commissions and expenses plus those of the collecting or presenting bank to the exporter . The latter can however give instructions that the commissions andlor expenses are to be borne by the buyer. In addition the exporter should give the name and address of a representative or agent in the country of destination who in the event of non-payment will be able to attend to the warehousing, resale or repatriation of the goods. This party is known as the "case of need. The collection order should also state whether the presenting bank may take instructions from the case of need and if so in what respects. Precise instructions on how the proceeds of the collection are to be paid to the exporter will speed up the transmission of payment and prevent misunderstandings.

Presentation and payment


When the presenting bank informs the buyer of the anival of the documents, it will normally include photocopies of all of them. These provide the buyer with the essential facts about the goods . They tell the buyer whether the documents received by the bank will enable it to take delivery and clear the goods through customs. The buyer may go to the bank's offices and examine the papers there. However. the bank will not allow inspection of the goods at the place of destination without express authorisation from the exporter. In a documents against payment transaction, the presenting bank forwards the proceeds of the collection to the remitting bank immediately after payment has been received from the buyer. However, in countries without freely convertible currencies, difficulties can arise if the buyer does not have the required amount of foreign exchange at its disposal. A practice now adopted by some banks, with the agreement of buyers and sellers, is to release the docu-

ments to the buyer against the deposit of an equivalent amount in local currency together with an exchange risk guarantee. The buyer can then take immediate possession of the goods even if the necessary foreign currency is not available at the time. The presenting bank then forwards the proceeds to the remitting hank as soon as the required foreign exchange becomes available. However, any differences caused by exchange rate movements have to be paid by the buyer.

Collection order checklist


The following checklist is suggested by Cridit Suisse in its manual on documentary credits, documentary collections and bank guarantees which it has prepared for the guidance of customers. The list is indicative only. Does the order state the buyer's full and exact address? Is the type of collection (i.e. against payment or acceptance) clearly stated? Have all the documents required by the buyer or agreed in the contract of sale been enclosed? Have the documents been drawn up in accordance with the laws and regulations of the importing country? Have the documents been filled out completely and correctly? Are the packing marks and numbers the same in all the documents? Are the ports of loading and discharge and the name of the vessel the same in all the documents? Have the documents been duly signed? Have the bill of lading, the insurance document and the bill of exchange been endorsed on the reverse (if necessary)? Is it possible to state the exact name and address of the presenting bank? Are the commissions and expenses of the remitting bank and the collecting bank to be charged to the buyer? If so an instruction to this effect must be given in the collection order. Is it possible to give the name and address of a representative or agent ("case of need") in the country of destination who will attend to the goods in the event of non-payment? If so the presenting bank must be told whether and on what matters it may take instructions from this representative. Should the bank be instructed to institute a protest in the case of non-payment or non-acceptance? Should a protest be made in the event of non-payment of an accepted bill? May the presenting bank permit the drawee to inspect or sample the goods? If the transaction is in a foreign currency is payment to be credited against a forward foreign exchange contract (currency hedge)? Does the order clearly state the bank account to which the proceeds of the collection are to be credited? Has the order been signed?
51

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Chapter 6:

Documentary credits general

Introduction
Documentary credits provide an international method of paying for goods and services, that links an irrevocable bank payment undertaking to the production of documents by the seller, showing that the relevant goods have been shipped or the appropriate services supplied. The procedure gives exporters a high degree of security against commercial, political and transfer risks. At the same time, it provides importers with at least a minimum degree of assurance that their money will not be paid away until documentary evidence has been produced to show that the seller has complied with its side of the bargain. This system thus constitutes a compromise between the ideal solutions for the seller and buyer respectively - payment in advance for the seller, and payment after arrival of the goods or performance of the service for the buyer. Also, documentary credits provide good - though far from absolute - security for buyer and seller and reconcile their conflicting interests with regard to the timing of payment. Accordingly, the documentary credit procedure has been for many years one of the most widely employed payment devices for foreign sales. The technique is particularly useful in cases where the parties do not have a well-established trading relationship and economic conditions in the importer's state give rise to fears about the availability of foreign exchange and the transfer of money out of the country.

Countries involved
It is common practice to insist on documentary credit terms for sales between parties in most advanced industrialised countries and third world states. In addition, there is a solid tradition of using the same device for deals between the rapidly developing counmes of South East Asia. This is partly because the region's legal and administrative structures tend to be unhelpful in the recovery of cross-border debts incurred on sales concluded on open account terms. This situation may be contrasted with western Europe, where open account trading between the countries of the region has become the norm. The progressive conversion of the European Union into a single market combined with the existence of a European directive facilitating the cross-border enforcement of debt judgments, underpin this more relaxed approach to payment terms. Even so, payment delays on intra-European deals are a continual source of friction, particularly in times of recession. On the other hand, the emerging economies of eastern Europe provide a higher degree of risk and therefore new opportunities for documentary credit packages. Often they are found as elements in larger structured finance arrangements and countertrade operations. Because of the costs and administrative procedures involved, documentary credits are rarely used for sales within domestic markets. In the United States though, banks frequently issue standby letters of credit to operate as guarantees on a wide range of financial and commercial operations carried out within the country. The United States internal market is distinctive both for its size and for its division for administrative purposes, into 50 federal states, each with its own commercial law and legal procedures. In some developing countries that retain tight state controls on foreign trade operations, the documentary

credit procedure provides a useful additional weapon in the government's armoury of control and supervisory devices. This is because the statistics and documentation generated by the banking system can be used for reporting and overview purposes. In these cases, use of documentary credits may therefore be virtually compulsory for all imports and exports. This practice is tending to become less common than it was a few years ago as developing countries are opened up increasingly to the full interplay of market forces.

Uses
Documentary credits operate essentially as a guaranteed method of payment . They do not constitute a vehicle for offering long or medium term credit to buyers and sellers, though they may be found as a method for assuring payments under a variety of financing packages. Forfaiting deals, project financing packages and BOT (build, operate, transfer) arrangements all provide examples of such financing structures in which documentary credits sometimes play a supporting role. In addition, in the more traditional context of straightforward export sales, documentary credits are commonly structured so that the buyer or seller may provide short-term credit to the other party. Payment terms of say 60 or 90 days after presentation of documents, are frequently encountered in practice. Conversely, credits can also provide for advance payments to be made to the exporter. This aspect is considered in the next chapter. Documentary credits have traditionally been most used to effect payment on exports of commodities, raw materials and general merchandise in respect of which immediate payment or short term credits are the usual procedure. Foreign sales of capital goods and equipment - particularly very expensive items - often involve medium or long term finance. In these instances financing procedures such as official export credits, forfaiting and factoring play a more important role. As the world economy develops, the supply of services as distinct from physical goods is increasing as a percentage of overall export volumes. Telecommunications, computer engineering, data-processing and construction-linked services provide examples. The documentary credit is proving sufficiently flexible to provide a suitable payment vehicle for services of these types as well as the more traditional forms of exports.

Main features
Many variations exist on the basic documentary credit structure. When applied to export transactions the system in outline works essentially as follows:@

The exporter and importer agree terms of sale including payment on documentary credit terms. The importer (the credit applicant) instructs a bank in its own country (the issuing bank) to issue an irrevocable documentary credit for the sales price in favour of the exporter (the credit beneficiary). The issuing bank opens the documentary credit. This constitutes an irrevocable undertaking of that bank to pay the credit sum to the beneficiary provided that the latter presents the documents including evidence of shipment, stipulated in the credit, and complies with the other terms and conditions of the credit. The issuing bank communicates the credit details to a bank in the exporter's country (the advising bank). The credit also nominates the advising bank as the bank from which the beneficiary may claim payment of the credit sum (the nominated bank).

The advisinghominated bank communicates the credit details to the beneficiary. When the exporter has dispatched the goods to the importer it presents the stipulated documents to the nominated bank. The nominated bank checks the documents, pays the beneficiary and debits the issuing bank. The nominated bank sends the documents to the issuing bank. The issuing bank checks the documents, obtains reimbursement from the credit applicant (the importer) and releases the documents to the importer. The importer takes delivery of the goods. At the heart of this procedure lies the concept of payment against documents relating to the goods. Typically these will include bills of lading or other transport documents such as air waybills or combined transport documents, commercial invoices, inspection certificates and insurance policies covering the goods. The seller and buyer should agree at the outset when they conclude their sales agreement precisely what documents are to be stipulated so that the buyer can give appropriate instructions to the issuing bank. Documentary credits are highly formalistic instruments. Banks are obliged to pay if, and only if, the exact rerms and conditions of the credit, including presentation of all the prescribed documents are complied with. If a single document is missing or varies even slightly from the description in the credit the beneficiary has no right to insist on payment. Conversely, if all the documents are in order and the other terms and conditions of the credit have been satisfied the issuing bank of an irrevocable documentary credit is obliged to pay the beneficiary even if the goods are faulty and do not comply with the terms of the sale between exporter and importer.
CONFIRMED IRREVOCABLE DOCUMENTARY CREDIT
SELLERKREDIT BENEFICIARY

CONFIRMING BANK

REIMBURSEMENT

ISSUING BANK

BUYEWCREDIT APPLICANT

55

Security
This means that documentary credits provide a high degree of payment security to the seller provided that it is meticulous about checking the credit terms and getting the documentation right. They provide the buyer with the assurance of knowing that the required documents will be presented before payment is made. This protects the buyer's interest in the goods if the exporter is a bonafide operator, but it gives the buyer virtually no protection in the case of outright fraud. Documentary credits thus provide a greater degree of security to the seller than they do to the buyer. They do not do away with the need for (particularly) the buyer and the seller to provide status checks against each other. The system is devised to provide relatively rapid payment against documents in the normal course of business. A further advantage for the credit beneficiary (the seller) lies in the fact that its bank may be readier to finance preshipment working capital needs if it has the security of the documentary credit issued by the foreign bank. Furthermore, in cases where the seller is concerned about the transfer risk attaching to the importer's country, it can ask for the credit to be confirmed by a bank in the importer's own country (the confuming bank). The confirming bank then gives its own independent payment undertaking which the seller can enforce even if the issuing bank is unable to obtain foreign exchange or transfer funds out of its country.

Nomenclature
Documentary credits are also sometimes more loosely referred to as letters of credit (Vcs). The expression "lener of credit" can also be used as a more generic term to cover bank undertakings to pay both against documents and against simple demands for payment. A standby letter of credit payable on the simple demand of the beneficiary provides one example of the lamer. The term "documentary letter of credit" is also sometimes employed to have the same meaning as documentary credit.

Generally speaking. banks provide documentary credit services on a commission basis, usually worked out as a percentage of the credit amount or drawing on the credit. Usually these commissions are payable by the credit applicant since it is its responsibility to provide the seller with the price agreed in the sales contract. The buyer and the seller can agree on a different division of the costs between themselves. However, in the absence of any agreement to the contrary, the banks will usually be entitled to look for payment in the first instance to the customer giving the instruction. Often banks publish fee scales for documentary credit transactions. Though the bank may not positively invite customers to try and bargain it down, there is generally nothing mandatory about such scales and credit applicants are free to attempt to get a better deal for themselves. The likelihood and extent of success will hinge on factors such as the size and importance of the customer and the amount and frequency of its business with the bank. The exact basis for calculating commissions will vary from one bank to another. Generally speaking a separate fee is likely to be payable on each stage of the operation such as issue, advice, confirmation, payment negotiation, acceptance or deferred payment. These will be levied by the different banks carrying out the succeeding stages of the operation. One typical arrangement would be to charge a quarterly commitment commission for issuing the credit from the date of issuance to expiry, and a similar quarterly confirmation fee from the date of confmation to expiry of the credit. One-off fees would be payable for single stage actions such as advice and payment of the credit.

Legal framework
Documentary credits emerged over time from banking and merchant practice. Few countries have devised detailed legislation specifically for documentary credits or letters of credit and in most cases their regulation depends on general legal provisions such as contract and agency law together with accepted trade practice. The United States provides one significant exception. A comprehensive set of commercial law provisions known as the Uniform Commercial Code (UCC) has been adopted as law by each of the individual states making up the Union. Article 5 of the UCC contains a full set of regulatory provisions for letters of credit. Internationally, the most significant set of provisions relating to Ucs is a code of practice drawn up by the International Chamber of Commerce and known as the Uniform Customs and Practice for Documentary Credits (UCP). The UCP have been revised several times since they were first drawn up in 1933 and the version now in force is the 1993 revision (ICC publication No 500). The UCP does not have legislative force but today it is accepted by the world banking community as a universal codification of best practice. Moreover, banks everywhere incorporate the UCP by express reference into virtually every documentary credit and other letters of credit. In essence the UCP constitute an eclectic mixture of standard contract terms and rules of good conduct. It covers most practical aspects of credit operations including issuance, confirmation and payment, the nature and extent of bank undertakings and banking responsibilities, the requirements to be met by documents presented in credit operations, and the rules applicable to transferable credits.

Fraud
The very essence of a documentary credit operation is the concept of payment against documents. Banks are obliged to pay provided that the documents appear on their face to comply with the credit terms. They do not check further to see whether the documents are authentic or whether the underlying commercial contract has been performed. Over the years dishonest parties have exploited this formalised procedure in order to obtain payment for non-existent goods by forging documents and by obtaining genuine documents and shipping containers or bales full of rubbish that would not be available for inspection until after the credit had been cashed. Conversely, fraudulent importers have sometimes managed to delude unwary exporters into shipping their goods against the illusory security of forged documentary credits. Nigeria, for example, has provided a number of instances of this practice. National laws and judges vary in their detailed approach, but in general terms all support the concept of the independent nature of the credit undertaking. This means that if an importer is defrauded by the seller it will generally have to reimburse its bank provided that the bank paid against correctly drawn up documents. The only legal recourse for the importer will then be against the dishonest exporter in a distant country. Also, even if the importer's suspicions are aroused before payment is made under the credit, it will be very difficult indeed to stop the bank from paying. The reason for this is again connected to the independent nature of the documentary credit. Generally speaking, courts have been persuaded that it is essential to the conduct of international business that banks should be allowed to honour their irrevocable payment undertakings in all but the most exceptional circumstances. Accordingly, in most cases an injunction or other order stopping payment will not be granted unless the importer can prove convincingly that a fraud has been committed. Suspicion is not enough. The requisite degree of proof is in most instances unlikely to be available at the moment when the beneficiary calls for payment. In these circumstances the ideal solution is for each party to check carefully the credentials of the other before fmalising the sale. Credit agencies and banks are possible sources of information. In cases where very serious suspicions exist, help may also be sought from more specialised institutions.

For example, the Commonwealth Fraud Office based in London and the Commercial Crime Bureau - a UKbased subsidiary of the ICC - are both involved in investigating trans-national business crime and providing advisoly services. In many instances the commercial pressures to conclude a deal may be so intense and the difficulties of obtaining reliable information in a realistic timeframe so forbidding, that the negotiator has to choose between taking a risk and losing the deal. If business people always followed good advice they might avoid making losses, but they would not make profits either. However, if a business takes such a risk, it will be its own choice - and it will not be able to pass the risk on to the banks in a documentary credit operation.

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Developments
Despite the changing patterns of world business, documentary credits remain today one of the most popular means for effecting payment on long distance export sales where the parties do not know each other well. However, the system may have seen its heyday at the time when world trade flows were dominated by the shipment of manufactured goods from the industrialised countries to the developing world and the dispatch of commodities and raw materials in the other direction. Today, newly industrialised and emerging countries are themselves fierce and effective competitors for world markets of all kinds, and some of the most

successful of these have a greater appetite for risk than the more traditional suppliers used to display. In a world in which credit management and financial dexterity have tended to become at least as important as the ability to deliver physical goods and services, the seller's capacity to offer flexible and attractive payment terms can often determine the choice of supplier. This means that in some instances, major companies will now be prepared to offer credit and open account terms in situations where previously they would have insisted on an irrevocable confirmed documentary credit. For example, in one instance, a European chemicals and para-chemicals manufacturer reported having to change its payment terns policy in Vietnam because of powerful competition coming from other countries in the region. This trend is being accompanied by ongoing efforts to eliminate or reduce the paperwork in documentary credit operations by replacing the documents with computer messages. The main aims are to reduce costs, speed up delivery of payment services, increase market share and boost profits. Such a move would also be in line with increasingly rapid and efficient international transport methods and it would fit in with the moves made by banks over the past few decades to automate most of their standard procedures. Some parts of the documentary credit operations are already generally carried out on screen or via computerised telecommunications links. This remark applies particularly to the issuance and inter-bank communication of credit details. For example, SWIFT (the Bmssels-based Society for Worldwide Interbank Financial Telecommunication) provides documentary credit message formats that can be used by the banks that are plugged into its international network. However, at the heart of this operation still lies the presentation,of a mass of paper documents and their manual checking by documentary credit clerks. The main difficulty here is that these documents come from many different sources outside the control of the banks, and they are drawn up in a huge variety of different formats. Also, legal and security issues related to the replacement of these documents by computer data also constitute hindering factors. Nevertheless, after many years of discussion at international level, several moves are now proceeding to help bring the computer into the centre of trade payment procedures. One example is a London-based scheme called Bolero aimed at devising an electronic bill of lading . Since this document provides the key to movement and control of the goods, it is often the most important document stipulated in a letter of credit. In a separate move the ICC in Paris is working on the establishment of a framework for electronic trade credits. The practical results of these efforts have yet to be seen. Also, most observers believe that in any event the traditional documentary credit will continue to exist side by side with any new schemes that may be devised, for many years to come. The attractions of an automated alternative so far as buyers and sellers are concerned could incude smoother payment procedures and - possibly - reduced costs. Also, as banks develop on-line links with corporate customers, new opportunities could be exploited to integrate trade payments procedures with companies' treasury management services and automated ordering and invoicing systems. In this context, it might one day become possible for banks - or other competing suppliers of trade payment services - to play a bigger role in the provision of information linked to companies' foreign trade and credit needs. For example, the new networks and computer and data resources that would have to be developed to support electronic trade payments procedures, might also be used to connect companies with credit information services and to search the marketplace for the best available sources of finance.

Personal comment: the case of the healthy herrings


Brief fads
When Vancouver merchant Michael Doyle agreed in March 1979 to ship frozen herring fillets to a Dutch buyer CIF Rotterdam, he little imagined that the deal would one day end up before the British Columbia Court of Appeal and cast new light on bankers' payment obligations and the meaning of conforming documents. The letter of credit issued by the importer's bank in the Netherlands called for presentation among other things of a health certificate. The l/c was advised to Doyle through the nominated paying bank, the Bank of Montreal in Vancouver. That bank accepted the 60-day usance draft drawn by Doyle and the anached documents, for each of the four shipments. The buyer wished to avoid taking delivery and instructed its bank to look closely for any discrepancies it could find in the documents. The certificate provided by the Canadian Department of Fisheries for each shipment certified the quality of the herring but did not contain the word "health. This certificate, already accepted four times by the Bank of Montreal, was accepted three times by the Dutch issuing bank. However, the Dutch bank rejected the documents for the last shipment and notified the Bank of Montreal that if it paid Doyle it would not be reimbursed. The Bank of Montreal then refused to honour Doyle's accepted draft at maturity. Doyle took the bank to court. The trial judge found that the certificate was a health certificate and that it was in fact the document to which both the letter of credit and the contract of sale referred, but that it did not, on its face, comply with the precise description in the credit. The deficiency, he said, was one of appearance, and appearance only. The Court of Appeal agreed. Michael Doyle still won the case though. The courts held that since the Bank of Montreal had accepted the draft without qualification, and because the defect was apparent on the document's face, it had waived any rights to refuse payment on maturity.

Personal comment by Michael Doyle


"I may have won in court, but I still lost money on the deal," comments Michael Doyle, who now works as an international trade consultant. "I paid out $30,000 in storage fees to preserve the asset and the evidence - the hening fillets - but I got back only a pittance. " My case vividly taught me that an exporter should always sell his accepted bill of exchange by discounting it with a second bank, the holder in due course. A drawee can attempt to escape payment of an accepted bill by alleging that the drawer has not correctly performed the underlying commercial contract, but he cannot assert this defence against the holder in due course: the latter has acquired the bill free from equities. "Under the new UCP 500, the danger that the issuing bank will reject the seller's documents on the instructions of the buyer is greater than ever", Doyle says. "Also, a nominated bank can refuse to pay the beneficiary, or to accept or negotiate his compliant documents, if it doesn't want to. The beneficiary may thus receive no accepted bill of exchange to discount. His certainty of payment is lost. "Exporters", Doyle says, " may be better off to sell on collection or even open account terms, with the buyer's obligation to pay secured by a standby letter of credit payable against a third-party certificate that payment has not been made as contracted."

Case study: exporting to the CIS


A Turkish exporter (the exporter) concluded a deal to sell cars to an importer in the Commonwealth of Independent States (CIS). A bank in the CIS (CIS bank) agreed to issue a deferred payment credit under which payment would be made two months after the date of issue of the transport document covering the shipment of the cars. The exporter requested that the credit be confirmed by his own bank (the Turkish bank ). The exporter was itself to buy the cars from a local distributor in Turkey (the distributor) on deferred payment terms of two months. The distributor agreed to this arrangement on the basis that the exporter provided security for payment. Accordingly, the exporter requested the Turkish bank to confirm CIS bank's documentary credit and to issue a letter of guarantee in favour of the dismbutor. The Turkish bank declined to issue a guarantee since the exporter was not able to provide sufficient collateral. Instead it was agreed that the exporter would assign the right to receive 80% of the deferred credit proceeds to the distributor. The Turkish bank agreed with the exporter to confirm the credit, but subject to a special restriction that its deferred payment undertaking would not become effective until CIS bank provided a notice of acceptance of the shipping documents. The bank indicated that it had decided to apply this unusual procedure to documentary credit dealings generally with the CIS countries, since banks in that part of the world had no previous experience of international trade transactions and often acted contrary to normal practice. The exporter accepted this condition. The Turkish hank then advised the credit and added its confirmation. The exporter assigned the right to receive 80% of the credit proceeds to the distributor, advised the Turkish bank of this assignment, and bought the cars from the distributor. Following shipment, the exporter presented the shipping documents to the Turkish bank which found them to be in order and sent them on to CIS bank. Two months later the distributor claimed payment of the assigned proceeds from the Turkish bank. The latter, however had not been reimbursed by CIS bank. The Turkish bank then contacted CIS bank and the latter stated that payment had been refused due to a discrepancy, and that this had been notified to the Turkish bank by telex when the documents were received. The Turkish bank could find no trace of receipt of such a telex. The distributor maintained that it was not bound by the Turkish bank's a-geement with the exporter that the confirmation would be effective only if the issuing bank accepted the documents. It threatened legal action if payment was not made. The Turkish bank then paid the dismbutor under the assigment and looked to CIS bank for reimbursement. The latter claimed that it was protected by Article 16 of the Uniform Customs and Practice for Documentary Credits (ICC Publication No 500). This provides that banks are not responsible for delay or loss in transmission of documents or telecommunications. The Turkish bank was subsequently unable to obtain reimbursement from CIS bank.

Chapter 7:

Documentary credits procedures

Types of Credit Irrevocable and revocable


A documentary credit may be issued in either irrevocable or revocable form. In practice sellers nearly always insist on the former since revocable credits can be amended or cancelled at any time before payment by the issuing bank. The Uniform Customs and Practice recognise this commercial reality by providing that if a credit fails to stipulate which of the two categories it falls into it is deemed to be irrevocable.

Sight credits
Credits can also be made payable to the beneficiary in several different ways. The most commonly used variety is the sight credit, which provides for payment to be made to the beneficiary immediately after presentation of the stipulated documents.

Acceptance credit
In the case of an acceptance credit, the beneficiary draws a bill of exchange payable at an agreed future date (a tenor or time bill) on the issuing bank or the nominated bank. Once all the other documents have been presented in accordance with the terms of the credit, the relevant bank endorses its acceptance on the bill of exchange and hands it over to the beneficiary. The beneficiary can then obtain payment from the accepting bank on the maturity of the draft. Alternatively, if an immediate cash payment is required, it can be discounted and the accepting bank will then pay the holder of the bill on maturity. Typically, bills of exchange drawn under acceptance credits have maturity terms of between 60 and 180 days. The purpose of such a credit is to give the importer time to make payment. If the goods are sold before payment falls due the proceeds can be used to meet the bill of exchange. In this way there is no need to borrow money to finance the transaction.

Deferred payment credit


A deferred payment credit provides the importer with the same financial advantage as an acceptance credit, though it does not result in the issuance and acceptance of a negotiable document that may be discounted. Under a deferred payment credit, the beneficiary presents the required documents and receives payment only

at a later date specified in the credit. Generally speaking, the period of deferment will be similar to the usual payment terms under an acceptance credit. Since there is no bill of exchange under a deferred payment credit, the beneficiary is not able to obtain immediate cash through a discount transaction. However, in some cases the bank's deferred payment undertaking under the documentary credit can be used as collateral for an advance. In many instances it may be only the issuing or confirming bank that is prepared to make this advance, whereas a discountable hill offers wider scope.

Negotiation credit
Another variant is known as the negotiation credit. Negotiation means the giving of value for the beneficiary's draft and/or documents by the bank authorised to negotiate under the credit. Payment of the drafts and/or documents is guaranteed by the issuing bank on condition that the documents presented by the beneficiary are in order. The most common form of negotiation credit permits negotiation by any bank. In rare cases the choice is limited to specified banks. The payment commission for a negotiation credit is payable by the beneficiary. This is in contrast to the usual practice for other types of documentary credit where charges are for the account of the credit applicant.

Red clause credit


In the case of a red clause credit, the seller can obtain an advance for an a,med amount from the relevant correspondent bank handling the credit. This advance is used to finance the manufacture or purchase of the goods that are to be delivered under the credit. On receiving the advance the beneficiary is typically required to give a receipt and to provide a written undertaking to present the required documents before the credit expires. Although the advance is paid by the correspondent hank, it is the issuing bank that assumes liability. If the seller does not present the required documents in time and fails to refund the advance, the correspondent bank debits the issuing bank with the amount of the advance plus interest. The issuing bank in turn has recourse to the credit applicant (the buyer) who therefore bears the risk for the advance and the accmed interest. The clause permitting the correspondent hank to make an advance used to be written in red ink. Hence the term red clause credit.

DOCUMENTARY CREDITS - PAYMENT TERMS


IMMEDIATE PAYMENT NEGOTIATION CREDIT? IMMEDIATE PAYMENT AGAINST DOCUMENTS AGAINST DOCUMENTS AND DRAFT AGAINST DOCUMENTS AND DRAFT AGAINST DOCUMENTS

ACCEPTANCE CREDIT

TERM PAYMENT

DEFERRED PAYMENT CREDIT

TERM PAYMENT

64

Revolving credits
Revolving credits can be used when goods are to be delivered in instalments at specified intervals. The credit specifies the overall amount for which it is available, and within that total it allows the beneficiary to make partial drawings up to a specified amount in respect of each delivery of goods. After the utilisation of each portion the next portion becomes available automatically and this process continues until the total vaue of the credit has been drawn. The revolving clause also often specifies the intervals at which the credit may be utilised. Also, revolving credits may be either cumulative or non-cumulative. Cumulative means that amounts from unused or incompletely used portions can be canied forward to a subsequent period. If a credit is non-cumulative, portions not used in the prescribed period cease to be available.

Transferable credits
Transferable credits are particularly well adapted to the requirements of international trade. A trader (middleman) who receives payment from a buyer in the form of a transferable documentary credit can use that credit to pay its own supplier. This enables it to carry out the transaction with only a limited outlay of its own funds. Under this procedure the buyer applies for an irrevocable credit issued in the trader's favour. As soon as the trader receives the confirmation or advice of this credit it can request the bank to transfer the credit to its supplier (the second beneficiary). The costs of the transfer are usually charged to the trader and the transferring bank is entitled to debit them in advance. As soon as the supplier has dispatched the goods, it presents the documents to the advising or confirming bank and receives the agreed payment. The documents are then sent to the transferring bank which debits the trader. The latter delivers its own invoice (made out to the buyer) to the transfe~~ing bank and receives the invoice of its supplier in exchange. The trader is then credited with the amount of its own invoice. The difference between this and the amount shown on the supplier's invoice represents its profit. Finally, the trader's invoice together with the other documents is forwarded to the issuing bank. The Uniform Customs and Practice provide that the trader has the right to substitute its own invoice for that of the supplier. In this way the final purchaser is prevented from discovering the trader's profit margin. Under the UCP a transferable credit is normally transferable once only.

Back-to-back credits
In cases where a trader cannot obtain the issue of a transferable credit in its favour as a means of paying its own supplier, it may be able to set up a back-to-back credit arrangement instead. Under this procedure the trader's bank opens a separate credit in favour of the supplier against the security of a non-transferablecredit already issued in the trader's favour.

Assignment of proceeds
In addition, even if a credit is not transferable, the beneficiary may be able to assign the right to receive the whole or part of the proceeds to a supplier. This approach is frequently employed, for instance, by manufacturing firms which assign part of the proceeds of the credit to sub-contractors. On the instructions of the

beneficiary, the relevant bank will notify the assignee that it has been instructed to pay a specified sum to the assignee out of the credit proceeds.

Stages in a documentary credit operation


Buyer and seller agreement
At the outset an exporter and an importer conclude their sales contract. This may either be a formal wrinen document or, for example, an exchange of telex or computer messages. They agree that payment shall be made by documentary credit. Ideally at this point, they should also agree on the main provisions that are to be inserted in the credit. Examples are, whether payment is to be made on presentation of documents, or at an agreed future date, what documents are to be presented, whether the credit is to be confirmed, insurance cover and delivery terms. It is important, for instance, that the type of transport document required should accurately reflect the shipping arrangements that will need to be made for the goods.

Credit issuance
Following the above agreement between the buyer and the seller. the buyer requests its bank to issue the appropriate documentary credit. Banks generally maintain stocks of credit application forms which list the specific items of information that the bank will need to complete the credit details. Many of these are based on model forms devised by the International Chamber of Commerce, which are themselves set out in accordance with a United Nations layout key for use in international trade operations. The bank will agree to issue the credit only if it is sure that it can rely on reimbursement by the applicant. In some cases it may require an advance deposit from the customer. In others it may rely on the security of the goods by becoming assignee of the bill of lading issued by a marine carrier. Often, however, the bank may not consider the goods on their own to be sufficient security, particularly if they are not a commodity that can be freely traded on an organised market. In other instances, the applicant may obtain the documentary credit facility on the base of an existing credit-line granted to him by the issuing bank or against the security of funds in his account with the bank.

SPECIAL CREDIT TECHNIQUES


RED C L AU S E C R EDIT

PARTIAL PAYMENT MADE BEFORE PRESENTATION O F DOCUMENTS


CREDIT ACCOUNT RENEWED AFTER EACH DRAWING

CREDIT CAN BE TRANSFERRED TO A SECOND BENEFICIARY

BACK CREDIT

FIRST CREDIT ACTS AS SECURITY FOR ISSUE OF A SECOND CREDIT BENEFICIARY TRANSFERS THE RIGHT TO RECEIVE THE CREDIT PROCEEDS TO ANOTHER PERSON

O F PROCEEDS

Transmission of credit
Once the issuing bank has drawn up the documentary credit, it generally transmits the credit details to the relevant correspondent bank in the seller's country. In many cases it will be possible for the buyer and seller to agree that the latter's bank should confirm or advise the credit. In this case the applicant needs to give a special instruction to this effect to the issuing bank. Depending on the degree of urgency, the issuing bank transmits the credit by airmail, telex or SWIIT. In rare instances - for example in cases where the credit is freely negotiable by any bank - no correspondent will be involved and the credit may be transmitted direct to the beneficiary.

Advice of beneficiary
If the correspondent bank in the beneficiary's country is instructed merely to advise the credit, it forwards the credit details to the beneficiary without undertaking any commitment to pay the credit when documents are presented. However, in accordance with UCP Article 7, it must take reasonable care to check that the credit appears to be authentic. The correspondent advising bank may add its confirmation if the issuing bank either requests or authorises it to do so. It then assumes a definite and independent obligation in addition to that of the issuing bank. Before adding its confirmation in this way, the correspondent bank will be careful to ensure that the credit is formally in order and that the issuing bank is trustworthy.

Checking the credit


As soon as the exporter receives the credit details he or she should check them carefully to ensure that they conform with the contract of sale and that it is able to comply with them. To a busy business with sales to be made, production schedules to be met and debts to be collected, it may at this stage seem overly bureaucratic and unprofitable to do more than make sure that the credit sum corresponds with the agreed price. However, half an hour spent at this stage may save lengthy and expensive delays later should it turn out that the documents presented do not exactly agree with the credit terms on presentation.

Credit amendments
The issuing bank can amend the credit only if its customer - the credit applicant - agrees. Accordingly if the seller finds discrepancies it is best to contact the buyer without delay.

Presentation of documents
When the exporter has dispatched the goods, it can prepare all the documents for presentation to the bank. First of all the requirements laid down in the credit have to be checked. In particular all the documents called for by the credit must be present (completeness), they must not contravene any stipulation of the credit (correctness), and they must not be at variance with one another (consistency). After the documents are presented, the bank checks them carefully against the wording of the credit.

Payment is due only if the documents are in strict conformity with all the credit requirements. In order to obtain payment, the beneficiary must not only present correct documents, he must also present them within the time limits laid down by the credit. Thus presentaion must be made not later than the expiry date specified in the credit instrument. In addition, if a shipping document is called for, all the documents must be presented not later than 21 days after the date of shipment unless the credit terms provide for a different period. Furthermore, the credit may also require a maximum date, for shipment of the goods, as a compulsory condition.

Irregular documents
If the bank decides to refuse documents because it has found them to be irregular, it must inform the beneficiary of this decision within a reasonable time. What constitutes a reasonable time will depend on the details of the case, but under UCP Article 13(b) the period cannot, in any event, he longer than seven banking days. The beneficiary may then in some cases be able to have the documents corrected or obtain replacement documents before the expiry of the time limits set out in the credit. For the purpose of complying with these time limits, no effective presentation will be deemed to have taken place unless and until a full set of complying documents has been presented. In practice the bank will not usually simply reject the documents outright since this could be prejudicial to its own and the other parties' commercial interests. Alternative action that the bank may take includes the following:
1. It notifies the issuing bank of the discrepancies by telex and asks whether it may pay despite the discrepancies.

2. It asks the beneficiary if it would like it to send the documents to the issuing bank for approval. In this event the documents will be handed over to the buyer only if the latter makes payment for the goods. This approach in effect converts the operation into a collection procedure. (See chapter on collections).

3. The correspondent bank may agree to make payment under reserve. If payment is then refused by the issuing bank because of the discrepancies, the beneficiary will have to refund the amount paid over plus any commissions, expenses and interest.
If the issuing bank decides to reject documents presented to it by the correspondent bank, it must notify the latter accordingly by rapid means of communication not later than seven banking days following the date of receipt of the documents. Its notice must state all the discrepancies on which it relies and indicate whether the issuing bank is holding the documents at the presenter's disposal or returning them (See UCP Article 14(d)).

Back-to-back reimbursement
If the documents are in order and are presented in accordance with the other terms and conditions of the credit, the bank that has made payment to the beneficiary obtains reimbursement from the issuing bank. Banks that have a correspondent relationship with one another will hold accounts for their correspondents on their own books. This means that if payment is made to the beneficiary in the local currency the bank making the payment can then usually reimburse itself by debiting the issuing bank's account. Conversely, if the payment is made in the currency of the issuing bank, that bank can credit the account that it holds for its correpondent that made the payment. If payment is made in a third country currency, the issuing bank normally authorises a bank in the relevant curency area to credit or transfer the amount in ques-

tion on demand to the correspondent bank. Finally, the issuing bank releases the documents to the buyer. This allows the buyer to take possession of the goods and proceed with the import formalities.

Documents
Documents are vital to an Yc operation since their presentation is the act that triggers payment. In general terms, buyer and seller are free to agree which documents should be called for in the credit. In practice these are usually documents that provide evidence of the existence, type, quantity and quality of the goods and of the fact that the goods have been shipped. In many cases the buyer can provide itself with a measure of safeguard against the delivery of inferior goods by asking for documents such as certificates of analysis and certificates of quality. Credits covering goods shipments will also most often specify that a cargo insurance document is to be presented. Under UCP Article 34 (f) (ii) the amount covered by the insurance document must be at least equal to the CIF (cost insurance freight) value of the goods plus 10%. Negotiable documents such as bills of lading are most often made out to order. This enables them to be transferred by endorsement. In cases where the goods are to be collected from a warehouse, it may also he possible to stipulate the presentation of a warehouse keeper's warrant issued by the storage company. This can be endorsed in a similar way to a negotiable bill of lading so as to transfer ownership and rights of control in the goods. An insurance certificate will be specified only in cases where it is up to the seller to take out insurance. This will be the case where the sale is concluded on CIF terms or similar. The commercial invoice is the accounting document which shows the sum of money due to the exporter from the importer. It will commonly be stipulated as one of the documents to be presented under the credit. In a number of cases the beneficiary may be required to present a consular invoice. This is an invoice anthenticated by the consulate of the importer's country confirming that the invoice amount represents the actual value of the goods. Consular invoices may facilitate customs clearance in the importer's country. The growing use of documentary credits in connection with transactions for the supply of services means that work progress certificates are now becoming increasingly important and are frequently stipulated in llcs covering this type of mnsaction. By signing a work progress certificate the buyer confirms to the seller that a part of the work has been duly completed. The stipulation of a work progress certificate involves an added risk for the credit beneficiary since the credit buyer can withhold its signature and thereby delay or prevent payment under the credit. This risk can be covered by including a latest date clause in the credit which will stipulate a date when the amount owed must be paid whether or not the work pro ss certificate has been presented.

Latin American Bankers' Acceptances


Beneficiaries of documentary credits available on deferred payment terms can obtain an immediate cash payment in several Latin American countries against presentation of a bill of exchange in a special form, to the negotiating bank. The scheme is known as Latin American Bankers' Acceptances (Aceptaci6nes Bancarias LatinoAmericanas - ABLAS). It operates where both the issuing bank and the negotiating bank are established in a member country of the Latin American Association for Integration (Asociaci6n LatinoAmericana de Integraci6n - ALADI). In outline the system works as follows: The beneficiary of the credit presents one or more bills of exchange to the negotiating bank which accepts them for the account of the issuing bank. The exporter can discount the bills with the negotiating bank or another bank or hold onto them until maturity. A bank that discounts the bills can either hold them until maturity or itself discount them on the New York markets. On maturity the accepting bank then pays the holder of the bill and obtains reimbursement from the bank that originally issued the documentary credit. This latter procedure takes place via machinery set up under a reciprocal credit agreement between the central banks belonging to ALADI. The maximum amount for which the exporter may draw up the bills of exahange is the total payable under the credit. Since they may be negotiated in New York. they have to be drawn up in English, and must be for a round figure in thousands of US$. The minimum is US$25,000. The draft is drawn on the negotiating bank and made payable to the credit beneficiary (the exporter). The maturity must be on or before the date on which the documentary credit is payable. Additionally, this date must not in any event be more than 180 days after the date of acceptance. Several reference numbers have to be noted on the draft. These are the references of the documentary credit, the goods exported, the countries of origin and destination, and the reciprocal accord under which reimbursement will be effected. A negotiating bank that decides to discount a bill sends the bill to its correspondent in New York for safe custody. At the same time it contacts a firm of brokers in New York to arrange for negotiation. Banks are obliged to accept exporters' bills under this system provided that the bills are of a category that can be negotiated in New York. Rights of recourse cannot be excluded. Eleven countries are members of ALADI. These are Argentina, Bolivia, Brazil, Colombia, Chile, Ecuador, Mexico, Paraguay, Peru, Uruguay and Venezuela. (The above presentation is based on information provided by Banco de A. Edwards, Santiago, Chile).

Pre-shipment inspection
Around 30 countries in Asia, Latin America and Africa impose regulatory pre-shipment inspection procedures on imports. This means that a government-appointed inspection company examines the import goods in the exporting country prior to shipment, and certifies whether they comply with factors such as quality and price parameters, contract description and quantity specifications. The import will be authorised only if the inspection company issues a favourable report, generally referred to as a clean report of findings. Accordingly, in cases where the procedure applies, it is vital for the documentary credit to stipulate the clean report as one of the documents to be presented. Governments in many developing countries have adopted pre-shipment inspection as a means of combatting over and under-billing and similar practices in the context of capital flight and evasion of customs duties and tax evasion. The first of these three is becoming less important as developing countries liberalise exchange controls. Most of the pre-shipment inspections around the world are canied out by a small number of multinational private-sector inspection companies. Major examples are Soci6t6 Gentrale de Surveillance (SGS), Switzerland, Bivac International (Bureau Veritas Group, France), and International Testing Services (Inchcape Plc, UK). Such companies also carry out commercial inspections of export goods in cases where this procedure is agreed by the parties to the contract.

Appendices

1.

Uniform customs and practice

2.

Transport documents

3.

Trade terms

Appendix 1:

Uniform customs and practice

The Uniform Customs and Practice for Documentary Credits (UCP) were first drawn up under the aegis of the International Chamber of Commerce (ICC) in 1933. The current - 1993 revision - UCP 500) came into operation on January 1 1994 and it is applied to documentary credit operations throughout the world. The UCP is drafted and revised by bankers from different countries who attend meetings of the ICC's Commission on Banking Technique and Practice. Other interested business parties within the ICC's worldwide membership are also able to comment on proposed changes through the ICC's national committees. The UCP acts in part as a self-regulatory code of practice to guide banks and other parties in the practical operation of documentary credit operations. It also constitutes a set of standard conditions which are incorporated by reference on a contractual basis in each individual credit. In brief outline some of the main provisions of the UCP are as follows :

Irrevocable and revocable credits


Credits should indicate whether they are revocable or irrevocable. In the absence of such indication the credit is deemed to be irrevocable.

Availability
Credits may be available by sight payment, by deferred payment, by acceptance, or by negotiation

Nature of credits
Credits are separate transactions from the sales or other contracts on which they may be based. In credit operations all parties concerned deal with documents and not with goods, services andor any other underlying performances.

Bank undertaking
A bank that issues or confirms an irrevocable credit assumes an irrevocable undertaking to pay at sight or on deferred payment terms or to accept or negotiate drafts, provided that stipulated documents are presented and all the other terms and conditions of the credit are complied with. An advising bank that advises the credit to the beneficiary without confirming it does not take on such an undertaking.

Examination of documents
Banks must examine all documents stipulated in the credit with reasonable care to ascertain whether or not they appear on their face to be in compliance with the terms and conditions of the credit. Banks have a reasonable time not exceeding seven banking days following the date of receipt to examine the documents and to inform the party from whom the documents were received whether or not they are accepted.

Transport documents
The UCP contains particularly detailed provisions on transport documents including separate articles on marinelocean bills of lading, non-negotiable sea waybills, charterparty bills of lading, multi-modal transport documents, waterway transport documents, coumer and post receipts and bransport documents issued by freight forwarders.

In general terms, transport documents must be of the type stipulated in the credit. Among other requirements, bills of lading and sea waybills must appear to have been issued by a named camer and indicate that the goods have been loaded on board or shipped on a named vessel. Unless otherwise authorised in the credit, transport documents issued by freight forwarders are acceptable only if the forwarder is also acting as a canier or as agent for a canier. Unless otherwise stipulated, banks will accept only clean transport documents - that is documents that do not contain a clause or notation which expressly declares a defective condition of the goods andlor the packaging. Unless excluded by the credit, transport documents stating that freight or transport charges have still be paid will be accepted.

Insurance documents and commercial invoices


Insurance documents must appear on their face to be issued and signed by insurance companies or underwriters or their agents. Unless otherwise stipulated, commercial invoices must normally appear on their face to be signed by the beneficiary and must be made out in the name of the applicant for the credit.

Partial drawings and shipments


Partial drawings and or shipments are allowed unless the credit stipulates otherwise.

Expiry and presentation


All credits must stipulate an expiry date and - with the exception of Freely negotiable credits - a place for presentation of documents. In addition to stipulating an expiry date, credits which call for a transport document should also stipulate a specified period of time after the date of shipment during which presentation is to be made. If no such period of time is stipulated, a 21-day period applies.

Transfer
A credit can be transferred only if it is specifically designated as transferable by the bank. Unless otherwise stipulated a transferable credit can be transferred once only. The first beneficiary can substitute his own invoices and drafts for those of the second beneficiary. Even if a credit is not transferable the beneficiary can assign the right to receive the proceeds in accordance with the applicable law.

Appendix 2:

Transport documents

Transport documents play a vital role in many international trade procedures and related payment operations. This is because the movement of the goods from seller to buyer constitutes an essential act in the performance of the deal, and since the parties are likely to be far removed from one another, documentary evidence of shipment is of pivotal importance. In byegone centuries, when ships provided the normal means of carriage, the maritime bill of lading issued by the ship's captain was the preponderant document on international trade deals. Over the years the practice evolved of using the hill of lading as a transferable certificate of title to the goods. This made it easier for traders to transfer ownership in goods that were still afloat on long maritime voyages and to use the goods as security to raise finance. Today transport times are much quicker and goods sometimes travel faster than the documents. Road, rail and air carriage now offer a wide range of alternatives. Companies that specialise in managing international goods movements are also able to provide multi-modal packages that link together several different forms of transport in order to provide door-to-door or end-to end shipment. Among the newer style documents frequently called for under documentary credit operations are air waybills, road and rail consignment notes, and combined transport documents. Partly because of the quicker transport times, most of these are not issued in a negotiable form, but provide simply for the delivery of the goods to a named consignee. Normally this will be the buyer, though in some cases banks with an interest in the deal may also be named. Multi-modal or combined transport operators will sign a contract with the company sending the goods (the shipper), undertaking full responsibility for their carriage from the point at which the goods are picked up to the ultimate destination. This provides a more flexible and complete service allowing the buyer and seller to free themselves from the task of organising the multi-stage transport operation. This service may be helpful for instance to an exporter who has undertaken to deliver the goods to the buyer's premises on delivered duty paid terms (See appendix on trade terms). The multi-modal transport operator (MTO) concludes a series of individual contracts on its own responsibility with the different carriers - road, rail, sea and so on - who will actually cany the goods during each succeeding stage of the movement. It is then said to act as a "contractual carrier" with regard to the shipper . The MTO assumes the contractual responsibilities of a carrier towards the shipper without itself owning or operating the means of transport. In this respect it is important to distinguish between the roles of a freight forwarder and those of a multimodal transport operator. The former arranges for the goods to be shipped on behalf of the shipper without himself taking on responsibiliry for their carriage. In this case the contract of carriage is concluded directly between the companies actually carrying the goods and the shipper. The distinction is not always easy to make since many freight forwarders also act as multi-modal transport operators and may use similar looking documentation for both activities. At the same time, a number of large maritime carriers have taken to competing for this type of business by acting as multi-modal operators as well. In contrast to other modem forms of transport documentation, combined transport documents are sometimes issued in negotiable form. This may apply particularly in cases where a sea movement forms the cenhal part of the transport operation. At the same time, the traditional maritime bill of lading remains of importance in a number of trades. This applies particularly to b u k commodities such as oil which may be the subject of several sales -known as spot trading -during their voyage.

Appendix 3:

Trade terms

Export sales revolve around the movement of goods from one country to another. Vital issues such as the transfer of ownership and risk in the goods from seller to buyer are usually linked to one stage or another of the transport operation. Furthermore, when techniques such as documentary credits and acceptance of drafts are employed to effect payment, the transfer of money or the acceptance of drafts most often takes place at some point between shipment and arrival of the goods. Accordingly, it is vital for the exporter and the importer to determine with precision, matters such as which pmy arranges and pays for the carriage of the goods, who takes out the cargo insurance, whether the goods travel at the risk of the seller or the buyer, and who effects customs clearance. An enormous loss of time would result if all these matters had to be negotiated in detail on every single deal. Accordingly, over the years, traders operating internationally evolved standard definitions known as trade terms covering the main alternative arrangements that buyers and sellers may make with regard to shipment of the goods. By referring simply to the short title of any one of these trade terms in their export agreement, the seller and the buyer automatically incorporate the detailed content of the term without having to take any further action. It should be noted that whilst these trade terms refer extensively to the carriage of the goods, they relate solely to the sale agreement between the exporter and the importer and do not form part of the separate contract of carriage. For example, if the seller agrees to arrange for the carriage of the goods it is up to it to ensure that the contract of carriage that it concludes is in compliance with the conditions of the trade term incorporated in the export contract. Similarly, if in this case payment is to be made by documentary credit, the buyer should ensure that the credit instructions that he gives to the issuing bank include the appropriate type of transport document. To assist standardisation and precision in the use of international trade terms, the International Chamber of Commerce has compiled a model set of the main conditions known as INCOTERMS. These were first devised in 1936. The current version is known as INCOTERMS 1990 (ICC publication No 460) . Exporters and importers around the world can incorporate the INCOTERMS into their deals by referring to them in their contracts. In brief outline, the principal trade terms in accordance with the INCOTERMS definitions are as follows: (The name of each term is followed by a three letter abbreviation which can be used to identify the term).

Ex-works (EXW)
The seller makes the goods available to the buyer at the seller's premises. The buyer thus normally bears full responsibility for carriage of the goods and all other formalities. This term therefore represents a minimum obligation for the seller.

Free carrier (FCA)


The seller hands over the goods cleared for export to a carrier named by the buyer at the place agreed by the buyer and the seller. The buyer is responsible for the contract of carriage and all other formalities.

Free alongside ship (FAS)


The seller places the goods alongside the vessel on the quay or in lighters at the named port of shipment. The buyer bears all costs and risks of loss and damage from that moment.

Free on board (FOB)


The seller delivers the goods to the ship and he is considered to have fully canied out his side of the bargain when the goods pass over the ship's rail. The buyer bears full responsibility from that moment onwards.

Cost and freight (CFR)


The seller delivers the goods to the ship and full risk and responsibility pass to the buyer when the goods cross the ship's rail. The seller pays for the contract of carriage to the agreed port of destination.

Cost insurance and freight (CIF)


The seller deliveis the goods to the ship and all risks and responsibility in the goods pass to the buyer when the goods cross the ship's rail. The seller pays for the contract of carriage to the port of destination and takes out cargo insurance at his own cost.

Carriage paid to (CPT)


The seller delivers the goods into the custody of the canier and pays for the costs of carriage to the agreed destination. The goods travel at the buyer's risk.

Carriage and insurance paid to (CIP)


The seller delivers the goods into the custody of the canier and pays for the costs of carriage to the agreed destination. He also effects insurance of the goods at his own cost. The goods travel at the risk of the buyer.

Delivered at frontier (DAF)


The seller fulfills his obligation to deliver, when the goods have been made available cleared for export at an agreed point, and placed at the frontier but before the customs border of the adjoining country. This term is primarily intended for cases where goods are to be carried by rail or road, though it may be used for any mode of transport.

Delivered ex ship(DES)
The seller fulfills his delivery obligation when the goods have been made available to the buyer on board the ship at the agreed port of destination. The risk in the goods passes to the buyer at that moment and the buyer is responsible for clearing the goods through customs.

Delivered ex quay (duty paid) (DEQ)


The seller fulfills his obligation to deliver when he has made the goods available to the buyer on the quay or wharf at the named port of destination cleared for import.

Delivered duty unpaid (DDU)


The seller fulfills his obligation to deliver when the goods have been made available at the agreed place in the country of import. The risk in the goods passes to the buyer at that point and he is responsible for clearing

the goods through customs.

Delivered duty paid (DDP)


The seller fulfills his delivery obligation when the goods have been made available at the agreed place in the country of import. The seller bears all risks and costs in the goods up to that point. The agreed point of delivery may, for example, be the buyer's warehouse or factory. This term represents the maximum obligation on the seller.

FAS, FOB, CFR, CIF, DES and DEQ are restricted to waterborne movements. The other terms may be used for all modes of transport.

Chapter 8:
Introduction

Factoring

Factoring is the practice whereby a specialised company buys a supplier's outstanding receivables (amounts due from customers) on an ongoing basis and collects them in return for a commission. In its purest form this practice involves the purchase of the receivables by the factor (the specialised collecting company) on a nonrecourse basis. In this case, the debt asset is assigned to the factoring company which collects on its own behalf. Under a variation of this procedure, the factor seeks payment of the outstanding invoices as agent for the supplier. Characteristically, this technique is combined with an advance cash payment against the security of the receivables by the factoring company to the supplier. These advances can be recouped by the factor if the debtors fail to pay. Factoring can also take place on either a disclosed or undisclosed basis. In the former case the factoring company's interest is notified to the debtor companies, whereas in the latter it is not. The practice of factoring began many years ago in the United States at a time when it was particularly connected with the textile business. Today it operates in many countries across the world and in a wide range of business sectors. The procedure is widely practised in western Europe for instance. Factoring can also now be found in emerging markets including Asian centres such as Hong Kong, South Korea, Singapore, Thailand and the Philippines though volumes remain relatively modest. Factoring also operates in South Africa, for instance. Since factoring involves collecting debts due from third parties outside the scope of the agreement between the factor and the supplier, the existence of a reliable and well-adapted legal framework is an essential element in the proper operation of this system. In this respect it is significant that Turkey - a country that both literally and figuratively provides a bridge between Europe and Asia - has recently adapted its laws to make specific provision for factoring. The procedure may be applied to both domestic and international receivables collecting. Several international networks of factoring companies and cross-border agreements between factors facilitate the use of this procedure on export-import deals. Many of the companies that operate in this sector are subsidiaries of major banks. Business people sometimes think that reliance on factoring shows that the supplier has a weak organisation unable to cope financially and administratively with credit management and receivables collection procedures. However, many successful and reputable companies make use of this facility which, in appropriate cases, can offer several advantages. For instance, it can allow companies to concentrate their executive and entrepreneurial resources on seizing and developing new business opportunities, plus providing them with a constant source of working capital which will grow as their business receivables expand. Such features are becoming more appreciated at a time when companies have flattened their hierarchies and have grown used to subcontracting many administrative tasks. Also, when real interest rates are high, the benefits of not having to wait for payment are especially obvious. Generally, factoring can be applied to cases in which manufacturers and distributors are trading with business clients on open account terms. It is not appropriate for retail selling and it is not required where payment is guaranteed by devices such as documentary credits. In terms of its practical effects, factoring has some similarities to forfaiting, particularly where the factor

takes over the debt assets in return for an immediate cash payment. However, the forfaiter is most often discounting negotiable instruments - namely bills of exchange and promissory notes - whereas a factor normally buys straightforward invoices without any negotiable bills or notes attached. In this respect it is interesting to note that factoring has so far developed relatively slowly in the booming markets of South East Asia partly because open account invoice trading has not become the normal practice in that part of the world. Instead short term credit on trade sales is usually secured by bills of exchange which are generally better recognised by local practice and laws. If the supplier wants an immediate cash payment in such a case he or she will discount the accepted bill with a bank rather than go to a factor. In addition to the technical structural differences between factoring and forfaiting, there are also more fundamental and commercially more important distinctions between the two. Forfaiting tends to be used for medium term financing and is particularly favoured for supplies of capital goods. Also, such financing deals are concluded on a one-off basis. By way of contrast the whole essence of factoring arrangements lies in the idea that the factoring company collects all or a determined part of the supplier's present and future receivables. Among other things, this is aimed at ensuring that the supplier does not off-load just his most difficult cases onto the factor. In addition, the procedure can cover all manner of supplies and it is devised essentially for cases in which short term trade credit is granted - for example 30,60 or 120 days. At the same time, cash advances made by factors on a with-recourse basis in the context of receivables financing achieve a similar business objective to that of the discounting of trade bills by banks. In this case the main differences lie in the different instruments employed - invoices on the one hand and bills of exchange on the other. Broadly speaking the factor's charges fall into two main categories. They are first a fee or commission for buying and collecting the debts, and secondly, if the factor provides advance financing, an interest charge by way of a discount on the face value of the invoices. This discount however, will apply only to the percentage of the invoice total in respect of which the advance is made - characteristically not more than 80%.

Types of factoring
Over the years factoring companies have developed different variations of the basic factoring concept to cater for the various needs of different customers. Not all factors will offer the full range and companies may wish to shop around in order to find the best deal. Also, the exact terminology and detailed structures also vary between countries and between individual factoring firms. Some of the principal arrangements are discussed briefly below. Two central concepts are the ideas of factoring with or without finance, and with or without recourse. When non-recourse terms are amgeedthe factoring company undertakes to pay the supplier whether or not it recovers from the supplier's customers. In the case of factoring with recourse, the factoring company is entitled to bill non-recovered debts back to the supplier. If the parties decide on a simple with-recourse factoring sewice without finance, the supplier receives payment from the factor only when the latter has recovered the amounts due. If the agreement has been concluded on a non-recourse basis the supplier is paid by the factor when the appropriate date for payment of the receivables has arrived, whether or not recovery has been obtained from the supplier's customers. Alternatively, financing by the factor may he amgeedin both recourse and non-recourse cases. In this event, the factor agrees to advance a percentage of the face amount of the receivables - for example up to 80% when they are assigned to it. If rights of recourse have been resewed, the factor is able to insist on selling back to the supplier any receivables on which he is later unable to obtain recovery. In the basic situation, the factor takes over management of the receivables bought and undertakes all the necessary steps to recover the amounts payable on the due date. This concept is sometimes referred to as full service factoring. In some cases a large company with efficient credit management and debt collection departments may decide to conclude an agency or bulk factoring arrangement. In such a case the supplier

continues to collect the receivables itself but does so on behalf of the factor. The latter guarantees payment on the due date andlor provides financing pending collection. In the basic factoring situation, the supplier's customers are informed that the right to receive the amounts they owe has been assigned to the factor. This is known a s disclosed factoring and the procedure enables the factor to obtain recovery in a straightforward manner. However, in some instances suppliers may not wish their trade customers to know that they are assigning their receivables to a factor. An undisclosed factoring service may then be arranged. One device employed is to invoice in the name of a specially created company owned by the factor but with a name similar to that of the supplier. Where a factor offers a collection service on non-recourse terms it does not thereby exclude absolutely all possibility of debiting the receivables back to the suppplier. It assumes the risk of buyer default and bears the loss if the buyer's failure to pay is unjustified. However it can debit receivables back to the supplier if the failure to pay results from the suplier's own breach of its contract with the buyer. Examples are where the goods supplied are defective or do not accord with the contract description. Where factoring is undertaken on a non-recourse basis many factors in practice agree to pay the supplier a fixed number of days after they have purchased the receivable, rather than for example, on the exact payment date specified in the contract between the supplier and its customer. Characteristically such arrangements are referred to as the fixed maturity period (FMP). In calculating this period the factor will calculate the average number of days taken by the supplier's customers to pay. In the trade jargon this period is often referred to as "the receivable term". One of the factor's aims will be to reduce this period as far as possible on a progressive basis.

Export-import factoring
International sales involve additional risks and complications over those that exist in the domestic markets. Accordingly, while the basic concepts remain the same, a number of special features apply in the case of factoring applied to export-import deals - see the following points. Characteristically, the factor will subcontract part of the work that he carries out to a factor in the importing countries. These arrangements operate on a reciprocal basis. Various international networks and agreements of this type exist based on different operating principles. For example, in some cases factors in each country report to a central holding company, others comprise a branch network based on one central operating company, and some are independent companies belonging to an association. Examples of this last shucture are International Factors Group and Factors Chain International. A factor can also operate directly in the importing country though this is less commonly found in practice. The reasons for this include the difficulty of assessing the creditworthiness of customers and the complications of cross-border credit management. Alternatively, the foreign supplier may reduce its costs by going direct to a factor in the importing state. However, if the supplier has a significant number of customers in several different countries, it may be more practicable for it to concentrate its arrangements on a single factor in its home state. In addition to providing financing, some factors can also assist export suppliers with hedging packages against exchange risks. Characteristically, these can include currency prepayment, forward exchange contracts, currency futures and options. Since factors build up extensive data bases on purchasing companies, the provision of credit information to suppliers is also a developing activity.

Risk assessments
Before taking on a new customer, a factor will assess how good a risk the supplier is and will also look at the quality of the receivables that are to be purchased. This will involve steps such as examining financial statements and recent management accounts, looking at the supplier's own payment history to creditors and examining the company's forecasts and development plans. So far as sums due to the supplier are concerned, the factor will be interested in matters such as the way the receivables are spread out among different customers, how quickly or slowly debts are collected, and how many claims for deductions are made by customers because of incorrect deliveries. At the same time, the supplier will also wish to assess the standing of the factoring company . This is particularly important since in many cases the factor will become virtually the sole source of customer payments. Elements to be taken into account in this assessment include matters such as how much the factor knows about the supplier's industry sector, expertise in credit management, performance of the factor's information systems and data-bases, procedures with regard to regular reporting on receivables, and reserves or reinsurance capacity to absorb losses.

Master agreement
Few countries have precise legal codes covering factoring as a specific topic, though UNIDROIT - the Rome-based international institute for the unification of private law - has worked on the preparation of a model international law on this subject. Accordingly, the effectiveness of factoring arrangements will depend in large part on the terms of the agreement drawn up between the supplier and the factoring company, and on the way receivables are assigned to the factor. The basic contract between factor and supplier is often referred to as the Master Agreement. In many cases this document will be drawn up as a so-called all turnover agreement. It will provide that all receivables arising in the course of the supplier's business will be sold and bought by the factor automatically. A less common alternative, sometimes known as a facultive agreement gives the factor an option to take an assignment of receivables as they arise.

Factoring in Turkey
Factoring companies started to operate in Turkey only in the 1980s. Today the procedure is widely employed in that country and several banks and business organisations are involved in providing this type of service. For example, the first two organisations to offer factoring in Turkey were Iktisat Bank in 1987 and Garanti Bank in 1989. Today several major Turkish factoring companies are members of Factors Chain International (FCI). This enables them to act as correspondents and carry out foreign trade-related activities. These include Facto Finance, Aktif Finance, Turkiye Kalkinma (Development) Bank and Is Bank. Also, in 1994 the 14 companies then operating in the sector formed a factoring association with the aim of developing common rules and practices. Turkish factoring companies will normally provide up to 85% of receivables purchased. Generally speaking, service commmissions charged by factors on full service factoring range from 2.5% to 5%. In addition, a discount rate applies to sums prefinanced. Areas in which factoring in Turkey are widely applied include paper production, printing and publishing, automotive components industries, distribution and marketing of machine parts, textiles, electronics, consumer goods, food products, construction materials, household furnishings and advertising services. Factoring services are used by Turkish companies of all sizes. Although basic Turkish legislation does not specifically deal with factoring relationships, a government decree published in the Oficial Gazene on June 27 1994 includes special regulations for this sector. Under this decree the Under-Secretariat of the Treasury Department is given the task of issuing operating permits for new factoring companies and of regulating interest rates and fees. In addition, the decree provides that factors have to operate in the form of joint stock companies and have to satisfy capital adequacy and management qualification requirements. Transfer and assignment of receivables under Turkish law is governed by the general legislative provisions on debt assignments set out in the law of obligations. In general terms, the seller can assign its right to receive payment to the factor. The payment terms agreed between seller and buyer will then apply equally to the factor.

Factoring in Morocco
Factoring is a relatively recent introduction in Morocco. Initially, the procedure was carried out directly by local banks who offered a limited service essentially as a straightforward guarantee of payment. Then in 1988 the Banque Marocaine du Commerce Extkrieur (BMCE) created a factoring subsidiary called Maroc Factoring. In addition to the guarantee aspect, this company provides a comprehensive receivables management service. Factoring on the domestic market accounts for around 60% of its activities, with the public sector in the lead. According to 1994 figures, import factoring accounted for only 8% of the total with 32 % being concentrated on the export sector.

Case study: UK export factoring


A British export factoring scheme run jointly by Lloyd's Bank Commercial Service and Alex Lawrie, also a member of the Lloyd's gmup, combines credit insurance with sales ledger administration and finance. Up to 100% export credit insurance is offered under a link up with the NCM credit insurance organisation. The financing option pays up to 85% of the value of the export invoices within 48 hours of billing the customer. Collection procedures can be conducted either directly or through the Factors Chain International network. Broadly speaking, the service is available to businesses with a minimum export turnover of 100,000 p.a. and a maximum of 20 million p.a. A separate package has been devised for smaller exporters with foreign turnovers of between 50,000 and 100,000. Commission for sales ledger administration ranges from 0.75% to 3% of annual export turnover. Interest is charged on sales linked finance at a rate of 3% maximum over Lloyd's bank base rate. Charges for credit insurance comprise an annual fee which is typically around 720 and premiums which range from around 0.75 % to about 1.5% of export turnover.

'

Import-export factoring - comparative study


Heller International Group (EIG) is a Chicago-based subsidiary of the Fuji Bank, whose headquarters are in Tokyo. HIG organises factoring, leasing and other financial services through an international network of affiliates in key OECD countries and selected emerging markets. The charts set out below provide two examples of international import and export factoring structures employed by the Heller group.

INTERNATIONAL FACTORING IMPORT

I 2m
1 I

DOMESTIC

OVERSEAS

CUSTOMER

CLIENT

I I I

I : 1m
2
FACTOR AURUM-HELLER
7
I
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PART 3
MEDIUM- AND LONG-TERM FINANCING TECHNIQUES

Chapter 9:
Introduction

Forfaiting - general

Forfaiting provides a source of non-recourse finance through the use of drafts, promissory notes, or other instruments representing sums due to the exporter. The procedure is particularly attractive when government sponsored finance is not available. Its main use is in medium-term - and to a lesser extent - short-term import financing. Capital goods are particularly favoured in this respect, though the technique can be applied to sales of goods and services generally, in both international and domestic transactions. The technique is sometimes referred to as B forfait financing. There is now an expanding market for forfaiting to raise money for financial operations, though the principal use remains the financing of exportlimport transactions. Although no exact figures are available, it is generally recognised that forfaitin? still represents a modest proportion of total export financing worldwide. However, its use is growing in a number of emerging markets, including east Asian and eastern European countries.

Operation
Forfaiting used in an export sales context operates in the following way. In the course of negotiations with the buyer the exporter agrees to supply the goods on credit terms. At the same time the exporter approaches a forfaiter - usually a bank or specialised subsidiary of a large banking organisation in the exporter's country and obtains a quote as to the terms on which the forfaiter will finance the deal. When the goods are shipped. the seller obtains signed promissory notes or drafts accepted by the importer with maturity dates corresponding to the credit terms a-geed between the buyer and seller. The total amounts for which these instruments are drawn up will cover the purchase price plus the interest to be paid by the importer in respect of the credit that is allowed by the seller. Unless the importer is a first class risk, the exporter will usually ask for the bills or notes to be underwritten by a bank in the buyer's country. This backing takes the form either of an aval endorsed by the bank on the instruments, or of a separate bank guarantee. The guarantee or aval is sent with the other documents to the seller. With all these documents in hand, the seller then obtains an immediate cash payment by discounting the importer's payment undertaking at the local forfaiting bank with which it has previously agreed the discount terms. An essential element of this arrangement is that any rights of recourse against the exporter in case of non-payment are excluded when the relevant papers are signed over to the forfaiter. Therefore the seller obtains the same kind of security that it would get from a confirmed documentary credit. This is because a bank in the seller's country commits itself in advance to pay the exporter without recourse if it presents the appropriate documents. In general terms, documentary credits are used where payment is immediate or very short-term credit is being granted. Forfaiting provides a comparable arrangement for larger sales that are being financed on a longer-term basis. There may however be some overlap between the two at the margins. The forfait- makes its profit from the margin between the price at which it agrees to buy the paper for an immediate cash payment, and the total sum including interest that the importer has agreed to pay to the seller.

The importer will undertake to make these payments by instalments -for example once every six months over the period of the credit. Accordingly the discounted paper will comprise bills or notes corresponding to each of the instalment dates and amounts payable at those dates.

Size of deals
There is no precise lower limit on the size of a transaction that may be forfaited, though in practice the procedure is unlikely to be attractive unless the amounts involved are relatively large - say US$1 million or more. There are no exact limits as to the minimum or maximum repayment terms that will be accepted by forfaiters. In practice adi most deals tend to range from about six months up to around six or seven years or sometimes even 10 years. The largest deals will usually be syndicated between several banks. This may be carried out in two different ways. Under one procedure, each member of the syndicate directly discounts separate tranches of the total. Under the other procedure the lead member discounts the total itself and then lays off individual tranches to other members by way of sub-participations. In addition, there is a growing market in secondary trading of ? forfait i paper. This is helping to improve market liquidity.

Costs
On average, total costs to the importer are likely to be higher than on traditional loans. This is in part because forfaiters tend to go in for higher margins since they are affording non-recourse facilities. In addition, costs of the deal will often include the granting of avals or guarantees by a local bank.

Advantages
As a means of financing, forfaiting presents a number of advantages. The exporter benefits because it is fixed rate without recourse, and it receives an immediate cash payment. Also, the exporter is relieved of the need to invest time and money in managing and collecting debts and it is able to pass most of the risks on to the forfaiter. These include currency, interest rate, credit and sovereign risks. The procedure also provides the exporter with flexibility. For example, while factoring, it is not obliged to use the procedure for all or any specified part of the export transactions. The technique is also generally simple and quick to use. Forfaiten generally pride themselves on being able to give rapid decisions as to the risks they will accept and the terms. In addition, the documentation is usually relatively simple. The importer also benefits from the flexibility, rapidity and relative simplicity of the forfaiting system. Moreover, since the exporter knows at the outset the cash sum that can be obtained from the forfaiter, it is able to extend fixed-term credit to the buyer. In addition, by issuing notes or accepting drafts the importer is not technically taking out a loan. Thus, this action may not use up the importer's credit lines in the same way as would tr tional borrowing. On the other hand, the importer also has to bear in mind the unconditional obligation to pay the notes or drafts which is independent of the underlying sales contract. This means that the importer cannot refuse to pay the forfaiter in the case of a dispute concerning the goods or the services. This is similar to the credit applicant's obligation to reimburse the bank when payment has been made under an irrevocable letter of credit.

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Credit rating
It is sometimes believed that forfaiting is used only by parties whose credit rating is not good enough to obtain finance from more traditional sources. However, since banks or other forfaiting specialists are taking on substantial risks without recourse over longish periods of time, they will be very careful about the companies whose paper they accept. Also, the forfaiting company will often look for the backing of a bank in the buyer's country unless, for example, the importer is a government agency or a multinational company with a solid reputation. The local bank will in its t u r n assure itself of the creditworthiness of its customer before giving such a commitment.

Emerging markets
Against this background, forfaiting is becoming increasingly popular as means of financing deals such as capital goods imports in many emerging markets. Several factors contribute to this trend. Examples are, rapid rates of growth in South East Asia and a tendency in OECD countries to reduce export credit subsidies and to bring premiums on export credit guarantees closer to market rates. This reduces the gap between the costs of such officially sponsored schemes and commercial market techniques such as forfaiting. Also, forfaiters -who used to concentrate on the industrialised countries -have now established a permanent presence in many markets outside the OECD. Latin America provides one significant example. Local banks in that region are now becoming increasingly practised competitors for this type of business. For example, Tradeway - a specialised forfaiting subsidiary of Banco Bamerindus do Brasil - has become a major trader in Brazilian paper on the London secondary market. Asia is a primary target for many forfaiting specialists with global aspirations. It is believed that China is a promising market for the future in this respect. This is particularly the case since Chinese exporters sell to

lesser developed countries where it is particularly important to offset risk. Korea is another example. Many companies in that country export to areas such as Pakistan and Eastern Europe where there are currency and payment risk exposures that lend themselves to forfaiting cover. However, apart from a few countries such as Japan, Taiwan and Korea, few Asian states are as yet large capital goods exporters. Elsewhere, commodity exports which generally involve shorter payment terms such as documentary credits, still typically form the bulk of foreign sales.

Secondary trading
Forfaiting revolves around the discounting of negotiable insrmments such as drafts and promissory notes or other trade receivables. Therefore, this technique allows scope for the development of secondary markets for the trading in discounted paper. Traditionally, secondary trading in forfaited paper has been restricted by the reluctance of sellers and guaranteeing banks to have the details of their transactions publicised. Forfaiters themselves also sometimes fear that indirectly divulging details of their customers' deals in this way may tempt other forfaiting specialists to try to poach business from them. Furthermore, even when repayment is spread out over a large number of instalments, the individual bills and notes issued tend to be for relatively high sums of money. All these factors have in the past had the effect of restricting secondary trading to small groups of banking specialists. In the classic inter-bank markets, the forfaiter keeps the paper to ensure that confidential details are not divulged and communicates only key names and amounts to prospective buyers. The original forfaiter then undertakes to cany out all the necessary steps to obtain payment on behalf of the buyer of the paper at the maturity dates. However, as the markets for a forfait deals expand and become more competitive this traditional picture of restricted secondary trading is changing. Efforts are now being made to attract more outside investors. Although there are no stock exchanges at which B forfait paper can be traded, such paper is now being treated increasingly as a capital markets product. For example, in the London market several banks have integrated the trading of forfaited paper into their capital markets divisions. Accordingly, they are now treating this as an investment product rather than as an adjunct to export finance. Furthermore, as an alternative to trading such paper between banks, several London houses now regularly sell it to overseas investors who have no particular connections with trade financing. East Asian investors play a major role in this. As more investors become involved in the B forfait markets, liquidity should increase. In this event it may become attractive for some large exporting countries to discount their paper directly in the market as an alternative to using an intermediate forfaiter. This would reduce their refinancing costs since they could expect to sell their paper for a better price. Such a move would be in line with the general trend towards securitisation that has been seen over recent years.

Forfaiting- What the name means


The word forfaiting comes from the French ~3forfait and thus conveys the idea of surrendering rights. This concept is of fundamental importance in forfaiting which revolves around negotiation of documents without recourse. The German expression for the same concept is Forfaitierung.The French refer to le forfaitage, the Italians to l a forfetizzazione and in Spanish the word is forfetizacion.

How forfaiting developed


The origins of the forfaiting market lie in changes in the world economic structure that took place during the late fifties and early sixties, at a time when the sellers' market for capital goods was gradually changing into a buyers' market. A considerable expansion in international trade took place accompanied by an increasing tendency for importers to demand periods of credit extending beyond the traditional 90 or 180 days. At the same period there was a general lowering of the trade barriers that had been created in the pre World War I1 years of depression and the cold war era. The resulting resurgence of trade between the west and the countries of eastern Europe coupled with the growing importance of the developing counmes of Africa, Asia and Latin America created new financial challenges for west European exporters. Furthermore, the demands created by these new markets came at a moment when the heavy investment commitments of western exporting firms prevented them from financing medium-tern supplier credits out of their own funds, and existing banking structures were unable to offer the services that exporters needed. A forfait finance was one of the solutions. With its traditional importance as a banking centre and long experience in international trade finance, Switzerland was one of the earliest centres to develop this new market. For example the Crkdit Suisse bank, which was one of the pioneers, now operates forfaiting subsidiaries in major centres around Europe. London is now also a particularly important centre for this type of trade financing.

Chapter 10: Forfaiting - procedures


Preliminary action
Wherever possible the exporter should contact his bank or other forfaiting specialist before concluding his sales negotiation with the importer. In most cases, the forfaiter should be able to indicate at this stage whether or not it is prepared to take the deal and if so the likely terms including the discount rate and guarantee requirements. This is particularly important since, typically, the forfaiter's discount rates tend to be higher than the usual interest rates agreed between buyer and seller. If the exporter does not have the forfaiter's estimate in hand it is thus likely to lose pas of its profit in the difference between the interest element added to the price and the discount extracted by the forfaiter. Before making a firm commitment, the forfaiter will require full details of the transaction. Typically, the exporter is asked to supply this by filling in a standard form. For example, the French based BVMP bank (a member of the Dresdner Bank Group) indicates the following questions in an information note prepared for its forfaiting clients : The currency amount and period to be financed Theexportingcountry The name and country of the importer The name and country of the guarantor The form of debt to be forfaited ( e.g. promissory notes, bills of exchange etc.) The form of security (e.g. aval or guarantee) The repayment schedule (i.e. amounts and maturities of the bills) The nature of the goods to he exported The date of delivery of the goods The date of delivery of the documents The necessary authorisations and licences (e.g. import licences, transfer authorisations, etc.) The place of payment of the promissory notes or bills of exchange.

In many instances the prospective exporter may require an indication of rates before all the detailed conditions of the projected deal have been finalised. In this case it may not be possible for the forfaiter to quote a binding figure but it will nonetheless be able to give an approximate non-binding rate.

Risk analysis
Before agreeing to take the deal, the forfaiter will also analyse the various risks involved. In coming to a decision it will look at issues such as whether there is still room within its portfolio for the particular sovereign risk involved, the creditworthiness of the guarantor, the basics of the underlying business deal, the status of the exporter and the importer and the resale market for the paper that it is being asked to buy.

Firm commitment
When the forfaiter makes a firm offer, this commits it to provide the finance at the fixed rate indicated. In the best circumstances, the exporter receives this offer before concluding the sale with the importer and is able to take account of it during negotiations. In this instance the exporter will want the forfaiter's offer to remain open during the intervening period since it will wish to accept it only if the negotiations are successful. Accordingly, forfaiters' offers include an option period during which the forfaiter continues to be bound by its offer and the exporter is free to decide whether or not to take it up. If the option is required only for a short period - say up to 48 hours - no option fee is usually charged. For longer periods - for example up to three months - a fee will normally be levied. When the export contract is signed, the seller will accept the forfaiter's offer to discount its paper and both parties are then bound by the forfaiting agreement. A further period, perhaps six months or longer, may then elapse before the goods are shipped and the papers presented for discounting. The forfaiting agreement is worded to remain valid throughout the whole of this period, referred to in the trade jargon as "the commitment period". Even if financial conditions change radically in the meantime, the forfaiter remains bound by the terms of its original offer. Accordingly a commitment fee is charged for this period of availability. At the same time, the exporter can withdraw from the forfaiting contract at this stage only with the agreement of the forfaiting organisation and it will normally be called upon to pay any costs incurred by the latter.

Documentation
The forfaiter's offer will indicate documents that he will need to see before discounting bills or notes. Possible examples are import licences, exchange control approvals and permits. The forfaiter will also specify particular legal requirements applicable to the countries concerned as to the form in which the commercial paper is to be drawn up. The exporter will then arrange for the necessary documentation to be drawn up and signed and will present this for discounting together with evidence of shipment after the goods have been dispatched. The bank discounting the paper will be particularly careful to note that the signature on the bills, notes, guarantees and avals are authentic and also that the signatory had the necessary authority to sign.

lnstalments
In the normal course of a forfaiting operation, the forfaiter will present each bill or note shortly before maturity for payment. If the demand for payment is not honoured the forfaiter may contact the,exporter to check whether there are any problems on the underlying deal that could explain the difficulty. Attention will also be paid to legal formalities such as protesting dishonoured instalments within the applicable time limits.

Acceleration
Traditional loan agreements normally contain an acceleration clause which provides that if there is failure to pay on one instalment the entire balance of the loan becomes immediately repayable. It should be noted that this possibility does not normally arise under a forfaiting arrangement where repayment from the importer is to be made by instalments. This is because by signing notes or drafts the importer enters into a series of separate legal obligations rather than a single overall loan agreement. On the other hand the 1988 UN convention on international bills of exchange and international promissory notes allows for the inclusion of an acceleration clause. [See appendix to chapter 4.1 However, that convention applies only in limited circumstances.

Currencies
Commonly the notes or bills are denominated in US dollars, Deutschmarks or Swiss francs, although it is possible to discount notes in any currency. These three curencies are particularly favoured because of their widespread use in the Euromarkets.

Forms of commercial paper


In the largest number of cases the paper discounted takes the form either of bills of exchange or of promissory notes. These instruments have a very long tradition in merchant practice and their use is well understood. Furthermore, precise legal provisions in national laws make it clear what the parties' rights and obligations are where these instruments are used. There is also a measure of international harmonisation amongst countries that have adopted the 1930 Geneva Conventions on this subject. At the same time other credit instruments may also be forfaited. Examples are book receivables and deferred letter of credit obligations. These are less common since documents of this type are less easily transferred than is the case with negotiable instruments, and considerable additional paper work is needed. Moreover, secondary trading is also more complicated and restricted. Where bills of exchange are used there is at least theoretically a technical difficulty if the deal is governed by the law of a country that has adopted the Geneva Conventions. The reason for this is that whilst under the convention an endorser of a bill can exclude rights of recourse, the drawer cannot. When a bill of exchange is used it is drawn up by the exporter who wishes to negotiate it without recourse to the forfaiter. In practice this causes little real difficulty. The forfaiter will undertake not to make use of its technical right of recourse in such circumstances. Even if this waiver is not legally effective in some countries it would be commercially unwise for a forfaiter to use this argument. Also, under English law the drawer as well as the endorser of a bill of exchange can exclude rights of recourse. The UN convention contains a similar provision.

Guarantees and avals


In many cases the importer's payment obligation will be backed by a bank guarantee or aval. The bank guarantee takes the form of a separate document signed by the guarantor setting out in full the conditions relating to the transaction. In this event the guarantee should mention both the total amount and the individual instalments payable at each maturity date. This is because the discount value is linked to the instalment arrangements. Also, forfaiters generally insist that guarantees are fully transferable and independent of the underlying transaction. An aval is in many ways simpler to operate than a guarantee and it has tended to find wider use in practice. It is written directly on each promissory note or bill of exchange and signed by the avalising party. Use of this procedure is particularly helpful in avoi ng complications on transfers of the bill or note, since the benefit of the aval is automatically assigned with the bill or note itself.

Costs
These include several elements. In outline some of the main features are as follows: First, the importer generally pays the fees for any bank guarantee or aval. In some cases where this is not acceptable to the importer, the exporter may do so in order to improve the discount rate and make secondary trading easier. The forfaiter's fees, expenses and interest rates are paid by the exporter and they calculated into the selling price quoted to the impotter. The forfaiter's fees include a charge for the use of money and the covering of interest rate and country risks. The interest rate risk arises because the forfaiter commits itself to a fixed rate in advance. A commitment commission is charged if the sale is to take place some time ahead.

Chapter 11: Leasing


Introduction
Leasing provides a means whereby corporate buyers, including importers, may obtain equipment on credit terms without overburdening the credit side of their balance sheets in the same way as a traditional loan would. Typically, the technique is also particularly effective for tax purposes since the rental payments can be deducted from taxable income and in some cases there may also be additional tax breaks. In everyday usage, the expression leasing is used as a general term to denote a wide range of situations in which the temporary use of goods or real estate is obtained in return for making rental payments. Confusingly the same term has been adopted for a much more specialised procedure under which the legal structures of a lease or rental agreement are used to provide medium-term finance for the purchase of capital goods and other equipment. In most such cases the rental agreement includes a purchase clause that allows the lessee (the company acquiring the equipment) to buy full ownership of the goods by means of a single payment at the end of the rental term. However, in some instances leasing agreements contain no purchase option clause. Unless the agreement is renewed for a further term, the property then reverts to the lessor (the leasing company) when the rental term expires. For example, a lessee might not require an option clause where the equipment has little residual value by the time the leasing agreement ends. The fact that the lessee may not always become owner of the goods can blur the distinction between the general concept of leasing and its specialised use as a means of financing corporate acquisitions of equipment. However, leasing arrangements falling into the latter category will generally provide for the lessee to bear full responsibility for the goods and to have full use and control over them in the same way as an owner during the rental term, whether or not a purchase option clause is included. Leasing agreements used as a financing vehicle first started to become popular in the 1960s. Following their initial use in the United States, they later spread to western Europe and they are now being increasingly adopted in developing countries to encourage industrial investment, including international investments. Multilateral financing bodies such as the International Finance Corporation have been involved in some of these efforts. Leasing structures can be used for financing purposes across a wide range of business sectors and may range from the acquisition of industrial plant by a small family company to the replenishment of an airline's fleet of passenger aircraft. Corporate vehicle fleets provide a further example. In some cases a manufacturer or distributor may provide credit by entering directly into a leasing agreement with the corporate buyer or user. More commonly, a specialised leasing company buys the equipment chosen by the corporate user and enters into the leasing agreement with it. Many of the leasing companies are banking subsidiaries. Some of the largest - which have their home bases in Europe or North America - have established subsidiaries in a number of emerging markets. Local companies are also increasingly entering this sector in developing countries. Also, there are now several international associations of leasing companies.

Finance and operating leases


A leasing arrangement used for financing purposes is often referred to as a finance lease. Other leasing arrangements under which the essential purpose is to obtain use of the item - normally for a relatively short period - are usually called operating leases. Short-term hire of computers and motor cars provide examples. There is no exact legally defined boundary line between these two concepts even in national laws, much less at international level. The difference can be of considerable practical significance, since the availability of special tax deductions and the exact rights of the parties may depend on the relevant agreement being classified as a finance lease. Generally speaking the tenor of a finance lease is for a period of several years. Moreover, during the rental term, the lessee enjoys most of the rights and obligations of ownership. Furthermore, under such an arrangement the lessor will normally calculate the rental payments so that they cover the full capital costs of the equipment and provide a profit on the funds invested. Finally, there would be no right to cancel the agreement during the term of the rental.

Sale and lease back


The technique known as sale and lease back can be found in both finance and operating leases. Under this procedure, a company that already owns equipment sells it to a leasing company which then leases it back to the seller. This technique can serve several purposes. These include providing working capital, refinancing on better conditions than an existing loan, or making the company's accounts look better if the resale value is higher than the written down value in the company's accounts.

Lease receivables discounting


Most leasing agreements will specifically allow the lessor to sell the equipment and the right to receive the rental during the lifetime of the agreement with the lessee. The latter's rights and obligations under the lease remain unchanged. This technique is often referred to as lease receivables discounting. It provides the lessor with additional flexibility in managing assets and raising liquidity.

Multi-investor situations
In the simplest case the lessor provides the whole of the purchase price for the equipment from its own resources. This is often called a direct or single investor lease. In other instances -particularly larger cases several institutional investors may combine to provide part of the funds. The usual expression for this type of arrangement is a leveraged lease. The lessor's stake is often known as the equity portion or equity funds. The investor's right to repayment will be solely against the lessor.

Domestic and cross-border leases


In addition, leasing arrangements may be either domestic leases or cross-border leases. This distinction does not correspond to any essential difference of a legal nature. However, cross-border leases are more compli-

cated since they are likely to involve considerations such as curency risk, exchange controls, import and export permits, withholding taxes, varying accounting and reporting requirements and choices of applicable law and enforcement procedures. The crosss-border leasing situation arises where the the lessor itself is in one country and the lessee in another. The supplier of the equipment might also be in another country but could equally be a domestic supplier in the lessee's market. As a corollary a domestic leasing agreement - with both lessor and lessee being situated in the same country - could be used as a means to finance an export-import deal. Export credit subsidies and guarantees may be available in the seller's country in some cases, where the supply of goods to a foreign country is financed by a leasing arrangement. In addition, leasing agreements sometimes form one element in international project financing packages. in this situation the project assets such as industrial plant are funded by way of finance leasing. [See chapters on export credits and on project financing ]

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Categories of leasing companies


Leasing companies fall into several different categories. They may be independent undertakings or subsidiaries of banks or other financial intermediaries. Some have been set up as subsidiaries of equipment manufacturers and suppliers. In a growing number of cases involving the establishment of a leasing company in a developing country, a joint venture structure is set in place. This will involve equity participation by a foreign leasing company and a local investor. This arrangement may be required to satisfy local regulations or to facilitate operations on the local markets.

Some advantages of leasing finance


A significant advantage to the lessee is the fact that this method can provide up to 100% of the cost of the equipment since payments are made by way of rental and often no down payment is required. On the other hand, some leases are structured to provide for a number of advance rentals at the outset and in some instances - small value items for instance - the lessor may finance only part of the acquisition. In addition, leasing avoids having to tie up valuable working capital or credit lines and thus preserves liquidity for other purposes. Since technically no loan is made it can be carried out off-balance sheet. However, since the agreement cannot be cancelled there may be an obligation to show the liability for future payments in some form in the lessee's accounts. The off-balance sheet nature of leasing is similar to the situation that arises on forfaiting operations. When forfaiting procedures are employed to provide import finance the importer generally accepts bills of exchange or signs promissory notes payable on future dates on a regular instalment basis. Moreover, both leasing and forfaiting credit tend to be granted on a medium-term basis. In some instances leasing finance may be cheaper than traditional forms of borrowing. This may be the case, for instance, where the lessor is prepared to offer a lower rental in return for sharing in the resale value of the equipment at the end of the rental term. A further important point is the fact that lease rentals are generally fully tax deductible as operating expenses. Also, in some cases, the equipment subject to the leasing agreement may form part of an investment in industrial capacity or other business unit that attracts additional tax breaks by way of regional or national government incentives. Sometimes the lessee company cannot benefit fully from such incentives, for example, because it does not earn enough taxable income. In this situation it is sometimes possible to structure the leasing agreement so that the tax incentive can be claimed by the lessor. In this event the lessor can offer a lower rental. The availability of tax breaks and investment incentives often depends on how the leasing agreement is categorised for legal and accounting purposes, and who is considered the owner of the equipment. In very broad terms basic legal and accounting rules in countries following the civil law traditions of continental Europe tend to centre on the lessor as the owner of the goods. Common law jurisdictions based on English legal principles on the other hand tend to favour the concept of economic ownership. Against this background the European Commission has worked on a harmonisation directive for accounting rules relating to leasing contracts.

Concluding the leasing agreement


Leasing practices and arrangements vary considerably. In outline a characteristic deal might be concluded along the following lines:
A leasing company receives an enquiry from a prospective lessee. At the outset the lessor ensures that the enquirer and the proposed deal satisfy its basic conditions such as size of the deal, business experience of the prospective customer, relationship between the equipment cost and the net value of the business, and the profits being generated by the business in relation to the annual rental under the proposed agreement.

If the basic conditions are satisfied, the leasing company asks for more detailed information on a wide range of issues so that the application can be processed. These will relate to matters such as the nature and intended use of the equipment, payment conditions, availability of security, financial management and ownership details of the prospective lessee together with the nature of its business and major customers and suppliers.

At the next stage the lessor gives a quotation of the terms on which it is prepared to offer a leasing contract. It may be possible for the lessee to negotiate these terms advantageously particularly if it is able to obtain competing quotations from several leasing companies. Typical matters covered in the quotation include the type of leasing facility, the amount of any initial rental, advance rental or security deposit, the lease tenn, the amount and frequency of the rental payments, the currency in which rentals are payable, whether the rentals are fixed or variable, the options available at the end of the lease, insurance and security requirements, and details of any fees and expenses to be met by the lessee. If the prospective lessee wishes to proceed, the leasing company then carries out a detailed credit appraisal. This looks at issues such as the purpose for which the equipment is being acquired, the nature of the business and its track record, and full financial information. Finally an offer is made to the prospective lessee. This is sometimes referred to as a facility letter or commitment letter.

Legal framework and contract drafting


Finance leasing agreements have developed from practice rather than any specific body of legislation. In basic approach they are similar to hire purchase agreements, though the consumer protection legislation which applies to such agreements in many countries has no application to leasing agreements between businesses. Characteristically, leasing agreements are lengthy documents, and they try to deal in advance with most of the catastrophes that might occur over the lifetime of the deal. Additional documentation may also be involved, particularly in cases where security is being taken over property, or third party investors are brought in. The agreement covers basic matters such as identification of the equipment, the rental and the period during which rent is to be paid. It also deals extensively with matters such as protection of the lessor from liabilities arising from its legal ownership of the equipment, assurance that the lessor obtains good title to the goods, maintenance obligations of the lessee and liability insurance. Events contituting default will be exhaustively listed and remedies set out. In some instances professional bodies provide contract forms or guides for use in drafting leasing agreements. One example is provided by Leaseurope, a Brussels-based association of European leasing companies. Among other activities, this association has drawn up a trilingual guide on key provisions for capital leasing in the real estate sector.

Hungarian real estate leasing


Because of the liberalisation of the Hungarian economy and the lack of suitable modem premises, there is an enormous demand for building finance. In many cases finance leasing is seen as the most appropriate solution. Types of property construction carried out on finance leasing terms in Hungary include offices, hotels and turnkey factories. Refinancing agreements in this respect can be secured by registration in the charges registry. One complicating factor is a law passed in 1987 which provides that foreign investors cannot acquire ownership in Hungarian real estate unless they obtain the prior permission of the Ministry of Finance. Also, under Hungarian tax law, tenants under leasing contracts can deduct only 13% of the gross rental payments per year.

Leasing in Morocco
Leasing arrangements are now common in many developing countries. Morocco provides one example. The development of leasing arrangements in that country took place in the context of a liberalisation of financial markets. For example, credit corsets were thrown off progressively between 1990 and 1993. Under the Moroccan banking law, leasing companies are treated on the same footing as credit institutions. This involves the management of a guarantee fund to protect depositors and a mandatory external independent audit. The country's central bank is reponsible for supervising leasing companies under these provisions. In the case of finance leasing of real estate, interests are noted in a charges registry. Equipment leasing plays an essential role in providing finance for small- and medium-sized companies in Morocco. Accordingly, a number of favourable provisions have been put in place in this respect. These include interest rate reductions, the possibility for equipment users to deduct the rental payments, and refinancing of leasing companies by the European Bank for Reconstruction and Development.

Leasing:- Example of costs and structure BANCO CONTINENTAL GROUP, SAN ISIDRO, PANAMA
Type of lease Beneficiaries Term Min Max Minimum amount Percentage financed Appmx. annual interest rare Mode of payment Guarantees

"Contilea5ing", Individuals for purchase of new vehicles l yr. 3 yrs. USS6.W or equivalent in local currency Between 51% & 80% of the pnce
24% plus

taxes

Equal monthly instalmenls

Guarantee ofan individual or corpmu: entity. Nezotiable

*Standard leasing structure *Sale and lease-back


SMCtUE

Corporate entities for purchase of:- machinery equipment

I yr.

3 yrs. USS 6.000

Up to 100% of the cost of the items purchased

21%plus taxes

Equal monthly instalmenls in arrear.

Appendices

1.

Cross-border aircraft leasing

2.

Leasing in Turkey

Appendix 1:

Cross-border aircraft leasing

Cross-border leasing has become a major means whereby airlines and other operators throughout the world can acquire aircraft on the most attractive terms. This formula gives operators maximum flexibility coupled with cost savings and tax benefits in many cases. Because of the numbers of parties and different jurisdictions characteristically involved, drafting such leases is highly complex and requires assistance from specialist commercial lawyers. Some of the main considerations are briefly outlined below.

Form of lease
Legally speaking the lease may take one of several forms. These include a true lease with or without a purchase option, a conditional sale under which the seller reserves title pending payment, and an instalment sale under which ownership passes immediately to the lessee. An additional complication in the case of cross-border leasing is the fact that the legal nature of the agreement may be construed differently in different countries. This may affect the tax position in particular.

Registration
Parties will have to consider in which country the aircraft can or should be registered. In some cases registration is a guarantee of title whereas in other countries it is not. It may also be a precondition for being allowed to fly in or over the jurisdiction concerned, and may additionally be important for civil claims purposes in the case of an accident. In some instances, national registration makes the owner liable to maintain the aircraft in accordance with the rules applicable in that country. A further important factor is checking whether or not the country concerned has ratified an international treaty known as the Geneva Convention on the International Recognition of Rights in Aircraft. This provides for mutual recognition by parties to the convention of various interests in aircraft including most leases and mortgages.

Termination and repossession


The lessor will wish to ensure that the lease includes comprehensive provisions for termination and repossession of the aircraft in case of default. For example, the lessor will try to ensure that it will be possible to bring proceedings in any place that the aircraft is likely to be operated and that default notices can be served at any time. It will also want to be kept informed of the rights of any third parties over the aircraft, for example airport authorities, and maintenance and repair companies.

Taxes
Questions that arise include the possible imposition of import duties or value added tax on the import of an aircraft into the lessee's country together with the levying of withholding taxes on lease-backs and liability to local income tax in places where the aircraft is to be operated. In some jurisdictions the imposition of withholding tax may depend on whether or not the agreement is legally construed as a lease or as a conditional sale agreement.

Tax benefits
Corporate tax rates have come down significantly in many countries over recent years. However, a large

number of opportunities to take advantage of tax shelters have been removed at the same time. Some opportunities remain however. One of the most popular of these is the so-called double-dipping arrangement. This involves structuring the agreement so that the lessor is entitled to tax depreciation in one country whilst the lessee can also claim depreciation in another state. Broadly speaking this depends on exploiting differences between national regulations such as whether the owner is considered to be the person with legal title or the one with economic control.

Permits
In some countries the carrying on of a leasing business may require special consents on the ground that this activity constitutes a banking or other financial activity that is regulated locally. In many parts of the developing world exchange control regulations will also affect the structuring of payments into and out of the country.

Appendix 2:

Leasing in Turkey

Finance leasing began to develop in Turkey during the 1980s, particularly following the promulgation of the financial leasing law of 1984. This sets out a regulatory framework. According to information collected by the Istanbul Chamber of Commerce, about 1 to 2% of total investments made in the country are financed through leasing agreements and 40 or so companies are active in providing this type of finance locally. Banks predominate. Sectors in which leasing finance is common in Turkey include computers, land, marine and air transport vehicles, textile and printing machines, and medical equipment. The technique has also more recently been applied to real estate acquisitions. In the three year period from 1990 to 1993 the volume of domestic leasing operations increased nine-fold reaching TLl Itrillion. Foreign leasing companies have been most active in the air transport sector. Government investment incentives are available for a wide range of goods acquired by leasing arrangements in Turkey. Under the financial leasing law, most a-geements have to run for a minimum of four years before they can be cancelled. Cross-border leasing is restricted to cases where annual rentals exceed specified minimum levels. Leasing agreements relating to equipment are registered in the notary's office in the district where the lessee has its place of business, and agreements concerning real estate are noted in the relevant deeds registry. This provides the lessee with priority over rights acquired subsequently. In the case of a foreign leasing company which does not have a Twkish subsidiary, the relevant agreements are registered at the Treasury under-secretariat. The lessee has the right to use the goods during the term of the a,pement and is responsible for damage caused to them. Parties can agree to a purchase option. The lessor has to insure the goods. In the event of bankruptcy, the bankruptcy officer can rule on whether or not the goods, the subject of the agreement, are excluded from the scope of the bankruptcy proceedings. The creation of leasing companies in Turkey is subject to a licensing procedure administered by the Treasury under-secretariat. Foreign financial leasing firms cannot open branches in Turkey unless they are authorised to conduct leasing operations in their home country and provide the Turkish branch with minimum endowment capital.

Chapter 12: Project financing - general


Introduction
The basic idea underlying the complicated practice of project financing is a simple one: that lenders will be reimbursed from the income earned by the completed project. In the purest form of this technique - which involves non-recourse financing - lenders agree to rely solely on the expected revenue streams for the repayment of their loans and interest, and to give up any rights to pursue the borrowers personally in the event of default. In practice, limited recourse financing is more common. Under this arrangement lending institutions look primarily to the income generated by the project but receive in addition guarantees from some of the parties involved, such as the project sponsors and -often - governmental authorities. Project financing techniques are used to provide funding for a wide range of infrastructure schemes in both the developing world and the industrialised counmes. They may be suitable in many situations where the completed installation will make money. For example, Commerzbank in Germany identifies four main categories that are most likely to form the subject of project financing. The first category is infrastructure projects such as road and rail schemes and cellular telephone networks. The second category covers industrial complexes such as chemical plants, paper-mills and aluminium smelters. The third category concerns the environment, energy and mining and includes waste disposal, water supply, coal, oil and gas. gold and non-precious metals. The fourth category covers power plants, including combined heat and power stations, thermal power stations and district heating. In practice, project financing deals are highly complex arrangements involving large sums of money and a multitude of parties. Often lending is syndicated between several different institutions. Increasingly, these include multilateral and regional development banks in the case of projects canied out in the third world or eastern Europe.

Basic structures
Each individual deal has its own characteristics and there are no standard form agreements or globally accepted ground rules. In outline however, the basic procedure will often operate roughly along the following lines: The project is identified either by the authorities in the country concerned or by a business on the lookout for opportunities. A group of companies - the sponsors - associate to carry out the project and manage the completed development. The sponsors appoint a bank as financial advisor and to find sources of funding. Technical experts draw up feasibility studies for presentation to prospective lenders. The host country government provides necessary authorisations for the project. In view of its size the loan is syndicated between several banks internationally. The sponsors form a.specia1purpose company. This owns and operates the utility and provides a separate legal entity to act as borrower from the financing banks. In some cases, prospective suppliers, purchasers or users of the project facility sign so-called "hell or high water" commitments. These provide the lenders with some assurance that the completed facility will generate a sufficient level of income to cover the loan repayments.

Advantages and disadvantages


Project financing is more expensive than traditional lending since it involves additional risks and extra work for the banks and since it requires a considerable expenditure of time by lawyers, experts and advisors on evaluating the project and negotiating complex documentation. Also, since the project and the financing procedure involve many parties and complex relationships, insurance cover may be more expensive than in similar deals financed by more traditional means. On the other hand, the borrower and the sponsors obtain the advantage that part or the whole of the payment risk is shifted to the lenders since the loan is made on non or partial recourse terms. Part of the political risk of the project being frustrated by acts of the host government is also removed in the same way. Furthermore, depending on the regulations applicable in the country of the borrower or the sponsors, nonrecourse financing in particular may weigh much less heavily on the company's balance sheet than other forms of borrowing. In addition, in some cases, the project financing structure can be used as a way to avoid falling foul of borrowing restrictions arising from existing debt commitments of the company or the wording of its articles of association. In some instances tax benefits may also be obtainable. In some cases sponsors are able to obtain better rates by issuing debt instruments in the markets rather than obtaining bank loans. Banks are then involved as organisers of the bond issue rather than as lenders.

Bank concerns
Before committing themselves to lending on project finance terms, banks will take exhaustive steps to confirm the solidity and expertise of the project sponsors and owners. Computer models of the projected performance of the facility will figure largely in this respect. Lenders will also look for various forms of security over the project assets and future income. In assessing the quality of the project sponsor lenders will consider a wide range of factors including relevant expertise, market experience, degree of involvement in the project and financial support. A previous successsful track record in undertakings of a similar type will be a particularly positive indicator.

Risks and assurances


Although banks assume all or part of the repayment risk, when the project is under construction, they will usually require the sponsor to take on a major part of pre-completion risks such as delays in completion, abandonmenl cost overruns and failure to achieve any stipulated performance levels. Also, significant equity contributions to the project, whether in cash or in kind, will be expected from the sponsors or other partners in the project. In appropriate cases banks also look for government assurances that action detrimental to the successul operation of the facility, such as restrictions on price levels or the granting of competing concessions, will not be taken. At the same time, security over revenues is frequently enhanced by the establishment of escrow or trust accounts. These can also help to avoid restrictions resulting from exchange control regulations in the host country. Often, sponsors are also required to establish debt service reserves to see the operation through its initial start-up months.

Lending terms
This caution is particularly necessary since the essence of a project financing package is to grant long term financing secured by the performance of the completed project. Characteristically, lending terms can be as long as 10 to 15 years. Such extended periods are necessary to allow the completed facility to cover running costs and make a profit as well as repaying the debt.

Advisers
Project financing deals are growing ever-more complicated and the already extensive time taken to negotiate them is tending to lengthen them even further. This means that the role of the adviser is becoming more and more important. The adviser - usually a merchant or commercial bank - analyses the project and sells it on behalf of the sponsors to the lenders. Especially on large projects, an important part of his or her work will be to weld the joint venture partners together into a cohesive team. One of the adviser's most basic tasks is developing and applying computer-based cashflow models for the prospective project financing. However, companies involved in owning and managing projects insist that advisers need much wider skills in order to knit together a successful deal and attract financiers. Among the requirements frequently emphasized by sponsors are qualities such as sector and country experience and expertise, staff availability, modelling ability and cost. For example, charges levied by a top merchant bank in London could be from around f1,500 to 2,500 per day. In some cases an additional fee of up to 1% is charged for a successful conclusion to the negotiations. At the same time a number of large companies that have built up a track experience in running projects are now developing their own in-house advisory teams.

Lawyers
In view of the vital importance of the documentation work in structuring the project, and a competitive climate that encourages parties to be litigious, the role of the lawyer in project financing is also of major importance. For this type of work lawyers can be chosen internationally on the basis of their skill and experience in the subject, rather than on a country basis. It is sometimes suggested that top British commercial lawyers have an edge in a number of respects. Many project financing deals arise from privatisation schemes, and British lawyers obtained early experience in this area. English law and the English language are also used in many of the contracts concerned. According to one opinion, London law firms may have the edge in infrastructure work - particularly transport - while New York firms are strong in areas such as power and environment. At the same time clients are tending to look for ways to control the size of lawyers' bills through techniques such as agreeing a fixed charge in advance, capping charges or linking payment rates to the successful conclusion of the project.

Developments
As countires open up their economies and new needs appear, project financing in its various forms now looks set to develop further. For example, in the economically dynamic areas of South East Asia, expanding sectors such as power, transpo~t and telecommunications are providing a new centre of interest for project financing techniques. China offers the biggest prospective market for project financing in Asia. However, continuing political uncertainties and the tendency of the authorities to change regulations relating to foreign investors

warning, still exercise a restraining influence. Also, the countries of eastern Europe provide new opportunities and particular problems for lenders and sponsors. Many of these dificulties arise from gaps in the legal framework or the still untested nature of new legislation. Characteristic examples are uncertainties over title to real estate, valuation issues and questions as to the priorities granted by mortgage laws. Furthermore, national authorities in eastern Europe have become less keen than they were just after the fall of the communist regimes, to grant special tax status and other investment incentives to foreign investors. As a result, there is much less enthusiasm on the part of banks to grant full non-recourse finance. Instead, projects tend to bring together several elements, such as limited guarantees, backing from national export promotion agencies and the involvement of the supra-national financial institutions. One particularly important element is the preferred creditor status of the European Bank for Reconstruction and Development (EBRD) and of the International Finance Corporation (IFC). Bringing these institutions in on projects can be a particular advantage in debt rescheduling situations. In many cases lenders and sponsors prefer the three most advanced eastern European states - namely Poland, Hungary and the Czech Republic. For example, the Vienna-based Creditanstalt bank has built up a significant project financing portfolio in the region, and 90% of that portfolio is situated in those three countries. At the same time, more advenurous companies may be attracted by opportunities for project financing in Russia, particularly in promising sectors such as oil, gas, gold-mining and pipeline construction. Support from multilateral lending agencies plays an especially major role in this respect. A particular aim of the EBRD, for example, is to use its own lending as a lever to attract private investment.

PROJECT FINANCING

ADVISORS AND EXPERTS ANALYSE PROJECTAND SEARCH FOR FINANCE

AND OTHER INTERESTED PARTIES

PROJECT COMPANY FORMED


I

CO~~'CESSIONS GRANTED

T
LOANS ARRANGED REPAYABLE FROM OPERATING REVENUES OF COMPLETED FACILITY

Project financing and Finnish guarantee board


National export credits guarantee agencies are playing a growing role in supporting project financing deals. One example is that of the Finnish Guarantee Board (FGB). The Board has supported a number of project financing deals in areas such as Asia and Latin America. FGB has established a Special Project Finance group within its Large Customer Service Unit. The group employs six project analysts and it deals with the financing of overseas projects, ship guarantees and guarantees for large domestic investments. Because of the size and risks involved on such projects, FGB normally shares the risks with project sponsors, other export guarantee agencies, banks and exporters. Since the preparatory work needed in arranging project financing tends to be both time consuming and costly, the board seldom considers small investment projects. FGB examines each project proposal in the light of a comprehensive feasibility study carried out by an independent consultant. This covers prospects and risk factors. Issues such as profitability, completion risk, the risks arising from cost ovemuns, exchange rate fluctuations and inflation, the general functioning of the project, the availability and price of raw materials, and environmental questions usually figure prominently. Specialised technical experts may also be involved. Points of particular importance to FGB are that equity funding should account for a substantial propomon (around 30% to 40%) of total project financing, and that the owners should be institutionally solid, experienced in the field and clearly committed to the project. It is very important to convince FGB that the project is likely to be profitable. The board will look for long-term projections indicating that cashflow will be sufficient to cover at least operational and debt servicing costs, even if the market situation deteriorates. FGB also requires collateral in addition to the cashflow generated by the project, and will negotiate for a collateral package that will be shared equally with other sponsors on a pro rata pari passu basis. Collateral typically sought includes mortgages on project assets and income, pledged shares and transfers of insurance and other rights. Risks arising from long pre-completion periods can be covered by guarantees provided by owners or third parties (completion guarantees), or with fixed price turnkey agreements concluded with the suppliers. In the case of countries that present a political risk, the board will expect currency transfers to be secured by means of offshore escrow accounts. Further elements of comfort to FGB, are the giving of undertakings by the suppliers of raw materials for the project, and the users of the end product, relating to deliveries and purchases at agreed prices. These help to even out the cost level and consequences of cyclical fluctuations. FGB restricts its risk taking by setting an upper limit on the risk that it is prepared to assume. Most of the completed projects in which it has been involved have been in the forestly, mining, telecommunications and power plant sectors and shipping. A strong recent focus is power projects (on a BOT basis) and telecommunications projects in emerging countries in Asia. In some, though not all cases, FGB's guarantee is restricted to the political risks.

Project financing - some examples


Mexican toll road
In 1993 the Mexican government decided to raise infrastructure funding to upgrade an existing highway known as the Cuernavaca toll road. It decided on a bond offering structure, and in July of that year it appointed Lehman Brothers to advise, structure and lead manage the offering. Major government aims were to establish a precedent for future infrastructure projects, including the pricing of further toll road offerings, to expand the investor base for such projects and to raise funds without a federal government guarantee. Bonds worth US$265 million with a seven-year maturity were issued by the toll road operator, MC - Cuernavaca Trust. The bond issue was backed by the existing value of the road which had been operated successfully since 1942. The offering was rated by Standard & Poor's and it closed over-subscribed in August 1994.

Indonesian power station


At the beginning of 1995 the US Ex-Im Bank announced financing support of more than USS500 million in respect of a scheme to build a 1,230 megawatt coal-fired power plant at the north eastem tip of Java, Indonesia. Before committing funds, the bank investigated the likely environmental impact and concluded that from this point of view the project was one of the best coal-fired schemes that it had examined. Total cost of the works - sited in a zone known as the Paton Complex - was estimated at some US$2.6 billion. Sponsorship of the project was undertaken by Mission Energy Company of Irvine, California, USA, and General Electric Capital Corporation of Stanford, Connecticut, USA. The project also involved several US suppliers of equipment and engineering services.

Russian pipeline
At the end of 1992, a project implementation contract was concluded to equip the existing gas pipeline running from Siberia to Western Europe with six new compressor turbine units. the parties to the contract were two Russian Companies - Gazprom and Tragaz - and two special purpose consortia of Italian engineering f m s called Snamprogetti and Nuovo Pignone. The project was worth some US$1.615 billion. The project arrangers, Medio Credito Centrale, Banca Commerciale Italiana and West Merchant Bank, put together a package combining project financing techniques with export credit support in the form of political risk cover from the Italian agency, Sace. Commercial bank financing amounted to 85% of the total value. Security features of the package included the establishment of an escrow account to receive revenues. A feasibility study by independent experts established that the completed project should generate additional foreign exchange revenues above the level needed to service the debt. Also, the finance structuring made use of a provision known as the Wodd Bank Negative Pledge Waiver, which allowed loans to be secured on incremental revenues resulting from the project. These provisions enabled the project to go ahead without a Russian sovereign guarantee. However, the Russian Federation nonetheless gave an undertaking to Sace in respect of the escrow account.

Pakistan power
Negotiations on the Hub power project in Pakistan, which was finally put together in 1994, stretched out over eight years. The project sponsors were Xenel Industries, Saudi Arabia and National Power, UK. The funding arrangers were Bank of Tokyo, Citibank, Ckdit Lyomais and Sakura Bank. In the middle of the negotiations, Pakistan revived the use of Shar'ia law, which excludes the payment of interest. The project sponsors and arrangers responded by employing deeply discounted debt structures which did not rely on interest payments. Full implementation of the project financing was nevertheless delayed pending relaxation of the legal rules in 1992. The final arrangement involved six term loans of $200 million, $100 million, $182 million, $43 million, $90 million and $37 million plus a World/Bank Jexirn credit of $476 million. A key factor was the provision of political risk cover through the involvement of the World Bank plus the Jexim, Miti, Coface and Sace credits guarantees agencies.

Chapter 13: Project financing procedures


The previous chapter provided a general overview of the concept of project financing and its uses. This chapter examines in summary form some of the main issues that have to be taken into consideration when project financing schemes are structured.

Sponsors
Typically, project financing deals involve a multitude of parties whose diverse interests have to be reconciled if the transaction is to succeed. The first of these is the sponsor. Particularly in large cases, there will usually be several sponsors such as contractors, suppliers of equipment and raw materials, and end users of the completed project. In some cases the host government is included as a sponsor or as a source of funds. If not, the government will almost certainly be involved in some indirect capacity, for example, as the ,pntor of a concession to run the works, or as a guarantor of foreign exchange availability.

Lenders
In many instances, the lenders will be composed of an international syndicate of banks. The choice of the countries of origin of the different banks can indirectly help to boost the project's chances of success. For example, if they include institutions from a wide range of countries with which the host country wishes to maintain good relations, the risk of arbitrary government action such as expropriation may he lessened. Also the inclusion of a local bank can be helpful if domestic law restricts or excludes the taking of security over assets by foreign institutions.

Experts
Often the sponsors will hire an adviser - usually a commercial, merchant or investment bank - to analyse the project and present it to prospective lenders. Conflicts of interest can arise if the adviser is also to be one of the lenders. In addition, experts may be retained to draw up or check the feasibility study. In some instances the experts continue to act in a monitoring role as the project progresses.

Lawyers
The sponsors and the banks will also retain firms of international lawyers. Legal opinions will be sought in all the jurisdictions that have a connection with the project. A main firm of lawyers retained by the banks will be responsible for coordinating the opinions.

Feasibility study
At the outset of a project, the sponsors will arrange for the preparation of a feasibility study covering both the technical and economic aspects of their scheme. This is necessary in order to make a convincing presentation to lenden. It will involve coordination of technical experts, together with financial and legal advisors. Typically, issues examined include questions such as projected throughput, acquisition and construction costs, availability and cost of energy, water, transport and communications. Access to raw materials, market accessibility licences and offical permits, and the availability of insurance against project and country risks are also likely to be looked at.

Rights of recourse
An essential element of project financing deals is the exclusion or limitation of rights of recourse by the lenders. In the case of a straightforward loan, the loan documentation will normally state this specifically and in detail. This is especially important in cases where the sponsors are not establishing a legally separate company to carry out the project and borrow the money. Often the project is divided for lending purposes into two distinct stages - the construction or development stage and the operation phase. Typically, the lending is on full recourse terms during the first of these two stages since this is the period of highest risk for the lenders. It is therefore of great importance to define exactly when the project will be considered to have been completed, since this will mark the point at which rights of recourse will cease or be limited.

Loan instalments
Capital and interest payments on the loan will normally be related to the projected income that the completed installation will generate. Furthermore, the loan documentation will usually provide for a dedicated percentage of these receipts to go directly to the lenders. There are also likely to be provisions for this percentage to be increased to as much as 100% if output and earnings fall below the anticipated levels.

Project agreements
However it is structured, a project financing arrangement involves a multitude of separate agreements. The first set is made up of documents relating to the creation of the project such as concession agreements, the creation of the project company, project management agreements, joint venture agreements between project sponsors and shareholders' agreements. Added to this will be the finance documents and related security documents. Examples are mortgages,

assignments of rights under related contracts, escrow accounts and pledges of shares in the project company including charges over dividend rights.

Credit risks
Before agreeing to advance funds, banks will analyse all the different risks involved in the project. Since lenders are looking essentially to the income generated by the project for repayment rather than to the borrower, all the different parties that are involved in ensuring the success of the project will form an element in the credit risk that the banks are assuming. Thus lenders will assess creditworthiness, track record, prospects and management abilities not only of the project owner and any guarantors, but also of other parties such as contractors, sponsors, product purchasers, suppliers and project users.

Construction risks
Lenders will also look for mechanisms to protect the project as far as possible from construction and development risks such as shortfalls in output costs, overruns, delays in completion and workforce availability. Possible protective measures include the putting into place long-term fixed price contracts for supplies, creating specific transport networks and power-generating capacity for the installation, and the issuance of performance bonds and completion guarantees on behalf of contractors.

Market risks
Banks will also wish to be assured that market and operating risks are minimised. Thus it is particularly important for the feasibility study to demonstrate convincingly that local or international markets for the product exist, that there is good access to these markets, and that the product is not likely to become obsolete. On the other hand, lenders are generally cautious about projects that use new untried technology, fearing extra costs and delays.

Financial risks
Financial risks such as fluctuations in exchange and interest rates, volatility in world prices, inflation and the imposition of new tariffs will also figure high on the lenders' list of concerns. The inclusion in the project package of hedging facilities such as currency and interest rate swaps and futures contracts can assist in this respect. In addition, the way in which capital and interest payments are to be made on the loan, and the percentage of revenues that is to be allocated directly to the lenders, can be linked to statistics such as movements in prices and inflation rates.

Political risks
Womes about political risks can be particularly acute in project financing deals, particularly since the project

is likely to be closely linked to the infrastructure requirements of the host country and may require a series of permits and concessions. In this context, assurances by the host government that it will not expropriate or nationalise the works, together if possible, with central bank undertakings to ensure the continuing availability of foreign exchange, are often important items. Where the completed installation will generate hard currency it may be possible to manage this offshore. Finally, insurance against political risks is offered by a number of commercial insurers and official agencies.

Regulations and legislative issues


In many countries where projects are canied out, legal protection in areas such as security over propeny and intellectual property rights may be absent or insufficient. Also, environmental regulations are of increasing importance to industrial and infrastructure projects in many parts of the world. This all underlines the vital importance of carrying out a thorough legal review at the earliest possible stage.

Dispute settlement
The inclusion of an appropriate arbitration clause in the contract documents may also be of assistance. This will help to ensure that disputes are referred to expert international arbitrators rather than to national courts. Characteristically, government authorities are readier to submit to the jurisdiction of a confidential international arbitral tribunal than to the national courts. On the other hand, international arbitration awards and foreign court judgments can often be difficult to enforce against official authorities in the host country.

Security over project assets


Lenders will seek various forms of security in respect of the project itself. Mortgages and, where the law permits it, floating charges over the project's tangible assets may be of some value. However, since the main value is the future income to be generated by the facility, the physical assets themselves are most unlikely to be of sufficient value to cover the sums advanced by the banks. Accordingly, the lenders will look for other, subtler types of security and guarantees, to secure their long-term lending. For example, banks may take an assignment of the right to receive payments under long term contracts to sell the product produced by the facility. They will also wish to have their interests noted in insurance cover on the project assets. In addition, banks may require undertakings from project shareholders or co-venturers to ensure that the scheme reaches the production stage and if this is not achieved they may have to satisfy the outstanding debt. Shareholders or project company sponsors may also be required to enter into working capital maintenance or cash deficiency agreements under which they undertake to maintain a sufficient level of capitalisation in the company so that the project may be completed and operated.

Letters of comfort
In addition, so-called letters of comfort, support or understanding are frequently obtained from the shareholders of the project company or from other interested parties. In essence, these comprise a statement that

the organisation concerned intends to maintain its interest in the project company and to ensure adequate staffing. They are a frequent source of misunderstanding since it is often unclear whether there was any intention on the part of the provider of the letter to bind itself legally. If the lenders are looking for more than a moral commitment, they need to make this clear from the start and ensure through their own lawyers that the letter is drafted appropriately. Conversely, if the sponsors do not intend to provide a legal undertaking this should be made clear .

Take-or-pay and throughput agreements


In some cases take-or-pay contracts or throughput agreements are used to provide the equivalent of a financial guarantee. With the take-or-pay agreement, a prospective user enters into a long-term contract to make periodic payments for specified minimum amounts in return for the supply of goods or services produced by the faciliry. With the throughput agreement, a user undertakes to channel a certain minimum quantity of raw product - for example oil or gas - through a completed installation, such as a pipeline. The benefit of such agreements is commonly assigned to the lenders.

Tolling agreements
Tolling agreements operate in a similar way. In this case the tolling party undertakes to provide minimum quantities of raw material for processing and return to that party. Such clauses are often found in projects such as smelting plants, refineries and some power projects. [This chapter was compiled with the assistance of information provided by the Clifford Chance intemational law firm. Among other matters this firm is frequently involved in advising on project financing deals.]

Sticking points
People who have been involved in project financing deals always say they take far longer to negotiate than could ever have been expected and that opportunities for misunderstanding are rife. Sticking points in many negotiations of this type frequently involve issues such as the amount of equity to be contributed by sponsors, the extent of guarantee arrangements, security over project assets, and the allocation of force majeure and political risks. In the case of project financing started with shareholder suppoa, the point known by practitioners as conversion often leads to disagreements if not clearly defined. This is the moment when the shareholders' support drops away and lenders take on the full risk. Other issues requiring precise definition if disagreement is to be avoided, include release of excess cash generated by a project over that required to service the debt, the circumstances in which a project can be abandoned, and what risks are to be covered by insurance. Force majeure is the situation that arises when circumstances outside the parties control make it impossible or totally impracticable to continue the contract. The concept is recognized by many legal systems, and English law applies a similar doctrine known as frustration of contract. However, there are differences in definitions and practices between legal systems, and accordingly contracts need to include detailedforce majeure clauses. Generally speaking, the project owner and lenders will wish to ensure that contractors, users and suppliers cannot too easily make use of a force majeure clause to escape from their obligations. It is common for lenders to insist that contractors should cany the major portion of the risk until completion by insisting on turnkey or design and consuuct contracts. However, this type of arrangement involves e x m expense since the contractor has to make provision in the price for contingent liabilities. Accordingly, an alternative 1s now emerging under which lenders agree that the work should be carried out through a series of contracts that are carefully project managed and cost monitored. One of the biggest areas for dispute on projects is that of inter-creditor relations, particularly on the largest projects involving a large syndicate of senior lenders and other lending institutions. Issues to be addressed include how to coordinate lending and reporting, voting entitlements amongst the members of the syndicate and action to be taken on default, including whether or not to cut off further drawings and to enforce securities.

Appendix Arbitration
When disputes arise on international contracts including trade and project financing deals, they may have to be settled by litigation if the parties cannot resolve the argument themselves. International commercial arbitration provides a private sector alternative to legal proceedings before public state courts. Detailed procedures adopted in individual arbitration procedures depend on the arrangements chosen by the parties and the applicable law. However the basic scheme is set out below. The parties to a contract include a clause agreeing to refer any disputes that may arise to an arbitration procedure rather than to national or local courts. They can also agree to such a proceeding when a dispute arises, though it is generally more difficult to reach agreement in the atmosphere that is then likely to prevail. In either case, the agreement effectively excludes the jurisdiction of the court and binds the parties to accept the arbitrator's decision. In the case of a deal involving several separate agreements and a multiplicity of parties it may be desirable if possible to ensure that all are submitted to the same type of arbitration procedure. Parties may ask a specialised arbitration institution to administer their case. This is known as a supervised or institutional arbitration. Alternatively, they may agree on the detailed procedures to be applied themselves and assume responsibility for the administration of the case. Lawyers refer to this variant as ad hoc arbitration. The parties choose the arbitrators. In the case of institutional arbitration they may delegate this task to the supervising body. The two most frequent arrangements are a panel - also known as a tribunal - of three arbitrators including a chairman, or a sole arbitrator. As a matter of principle arbitrators should be independent of the parties involved in the dispute since they will be called upon to decide the case in the same way as judges. The pardes present their arguments to the arbitrators. This procedure may include both oral hearings and written presentations. Like judges, arbitrators apply legal principles in arriving at their decisions. However, they tend to have greater freedom than state judges in deciding what laws and procedural rules to apply and they may also be better placed to give full effect to reco,gised international trade practices. The arbitrators hand down their award. This is then legally enforceable in a similar way to a court judgment. Most major countries have ratified an international convention known as the New York Convention of 1958 whereby they agree to recognise and enforce arbitration awards rendered in other countries without rehearing the case. If the Losing party does not cany out the terms of the award voluntarily, the other party may make use of the enforcement machinery provided by national court systems. Arbitration can offer a number of advantages over court proceedings. In particular, it is confidential in nature and all hearings are held in private. Furthermore, parties can choose their own procedures and arbitrators, and the procedure avoids the psychological difficulty of presenting a case to the courts of one of the parties to the dispute. Government agencies may be readier to accept an arbitration than to submit to the courts in their own or a foreign country. On the other hand, arbitration involves extra fees since the parties have to pay the arbitrators and the administering institution, if any, as well as their own lawyers. It is also doubtful whether on average arbitration procedures are any speedier than a well-conducted court case. In addition, arbitrators generally do not have as much p w e r as judges to deal on a summary basis with simple monetary claims. This is because arbitration awards are legally enforceable only if both parties have been given an opportunity to present their arguments in full. Urgent interim and conservatory measures can also usually be more easily dealt with by judges than by arbitrators. The organisations that supervise arbitration cases are very diverse in nature. Some are governmental or inter-governmental offshoots, others were originally set up by groups of arbitrators, and yet more are connected with chambers of commerce. There is no central coordinating body for arbitration institutions.

Centres can compete for the available business and in general parties, are free to choose whichever system they wish. Institutions include the following : The International Chamber of Commerce (ICC) in Paris provides a widely used procedure for settling transnational business disputes of all kinds arising anywhere in the world. The American Arbitration Association (AAA) administers a large number of claims arising between US parties and a smaller number of international business disputes. China has a special arbitration commission for commercial cases involving foreign entities. Arbitrators can be chosen from the 65 members of this commission which operates through a combination of legal arbitration and non-binding conciliation. The International Centre for the Settlement of Investment Disputes (ICSID) handles disputes between sovereign states and foreign investors in those states. The centre was created by an inter-governmental convention of 1965 and it operates under the umbrella of the World Bank in Washington D.C. (USA). The London Court of International Arbitration (LCIA) was named by that city's Lord Mayor in 1981, though it started life in 1892 as the London Chamber of Arbitration. International cases submitted to the LCIA include construction projects, reinsurance deals and commodity contracts. The Kuala Lumpur Regional Centre for Arbitration in Malaysia was established in 1978 under the auspices of the Asian-African Legal Consultative Committee (AALCC). This is an inter-governmental body. It aims at promoting arbitration in the region and it also offers facilities and rules based on provisions for the conduct of arbitration cases drawn up by UNCITRAL. (See UNCITRAL below) The Hang Kong International Arbitration Centre administers transnational cases under UNCITRAL rules. However, it finds the bulk of its business in domestic construction contracts. Other regional bodies include centres at Cairo and Seoul. In addition, the United Nations Commission on International Trade Law (UNCITRAL) offers rules that can be used both in ad hoc proceedings and in cases administered by specialised institutions. UNCITRAL itself does not administer proceedings conducted under its rules. The UNCITRAL rules are referred to particularly in projects involving developing countries which sometimes prefer not to use systems originating in the older industrialised states.

Chapter 14: BOOT operations


Introduction
"BOOT' means "Build, Own. Operate, Transfer". This and similar expressions are used to denote projects under which private sector interests are granted a concession to build a public sector facility and operate it for their own account and profit over a number of years. In most cases t h e facility is transferred to the govement at the end of the relevant period. The basic idea is that the company or group of companies carrying out the work will receive payment for this work out of the income earned by the completed facility. Thus the government or government agency granting the contract avoids having to borrow to fund the project and does not have to expend foreign exchange resources on it. BOOT and similar structures can thus be regarded as a specialised variant of project financing. The reason for this is that in both cases the lenders or investors look to the income generated by the completed works for repayment of the sums due to them. Typically, BOOT deals are concluded in developing countries and eastern Europe in the context of privatisation and liberalisation of the economy. The technique provides a means whereby the govemment can obtain private sector participation and funding without losing all control over the facility. Examples are countries in east Asia such as Thailand and Malaysia and several of the Gulf states. Utilities such as power stations, waterworks and toll roads figure prominently among the operations that may be funded by BOOT schemes. Some BOOT projects aim at catering solely for the govemment as a bulk purchaser. Some power and water projects fall into this category. In others the BOOT operator will deal directly with the consumer. Investors and lenders often prefer the first of these two scenarios since risks are more limited and better defined. All such schemes involve a large number of parties and highly complicated cross agreements. For this reason the number of concluded agreements has probably fallen far short of the total number of attempted negotiations. Furthermore, since the underlying structures are still recent there are few cut-and-dried legal parameters. Specialised legal advice is accordingly essential throughout the negotiation process.

Basic structures
There is no standard shape and no precisely defined procedure for setting up a BOOT scheme. In simplified form a characteristic deal could proceed as follows. The govemment of a developing country puts out an invitation to bid inviting tenders to build and deliver a public utility on BOOT terms. In view of the size A d importance of the project several companies form a consortium to make a joint bid. These include foreign construction companies, manufacturers, utilities and potential suppliers. The bid is accepted. The consortium is now known as the "project sponsors". 127

The sponsors agree among themselves in detail on how they will fund the project. This will include an equity investment by each member company of the consortium plus loan finance from banks and bond issues in the market. The project sponsors conduct lengthy negotiations with the government and other interested parties over the precise structuring of the BOOT operation. Questions examined in minute detail include the granting of permits to operate the facility, concessions to use the site, access to necessary services, and govemment undertakings not to prejudice or hinder the future operation of the facility. Undertakings are also sought from potential suppliers of raw materials and potential users of the facility. These take the form of promises to provide or use specified minima at least. The government will look for performance g u m tees and often security with regard to the building of the utility. The project sponsors appoint an investment bank to present their project to potential lenders and the markets, and to fit together an appropriate financing package. Banks from several different countries form a syndicate to provide the necessary loan finance on a joint basis. One of their number is appointed as lead manager for purposes of coordinating negotiations and centralising information. The syndicate includes banks from the sponsors' countries and from the country in which the project is to be carried out. Development banks and export credits agencies are also involved. The banks negotiate with the project sponsors, the host govemment and other parties involved. The loans are being provided on limited recourse terms with the lender looking essentially to the revenue generated by the facility for repayment. Accordingly the banks look for ways to ensure that loan instalments are secured by rights over these future revenue streams. As additional safeguards they also seek security over project assets and pay particularly close attention to undertakings given by the govemment and potential suppliers and users. Once all the agreements are in place, the project sponsors form a separate project company in which they all hold shares. This company takes over the rights and obligations of the consortium members in the project, and will be responsible for ensuring its successful completion. The creation of such a separate joint venture company is not obligatory, but it helps to simplify project performance and administraton. It may also protect the assets of individual consortium members in the case of project failure. Moreover, in some cases, additional shareholders may be admitted after the initial negotiations have been concluded. This is easier if there is a separate company in which they can be allotted shares. In other cases under the terms of the agreement with the government, the company may be floated on the local stock exchange with the intention of allowing local and/or international investors to acquire portfolio holdings in the utility company. The govemment may also be a shareholder. Characteristically the project company is responsible for overall management and financial coordination. Often a separate operating company is appointed to carry out the actual operation of the facility on a contract basis. The operator may also be a shareholder in the project company. Building of the facility goes ahead. On completion successful completion tests are carried out and the facility starts operating. The facility is operated by the sponsors for the agreed period - e.g. 20-30 years. The income generated pays off the bank loans and provides funds to redeem the debt issues at maturity. It also covers the sponsors' costs and provides them with a profit.

At the end of the agreed period the facility is transferred to the host government or government agency. Henceforth it is owned and operated by the government or agency concerned.

Regulations
If the facility operators are to deal directly with the public, government legislation will generally be needed to lay down comprehensive regulations. It is also likely that an independent regulator will be appointed. If the project sponsors have to deal only with the government as bulk buyer, a different sort of mechanism will be required to provide a framework for the relationship between the service provider and the user. In this case the relevant regulations can be included in the contractual agreements between the parties. In all cases issues such as prices and standards of service will need to be addressed and relevant controls introduced to safeguard performance.

Initiating a BOOT project


A BOOT scheme is viable only if the projected income is sufficient to enable debt servicing and adequate commercial returns to investors. At the same time, the cost to users must be both economically and socially acceptable. Governments seeking to privatise the functioning of a facility through a BOOT arrangement can either put the project out to tender or negotiate with selected parties. In any event, because of the great complexity of project agreements any bidding process is likely to be followed by a substantial period of negotiation relating to documentation and vital details of the scheme. This process will inevitably involve significant preparation costs for all parties concerned, whether or not a deal is finally concluded. In most such schemes involving the developing world, much of the equity and by far the largest part of the debt financing will be provided from outside the country in which the project is to be carried out. Lenders and investors will be concerned particularly by issues such as currency risk and convertibility and are likely to seek government guarantees on payments and transfers of profits abroad. At the same time, the government may have particular requirements as to debtlequity ratios, methods of raising equity and long-term commitment by the project sponsors. For example, the government may wish t o ensure that part of the share capital of the project company is made subject to a public flotation.

Contract networks
Any BOOT transaction involves a dense network of interrelated and overlapping contracts and parties. For instance, the project sponsors or the project company are likely to become party to 20 or more contracts by the time the deal is complete. As one vital element in this bundle of contracts, the project company will seek to lay off major risks against contractors and operators and to cover payment risks with guarantees and insurance. This is essential to make the project marketable to lenders and investors. Generally, the initial bid documentation will set out the main principles guiding apportionment of the risks between the different p h e s . This will still leave the definition of precise risks and their apportionment to subsequent and usually lengthy negotiation.

LENDING BANKS
l -

COMPANY

2 3 Z
Y

8
PROJECT SPONSORS FINANCE
I _ _ _ _ I

1 2 ________---- I
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TRANSFERS UTILITY TO GOVERNMENT

Negotiations with the government


Characteristically the project country government will seek to obtain a substantial degree of control over the r y to resist development of the project and the operation of the completed facility. Investors and lenders will t this approach since it is liable to complicate commercial operation and to exacerbate risk. Parties and lawyers frequently involved in BOOT operations readily remark that the size and number of negotiating teams can very easily grow out of all proportion. This makes negotiation highly cumbersome and can prejudice a successful outcome. In practical terms, it is important to restrict the size of teams to the necessary minimum and to vest negotiators with adequate authority to clinch the agreements. It is also vital to ensure that a l l parties concerned, including government representatives, have the necessary formal authorisations to bind the organisations they represent if they are to sign any of the contracts. It is tempting to overlook an apparently bureaucratic point of this nature when there are so many substantive issues to settle and when simply getting everyone to agree is a major task in itself. However, failure to check credentials may later cause considerable disruption if disagreements arise in the course of the project. In particular if a dispute ends up in court or before arbitrators, a party acting in less than total good faith will not hesitate to use the argument that the person who signed on its behalf had no authority to do so.

Key issues
While there is no such thing as a standard deal or standard conditions in this field, a number of issues are likely to figure at the centre of negotiations in most cases. Examples are force majeure or circumstances exonerating failure to perform the contract; how to deal with delay and additional costs arising from any changes of law that affect the project; and procedures for resolving disputes. Project sponsors may also want to see a waiver of sovereign immunity on the part of the government party so as to facilitate contract enforcement in case of dispute. The consequences of termination, including levels of compensation or liquidated damages, also require close anention. Two issues at the heart of the discussions are likely to be the form that the project company is to take, and

security for lenders. Debt and equity levels of the project company will need to be negotiated. In the case of non-recourse financing in particular lenders will require an extensive range of security rights over project assets and agreements. Moreover, the various agreements need to be drafted so as to take account of the impact of local laws and regulations on payments under the project and its profitability. Examples are, the availability of tax exemptions, labour laws, insurance legislation and local provisions as to the enforcement of interest on sums due. Further, if the documentation fixes the tariffs that are to be levied by the operator once the facility is working the relevant documents should also include a formula to vary the tariff if operating costs increase.

Agreements between consortium members


The consortium will evolve through several stages. Initially there is unlikely to be a detailed agreement, but undertakings will be required on matters such as confidentiality, exclusivity, and sharing or liability for costs. In a bid situation the consortium will probably wish to finalise its joint venture before the bids are tendered. Apportionment of development costs and a commitment to future costs following a successful bid should also be the subject of an explicit agreement. Moreover, in order to carry out meaningful negotiations it will be essential to appoint a leader with sufficient delegated authority. At the same time a consortium clearing house will have to be established for the large volume of paper work that will be produced.

Forming the project company


A detailed agreement between shareholders will be needed to govem conduct of the project company's operations and the rights and obligations of the participating companies. This can be accomplished fully only when the constitutive documents of the project company have been settled. However, the main principles may be established at an earlier stage. The formation of a special-purpose project company may take time, particularly if a public flotation is required. Therefore the consortium may have to sign and accept joint liability pending formation of the company. If the project company's shares are to be subject to a public flotation several matters will have to be addressed. These include local stock market and regulatory requirements, preparation of the prospectus, and the placing of underwriting agreements. Difficulties may arise out of having the government on both sides of the negotiating table. Statutory approvals for public participation, appointment of directors, signing authorities and so on, may well also need attention. It is likely that all consortium participants will be required to make some equity contribution. Sponsors may wish to consider establishing different classes of equity shares giving different voting rights, provided this is possible under the applicable law. In this event care will need to be taken to ensure that the differentiation between the various classes of equity does not prejudice the marketability of the project to investors.

Lenders' requirements
In addition to equity participation, debt financing will also be required. Initial project finance will be directed at the construction of the facility with the intention of being repaid out of the revenue generated. Lenders will wish to address such issues as sovereign immunity, political risk, currency risk, change of law, guaranteed feedstock, guaranteed offtake, sovereign guarantees, choice of law, and dispute resolution. Lenders may also look for construction guarantees and they are likely to demand rights of supervision or monitoring of construction and project disbursements. In some instances refinancing of the project takes 131

place after completion of construction. In this instance a securitisation approach is sometimes used to protect revenues. Lenders will require adequate security over assets of the project company, the rights and obligations under the project agreements, land and the plant and equipment pending completion. They may also wish to see an escrow account established to hold revenues. Sufficient standby facilities must be available for contingencies, and working capital will also be required.

Agreements with contractors


Questions that arise on the construction agreements include limitation of liability, and risk lay-off to the contractor. On the first point, local legislation on limitation periods may create disparities between suppliers and contractors and the project company. Parties also need to be aware of any suict liability provisions in local legislation. The consortium is likely to push for the contractor to accept all the construction risks often on a lump sum turnkey contract basis. However, the ultimate risk of loss of revenue resulting from delay may remain with the project company. Management, operation and maintenance agreements will be concluded to cover the period when the facility enters into operation. The project company is likely to seek to lay off risks back-to-back with the operator and maintenance contractor and with any management company. [The above chapter was compiled by the author with the assistance of information provided by Martin Amison of commercial lawyers Trowers & Hamlins. Among other matters the firm advises on BOOT and similar structures, and it publishes a newsletter entited Lower Gulf Business Law Review. The firm has offices in Oman, Dubai, Abu Dhabi, London, Manchester and Exeter. Its principal office is in London.]

Some key terms


Several different expressions are used to denote the BOOT concept and similar structures. The following are among the terms commonly applied: BOOT BOT BLT BOO Build, Own, Operate and Transfer Build, Operate and Transfer Build, Lease and Transfer Build, Own and Operate

Under the BOO structure, the private sector interests that have undertaken to build and operate the facility retain permanent ownership and there is no. transfer back to the government. This contrasts with most of the other formulae under which the return of the facility to the government at the end of the agreed period is a vital term of the agreement. In cases where the government is willing to privatise the facility completely, the BOO arrangment can offer a number of practical advantages. In particular, it frees the parties from the need to set up complicated mechanisms and related security devices to ensure that transfer takes place effectively. Furthermore, since the government hands over the project definitively to the private sector the BOO structure can also relieve pressures to restrict prices charged for the product or service provided by the facility, on political rather than commercial grounds.

Power in Oman
Often BOOT and BOO projects are launched in the context of wider government programmes for privatisation and deregulation of public utilities. One major example is the Manah power project initiated in the latter half of 1994 by the Sultanate of Oman. Under this BOOT operation the United Power Group - a private consortium of investors contracted with the government for the implementation of the scheme. The project consists of a concession for the private development and ownership of a power station involving a total investment of around U S 2 1 7 million. International commercial lawyers Trowers & Hamlins - who have offices in Britain and in the Gulf states - advised the United Power Group in connection with the development of the project agreements, security package and related public company flotation. Under the terms of the agreement, the United Power Group is building and operating an independent power station in Oman. The contract for construction and operation of this power station will run for a total of 23 years including two years for the actual construction phase. Two thirds of the investment is being raised by means of long-term debt involving the International Finance Corporation (a World Bank subsidiary) and syndicates of commercial banks. Export credits are being used to finance a portion of this tranche. It was decided to fund the remaining one third by way of subscription for share capital in the project company. The completed power station is to have three gas turbines of 30 mw each together with some 200 kilometres of 132 Kv transmission lines and transformer stations. These will link the power station to three cities and to the Oman electricity grid. This project is being carried out in the wider context of Omani privatisation measures and related changes to commercial legislation aimed at simplifying procedures and encouraging local and foreign investment in the economy. Privatisation initiatives in Oman have been focussing on utilities including the Salalah electricity privatisation and that of the electricity system covering the north of the Sultanate. Sewerage schemes are providing a further area of interest in this connection. Legislative moves include changes to the commercial companies law and a new foreign capital investment law. Land law, securities market regulation and industrial registration procedures have also been the subject of studies and new legislation.

BOOT in eastern Europe


BOOT financing models were originally designed for projects in countries which have fully functioning capital markets and where suitable hedging instruments are provided by the financial services industry. Accordingly the concept requires some modification when applied to projects in eastern European countries. The reason is that they have less developed capital markets, operating revenues may be generated in a currency that is not freely convertible, and state control of pricing may still be relatively inflexible. Moreover, legal structures may not be adequately developed to give full security to complex BOOT structures. Implementing BOOT structures in this context thus demands a good deal of financial engineering and even more detailed legal work than usual. Nonetheless some examples of eastern European projects of this type already exist. For instance, Hungary's Bureau for Motorways has managed to attract investors and financiers for the M I M I 5 express way on a BOT basis. However, commercial banks generally maintain a cautious attitude to long term financing in view of the transitional state of the region's economies. This means that the bulk of debt financing is likely to come from supranational financing institutions such as the EBRD and the IFC. The advantage here is that they can pass on their preferred creditor status to commercial banks willing to participate in co-financing arrangements. In addition, the European Investment Bank - an institution of the European Union (EU) - can complement EBRD efforts in some cases. Furthermore, these institutions can also pave the way for local currency financing by providing a number of guarantees to hoiders of bonds denominated in local curency. Foreign equity investors in BOT projects in eastern Europe also typically try to limit their political risks by seeking guarantees from MIGA, OPIC or other guarantee institutions such as the Austrian East-West Fund. (The above presentation was compiled with the assistance of information provided by the Creditanstalt Bank in Vienna. Austria. Amongst other activities, Creditanstalt is active in financing and arranging East-West investment projects.)

Chapter 15: Interview: Power station development - protecting the utility's interests
Though relatively few deals have yet been signed. power station developments in Asian countries and other emerging markets are likely to constitute a major source of Build Own Operate and Transfer deals in the future. This is in line with a developing trend towards deregulation, commercialisation and privatisation of power facilities in counmes such as Pakistan. Malaysia and Thailand. Within this context, successful independent power projects are based on a partnership between a project developer and a power purchaser who is usually a power utility. Dr Tony Wheeler, Studies Manager with Mott Ewbank Preece Ltd, consulting engineers in Brighton UK. believes that all too often discussions seem to focus excessively on the project developer's requirements. In thls interview Dr Wheeler looks at how utilities can make sure that they obtain the best deal. His firm is frequently involved in working on projects of this kind in emerging markets ROWE: Despite the intention of many countries, particularly in Asia, to encourage private sector participation in power station development, in practice few projects have yet been implemented. Why is this, and what steps can utilities and other authorities take to improve the situation? WHEELER: One important reason is the fact that project sponsors are frequently required to develop projects in the absence of an appropriate institutional framework. In this respect, both procedures and documentation require more careful attention. A private sector proposal will characteristically pass through a dozen or so key stages. These start with initiation and the invitation of expressions of interest and continue through to supervision of implementation and the resolution of disputes. This whole procedure can be greatly assisted by the creation of an appropriate government agency which calls for projects, sets out the basis for proposals, appraises these, undertakes negotiations and reaches agreement on the necessary details prior to issuing the necessary permits. In the absence of such a coordinating body, the process can be seriously impeded as different government organisations seek to incorporate their own requirements. Moreover, this agency will need to be provided with a range of legal, financial and technical skiIls either on a staff basis or through outside consultants. Further, the power utility itself has an important role at several points in this process, and failure to take proper account of its views may lead to an injudicious project selection or tariff structures resulting in unnecessarily expensive electricity. Clear and comprehensive documentation also plays a vital role by helping to create transparent procedures and a level playing field. Standard documentation should be devised to cover matters such as the invitation for proposals from private sector developers for both specified and unspecified projects, the letter of intent, the format and contents of the proposal to be submined by project sponsors, and draft implementation, power purchase and other key agreements. Procedures also need to be clearly spelled out for matters such as project approvals, fiscal treatment, and

extent of cover for risks such as foreign exchange variations. The preparation of a written procedural manual which includes information on the techniques to be employed in reviewing and evaluating proposals is particularly beneficial. The participation of the utility in this respect is essential. ROWE: Power systems are made up of three individual elements -generation, transmission and distribution - and all of these have to be integrated. In this context, how can project purchasers and utilities help to ensure that they make the best choice - or at least a good choice - for the future when deciding on a new power project ? WHEELER: Projects need to be selected on the basis of both economic and operational requirements. This can involve selection on the basis of inviting private sector proposals for schemes specifically identified as part of a conventional least-cost planning study, for instance. Another approach is to appraise proposals by reference to alternative offers and existing generating costs to reassure the power purchaser that an economic proposal is being offered. The utility is concerned to ensure that the project will both provide economic power and energy and that its technical characteristics are acceptable, particularly with regard to integration into the transmission network and its dynamic performance. Physical location is also of importance in terms of environmental and technical acceptability, access to fuel, ability to transport large plant items, cooling requirements, plus transmission network performance and dispositions of system load. Although the utility may not be the sole arbiter of project selection, it is essential that the utility should be involved throughout the whole project cycle. It has a particular role in evaluating projects with regard to its own power station costs, technical plant aspect and interconnection and system compatibility. ROWE: The power purchase agreement (PPA) is a key document since this is the vehicle for defining the commercial and technical interface between the utility and the project developer. How can this agreement be devised so that it affords adequate protection to the utility's interests and not just those of the developer ? WHEELER: To begin with the PPA should not place constraints on the utility in the way in which plant is despatched. In particular, minimum offtake agreements should be used with caution since they may constrain the ability of the utility to despatch generation plant in merit order and at least cost. In many systems, particularly those where there is a shortfall in generation capacity, the availability of plant will, quite reasonably, be of particular concern to the utility. The PPA should therefore place particular emphasis on this issue and provide for penalties to be exacted in the event of unplanned outages. One useful approach can be to set a two part tariff based on separate capacity and energy payments. In this event the capacity payment is set to cover the project fixed costs including investment, with an element of profit coupled with penalties for failing to meet availability expectations. The energy component can be a pass through arrangement which reflects the actual incremental cost of generation. Tolling contracts as well as more conventional energy-based arrangements can be devised to encourage energy efficiency. The ability of the plant to respond properly after major system incidents and to maintain stability of the interconnective stations is a further important issue for incorporation in the PPA. For instance, utilities may wish to consider means of monitoring this ability. Agreed methods for testing plant on an occasional basis so that the power purchaser is able to satisfy itself that the plant is capable of providing its stated capacity are also appropriate.

ROWE: All projects involve risks at all stages including consmction, commmissioning and operation. How should the identification and allocation of these risks be approached ? WHEELER: Throughout the preparation and negotiation, all parties should carefully monitor the nature and extent of their potential exposure. In some instances these may be covered by insurance but this is not always possible. The main risks which a utility or power purchaser may reasonably be expected to accept include matters such as difficulties arising from a site selected by the utility or its agents, changes in the local fiscal conditions and in environmental requirements, certain failures to take power when available under PPA provisions, and changes in the financial environment such as interest rates and forex rates. The utility may be able to obtain recourse from the government with regard to fiscal changes, and can also provide for cost pass through under some circumstances in the event of changes in environmental requirements. Equally the PPA can include some protective provisions in case of financial disturbances. It is important to differentiate between the government and the public sector power utility. Although they are institutionally closely associated, it is questions concerning the financial capability of the utility itself that may prompt plant sponsors to seek guarantees from the government. Negotiators need to check that parties to whom risk is being allocated are in practice able to accept and service the risk involved. ROWE: Once the utility is up and running the technical and operational interface between the utility and the plant operator becomes of especially crucial importance. What son of procedures and documentation need to be in place to help ensure the smooth-running of this interface ?

WHEELER: Procedures should be set in place for matters such as system despatch, advising on plant capacity and outages, communicating key data and metering. These should he reflected in the procurement documentation as well as in the agreements. Perhaps even more importantly, day-to-day working arrangements need to be established and allowed to evolve and improve as experience is gained and confidence built up.
Accordingly, it is particularly desirable for the parties to nominate officials with clearly defined responsibility and authority to move projects forward. ROWE: Finally, out of all the many factors involved, is there any one particular aspect that you consider to be of key importance to the success of the project ? WHEELER: It can be strongly argued that one of the major restraints on the rate at which projects have in the past been successfully brought to a conclusion is the fact that there have not been individuals with the necessary authority, vision and driving force to cany the project through. A project champion wholly committed to the success of the venture can be vital in this respect.

BOOT in the Philippines


In the late 1980s, the government of the Philippines drew up new policies aimed at encouraging private sector participation in power development. This was in response to a rapid growth in demand for power and a resulting projected shortfall in generating capacity. Previously power development had been mainly the responsibility of the govemment-owned National Power Corporation. The first private sector proposal accepted by the Philippines government was for a 200 MW single cycle gas turbine BOOT project at Navotas, 30 kms north of Manila. The purpose was to provide peak power to the Luzon grid. Under the terms of the agreement with the government, the project sponsor, Hopewell Energy (Philippines) Corporation. was granted the right to own and operate the plant for 12 years. During that period it has to provide peak load power for about four hours each day and to stand by at other times for emergency use. At the end of the cooperation period, the plant will be transferred at no cost to the National Power Corporation. Initial calculations placed the total project cost at around US$45.5 million. National Power Corporation agreed to provide some USU.5 million of this sum in the form of support services at no cost to the project sponsor. The sponsor undertook to finance the remaining amount through equity and debt. Subsequently the Asian Development Bank agreed to contribute US$1.1 million of equity and a loan of USSlO million for the project. In addition, commercial bank equity funding and an equity contribution by the International Finance Corporation (IFC) were also obtained. IFC provided US$10 million, while an equal amount was co-financed by commercial sources under a special arrangement known as the Complementary Financing Scheme run by the Asian Development Bank. [Presentation based on information provided by the Asian Development Bank.]

PART 4 COUNTERTRADE

Chapter 16: Countertrade - general


Introduction
The tenn countertrade covers a multitude of different trade relations. These range from straight barter - say oil for machinery - to complex counterpurchase and industrial cooperation agreements. In general, parties concluding countertrade deals of one son or another, seek to tie the conclusion of exports and other sales to an undertaking from the seller to purchase products from the buyer or from a third party. Around 100 countries practise countertrade in some form or another, though there are no comprehensive statistics to show its prevalence. Observers estimate variously that it could account for anything from 5% to 35% of total world trade. Trading partners and governments may seek to link sales and purchases for many different reasons. Promoting exports, saving scarce currency, balancing trade flows, and the desire to obtain guaranteed sources of supply are all frequently cited motives. Typically, each prospective countertrade deal is preceded by lengthy negotiations and only a tiny proportion reach signature. Modem countertrade techniques can be seen as a complex development of the ancient system of barter. This involved trading by exchanging goods before money was invented as a medium of exchange. Countertrade on the other hand does not usually seek to do away with the monetary element in trading but rather to extract reciprocal concessions in return for agreeing to do business.

Trends
Such techniques are once again on the increase as new countries with scarce reserves of foreign currency and an urgent need to develop their infastructures enter the world trading system. In addition to developing regions in Asia and Latin America, they include former eastern bloc European countries. Ironically, in the 1960s the eastern bloc European countries, were the initiators of many modem countertrade techniques at a time when they ran centralised economies and were seeking long term industrial cooperation agreements. Governments as well as commercial enterprises also practise countertrade techniques. One good example is defence procurement in which government buyers will insist on obtaining local content in procurement deals. When used in this way the technique generally goes by the name of offset.

Bank involvement
Banks may be involved in countertrade operations in various guises. In the most straightforward case they frequently provide their normal range of txaditional payment and financing procedures for international deals that include some reciprocal element such as counterpurchase or buyback. In addition many banks have set up countertrade units to service corporate customers that take on commitments of this type. Also, large banking institutions operate international trading departments that buy and sell on their own account. They may therefore become direct party to deals that include countertrade elements. hdependent trading companies as well as banks are also active in this area.

Risk factors
Countertrade agreements fall into many different categories and typically involve several interlinked deals. They are also likely to bring into play a multiplicity of parties. Accordingly such transactions generally give rise to an extended range of risk factors, including legal and contract drafting issues, as well as the usual commercial, political, payment and transfer risks. In general there are no standardised international rules or specific national laws for countertrade transactions. Accordingly, the detailed terms of each deal have to be negotiated individually.

International organisations
Multilateral organisations with an interest in trade issues as well as major trading nations, have tended in principle to frown on the use and development of countertrade on the grounds that it may distort free competition in the world economy. practice however, techniques of this sort have become an established feature - In of doing business in many parts of the world and in some situations, the only alternative may be not to do business at all. Furthermore, the very governments that are the most vocal in support of the principle of free trade, are enthusiastic to the use of techniques such as offset, when it comes to guarding their own national interests and local employment in public sector procurement contracts. In addition. a number of international organisations concerned with trade facilitation have examined countertrade techniques from a practical standpoint. For example, the United Nations Commission on International Trade Law (UNCITRAL) has drawn up a comprehensive legal guide on this subject.

Nature of countertrade techniques


Most countertrade operations can be broken down - at least in part - into a succession of more traditional procedures in which the payment and financing techniques common to international trade in general are used. Also, countertrade procedures arise from practice and therefore do not correspond to a specific legal category. Accordingly, different terms are often used to describe the same procedures or a single term is used confusingly to mean different things. The descriptions and titles set out below provide a brief summary of some of the principal techniques employed in practice.

Barter
Using this technique, goods and/or services are exchanged against other goods andlor services of equivalent value and no money changes hands between buyer and seller. In the simplest case the goods being offered in payment are delivered to the exporter which tries to sell them. In practice a third party - typically a specialist in this type of operation - frequently agrees to take the goods and pay their value less a discount to the exporter. In barter deals, goods may come direct from the importer or from an exporting company of the same country where the two parties have a trading relationship in that country. Government to government clearing account arrangements often closely resemble barter deals in their practical operation and effects. However, governments prefer to use other terms to describe them.(See for

example bilateral agreements and clearing accounts below). Often baaer agreements are concluded on a government to government basis and the motives for entering into them may be more political then economic or commercial. Barter deals struck for commercial reasons include those in which commodity traders swap deliveries of equivalent products for delivery to their respective customers in different locations around the world. They thereby achieve a saving on transport costs.

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Strictly speaking, this expression refers to an arrangement whereby a seller agrees to accept part of the selling price in money and the balance in goods or services. It is also used more loosely to cover counterpurchase and buyback schemes. (See counterpurchase and buyback further below).

Counterpurchase
Counterpurchase is one of the most widely used of all the countertrade techniques. It is found particularly in key industrial sectors such as machine tools, transport supplies and chemical and metallugical products. In outline the technique works as follows : An exporter agrees to sell goods to a foreign importer. As a condition of the deal the seller undertakes with the importer: a) to buy goods from the importer or from a company nominated by the importer or b) to arrange for their purchase by a third party. The value of the counterpurchased goods is an agreed percentage of the price of the goods originally exported. Separate contracts are concluded for the original export sale and for the counterpurchase. The second agreement sets out the general agreement to buy and the time period for performance. Buyback may be considered a special form of counterpurchase in that the supplier undertakes to purchase from the importer production resulting from the equipment or other facilities that he is selling (See further Buyback below). At one level counterpurchase constitutes a method whereby countries that lack foreign exchange resources may continue to trade internationally. It may also help importing states to export products that they would otherwise have difficulty in selling abroad. Furthermore the practice can also contribute to the establishment of a foreign distribution network for such countries. Often companies from indusmalised countries undertake counterpurchase operations as a necessary evil in order to obtain the principal business, while regarding the counterpurchases as substandard products which

will be difficult to sell on international markets. However, some companies use counterpurchase as a way of obtaining guaranteed supplies of materials that they can use in their production operations or that they can trade profitably. In addition, trading houses are often willing to take assignments of companies' counterpurchase commitments. They are usually readier to do this in the case of counterpurchase than of buyback. The reason is that buyback offers a more restricted scope of products, longer commihnent periods and much greater financial involvement.
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Buyback
A buyback agreement contains the following main ingredients: 1. A principal supply contract under which the supplier undertakes to sell plant, equipment, technology andlor services. 2. A subsidiary agreement under which the supplier agrees to buy part of the output resulting from the installation it has supplied. The buyback obligation covers the whole or part of the price paid for the original supply. This practice has developed rapidly since the 1960s. Initially its use was particularly fostered by the growth of eastlwest industrial cooperation agreements in the days when COMECON - the eastern European common market - was still functioning. Buyback agreements operate on a long-term basis. They tend to cover lengthier time spans than do, say, barter or counterpurchase contracts. They have some similarities with tolling agreements which form one aspect of some project financing arrangements. Buyback agreements may at the outset be suggested by either the buyer or the supplier. In either case one essential element is that the principal supply should be capable of generating production of some kind that can form the subject-matter of a buyback arrangement. In some instances suppliers manage to negotiate a general counterpmhase obligation instead of a specific

buyback obligation. This means that they are not limited to the specific production of one installation. For this reason, buyers sometimes offer counterpurchase as an alternative, subject to a higher percentage buying commitment by the supplier. Moreover, buyback agreements may cover all types of output including raw materials, semi-finished or finished goods. The supplier - typically a company from an advanced industrialised country may use the production that it buys back either for its own internal purposes or for resale on its own domestic market and/or international markets. In some cases the supplier may undertake a buyback commitment exceeding the value of its own supplies. Buyback agreements often cover supplies and counter-supplies worth many hundreds of millions of dollars. Thus such contracts are generally of a much higher value than other types of countertrade deals and the financial risk borne by the supplier is correspondingly greater. In undertaking a buyback obligation, the supplier is in effect taking on a task somewhat similar to that of pmviding project finance. He or she is anticipating as well as underwriting a profitable return from the project. The period during which products have to be bought back is often lengthy - most often from five to 25 years. Near total cover of the buyer's outlay by means of buyback is often called for and obtained. Under such arrangements the buyer obtains a means of financing its imports and access to foreign marketing. This is particularly important for many developing countries which lack hard cumncy reserves, have not developed foreign markets and lack the resources to cany out overseas marketing campaigns. Furthermore, the supplier is strongly motivated to provide its most advanced and/or most appropriate technology to the buyer and generally to ensure that the latter obtains a facility that functions well. The reason for this is that the supplier will be taking back production from the facility on a long-term basis and will have to market the products thus obtained or use them in its own internal operations. Despite the additional strains such an agreement may place upon them, many suppliers find advantages in concluding this type of arrangement. For example, buyback may help to secure the supplier's bid to sell its products and facilitate the marketing of those products in areas where selling would otherwise not be practicable. Also, buyback agreements can be used by supplying companies to establish new and guaranteed sources of supplies in buyers' regions and to secure a potential competitive advantage in local markets. Furthermore, if the products are manufactured goods rather than raw materials, the supplier who is buying them back may also benefit if wage costs in the country manufacturing the goods are lower than the supplier's country.

Advance compensation
Using this technique the exporter buys the required counterpurchase products before he has exported his own goods. The parties concerned agree that the purchases made by the exporter from the customer's country give the right to a credit against counterpurchase obligations arising on later deliveries. A 1 1 sales and purchases are noted in a special evidence account usually held with the central bank in the buyer's country.

This method is practised essentially by governments in both developing and industrialised countries. Offset agreements most often cover government acquisitions of military and major civil procurements. In the civil sector, for instance, commercial aircraft and telecommunications deals frequently involve offset tmding. Typically, offset agreements are demanded in cases where countries are seeking to squeeze maximum benefit from their investment in high value areas. Purchases are frequently tied to requirements by the importing country for a domestic content of the purchases. Such demands may cover co-pmduction arrangements involving transfers of advanced skills and technology and include investment in manufacturing plant and undertakings to train and employ local technicians and other personnel.

Procedurally, offset arrangements may be divided into two major sub-categories -direct offset and indirect offset. Direct offset involves co-production arrangements based on transfers of production technology to the importing country. Such deals are used by the importing state as a tool for industrial development, domestic employment generation, and as a means to finance payments balances. Indirect offset occurs when the selling country agrees to purchase unrelated products from the country of the purchasing government. Such arrangements help the buying country - typically a third world state - to claw back some of the cost of the imports. Direct offsets are often most extracted by the governments of industrialised countries and third world states at a relatively advanced stage of development. Often developing countries with an infant industrial and technological base may find it difficult to secure co-production arrangements and find direct offset appropriate to their needs.

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Switch trading
This method involves at least three parties. Essentially it constitutes a special method of payment rather than a trading condition. In outline switch trading operates as follows: An exporter agrees to sell goods to an importer. The buyer cannot or would rather not pay in convertible curency. At the same time the particular buyer is already the beneficiary of a credit held in a special clearing account in a t h i r d country for services that he had provided on another operation (see clearing account section below). This credit cannot be transferred out of the third country in the form of currency because of exchange control restrictions, but it can be used to buy goods in that country. Accordingly the importer offers to pay the exporter from the credit in the third country clearing account and offers to pay a higher price for the goods or services to compensate for the non-convertibility of the currency credit. If the offer is accepted, the seller employs a specialist - a switch trader - who buys the credit at a discounted rate. The switch trader then finds a buyer willing to purchase goods from the third country and uses the credit to obtain them. The switch trader's profit is the difference between the price paid to obtain the credit and the price charged the buyer for the goods.

Cooperation agreements
Long-term industrial and commercial cooperation agreements - which used to be a feature of easdwest trade in particular - usually involve a countertrade element. Such agreements are now less commonly found since the break up of COMECON. Under a cooperation agreement, the countertrade obligation will usually relate to production from the plant which is set up in pursuance of the cooperation. Such cooperation ageements do not constitute a category of countertrade on their own. Rather they provide a specific framework within which different forms of countertrade are operated on a long-term basis.

Bilateral agreements
Bilateral ageements or trade protocols between two governments are designed to facilitate countertrade between the two countries concerned. They may aim at cementing straightforward trading relations and at smoothing the way to closer technical and political cooperation. Such agreements range in content from an unspecific commitment to improve trade relations to contractually binding agreements. The latter may specify the products to be traded as well as the value of the transactions and their timing. Often such arrangements provide that the trade between the two partners is to be balanced over a particular time period. This may allow the trading parties to conduct their trade using mutually acceptable clearing currencies, thereby avoiding the use of foreign exchange.

Clearing accounts
Bilateral trade agreements normally provide for the goods traded under the agreement to be denominated in clearing account units. These are expressed in a selected major currency - such as dollars, Swiss francs, rupees. Characteristically such agreements specify that all trade exchanges stop once a maximum trade imbalance - referred to as a swing has been exceeded. Often this swing is set at around a third of the annual trade volume outlined in the ageement. Imports to the country with a clearing account deficit are then frozen until its exports accumulate sufficient accounting units to satisfy the swing required. When the bilateral agreement expires, outstanding balances will have to be settled. Usually this is achieved in one of the two following ways: The balances due are settled in cash in the specified currency or The balances are convened into cash by switching the rights to the trade imbalance, to interested third parties. The balances involved are then dealt with under switch trading arrangements. (See switch trading section).

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International trading certificates (ITCs)


These are transferable documents which can be used as an element in some countertrade operations. In outline countertrade deals using ITCs work as follows: A party in the country requiring countertrade first ships its goods to a buyer in another country. The central bank or other relevant authority in the first countly issues to the shipper an ITC. The ITC authorises the holder to sell goods in the issuing country without an import licence up to the amount specified in the certificate. In addition, it constitutes a guarantee by the issuing authority that convertible funds up to the amount of the ITC will be available for payment. The seller hands the ITC over to the buyer. That buyer can either use the certificate itself in supplying the goods to the country that issued it or transfer it to a third party. Such schemes represent an effort to facilitate countertrade by multilateralising it. ITC issuing authorities hope to stimulate exports of goods by issuing transferable certificates.

Warehouse receipts
The use of warehouse receipts is a common feature of countertrade deals such as barter. These receipts provide evidence that specified physical assets of a creditor are being held in storage. Accordingly they may be employed as a form of guarantee in countertrade operations. It is important to ensure that a warehouse receipt is issued by a reliable institution. If not, the use of such receipts may increase the risks associated with countertrade operations.

Escrow accounts
Parties to countertrade deals sometimes enter into escrow agreements. This means that they set up a special bank account called an escrow account into which are paid the sums which are ultimately to be used to pay for goods or services supplied. Money in the escrow account is frozen until the agreed counterdeliveries have been made or the counterservices performed. Accordingly, such accounts form an adjunct to particular categories of countertrade agreement and do not of themselves constitute an independent type of countertrade.

Evidence account
This is the name given to an account with a bank which records credits and debits in countertrade transactions. Unlike an escrow account (see above) an evidence account does not constitute a method of blocking funds pending performance of obligations. Rather it simply performs a recording function. In common with the escrow account it constitutes an adjunct to particular types of countertrade agreements and it does not in itself constitute an independent category of countertrade.

Counterpurchase and buyback


Counterpurchase
A counterpurchase deal entails several different contracts. These can be analysed briefly as follows: The principal sale contract between the exporter and the importer. This is framed as a definite agreement to buy and sell specified goods or equipment or to make deliveries at a specific price. Normally it makes no reference to the counterpurchase obligation. The counterpurchase agreement between the parties. This is usually a general framework agreement and it will not normally specify particular goods or the price of the goods. It will indicate the extent of the counterpurchasc obligation either as a global monetary amount or as a percentage of the value of the principal supply contract. If it is agreed that the counterpurchased goods may be bought by a third party, the principal supplier/counterpurchaser will then enter into a separate agreement with a trading house or other entity willing to take on the counterpurchase commitment. The trader undertakes to perform that commitment in return for a commission paid by the principal supplier. If it has been agreed that the counterpurchased goods may be supplied by organisations other than the importer, agreements with those other organisations to ensure that the goods will be available will also have to be made. Also, each time goods are selected for delivery under the counterpurchase agreement, a specific sale contract comes into existence for those particular goods. Both parties to the framework agreement may additionally enter into separate financial agreements with banks. These will relate to questions such as the issue of documentary credits to cover cash payment, and the provision of guarantees payable in the event of default. Typically, the counterpurchase agreement itself is set out in a brief document containing perhaps no more than two or three pages. This document does not constitute a contract to buy and sell specific goods, services or other products. Rather it is a framework agreement recording the general commitment of the parties to buy and sell respectively at a later date and setting out the principles to be applied to such future sales. Normally, the agreement refers to the principal supply contract which may be made conditional upon the supply contract being effected. Often it will also define the extent of the counterpurchase commitment in terms, for example, of a percentage of value of the principal supply contract. Sometimes the agreement also specifies the types of goods to be acquired by the principal supplier/counterpurchaser.In this event the relevant categories are nonnally listed in an appendix to the agreement. The prices at which goods are to be acquired will seldom ever be fixed by the agreement, since pricing normally depends on market conditions at the date that counterpurchases are made. Usually the agreement will contain wording aimed at ensuring that goods are offered at competitive prices in accordance with prevailing market conditions. If the importer is not to be the only countersupplier. the agreement will also designate other permissible suppliers. Furthermore the agreement should also provide a realistic timeframe for the performance of the counterpurchase commitment. This is particularly important since the counterpurchaser will wish to avoid having to stock goods for extended periods. Most often the agreement provides for the establishment of an evidence account with a designated hank. The counterpurchases are registered in this account, thereby providing evidence of the fulfillment of the counterpurchase obligation. A penalty clause may provide for the payment of specified penalties by the counterpurchaser should it fail to respect the counterpurchase commitment. A bank guarantee is often stipulated. The penalty is usually expressed a percentage of the value of the counterpurchases, the usual range being from around 5% to 15%.

In addition, the agreement may contain a clause preventing resale of the counterpurchase goods in the importer's own principal sales area. Ideally it will also express the law applicable to the framework agreement and stipulate the court or arbitration procedure that is to rule on any disputes. Particular attention is required to ensure consistency of such clauses when there are a multitude of interlocking agreements.

Buyback
The buyback scheme has several variations. Among the commonest of these are the following: Product sharing This practice is used particularly in the petroleum industry and in mining. The party providing expertise undertakes exploration in the agreed area which is normally in the territory of the other party. If the exploratory work is successful the contractor goes on to organise production jointly with its partner. The contractor is paid by receipt of a predetermined share of the physical output. International subcontracting The supplier of a factory or other production facility undertakes to provide in addition most of the component parts and materials for manufacturing the end product. The buyer who is to manufacture the goods plays a limited role in the process. In some cases this role may consist merely of providing workers and a building for the production process. Work is then subcontracted out or other similar arrangements are put into place. The buyerhanufacturer undertakes to deliver the whole or part of the production to the supplier and receives a fee for the production units delivered. Agreed deductions are made from this fee until the supplier's agreed price for its supplies of equipment and technology has been paid. Industrial cooperation In this situation, the buyback transaction constitutes just one element of a wider long-term deal. Essentially each party to the agreement specialises in the production of particular components or of particular products in a range. The parties exchange products so that each can complete its offerings. Multilateral buyback In some instances it is agreed that the products which are the subject of a buyback arrangement will be bought by a third party nominated by the supplier rather than by the supplier, itself. In other cases the agreement provides for the supply of equipment and technology to different parties who are to cooperate in manufacturing a joint product. In view of their complexity, time span, and usually high monetary worth, buyback a-geements involve lengthy negotiations before conclusion. Among the issues that it is important to take into account in the negotations, and to include in the contractual documentation are the following: Extent of buyback obligation. The supplier's buyback obligation is usually expressed as a percentage of the value of the principal delivery. If the obligation is expressed as a fixed amount there is the disadvantage that this will not take account of changing prices.

Price of principal supply. The supplier needs to make careful calculations concerning the costs of disposing of the buyback products before giving a definite quote of its own price.

Standards. The quality and technical standards of the products to be bought back need to be clearly specified, and appropriate contractual provision made to protect the principal supplier against the consequences of defects resulting from the fault of the buyer's product. Buyback performance period. The contract should specify when the period is to begin, usually by reference to the start-up of production. Buyback pricing. Issues to be covered include the initial price and price fluctuations during the buyback performance period. Territorial restrictions. Any restrictions on the areas where products can be resold will be set out in the agreement. Generally the party accepting a buyback obligation will try to bargain for as wide a sales area as possible. Assignment. A transfer clause ensures that the supplier's buyback commitment can be transferred to a third party. In general, trading houses are not keen on taking over such commitments because of the long-time periods involved. Penalty clauses. These will cover issues such as the liability of the principal supplier to pay penalties for failure to carry out its buyback promises and penalty payments for product defects, delays and non-performance by the importer of its counter-delivery obligation.

A growing business
At the beginning of 1995, the Ukrainian ministry of foreign economic relations reported that nearly 90% of that country's foreign trade contracts were being concluded on a barter basis. The ministry wanted to reduce this to 60% or 70% believing that excessive reliance on barter arrangements was seriously undermining the Ukraine's potential to earn foreign exchange. The Ukraine is an extreme example, and its extensive use of barter is based on its recent history and the involvement of its economy with the former Soviet Union. For instance, shortly after the ministry made the above announcement the Ukraine concluded yet another barter deal with Russia. This called for the latter to supply 56 billion m3 of natural gas, plus oil, diesel fuel, petrol and coal, and manufactured products including trucks, cars and tractors. In return the Ukraine undertook to supply two million tonnes of rolled metal plus pig iron, aluminium, magnesium, meat, dairy products, sugar and vegetable oil. In other emerging markets across the world, governments and public sector agencies are increasingly bringing into play a wide range of sophisticated countertrade and offset devices aimed at clawing back part of the foreign exchange expended on overseas purchases and boosting local activities. Malaysia provides one example. Following a long period during which the govemment of that country favoured counterpurchase arrangements, authorities have for some time been moving towards industrial development through offset. Particular emphasis is placed on technology transfer and local production. Tunisia provides another instance. It is strengthening its ties with the European Union and accordingly it is lowering tariffs on industrial goods imports. Because of womes that this could put many local companies out of business, in Spring 1995 the Tunisian govemment introduced tighter offset rules for vehicle imports. These restricted the exporter's choice of countertrade goods to the vehicle industry sector itself, and aroused concern among foreign suppliers who were fearful of not being able to earn a profit under the new arrangements. Supplier companies that are able to organise effectively to meet importer demands for countertrade and offset arrangements are often able to arrange profitable deals that would otherwise have been unavailable to them. For example, in mid-1994 Bell Helicopter Textron of the US won a US$30 million to supply helicopters to Slovenia. At the time it was indicated that the deal had been arranged largely because of Bell's willingness to enter into counterpurchases covering 100% of the contract value. Under the deal it was agreed that products to be provided by Slovenia would include buses, chemical products and cut crystal. The sale of these was to be handled by countertrading specialists. Such deals often benefit from special export credits cover in the exporter's country. One instance is provided by French cereals exports to Cuba which have traditionally fwussed on barter arrangements involving soft wheat for sugar. At the beginning of 1995 the French export credit guarantee company, COFACE, announced the availability of some US$120 million of guarantees for use in such barter transactions over the course of 1995. This is also an area that lends itself to new initiatives by banks and other financial intermediaries willing to provide back-up services for countertrade operations. For example, in Autumn 1994 a consortium of 22 German industrial companies and banks led by Klockner and West LB formed a new countertrade company called Deutsche Clearing und Countertrade (DCDG). The objective was to tackle projects and facilitate trade in the former Soviet Union and other countries with payment difficulties.

Chapter 17: Countertrade - management and legal issues


Introduction
Countertrade transactions involve complex interlinked procedures and a large variety of risks. This means that parties engaging in countertrade operations need to pay particular attention to management procedures and the legal structuring of their agreements. The steps involved in both of these areas will vary enormously according to factors such as the exact type of operation, size of the companies involved and the geographic area concerned. In very general terms the management issues can be divided into three main broad categories - organisation within the company itself, the use of countertrade intermediaries, and risk insurance. The legal issues relate characteristically to the areas of contract drafting, dispute resolution and the effect of government regulations on the deal.

Organising for countertrade


No two businesses will pursue the same policy or have the same internal procedures for handling countertrade operations. However, most business people with long experience of the subject would agree that a basic policy needs to be set by top management and followed consistently. One successful approach can be, for example, to allot the task of both formulation and implementation of countertrade policy to a single senior executive. At the same time there is a big difference between businesses that have adopted a strategy of actively offering countertrade arrangements as a positive marketing ploy, and those that will merely accept countertrade commitments if this is necessary in order to obtain a contract. State trading organisations (STOs) and others that have adopted a positive policy of competing for business on a countertrade basis will ask themselves key questions such as the following: Should linkage be limited to the company's own products or extended to others?
If products from bodies other than the countertrading company are to be included, what arrangements need to be made with other suppliers to ensure reliability of supply?

What sort of product mix should be offered? For example, should this include different proportions of readily saleable goods together with those with a more limited market? To what extent should territorial restrictions be placed on markets in which the goods may be resold? Companies taking on countertrade commitments then need to decide whether to handle resales themselves or to appoint a trading house or other intermediary to do this. Smaller companies or those new to countertrade often start by retaining the services of an outside consultant with experience of the markets involved.

Such consultants nonnally represent several firms and are paid on the basis of results. In some instances the company may employ a staff consultant who acts as advisor to the departments concerned with countertrade issues or a countertrade coordinator. Larger companies and those with more linked deals often set up countertrade units. They differ from one organisation to another but normally they include both country specialists and operations processing staff. In addition, they often employ product specialists. Some large companies have set up their own wholly owned trading house subsidiaries. Trading houses cany out a variety of international trading activities. Some, but not all, handle countertrade operations and many of those that do. tend to specialise in specific areas of the business. Some started life in inua-company trading as subsidiaries of large trading groups, while a few are direct bank affiliates. Many large trading houses have varying connections with a bank. Some companies that use trading houses say they do so because they find it convenient to use a single trading house for particular products. This enables them to deal, on what is in effect a cash basis, without being concerned with the administration of the countertrade element of their deals. The trading house will have far more contacts than, say, a manufacturer that it represents, and it will be more familiar with a wide range of product lines. Furthermore, manufacturers may not want it known that they are reselling, probably low quality goods, at subsidised prices. Use of an intermediary can prevent this information becoming public. On the other hand, companies may have to pay relatively high commissions to trading houses. A number of state trading organisations resist the use of intermediaries by their trading partners, fearing that the increased costs will finally be reflected in the prices they have to pay to the foreign supplier. In addition to trading houses, banks become involved in countertrade transactions in various ways. At the simplest level they issue guarantees, letters of credit and other instruments in respect of cash payments under linked deals. This is the most traditional banking approach, which steers clear of involvement in the underlying commercial deal. At the next level of involvement, banks can simply introduce two of their clients to each other who then combine their selling and buying capabilities to cany out a countertrade deal. In addition, some banks have set up countertrade units which offer a fee-based service to help customers structure their countertrade operations. Others act as clearing houses on deals arranged by trading companies or match buyers and sellers. A smaller number of banks trade in countertrade operations on their own account. As part of their countertrade management function, companies can also take out insurance against commercial and political risks involved in trading on this basis. In many countries both public sector export credit insurance and private sector insurance cover may be available.

Legal issues
Whenever parties negotiate countertrade deals, legal issues are a major area of concern. One aspect will be government regulations which can determine the legality and practicability of their project. Examples are the need to obtain planning permissions and specific authorisations for works, the impact of environmental legislation, and the capacity of public sector entities to conclude particular types of agreement. Parties will also be concerned to ensure that their agreements.are fully effective between themselves and that they accurately reflect the intention of parties. Sinze countertrade deals generally do not fall into any specific category of contract law, and since they also tend to involve complicated interlinking structures, detailed negotiation and careful drafting of all the clauses to be included in the various contracts are matters of vital importance. Finally, if disputes arise, the parties will have need of effective dispute settlement procedures. Both national courts and private arbitration tribunals provide possible responses.

Contract structures
One important initial consideration is how are the various individual contracts making up an overall countertrade deal to be structured? In some cases the parties conclude two legally independent contracts, one covering the original supply, and the other the countersupply, without any reference in either contract to the other. In this event, the link between the two deals forms part of the commercial reason for the parties' agreement to sign, but it does not form part of the legal contractual structure of either agreement. Thus the rights and obligations under each contract operate independently. Breach of one contract does not affect the legal position of the other, though it will certainly disturb the normal commercial relations of the parties. This type of arrangement may be adequate where the two sides have a well-established and continuing trading relationship with each other. However, since parties to countertrade agreements usually require assurance that the central link between the deals will be maintained, this arrangement is not widely adopted in practice. By way of contrast, under a single contract approach, both agreements to buy and sell may be incorporated in a single contractual agreement. This approach is different from barter since each supply is to be paid with money, even though each party is receiving goods from the other. It differs from the independent matched contracts method also, since the supply and countersupply obligations are contractually linked. Although this method seems attractive as a means to establish the connections between the two deals involved, and to help ensure that both sets of obligations are performed, ir can present a number of difficulties. For instance, the close linkage of the two deals creates problems with regard to contract description and quality of the goods. Furthermore, banks providing finance andlor guarantees are typically anxious to ensure that their undertakings are limited to the side of the deal that they are being requested to support, and they do not like being involved with documentation that shows the links with the other supply obligation. In addition, in some instances, official export credit agencies may not be empowered to cover transactions that visibly form part of a countertrade operation.

Framework agreement
Against this background, the most common approach is for the parties to set out their general agreement to a countertrade deal in a framework agreement. This will include as many details of the intended operation as practicable. When this method is used the parties will normally adopt one of three basic schemes: 1. The framework agreement is entered into prior to the conclusion of any definitive supply contract. Often when this approach is adopted, the agreement includes a provision that the price is to be paid into a blocked account that can be used only for paying for counterpurchases. 2. The original supply contract and the framework agreement are concluded together. The framework agreement will usually be set out in a separate document, although it may be included in the original export or other supply contract. 3. The framework countertrade agreement, the original supply contract, and the countersupply contract are all concluded at the same time. In this case the framework agreement will contain only those provisions that link the other two contracts.

Effect of default
One question that can frequently arise is whether one party can refuse to carry out its obligations andlor

revoke one of the contracts involved, if the other party defaults under one of the other connected agreements. A frequent contractual provision in this regard is thal a countertrade commitment ceases to have effect if the principal supply contract is not performed or does not come into force. If there is no specific provision, the answer may depend on whether or not there is a legal link between the various separate contracts.

Crediting counterpurchasers
Usually the supplier fulfills its countertrade obligations by purchasing the required goods or services from the buyer or from other specified organisations. However. the supplier may also buy from the same sources outside the countertrade agreement, particularly when the counterpurchases are to be obtained from a third party. Therefore it is important to establish that purchases made by the supplier are to be credited towards fulfillment of the countertrade commitment. When there is a framework agreement, this should contain as much detail as possible regarding the goods or services which are to be covered by individual counterpurchase products. In addition, when individual counterpurchase contracts are concluded, it is useful to include a statement that the amount of the contract is to be credited against the countertrade commitment. Where payment is to be made by documentary credit it can also be agreed that one of the documents to be presented by the beneficiary shall be a statement that the payment fulfills or counts towards fulfillment of the countertrade obligations.

Content of framework agreements


The framework agreement or other document setting out the general countertrade obligations seldom contains all the detailed terms that are to be included in each individual countertrade delivery contract. Rather it lays down guidelines to help the parties come to detailed agreement and it sets out procedures to be followed in their subsequent negotations. Matters typically covered include the type of countertrade goods and their quality and quantity, the extent of the countertrade obligation, and pricing mechanisms including the basis for calculation and currency provisions. In particular, if the precise nature andlor value of the goods to be supplied is not known at the time the countertrade deal is agreed, it would be necessary to lay down a procedure or price reference standard to determine the price at the time when deliveries are made. A number of different methods are used to establish this. For example, under the so-called quoted standard price method, the contract links the price to the prices quoted in an organised market. Prices based on the production costs of an agreed producer, resale price, competitor's price and most-favoured customer clause are also employed. One common approach is the average price formula. When this is used the applicable price is calculated as an average of several comparable prices.

Effect of countertrade agreement


By their nature, most countertrade agreements cannot initially cover all the elements that will be needed to perform the subsequent individual transactions. Though they differ in detail, all legal systems require contracts to contain agreement on a minimum number of items in order to be legally enforceable. This means that in a number of instances, typical countertrade framework agreements may not have legal effect on their own but will depend on the subsequent, more detailed agreement of the parties, to become effective at law.

Gap filling
At the same time, a number of techniques may be adopted to help parties fill in contractual gaps in cases where consensus on essential terms is not possible at the time the original agreement is concluded. For example, one common approach is for countertrade agreements to provide for price, quality and other features to be fixed by reference to accepted standards in the relevant trade. Some agreements give one party a unilateral right to fix certain terms such as price and quantities. Most legal systems agree that in principle such an approach is valid, but normally they seek to limit the parties' unilateral power by applying tests of reasonableness, good faith or fairness to its exercise. In addition, many framework countertrade agreements concluded in general terms, include clauses requiring the parties to negotiate provisions subsequently with a view to reaching an agreement. However, legal systems cannot force the parties to come to such an agreement since its content is indefinite and cannot be determined by the application of formulae or other automatic procedures. Nevertheless, a party that refused to negotiate or acted in bad faith to frustrate the negotiations might be held to have breached its contractual undertaking to discuss the contract terms at least, and might in some instances be held responsible for loss caused to the other party. However, it would be very difficult to calculate the damage caused in such instances and the practicality of proceedings would often be doubtful. Another possible approach is to arrange for the filling in of gaps to he done by a third party or independent body. For example, the International Chamber of Commerce in Paris offers rules under which experts can be appointed for this purpose. Most legal systems allow parties to agree to such a provision contractually. In some countries the third party is able to act in the same way as an arbitrator and a decision can be directly enforceable in the same way as an arbitral award. In other countries the third party can act only as the common agent of the parties and its decision does not constitute a directly enforceable judgment. Rather it becomes a new term of the contract which can be enforced in case of breach, by further court or arbitral proceedings.

Compensation deals - case study


Texmas AG, a Swiss exporter and Masimp Ltd, an importer in a country lacking foreign exchange reserves, sign a contract for the delivery by the former to the latter of manufactured goods. Because of the transfer and credit risks involved, Texmas AG is prepared to deliver only against either full payment in advance or an irrevocable documentary credit confirmed by a bank in Switzerland. However, Masimp Ltd is not in a position to pay in advance because of the lack of foreign exchange in its country. Moreover, there are no Swiss banks that are prepared to add their confirmation to a credit issued by a bank in Masimp's country. Accordingly, Masimp Ltd suggests that the payment should be made in the form of agricultural commodities to be delivered by an export trdding firm in its own country, called Agrex Ltd. With the assistance of the trade and export finance department of its own bank, Texmas AG finds a Swiss importer called Foodimp AG that would be prepared to buy the commodities from Agrex Ltd. Foodimp AG and Masimp Ltd then each give instructions to their own banks. Those two banks then conclude an agreement between themselves under which the amount payable by Foodimp AG in Switzerland is to be credited to an escrow account at Crkdit Suisse (CS), also in Switzerland. Following this move. Foodimp AG arranges for its bank to issue a documentary credit in favour of Agrex Ltd. Masimp's bank then issues a documentary credit in favour of Texmas AG. Once the above payment arrangements are in place, Agrex Ltd dispatches the commodities it has agreed to deliver to Foodimp AG. Agrex Ltd presents the documents stipulated in the credit opened in its favour to the bank in its own country. That bank then forwards the documents to CS. The latter then debits Foodimp's account and credits the amount involved to the escrow account. On the basis of the cover in the escmw account, CrAdit Suisse is now in a position to confirm the documentary credit issued on behalf of Masimp Ltd in favour of Texmas AG. The bank in Masimp's country then credits the relevant sum to the food exporter Agrex Ltd. Once the above arrangements have been concluded Texmas AG dispatches its manufactured goods to Masimp Ltd and presents the documents stipulated by the credit issued in its favour to CS. The latter then debits the escrow account and credits the relevant sum to Texmas AG's account. CS forwards the documents to the bank in Masimp's country. That bank checks the documents and debits the relevant amount to Masimp Ltd. The linked transactions are now completed and all the relevant payments have been made. (The fictionalised case presented above was drawn up on the basis of material supplied by Credit Suisse in Switzerland. That bank's trade and export finance department is frequently involved in a financing and advisory capacity on countertrade operations.)

Appendix 1:

Offset in Saudi Arabia

Saudi Arabia is a significant customer for overseas military and civil works equipment and services suppliers. The attractiveness of this market for military equipment suppliers in particular, has been heightened by reduction in the military budgets of NATO and former Warsaw Pact countries following the end of the cold war. Furthermore, the decline in Saudi Arabia's oil revenues has over recent years made the government in that country keener on extracting offset investment undertakings from foreign suppliers as a means of compensating for foreign exchange expenditure on overseas purchases. This move has been particularly marked in defence contracts such as Saudi Arabia's Peace Shield, Al Yamamah and Sawari 11 programmes. The strategy is also being extended beyond defence to area? such as telecommunications. Announced in 1984, the Peace Shield project aims at providing the country with integrated data-processing display and communications equipment in connection with ground support for Saudi Arabia's airborne warning and control systems (AWACS) aircraft. The Al Yamamah project was initiated in 1985 by the Saudi and British governments in connection with the supply of Tornado, Hawk and PC9 aircraft together with associated weapons, equipment and support. A linked programme launched in 1989 and known as the Al Yamamah Economic Offset Programme is intended to encourage and assist in creating joint ventures and other commercial partnerships between Saudi and British companies. The Sawari I1 programme concluded in 1990 by the Saudi and French governments aimed at equipping the Royal Saudi navy with three French supplied Lafayette-class frigates. The total programme was worth around US$3 billion and it contained a contractual commitment to reinvest 35% of the programme's technical value in Saudi Arabia. Peace Shield included a similar percentage requirement, though A1 Yamamah did not. Though such programmes differ appreciably in detail and amounts involved, several common features can be detected. For example, projects typically involve the establishment of an offset committee which evaluates proposed investments. For instance, the Peace Shield Offset Committee is chaired by the Saudi ministry of defence and aviation and includes high level representation from the Saudi ministries of finance and national economy, commerce and industry, and electricity. The Al Yamamah project on the other hand is administered throush a UWSaudi Joint Offset Committee. Normally, the committee will expect to see a feasibility study before approving any investment. The study will have to demonstrate in detail that the proposed project is likely to be profitable, and include considerable information on assessed market demand plus technical information on products and processes. The ability of the proposed projecr to transfer technology to Saudi Arabia will be an essential factor in many instances. The likelihood of the project's enhancing Saudi Arabia's domestic and overseas market will also usually be vital elements. Generally speaking, offset investment projects involve the creation of joint ventures between the foreign investor and Saudi commercial parties. Offset committees are likely to pay particularly close attention to ensuring that such arrangements are professionally managed. For instance, it may be necessary to bring in an additional company with prior operating experience in the relevant area if the joint venture participants lack this themselves. Initially at least, the foreign joint venture partner will normally be expected to bear operating responsibility for the venture and to have a significant equity interest in it. Subsequently, the foreign contract participants will be expected to share responsibilities with the participating Saudi interests with regard to technical, commercial, financial and administration aspects of the venture. The preferred ownership structure is likely to vary from case to case. For example, in Peace Shield the normal requirement was 50% by the overseas contractor group and 50% by the relevant Saudi public sector group. Subsequent sales of equity interests in the joint venture are also likely to be subject to restrictions and authorisation procedures. A further concern of the Saudi authorities is to ensure that the joint ventures are adequately capitalised. For example, Peace Shield included a stipulation that joint venture debt should not exceed 75% of total capitali-

sation. Often it is stipulated that equity contribution to joint ventures may be either in cash or non-monetary contributions such as capitalised licences, trade marks, and research and development costs. Restrictions may also be imposed on dividends that may be paid out of the venture's profits. For example, during the first 10 years of a joint venture formed under the Peace Shield Offset Programme, cash dividends may be paid only out of retained earnings. A1 Yamamah on the other hand contained no such restriction. (The above presentation is based on information provided by the Clifford Chance international law office. Clifford Chance has offices in London and other major world centres and its activities include advising corporate clients in connection with offset programmes).

Appendix 2:

Countertrade in Indonesia

Indonesia operates an official countertrade policy which requires a 100% countertrade commitment under govemment procurement contracts with foreign suppliers. The main objective is to boost Indonesian nontraditional export products with the exclusion of petroleum and natural gas. Imports that benefit from a wide range of foreign government and multiateral subsidized loans are exempted from the regulations. Where the countertrade rules apply, a foreign company bidding for a govemment procurement contract has to submit a document called a letter of undertaking along with its tender documents. The Department of Trade checks whether the proposal in the letter of undertaking is acceptable and if so it issues a letter of agreement. In most cases prior approval is also required from the co-ordinating minister of economy finance and development supervision (EKU-WASBANK). If the minister's consent is forthcoming he sends a letter of approval to the government entity that has sent out the invitation to tender. Following these approval procedures, the successful bidder is required to send to the Department of Trade a draft of the official document in which the conditions of counterpurchase are set out, together with an assignment agreement in approved form. Using the assignment agreement. the supplying company assigns the counterpurchase obligahon to a third party trader that is already registered with and accepted by the Department of Trade. At the same time, the Indonesian importing authority sends a written statement to the Department of Trade indicating the total amount of the counterpurchase undertaking and the fulfillment period for the counterpurchase obligation. This latter is usually identical to the supplier's delivery period under the main contract. The Department of Trade then confirms the assignment agreement and issues the official documents specifying the counterpurchase conditions. It will also subsequently give its approval to the Indonesian importing authority to sign the contract with the foreign supplier and for the related financing arrangements. In the letter of undertaking the applicant declares his readiness to effect counterpurchases for an amount equal to 100% of the foreign currency FOB value of his exports to Indonsia. He may either cany this obligation out himself or through an accepted third party. The letter of undertaking is in a standard format drawn up by the Department of Trade. Since it has been amended several times, suppliers need to ensure that they receive the latest version for signature. In accordance with the terms of the standard undertaking, the counterpurchases have to be started within six months from the date of award. Furthermore, the letter commits the supplier to paying a penalty of 50% on any unfulfilled portion of the obligation. The supplier - or the third party trader if the counterpurchase obligation has been assigned - has to produce evidence of the fulfillment of the counterpurchase undertaking. This is carried out by submitting specified export documents in respect of each completed purchase. They include a set of official forms known as the PEB (Pemberitahuan Ekspor Barang forms) and a standard form letter which have to be sent to the Department of Trade. [This appendix was compiled with the assistance of information provided by CentroBank which is based in Vienna, Austria. The bank has been involved in Indonesian counterpurchase since the policy was initiated, and it continues to be active in this field.]

PART 5 GUARANTEES

Chapter 18: Guarantees - general


Introduction
A guarantee is a promise by a third party to carry out the obligations owed by one person to another in the event of default. This concept forms the basis of undertakings given by banks, insurance companies and other institutions that facilitate the performance of countless international project and trade deals around the world every day. Unlike payment and financing vehicles such as documentary credits and forfaiting, guarantees do not provide a complete procedure for effecting payment or granting credit. Rather, by providing third party security against default, they enable business people to conclude deals and ,pnt to or benefit from credit on more advantageous terms or in circumstances that they would otherwise have found too risky. The majority of guarantee instruments provided in connection with transnational projects and trade are issued by banks in the form of irrevocable undertakings payable on the demand of the guarantee beneficiary. (The beneficiary is the person in whose favour a guarantee is issued). Characteristically the supplier's bank on an international project such as a construction or civil works contract is required to issue a guarantee sometimes called a bond - underwriting the supplier's performance obligations. At the same time, guarantees can also be provided to the seller in order to underpin the buyer's obligation to pay. Other guarantee instruments employed in international deals include guarantees in respect of missing documents on trade operations and customs guarantees. Such undertakings are equally common on agreements between parties in western countries and the third world, and in deals between emerging market countries. Also, bank guarantees, together with bonds issued by insurance companies or specialised surety companies, can frequently be found as an additional security element in more complex trade and project financing structures. For example, where a factory is being financed on BOOT terms, performance bonds may be issued to underwrite the delivery obligations of equipment suppliers. In another example a bank guarantee may be issued to support the acceptance of a draft by the purchaser of capital equipment. This makes the draft acceptable to a foreign bank that is financing the deal on i forfait terms. A guarantee can provide comfort to the beneficiary in several different ways. Most importantly, it is an assurance that compensation will be available in the case of default by the other party to the deal. If the guarantee is issued by a bank, this compensation will take the form of a money payment. Other types of guarantee sometimes provide that the issuer will take over the project or repair the damage. Furthermore, particularly where the guarantee takes the form of an irrevocable bank undertaking payable on demand, the bank is unlikely to issue the undertaking unless it is confident of its customer's financial status and technical capability. This provides the guarantee beneficiary with a degree of assurance - albeit indirect - of the solidity of the party with which it is entering into contractual relations. In addition, the party on whose instructions the guarantee is being issued (the principal) stands to lose the guarantee amount if it fails to fulfil the contract terms. This gives it a strong incentive to complete the contract even if the transaction has become unattractive in the meantime.

Guarantees of suppliers' obligations


The most important forms of guarantees issued in respect of intemational business operations underpin the obligations of suppliers. Tender bonds, performance bonds, and advance payment guarantees in particular are frequently called for in this context. The practice in this area has developed largely since the 1960s and has been much influenced by the burgeoning of major infrasuucture civil works and construction projects in the developing world. Tender bonds. Also known as bid bonds -these are frequently stipulated by governments and other public sector agencies in connection with intemational public invitations to tender. The basic purpose is to deter companies from tendering and then rejecting the contract when it is awarded to them because they have lost interest in it. By making tenderers post a bond, the buyer also hopes to make companies think out their bid properly before deciding to submit it. The procedure accordingly helps the buyer to avoid the cost and delay of putting the contract out to tender more than once. The amount of bond demanded varies from case to case, but a typical range is from 1% to 5% of the tender price. Such bonds will normally remain in force until a contract is signed with the bidder or until a performance bond is issued following the signature of the contract. Normally the bond can be called if the tenderer withdraws the tender before the expiry date, refuses to accept the awarded contract, or is unable or unwilling to provide the required performance bond. Performance bonds. These are issued when the contract has been awarded and they underwrite the contracton' or suppliers' obligations to complete the project correctly. Such bonds , drawn up as demand instruments, are issued for a specified sum usually between 5% and 10% of the project value. Ideally, they will contain a precise expiry date beyond which they cease to have effect. In some countries negotiating this is difficult. In addition, the bond should also be worded so as to cease to have effect before the expiry date on successful completion of the contract. Advance payment bonds o r guarantees. These are also commonplace in respect of major projects involving works over an extended period of time. In these instances the contractor normally requires an advance payment on the contract price to finance the initial costs. Typically such advance payments range from 5% to 20% of the total price. Since such advances are made before the work has been carried out, they are underpinned by an advance payment guarantee in favour of the buyer (known as the employer in the context of construction works). Such bonds are issued to cover the full amount of the advance payment. In some instances the amount of the bond may be reduced as work proceeds. Retention money bonds. These are relevant to cases in which the contract provides for stage payments to be made as work progresses. It is customary in such cases for the employer to require a clause in the contract allowing him to retain a certain percentage from each stage payment to cover contingencies, such as the costs of canying out remedial works if there are defects. The percentage retained is normally between 5% and 10% of the stage payment. As an alternative to making this deduction, retention money bonds allow immediate release of the total amount of the stage payment to the contractor. Maintenance bonds. In addition, the contractor will be required by the contract to remedy defects and carry out repairs during a maintenance period following completion of the project. This obligation is secured by the issuance of a maintenance bond.

Payment guarantees covering the buyer's obligation


The great majority of guarantees issued in international business relate to the obligations of suppliers. The buyer's obligation to pay is most often secured by other means. Characteristic examples are documentary credits and collections, acceptance of drafts, and the provision of official export credit guarantees or insurance. However, bank guarantees can also be issued to underpin the buyer's obligation to pay. For example, this procedure might be adopted in a case where the documents allowing the buyer to take posession of the goods were being handed over against his acceptance of a bill of exchange, but additional security was wanted from a financial institution. Although both an official export credit guarantee and a bank guarantee may cover buyer default, there are important differences of principle and practice between the two. In particular the former is obtained by and at the expense of the exporter, whereas the latter is issued by the importer's bank at the importer's expense. Furthermore, a bank guarantee will be drawn up as an instrument payable on demand, whereas export credit guarantees agencies will look for proof of default and may require the exporter to attempt to recover the debt first from the buyer.

Other types of guarantees


In addition to the two broad main categories of guarantees summarised above, many other types of guarantee instruments have been developed to deal with more specific situations arising on transnational deals. Some of these are described briefly below.

Letters of indemnity. Guarantees often referred to as letters of indemnity are sometimes issued by banks when bills of lading or other transport documents go missing on goods shipments. In particular in the case of lost bills of lading, the canier will be reluctant to hand over the goods to the consignee because if that person is not the current bolder of the bill of lading the canier will incur liability to the holder if the goods are delivered to someone else. This situation sometimes arises in the case of bulk shipments where the cargo has been sold and resold during the voyage. The issue of a letter of indemnity by the consignee's bank will cover the camer against claims and thus make him readier to release the goods. Typically such guarantees are issued for between 100% and 200% of the value of the goods. Customs guarantees. These provide cover against possible customs duties. They are often used when goods are imported into a country on a temporary basis. The customs authorities can then claim under the guarantee if the goods are not re-exported within the prescribed time limit and the customs duties that then become chargeable are not paid. Loan guarantees and guarantees for legal proceedings. Bank loans are often made conditional on security provided by the borrower or a third party. A bank guarantee is one of the means by which the lender can obtain assurance that the loan will be repaid. Bank guarantee instruments are also issued in respect of legal procedures - legal costs guarantees and distraint guarantees, for instance. Equipment bonds. In some instances under projects such as construction contracts, the buyer or employer

buys and delivers equipment needed for the project instead of making an advance payment in cash to the contractor. In this case the transaction may be covered by the issuance of equipment bonds.

Transportation bonds. These cover advance payments made by the employer to the contractor for the specific purpose of importing capital goods or materials. Normally they operate from the moment the materials anive in the port or airport of destination until delivery on-site.

DEMAND GUARANTEES:- CONDITIONING CALLS

AMOUNT

MAXIMUM SUM SPECIFIED I N GUARANTEE

WHEN APPROPRIATE REDUCTION OF MAXIMUM AVAILABLE AS WORK PROGRESSES

v
D A T E LIMITS

O N OR AFTER DATE OF ENTRY INTO FINANCE O N OR BEFORE EXPIRY DATE

CLAIM PROCEDURES

>

WRITTEN DEMAND STATEMENT OF DEFAULT OTHER CONDITIONS

Structures
The basic idea of a guarantee is that if a party who has undertaken an obligation towards another fails to perform, the third party guarantor will step in and cany out the obligation itself. Furthermore, the guarantor becomes liable only if there has indeed been default on the part of the person primarily obliged to carry out the obligation in question. This means that the party in whose favour the guarantee has been issued has to prove to the guarantor that default has occurred before the latter can be compelled to take action. This in simple terms is the essence of the traditional form of guarantee. Such instruments are often referred to by lawyers as accessory guarantees. The guarantee obligation is accessory to the primary obligation undertaking given by the person whose performance has been guaranteed (the primary debtor). If the primary debtor has a good legal reason for refusing to cany out the deal, that defence can be asserted equally by the guarantor. In the above context, the term debtor is used to mean someone who is legally obliged to perform any sort of obligation towards another, whether or not it is a monetary obligation. Thus it would include for example, a company that has contracted to supply equipment to construct a power station, or to design a software application system for a hank. If an accessory guarantee is issued in these circumstances, the guarantor's basic obligation in the event of default by the principal debtor is to deliver the goods or services or to complete the works, and not to pay a sum of money by way of compensation. An accessory guarantee may equally be issued in respect of a money debt - for example an importer's obligation to pay for goods delivered. In this case, should the buyer fail to pay, the guarantor will have to pay

in his place. In this event he is performing the importer's side of the sales bargain rather than paying damages or compensation for loss. Accessory guarantees based on the above principles have long been issued in the marketplace by financial institutions such as insurance companies and specialised surety or bonding companies. (The last two for example, are characteristic of US practice.) Organisations of this type are in business to investigate claims and calculate losses. Accordingly, they are well placed to take on guarantee undertakings that will require them to examine whether or not default has occurred and to calculate the costs of putting the matter right. Accessory guarantees of the above type were developed essentially in the context of individual national markets, and they are still very commonly employed on domestic operations in many parts of the world. However, a radically different practice has come to dominate guarantee structures for international trade and project deals. This is the demand or first demand guarantee under which the guarantor undertakes to pay a specified sum of money on the demand of the beneficiary in whose favour the instrument is issued. Undertakings of this type are usually issued by banks rather than insurance companies. This practice began developing in the 1960s and it became consolidated over the following decade. The trend started when developing countries - particularly those with significant oil revenues -began launching major new infrastructureand investment projects. Governments and other buyers in developing countries had to turn to foreign suppliers with whom they had previously had little or no contact. As a protection against the risk of suppliers abandoning projects that became less attractive in mid-course, such buyers started to insist on strong cash guarantees that would assure them of receiving a predetermed sum of money against their simple demand. In a buyers' market they had little difficulty in obtaining the sort of security that they wanted and the simple demand guarantee structure has now become a deeply entrenched feature of international projects of all kinds.

Demand guarantees - characteristics


Guarantees of all types and for all purposes may be issued in demand form. Characteristically they include tender, performance and repayment guarantees, and guarantees underwriting a buyer's payment obligations. The terms bond and guarantee tend to be used interchangeably. Though the former usage is particularly common in sectors such as the construction industry, no particular legal significance attaches to the use of one term or the other. Procedures vary , but a simple case could operate as follows. A buyer and a seller finalise their negotiations which includes a requirement for the issue of a first demand performance guarantee to be opened by a local bank in the buyer's country. The seller gives the appropriate guarantee instructions to its own bank. The seller's bank instructs a bank in the buyer's country. The buyer's bank issues the guarantee in favour of the buyer. In accordance with the sales agreement between the buyer and the seller, the guarantee is issued for a sum of money equivalent to 10% of the sale price. The buyer can cash this sum by presenting a simple written demand to the issuing bank without the need to produce any supporting documents or other evidence. In addition to sending guarantee opening instructions to the issuing bank, the seller's bank also issues a counter-guarantee in the issuing bank's favour. This also covers 10% of the sales price and is payable on the simple demand of the issuing bank. It is intended to be used if that bank has to pay a claim by the buyer.

In return for the above facility the seller has to sign an unconditional undertaking to reimburse its own bank if claims are made and met under the guarantees. Provisions of the above type clearly place great power in the hands of buyers and they have led to much anguished debate and controversy in business and legal circles. In particular an unscrupulous purchaser can treat a demand guarantee much as if it were a discount on the price and cash the instruments even if the other party has fully performed its contractual obligations. Banks are in the business of paying against documents and instructions or demands to pay. They will not look into the underlying rights and wrongs of the parties' commercial deal before transferring the money. In the early years lawyers representing companies - mainly sellers - that had supplied such guarantees often argued that such instruments should not be enforced by the courts. One of the main assertions was that first demand guarantees were contrary to basic legal principles since the right to claim payment was totally divorced from the commercial reality of the case. However, over the years, courts in most countries have come to recognise the full effectiveness of demand guarantees on the basically simple ground that the parties concerned have contractually agreed to their issue. The old latin tag pacta sunt servanda (parties must stand by their agreements) is sometimes quoted on these occasions. Though national courts differ in their detailed approaches, it is nowadays mostly accepted that the beneficiary can cash a demand guarantee without hindrance unless it can be proved that his action amounts to fraud or, under some systems, flagrant bad faith. This issue, together with steps that can be taken at the outset to reduce the risk of an abusive demand for payment being made, are considered further in the next chapter. In general terms a party that obtains the issue of a first demand guarantee by its bank is relying essentially on the good faith and integrity of the guarantee beneficiary, which will be the sole judge of whether or not the guarantee can be called.

International practice
There is no overall international law for either accessory or demand guarantees. The legal foundations of such instruments are to be found instead in the different national laws. At the same time, there is a large degree of uniformity of practice with regard to the structuring of demand guarantee instruments. This may be accounted for largely by the fact that they developed from the very beginning in an international context involving parties from many different countries in similar situations and with similar requirements. The well-known "me too" syndrome has doubtless helped as well. In addition, the International Chamber of Commerce has developed several sets of uniform rules for guarantees. Such ICC rules now exist for both demand and accessory guarantee instruments. [See further appendix to this chapter.] The idea behind these ICC rules is to provide greater certainty and security in international practice and to try to discourage unjustified calls on guarantees. The rules also deal with issues such as the responsibilities of banks and other issuers of guarantee undertakings. To date the various sets of ICC rules for guarantees have not been widely adopted in practice. It remains to be seen whether some of these rules may enjoy greater popularity as they become better known.

Standby letters of credit


Standby letters of credit perform essentially the same function as demand guarantees though they are used in a much wider range of financial and commercial settings. They are most commonly issued in the United

173

States but can also be found increasingly in other countries. Standby letters of credit adopt the same legal structures as documentary credits and they are subject to the same basic rules. However, their purpose is different. Documentary credits are used essentially to effect payment for goods and services. Standby letters of credit, on the other hand, are called in the same way as demand guarantees in the event of default. Their use has developed particularly strongly in the United States since, with limited exceptions, banks in that country are not generally empowered to issue true guarantees. Underwriting another party's performance is considered by the US courts and the regulators to be outside the definition of normal banking business. However, US banks are allowed to issue letters of credit and to deal in negotiable instruments. The expression "standby letter of credit" is not a precise legal term. It was devised by those using and operating the system as a convenient title to describe what the instrument does. The expression "guaranty letter of credit" has also sometimes been employed, but US banks now generally avoid the term since the title suggests too close a connection with the sort of business that they are not supposed to do. In both practical operation and effects, standby letters of credit operate in a similar way to demand guarantees. However, since they take the form of a letter of credit they generally incorporate the provisions of the ICC's Uniform Customs and Practice. The more recent ICC rules concerning guarantees are not appropriate for standby letters of credit. Standby letters of credit are frequently issued by banks in the US to cover the obligations of American suppliers on contracts with parties in developing countries. In most such instances the local buyer will want a guarantee undertaking from a bank in his own country. Since the letter of credit structure is being used, one possibility is for the American bank to issue its standby letter of credit directly in favour of the foreign beneficiary and to request a bank in the beneficiary's country to add its confirmation to the credit. However, a more frequent approach is for the local bank to issue a simple demand guarantee. In this instance the US bank issues its standby letter of credit in favour of the local bank by way of counter-guarantee.

Costs
Generally speaking the costs of a guarantee are borne by the party that gives the inshuctions for its issue. These will include the commission and expenses of the issuing bank and in the majority of cases of the correspondent bank in the beneficiary's country. A characteristic provision is to charge commission on a quarterly rate. This covers the risks borne by the bank, the work done and the capital allocation costs relating to the operation. It may be possible to reduce commission rates by providing collateral (for example stock market securities) to cover the bank's commitment. Some very large guarantees are syndicated between several banks. In this case additional costs may include an agent fee or management fee payable to the agent bank for the syndication, coordination, documentation and bookkeeping work involved throughout the life of the guarantee. In some instances the principal's bank may charge a lower fee for a counter-guarantee than for a guarantee issued direct in favour of the foreign beneficiary. This reflects the fact that in the former case the bank's risks may be reduced by using an intermediary that is better acquainted with local practice and regulations.

Demand guarantees in Turkey Late claim


A Turkish bank issued a counter-guarantee in favour of an Arabian bank in order for the latter to issue its own letter of guarantee in favour of an Arabian company. The guarantee was payable against the company's simple demand and did not require the submission of a statement of default. The counter-guarantee contained the following statement: - "This counter-guarantee will expire on August 2, 1994 whether returned to us for cancellation or not, and any claim hereunder must reach us at our office on or before that date at the latest." Some 10 days later the Turkish bank received a telex from the Arabian bank asking for an arnendment worded as follows: "Our counter-guarantee will remain valid until August 2, 1994, however any claim made within the lifetime of our counter-guarantee shall be accepted though reached us after such date for a reason or another." The Turkish bank amended its counter-guarantee as requested. No claim had been received from the Arabian bank by August 2, 1994. The Turkish bank obtained a letter from its customer attesting that its obligations towards the beneficiary (the Arabian company) had been fulfilled. The bank closed its file on August 10, 1994 and released the customer. Two months later the Turkish bank received a letter of simple claim dated August 2, 1994 sent by the bank in Arabia. The Turkish Bank then looked to its Turkish principal for payment only to discover that it had gone bankrupt a few weeks previously. Replying to the bank in Arabia, the Turkish bank claimed that such a long delay in submitting a claim was unusual in banking practice. The Arabian bank then pointed to the amendment. The Turkish bank paid up.

Payment on demand
An Austrian bank issued a counter-guarantee in favour of a Turkish bank instructing the latter to issue its letter of guarantee payable on the first demand of the Turkish beneficiary who was a Turkish fruit exporter. The counter-guaranteecontained the following statement :"We, [the Austrian bank] will pay you upon your first demand by tested telex informing us that your bank has been called upon to make payment by the beneficiary within validity period of your letter of guarantee." Some months later the beneficiary claimed under the letter of guarantee and the Turkish bank paid him on his first demand. The Turkish bank then claimed reimbursement from the counter-guarantor stating that it had paid the beneficiary against the latter's written demand within the validity period of the guarantee. The Austrian bank replied three days later that the claim was not in accordance with the wording of the counter-guarantee and it refused payment. When the Turkish bank asked what the discrepancy was, the Austrian bank replied as follows:- "Our bank did not authorise you to issue a 1Ig payable immediately on first demand, instead you should have informed us that you have been called upon to make payment by the beneficiary and should have paid following our payment to you." The Turkish bank first attempted to obtain a refund of the amount paid from the beneficiary, but the latter threatened legal action against the bank. The Turkish bank then looked to the counter-guarantor (the instructin,gbank) for reimbursement but without success.

Appendix:

International rules for guarantees

The International Chamber of Commerce has drawn up several sets of rules for guarantee operations. The first of these was completed in 1978 and is known as the Uniform Rules for Contract Guarantees (ICC publication N o 325). However, these rules do not opt clearly for either the demand guarantee or accessory guarantee structure and they have not been very much used in practice. In 1992 the ICC published a new set of provisions specifically covering demand guarantees. These are known as the Uniform Rules for Demand Guarantees (URDG) (ICC publication N o 458). In 1993 the ICC brought out a further set of rules relating to contract bonds of an accessory nature. These are known as the ICC Uniform Rules for Contract Bonds (ICC publication No 524). Each of the above sets of rules may be incorporated into a guarantee by contractual reference in the guarantee document. Some of the major features of each set of ~ l e are s summarized below.

ICC Uniform rules for demand guarantees (Publication No 458)


A demand guarantee provides for the payment of a sum of money against a written demand for payment and, if stipulated, other documents. Such guarantees are separate transactions from the contracts or tender conditions on which they may be based. The same principle applies to counter-guarantees. Guarantee instructions and guarantee instruments should be clear and precise and should avoid excessive detail. Guarantees are not assignable unless the contrary is stated, thoush the beneficiary may normally assign its right to receive the proceeds. Unless otherwise indicated, guarantees and counter-guarantees are irrevocable. A guarantee normally enters into effect from the date of its issue. Guarantors have to examine documents presented with reasonable care to ascertain whether or not they appear on their face to conform with the terms of the guarantee. The guarantor has a reasonable time to do this. If a demand is rejected the guarantor must inform the beneficiary by teletransmission or if that is not possible by other expeditious means. If a demand is made on a guarantee the guarantor has to inform the principal or the instructing party without delay. Demands have to be made before the expiry date. They have to be in writing and must be supported by a written statement indicating that the principal is in breach of its obligations and what the breach is. A guarantee is cancelled on presentation to the guarantor of the guarantee itself or the beneficiary's written statement of release from liability under the guarantee. In the latter case this applies whether or not the guarantee or any amendments thereto are returned. Retention of the guarantee document does not preserve any rights of the beneficiary under the guarantee after termination of the guarantee. If the beneficiary requests an extension of the validity of the guarantee as an alternative to a demand for payment, the guarantor shall without delay inform the party who gave the guarantor its instuctions . The guarantor then suspends payment of the demand for a reasonable time to permit the principal and the beneficiary to reach agreement on the granting of the extension. Unless an extension is granted the guarantor is obliged to pay the beneficiary.

ICC Uniform rules for contract bonds (Publication No524)


Liability of the guarantor to the beneficiary under a bond subject to the rules is accessory to the liability of the principal to the beneficiary under the underlying contract, and it arises on default. The contract is deemed to be incorporated into and to form part of the bond. The liability of the guarantor is limited to the maximum amount set out in the bond. The guarantor can make use of all defences and other legal means available to the principal against the beneficiary under the underlying contract.

Unless othenvise stipulated, bonds expire six months from the latest date for the performance of the relevant contractual obligations. The bond may be cancelled at any time by the return of the document itself to the guarantor or by written notice. The bond must be returned to the guarantor after release or discharge. though retention of the document does not confer any right or entitlement on the beneficiary. Claims have to be made in writing and have to be served on the guarantor on or before the expiry date. Claims may be submitted by authenticated.teletransmission,EDI, telex or other means of telefacsimile or electronic transmission. The claim must state brief details of the contract, indicate that there has been breach or default, set out the circumstances and any request for payment, performance or execution. The guarantor has to notify the principal in writing of any such claim as soon as reasonably practicable and before taking any action to satisfy the claim. If requested the beneficiary must supply any further information that the guarantor reasonably requests and allow the guarantor to inspect relevant works, goods or services. A claim cannot be honoured unless there has been default and the claim has been duly served on or before the expiry date. Default is deemed to be established by the issue of a certificate of default by a third party if the bond so provides, or otherwise on the issue of a certificate of default by the guarantor or by the final judgment, order or award of a court or tribunal of competent jurisdiction. Unless othenvise agreed, disputes concerning the bond shall be settled by ICC arbitraton.

Uniform rules for contract guarantees (Publication N o 325)


These rules cover tender performance and repayment guarantees. The guarantor may be a bank or other body. The guarantor is liable only for the amount mentioned in the guarantee. Unless so specified the guarantee sum is not reduced by partial performance of the contract. The guarantee itself may state expressly the latest date by which claims have to be received. If not, the expiry date is fixed at six months from the date of the guarantee in the case of a tender guarantee. and six months from contractual date of completion or delivery in most other cases. The guarantee expires when any claims have been settled or on the expiry date if no claim has been received. Retention of the guarantee document after expiry does not prolong the life of the guarantee and the document should be returned. Claims must be made not later than the expiry date and they must be supported by specified documentation. Parties are free to specify documents required to support a claim. If no such specification is made or the guarantee calls only for a statement of claim, the following provisions apply: in the case of a tender guarantee the claim must be accompanied by a declaration of acceptance of the tenderer's bid and of his default, and the agreement of the beneficiary to have any resulting dispute with the tenderer settled by arbitration or court proceedings; in the case of a performance or repayment guarantee, a court decision or arbitral award justifying rhe claim or the written agreement of the contractor must be submitted.

Chapter 19: Guarantees - procedures


Introduction
The requirement for the issue of a guarantee is raised when the initial contract between buyer and seller is negotiated. It is at this stage that the main guarantee contents are decided. It is therefore at this point that either party should raise the points that it wants to have covered in the guarantee or suggest any modifications to the other side's proposals. When the contract has been signed it will be too late to change the shape of the guarantee contents

Form and contents


In some cases the form and contents of the guarantee are prescribed by government regulations. In other instances a particular form may be dictated by the conditions of an invitation to tender. Often at the negotiation stage the form of guarantee may appear to be a marginal matter and a supplier will not wish to risk losing a valuable contract by haggling over what appears to be formalities. The point may become of more than academic interest later though, if the instrument is called. Furthermore, in some cases the local law and practice may be less inflexible than it appears at first sight and amendments to a model form produced by the other party may be possible.

Reference to underlying contract


Demand guarantees are legally independent of the underlying contract. Nevertheless it will be useful for the guarantee to identify the project and the commercial purpose for which the guarantee is granted. Such a reference may provide a helpful item of evidence in the case of an unjustified call on the guarantee, though it will not restrict the independent nature of the instrument.

Guarantee amount
It is also important for the parties to agree on the maximum amount for which the guarantee may be called. This is vital so far as the principal is concerned, and in any event banks will not issue instruments under which liability could be open-ended. Furthermore, where performance of the underlying contract over a period progressively reduces the value of the outstanding performance responsibilities, the supplier can suggest the inclusion of a mechanism to reduce the maximum amount secured by the bond at staged intervals. This will help to reduce the supplier's contingent liability on the bond, and to cut down on bank commissions payable during the life of the guarantee

Entry into force


If entitlement to use the guarantee depends on the beneficiary'$ first performing some act itself, such as obtaining the issuance of a documentary credit, it may be possible to obtain a condition that the guarantee will enter into force only when a document has been presented to show that the relevant act has been performed. Even better is an agreement that the bond will be issued only when the document has been produced.

Expiry
To avoid the obligation being open-ended in nature. the parties should also come to an agreement as to the definite date on which the guarantee will expire. At the same time parties will need to know whether local laws and regulations make it difficult to enforce an expiry date effectively. This is the case with a number of middle eastern states in particular. Even if an effective expiry date is included. the problem is not entirely resolved. For example, if the contract beneficiary considers that the other side has still not completed all its performance obligations before the guarantee expiry date, it may serve a pay or extend notice on the bank just before the expiry date arrives. Provided that the call complies with the formal requirments of the guarantee, this triggers the payment mechanism. Accordingly, the guarantee principal has little alternative but to authorise the guarantor to extend in order to avoid having to pay out.

Call mechanism
Wherever possible, the beneficiary should not be able to call the bond by making a simple demand for payment. This is a very common situation in practice though and it may be difficult to negotiate a different procedure in in cases where the buyer is in the stronger bargaining position. However, in some cases a solution such as presentation of a third party certificate of default may be acceptable. At the very least the beneficiary could be required to state a specific default justifying the claim in writing.

Counter-guarantee and insurance


In a few cases the beneficiary might itself agree to provide a guarantee against its own wrongful calling of the supplier's bond. An alternative approach in some cases is for the supplier to take out insurance against unfair calling of the guarantee. This sort of cover is provided by a number of export credit guarantees agencies. (See chapter on export credits.)

ICC Rules
An additional option open to negotiating parties is to agree on the inclusion of the ICC's Rules for Demand Guarantees as part of the guarantee terms. This will cover automatically some of the points referred to above and will also provide a number of practical guidelines for banks handling the operation.

SUPPLIER PRINCIPAL

t -

COMMERCIAL CONTRACT INCLUDES AGREEMENT TO OBTAIN GUARANTEES

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BUYER BENEFICIARY

GUARANTEE

SUPPLIER'S BANK

INSTRUCTIONS TO ISSUE GUARANTEE COUNTER GUARANTEE

BUYER'S BANK

Working capital
The granting of guarantee facilities ties up the principal's credit lines and reduces its entitlement to further finance from the bank granting the guarantee. In many instances the issuing bank treats the bond in the same way as it would a loan of the same amount for the purposes of calculating credit limits. In the case of tender bonds some banks also take into account the amount of any additional guarantees that will have to be provided if the bid is successful. Contractors frequently put in bids for more deals than they would be able to perform in order to ensure enough orders to stay in business because they know that only a proportion of their tenders will be accepted. They can therefore find much of their credit tied up in bonds. These points illustrate the importance of definite expiry dates and mechanisms to reduce the outstanding amount of guarantees as work progresses.

Issuing the guarantee


To a large extent guarantees are made-to-measure transactions and they have not become standardised to anything like the extent that documentary credits have. The party that is called on to provide a guarantee may initially discuss the matter with its bank which should be able to advise on matters such as local regulations and practices. In a typical case the bank then draws up a guarantee text adapted to the specific transaction and submits it to the customer for approval. The customer will then be asked to sign a letter of indemnity stating, among other things, that the bank may debit its account if a claim is made under the guarantee. In some cases the beneficiary may agree to accept a guarantee issued in its favour by the principal's bank. In practical terms this may give the principal more scope for exerting influence on the guarantee text with a view to its reflecting his requirements more effectively. However, more often the beneficiary will insist on an instrument issued by a bank in its own counuy.

Beneficiaries like to feel that they havc an undertaking from an institution close at hand and with which they feel comfortable. In addition, the fact that any claims will be submitted to a local bank means that the risk of documents going astray in the post is reduced and claims cannot be obstructed by exchange controls or resmctions on the transfer of funds. Furthermore, the principal may be less likely to try to frustrate a payment demand by applying to the courts for a restraining order if it has to do so in the other party's country rather than its own.

Calling the guarantee


When asked, bankers always state that in most cases guarantees are not called, and the contract is performed without need to use this security device. All the agony is reserved for the small minority of cases in which the beneficiary cashes the bond. In the majority of cases a simple written dcmand made within the validity period of the guarantee instrument will be all that is required. If the guarantor bank has entrusted the issue of the guarantee to a correspondent bank in the beneficiary's country, the claim will be made there. The local bank pays the claim and then demands reimbursement from the principal's bank on the basis of the counter-guarantee that will have been issued in its favour. In this instance, the correspondent bank decides whether or not the claim meets the terms of the guarantee. In view of the simplicity of the documentation typically called for, this should not be an excessively onerous task. The principal's bank then reimburses its correspondent and debits the principal's account on the basis of the letter of indemnity that it holds. Generally speaking the banks have no discretion as to honouring a claim that formally complies with the terms and conditions of the guarantee, even if the principal asserts that it has not breached its contractual undertakings with the beneficiary. Banks are unanimous that any attempt to accommodate a principal's request to refuse or delay payment in these circumstances, could lead to a substantial and lasting loss of confidence in the bank and would lay it open to a claim for damages.

DEMAND GUARANTEES:- SOME NEGOTIATING POINTS


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REFERENCE TO UNDERLYING CONTRACT GUARANTEE AMOUNT

I
I
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/

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TO SHOW PURPOSE OF GUARANTEE GUARANTEE SHOULD SPECIFY MAXIMUM SUM THAT CAN BE CLAIMED AND ANY REDUCTION MECHANISM SPECIFY DATE AND/OR LINK TO PRESENTATION OF DOCUMENTS SHOWING FULFILMENT OF PRIOR UNDERTAKINGS OF THE OTHER PARTY SPECIFY A PRECISE DATE O N WHICH THE GUARANTEE CEASES TO HAVE EFFECT ESTABLISH LIMITS TO RIGHT TO PAYMENT O N SIMPLE DEMAND. EG WRITTEN FORM, STATEMENT OF DEFAULT, EXPERTS CERTIFICATE.
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ENTRY INTO FORCE EXPIRY DATE CALL MECHANISM ICC RULES COUNTER GUARANTEE AND INSURANCE

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IF POSSIBLE, OBTAIN AGREEMENT TO INCORPORATION OF RELEVANT ICC RULES I N THE GUARANTEE

IF OBTAINED, THESE AFFORD PROTECTION AGAINST UNlUSTlFlED CALL

Blocking payment
Demand guarantees operate in a similar way to letters of credit. They constitute an undertaking to pay a specified sum of money against presentation of a demand, and in some cases additional documents. Though the practice varies from one country to another. most courts generally accept the independent nature of demand guarantees. Accordingly. in most cases. the possibility of obtaining a court order to prevent payment on a formally complying call are limited to the rare cases in which the law will set aside the independence of the guarantee from the underlying deal. Illegality of the underlying contract might constitute one such instance. In practice, the usual allegation is that the beneficiary is acting fraudulently or in abuse of its rights under the guarantee. In principle the hank could also refuse payment on its own initiative if it had proof of fraud or illegality, but in most cases it will be most reluctant to do so. If a bank pays in circumstances where it is clear that the beneficiary's conduct disentitled it to payment, the principal could refuse reimbursement. Such a clear cut situation will rarely arise in practice. A principal suspecting that an unjustified claim may be in the offing should rapidly inform the guarantor and supply it with all the available evidence. If the principal tries to obtain a court order to prevent the bank making payment, different mechanisms wil! be applicable in different countries. For example, interim injunctions are the normal procedure in many countries whose systems are based on common law principles. Civil law countries have similar procedures often referred to as interlocutory relief. Possible alternatives are distraint or an attachment order. The normal purpose of interim injunctions and similar procedures is to block payment temporarily pending judgment on the underlying dispute and in particular to prevent the money leaving the country in which the case is to be heard. Typically the party applying for the order will have to show convincing evidence that the beneficiary is acting fraudulently or in flagrant bad faith. It may also have to demonstrate that there will be no effective remedy if the money is sent abroad and that the hardship it will suffer if the order is not granted will exceed that which will be suffered by the beneficiary if a restraining order is made. In general terms the beneficiary may be regarded as fraudulent if it calls the guarantee without having any possible claim as to the substance of the deal. However. a beneficiary can defeat an allegation of fraud by showing that it has a possible claim against the supplier, even though it is not likely to win it. All that is required usually is an honest belief in the claim and it is up to the party attempting to stop payment to show that the belief is dishonest. The situation becomes particularly complicated when, not infrequently, a local bank issues the guarantee in favour of the beneficiary and this is counter-guaranteed by the supplier's bank which cannot be restrained from reimbursing the beneficiary on the grounds of its fraud unless the local bank was in some way party to that fraud. Possible approaches in this situation are to bring proceedings simultaneously against each bank in each country or to join the local bank in an action against the supplier's bank in the latter's country. In practice few attempts to use the courts as a means to block payment on demand guarantees have proved successful. Courts in major trading countries have come to give particular weight to the importance of safeguarding banks' ability to pay their irrevocable undertakings as an essential feature of international business. It is therefore necessary to produce very clear evidence to overcome the reluctance of many judges in this respect.

Guarantees and documentary credits - case study


A consortium in an African country invites tenders for the delivery and installation of textile machines. It requires each tenderer to furnish a tender bond for 2% of the lender amount. In addition, the award of the contract is made conditional on the provision of a performance bond for 10% of the contract value. Following the publication of this tender, a Swiss textile machine manufacturer prepares a bid. Its tender price takes into account the cost of the required guarantees. The tender submined by the Swiss firm includes the payment terms that it will accept if it is awarded the contract. These are as follows: Advance payment of 10%. Part payment of 60% following shipment of the machines Final payment of the outstanding balance after an acceptance test by a neutral firm of inspectors. In addition, the manufacturer also stipulates that payment is to be made by an irrevocable documentary credit confirmed by a Swiss bank. At the same time, the Swiss manufacturer instructs its bank to issue the required tender bond. It then sends this bond together with the tender to the African purchasing consortium. In due course the Swiss firm is awarded the order and the parties sign the contract. The buyer consortium then instructs its own bank to issue an irrevocable documentary credit and asks for it to be confirmed by a Swiss correspondent of the issuing bank. In accordance with the buyer's instructions, the credit also contains the following provisions relating to guarantees: The credit is to become operative only when the importer confirms to the issuing bank that it has received the required performance bond. The advance payment of 10% may not be made until the correspondent bank is in possession of the advance payment guarantee issued by the Swiss manufacturer's bank. The exporter's bank then issues the performance bond. The documentary credit becomes operative as soon as the Swiss correspondent bank receives notification to this effect from the issuing bank in the buyer's country. The tender bond has now fulfilled its purpose. In accordance with the wording of that bond it now ceases to have effect. Acting on the Swiss manufacturer's instructions, the exporter's bank now issues an advance payment guarantee in favour of the African importer for 10% of the credit amount. (Since the documentary credit in this case covers 100% of the price the amount of this bond also corresponds to 10% of the price.) The exporter's bank sends the guarantee document to the confirming bank (the issuer's Swiss correspondent). In accordance with the credit terms the confirming bank pays the exporter's bank which in turn credits the Swiss manufacturer with the amount of the advance payment. The exporter then ships the goods and presents the stipulated documents. These identify the goods and show that shipment has taken place. The exporter then receives the agreed part payment under the documentary credit from the confirming bank. Subsequently the machines are installed and they pass the independent acceptance test. The inspection company presents the relevant certificate of inspection stipulated in the documentary credit to the exporter. Following presentation of this certificate by the exporter to the confirming bank, the exporter receives payment of the remaining 30% of the documentary credit amount. At this point the advance payment guarantee lapses since it was worded to be cancelled once the acceptance certificate had been presented. On the other hand, in accordance with its wording the performance bond remains effective until its expiry date or, if earlier, until the end of the guarantee period laid down in the contract of sale. (The above fictionalised case was prepared on the basis of information provided by Cr6dit Suisse, Switzerland.)

PART 6 OFFICIAL SUPPORT FOR EXPORT AND PROJECT FINANCE

8 EXPORT CREDITS

8 DEVELOPMENT BANKS

Chapter 20: Export credits procedures general


Introduction
Many countries around the world maintain official systems for supporting national exports and corporate investments in other countries that can benefit the home country economy. The way these systems are structured varies considerably from one country to another but in pneral terms the main provisions available include loans, interest rate subsidies and guarantees of export credits and foreign investments. Some governments run a national export-import bank (Ex-Im bank) which lend funds directly and also guarantees credits extended to overseas importers by exporting companies. In these cases the exporter can apply direct to ihe Ex-Im bank for financing. In other instances lending is conducted through normal commercial banks. Loans made for governmentapproved export purposes are supported by official guarantees or subsidies. In these cases the exporter will obtain the export finance from his normal bank. In countries where no Ex-Im bank exists but where an export credit support system has been established, there will generally be an official export credit guarantees agency or company. This provides insurance and guarantees against a wide range of commercial and political risks arising on export deals and on qualifying foreign investments. Cover may be granted to an exporter selling on credit terms or to a bank in the exporter's country that is financing either the seller or the buyer. In general the purpose of Ex-lm banks and export credits guarantee agencies is not to extend aid but they have to cover their costs and act on a commercial basis. However. in many countries a distinction is made between insurance cover granted on the agency's own account and cover issued as agent for the government. In the former case, the company issuing cover will apply normal commercial criteria in deciding whether or not ~tis prepared to take on business with particular countries and companies and, if so, on what terms. In the latter event the decision is the government's and it is influenced by more general foreign policy and trade expansion criteria. Any losses are paid for out of public funds. In assessing risks export credit guarantee companies maintain extensive data bases on countries and businesses. Typically they divide countries into several risk categories depending on political, economic and social circumstances. On this basis the company can decide whether cover to certain countries is to be restricted or whether in the worst scenario, particular countries are to be placed entirely off cover. In some cases premium rates are also affected by the insurer's assessment of the country risk involved. The information gathered by credit insurers can also be used by them as the basis for selling credit information services to customers. One leading example is the French credit insurer COFACE which has established a number of credit information subsidiaries in Europe, North America and Asia. In many countries, exporters can also obtain such information on potential overseas customers from private sector credit rating agencies. In a number of countries private sector insurers also compete for profitable parts of the export credits guarantees business. Britian provides one example. The government of that counuy adopts the philosophy that the official insurer (ECGD) should operate only in areas where the private sector cannot provide adequate cover. This means that other insurers such as Trade Indemnity PLC and credit insurance multilateral NCM are active in the British market.

EXPORT CREDITS: THE REGULATORS


ORGANISATION FOR PUBLISHES GUIDELINES FOR

> MEMBER STATES AIMED AT LIMITING


OECD

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THE DISTORTING EFFECTS O N TRADE OF EXPORT CREDIT SUBSIDIARIES

> MEMBER STATES' REGULATIONS

ATTEMPTS TO H ARMONISE

BERNE UNION

>

INTERNATIONAL ASSOCIATION OF CREDIT INSURERS. ENCOURAGES BEST PRACTICES INTERNATIONALLY

Wro
WORLD TRADE

>
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POLICES GATT INTERNATIONAL TRADE RULES. THESE INCLUDE ONE PROVISION O N THE COMMERCIAL OPERATION OF EXPORT CREDIT GUARANTEES AGENCIES

International regulations
Export credit authorities exist and work for the benefit of their nationals. The essence of their job is to help local companies export more by reducing risk exposure and providing attractive financing terms. An important feature in this respect is the ability of the seller to offer competitive financing terms to his foreign buyer. However, governments and inter-governmental organisations also worry that if this process gets out of hand more and more public funds will be spent in helping companies to create business on the basis of subsidised loans rather than the quality of the goods and services and their price. This distorts world businesss flows as well as being expensive for taxpayers. Against this background. several international oganisations are involved in trying to regulate the conduct of export credits business. In Europe the European Union (EU) has been conducting an uphill battle to harmonise member states' provisions in this sector, in an attempt to produce a level playing field. The GATT rules administered by the World Trade Organisation (WTO) refer briefly to export credit , t e e s , saying that such agencies should be run essentially on a self-financing basis. The most important inter-governmental rules in this field to date, have been drawn up by the Paris-based Organisation for Economic Cooperation and Development (OECD). In addition, the International Union of Credit and Investment Insurers (the Berne Union) strives on behalf of member agencies for international acceptance of sound principles of export credit and foreign investment insurance. The OECD provides a talking shop for the govemments of the world's ricbesi countries. Member states

use the organisation among other things as a forum to agree on guidelines for export credits which the member states then undertake to apply. These rules of good conduct - sometimes referred to as the OECD Consensus - were first drawn up in 1978. Their full title is the Arrangement on Guidelines for Officially Supported Export Credits. The main purpose of the arrangement is to provide the institutional framework for an orderly export credit market and thereby preventing an export credit race. The arrangement covers financing by way of export credits but so far it has not been extended to export credit guarantee systems. The Consensus sets limits on the terms and conditions for officially supported export credits with a duration of two years or more. The most important conditions are as follows: At least 15% of the contract is to be covered by cash payments. The maximum repayment term is normally eight and a half years. This may he exended to ! O years for relatively poor countries and for a limited number of intermediate countries. Minimum rates of interest are set for credit periods of up to five, eight and a half, and 10 years. These minima are referred to as the matrix. They are subject to revision twice a year according to an automatic mechanism based on the weighted average of five major currencies. Two important sectors - agriculture and defence - have so far been excluded from these guidelines. Furthermore in certain cases member countries are allowed to make certain derogations from the mles which the other members are then entitled to match. For the purpose of determining minimum interest rates, importing states are divided into three different categories. These are: I - Relatively rich countries; 11 - Intermediate countries; and 111 - Relatively poor countries. In addition to export credit activity, the arrangement also covers government aid financing that is wholly or partially tied to trade agreements. A number of governments combine such development aid with export credits to create mixed credits or soft loan facilities. The guidelines allow the export credit portion of such mixed credits to be granted on more favourable terms then would normally be permissible, provided that the aid portion is at least 35% of the total. The Berne Union acts as an international fomm for most of the world's main credit agencies. In addition to national agencies, the Multilateral Investment Guarantee Agency (MIGA) attached to the World Bank is also a member. MIGA provides insurance for international investment projects (See chapter on Development Banks -World Bank Group).

OECD "CONSENSUS" O N EXPORT CREDITS


MINIMUM "CASH" PAYMENT

MAXIMUM R E P A Y M E N TT E R M

MINIMUM R A T E S OF INTEREST

1 :1. I-

15%

USUALLY 8'b YEARS. 10 YEARS I N SOME CASES

CALCULATED O N AN ADJUSTABLE MATRIX BASIS FOR DIFFERENT CREDIT TERMS

Terms of cover
The precise terms on which export credits and foreign investment guarantees will be provided vary from one country and one agency to another. Some examples are given briefly in the following two chapters. In very general terms, some of the main features of cover can be summarised as follows: Insurance against commercial risk applies to the risk of non-payment in the case of default or insolvency of the buyer. Political risk cover relates to frustration of payment by reasons such as expropriation, war, insurrection, and government action preventing transfer of funds out of the importing country. Both private sector and public sector buyers may be covered. In some instances political risk cover on its own may be available in respect of sales to governments and government agencies. Cover can also be divided into pre-shipment cover relating to the manufacturing risk and post-shipment cover relating to payment risks. The first cover protects the importer if completion or delivery of the goods is rendered impracticable or impossible for political or economic reasons. Post-shipment cover concerns the risk of not being paid after the goods have been shipped arising from commercial or political reasons. In most instances policies may be issued both in favour of exporters and also financing banks. Specific policies may be issued to cover an individual contract with a foreign buyer, whilst comprehensive policies are available to cover the exporter's whole turnover. Most insurers expect the exporter to bear a portion of any loss itself. This is intended to encourage prudent behaviour. Percentage losses covered by policies typically range from around 7 5 6 to about 95% depending on the type of risk and the insurer involved.

EXPORT CREDITS ORGANISATIONS


EXPORT CREDITS GUARANTEES COMPANY EX-IM BANK

A N D IMPORTERS FOR PROJECTS

PROVIDE PROTECTION FOR:-

EXPORTERS
INVESTORS FINANCING BANKS COMMERCIAL RISKS POLITICAL RISKS

>
AGAINST:.

Export credits for Lithuanian purchases


Lithuania is one of the sovereizn states that resulted from the break-up of the USSR. Lines of credit opened by banks in exporting countries in favour of Lithuanian banks provide an important means of financing imports into the country. In general, such credits are underwritten by the export credits authorities in the exporting countries and they allow banks in Lithuania to grant credits to importing customers on favourable tenns. This is a vital factor since loans at commercial rates in Lithuania have attained very high levels. For example, in the first part of 1995 they stood at around 30% to 40%. Vilniaus Bankas. a commercial bank with headquarters in the capital city, Vilnius, provides one example. By mid-1995, that bank had obtained lines of credit for short term loans to importers from banks in Germany, Denmark, Poland, France, Austria, India, the Czech Republic, Sweden, and the US. At the same period, it had obtained similar funding to support medium-term loans on favourable terms for imports of capital goods from Germany, Switzerland, the Czech Republic, Denmark, Sweden the US. Norway, Italy, and Britain. Most of the short term loans could be granted for periods up to three months and interest rates ranged from 18% to 2 4 8 . The rates for subsidised medium term loans were between 10% and 1 5 8 and could be used to finance up to 85% of the contract value. In addition, subsidised medium-term loans of from three to five years are also available for small and medium sized Lithuanian enterprises under the EU's Phare programme. Loans under this programme can be used for the purchase of capital goods and permanent working capital needed for project implementation.

Chapter 21 : Export credits in emerging markets: country examples


Introduction
Export credit, investment guarantees and financing procedures play an important role in developing the national economies of many countries with emerging markets. Such provisions can help diversification into new, non traditional exports for instance, and help companies that carry out engineering and construction projects overseas. In eastern Europe several countries have recently established export credits mechanisms. These are particularly significant in the context of the region's transition to the market economy system. For example, since most local companies engaging in foreign trade were previously state-owned, the concept of commercial risk is a novel one. The brief country studies set out below are not exhaustive, but they provide some characteristic examples.

Section A - eastern Europe Hungary


The Hungarian government initiated official export credit insurance and export financing facilities in November 1991. This was closely linked with the country's need to maximise development of its export potential as part of the transitional process to a market economy. A single company called Exportgarancia Limited was established to handle both insurance and financing. The National Bank of Hungary was the sole shareholder. At this stage provisions in the country's banking law effectively prevented the exercise of the export financing activity. New legislation was introduced in March 1994 (Act XLII) . This changed the entire legal framework of export financing and export credit insurance, and split up Exportgarancia into two separate companies. These are Mehib Hungarian Export Credit Insurance, which issues export credits guarantees, and an export-import bank called Hungarian Eximbank. The Hungarian state is the sole shareholder of both companies. Shareholder rights are exercised by the Ministry of Finance. Each company has a board of directors. They are the same people in each case and they represent the relevant government ministries. The act also includes provisions for budgetary ceilings in respect of each company. For instance, the limit for political risk insurance obligations to be undertaken by Mehib was set at Ft80,OOO billion (US$700 million) for 1994. The legislation also regulates the government's responsibility as guarantor of commitments undertaken by Mehib arising from political risk insurance. Mehib is now building up its marketplace skills and is making use of training and technical assistance from other, longer established, institutions in the field. This includes cooperation with the Berne Union and ongoing contacts with most OECD country agencies. Assistance is also being provided under the European Union's PHARE programme. Mehib has committed itself to following the Beme Union's code of behaviour and to act in accordance with the OECD consensus guidelines.

Insurance offered by Mehib includes cover against the following risks: Protracted default or bankruptcy of the buyer. Cancellation of export contracts due to political events. Non-payment of export invoices or significant payment delays resulting from war, prohibition of transfers or other government measures in the buyer's country. Loss of Hungarian investments made abroad because of government measures or war. The government measures covered are nationalisation, cxpropriation, confiscation, and the withdrawal of export or import licences relating to capital transfers made in kind. Losses resulting from adverse exchange rate movements in the case of export credits granted for a period longer than 360 days. Losses resulting from rejection of bids submitted in response to invitations to tender made by international financial institutions. Mehib's exposure to political risk is backed by a full scale government guarantee. The commercial risk exposure is partially laid off in accordance with a quota share treaty with the Netherlands insurer NCM. Applications for political risk-related coverage are processed on a case by case basis, and single transaction coverage is available. Commercial risk insurance policies are sold under the whole turnover principle. Commercial banks accept Mehib's policies as export credit collateral. The Hungarian export import bank also partly ties its financing to the issue of insurance coverage by Mehib. Most Hungarian export sales are concluded with OECD markets, particularly EU countries. Commercial risk coverage is available for exports to these markets. Political risk coverage is concentrated on developing countries. The counrries of the former Soviet Union and a number of East European countries currently offer particular challenges to Mehib and the Hungarian export finance system.

Czech republic
The Export Guarantee and Insurance Corporation (EGAP) offers a range of export credits related services. Cover available includes the following: Short-term (up to one year) commercial risk insurance with a political insurance risk option for private sector buyers. Short-term political risk insurance for public sector buyers. Supplier's credit insurance (medium- and long-term commercial and political risk insurance) Buyer's credit insurance (medium- and long-term commercial and political risk insurance including coverage of bank loans to foreign buyers) with an option to take out production risk insurance. Insurance products may be combined under one policy. Insurance is also available against the risks of undue calling of bid bonds, advance payment bonds and performance bonds.

Poland
The Export Credit Insurance Corporation (KUKE) was established in 1991. The state owns directly 66.8% of the shares in KUKE. The main shareholders are the Ministry of Finance. the Ministry of Foreign Economic Relations, the National Bank of Poland and Bank Handlowy w Warszowie SA. The corporation is empowered to cover both commercial and non-commercial country risks and to engage in reinsurance activities. Principle factors influencing the decision to establish KUKE were the desire to bring the practice of Polish enterprises more in line with market economy rules and to promote Polish exports through the replacement of direct state subsidies with export credit insurance and guarantees. Initially, the corporation restricted its activities to insuring short term commercial risks. Following supplementary legislation passed in 1994, KUKE now offers medium term and political risk coverage as well. Short-term commercial risk cover is offered on a whole turnover basis, and relates essentially to business with developed market economies. The cover applies to cases in which credit terms do not exceed 180 days. Indemnity is provided against the buyer's failure to pay resulting from insolvency or protracted payment default. Cover for 100% of the loss is available. KUKE has also devised a scheme to insure Polish banks that grant customers special short-term turnover credit, or discount credit, against export receivables. Agreements to this end have been signed with around a dozen Polish banks. The scheme aims at helping to overcome funding difficulties experienced by Polish exporters.

Slovakia
The Export Credit Insurance Corporation (SPE) was officially created in February 1993 following the split up of the former Czechoslovakia. The Ministry of Finance of the Slovak Republic is the sole shareholder. SPE offers coverage againsr both commercial and political risks. It also offers cover against the wrongful calling of bid bonds, performance bonds and advance payment bonds. Exporters can obtain an advance commitment from SPE when bidding for contracts to be awarded by public tender. Production risk insurance is also available. In 1993 SPE covered exports worth SK486.5 million with a total exposure of SKI00 million. OECD buyers accounted for most of these transactions.

Romania
Eximbank of Romania was created in 1992 as part of a government policy aimed at promoting Romanian exports during the period of economic transition. The bank exercises both export credit insurance and financing functions. Its creation is also associated with wider moves to remove commercial banking activity from the direct control of the state and to establish private sector commercial banks. Eximbank is owned 70% by the state through the state ownership fund and 30% by other interests through five private ownership funds. A govenunent committee known as the Interministerial Committee for Foreign Trade Credits and Guarantees coordinates Eximbank's specific activities under government export promotion programmes. They are carried out as agent for the government. In other cases Eximbank acts for its own account. Eximbank offers exporters insurance against both commercial and non-commercial risks and can cover both post-shipment (payment) risk and pre-shipment (manufacturing) risk. The major part of Romanian export trade is denominated in foreign currencies. Exporters and banks may finance or refinance export credits in foreign currencies and insure these transactions with Eximbank to cover the default risk.

Because of a shortage of hard currency, most cover against the risk of non-payment is provided in local currency. Claims are thus settled in Romanian Lei. Accordingly, in these cases the bank offers additional cover for national currency depreciation against a supplementary premium. In the case of sales to OECD and similar countries, commercial risk only is covered. Cover in other cases is for both commercial and political risks. Insurance is available for consumer goods, raw materials, semi-finished products and for services. Short term cover is normally granted on a whole turnover basis covering post shipment risks only. Specific policies may also be concluded for one or more countries or for specific business sectors. Each policy issued by Eximbank specifies a credit limit for sales to individual buyers. In this contexb cover is usually for 85% of the seller's risk. Eximbank has entered into a reinsurance arrangement for commercial risks with the Netherlands insurer, NCM. Political risks are covered by the state. All exporters registered and established in Romania are eligible for cover under Eximbank's schemes. The minimum premium for short-term transactions on a whole turnover basis is US$1,000. In addition, Eximbank offers guarantees for working capital financing, import of technology intended for use in export production, bid bonds, down payment guarantees and performance bonds. Eximbank has also developed a commercial credit information activity. This supplies information regarding both Romanian and foreign businesses. Furthermore, ~ximbank offers a number of export finance programmes. They include short-term export credits of up to 12 months providing both pre-shipment and post-shipment finance. In order to qualify, exporters have to provide evidence that they have concluded relevant export contracts. Such credits are available in both local currency and hard currencies. Repayment terms may not exceed 12 months. The Romanian government operates a special programme to stimulate exports. Under this scheme exporters are entitled to reimbursement of part of the interest paid to Romanian commercial banks from which they have obtained export finance. Claims under this scheme are assessed by Eximbank and reimbursements are made to exporters following submission to the lnterministeral Committee for Foreign Trade.

Section B - other emerging markets

Malaysia
Malaysia Export Credit Insurance Berhad (MECIB) was established in 1977 as a joint venture between the Malaysian government and the private sector. Today, it is wholly owned by Bank Industri Malaysia Berhad, a development bank owned by the government. MECIB's facilities are divided into two broad categories. They are export credit insurance, and export finance guarantees. MECIB's export credit insurance policies cover both buyer risks (commercial) and country risks (economic and political). Claims are paid immediately upon proof of buyer's insolvency, after six months for protracted default, and after four months for most other causes of loss. In addition the policies can be assigned to any Malaysian bank for export financing under a letter of authority. In the case of comprehensive short-term policies (see below), premium levels range from 0.05% to more than 2% of the gross invoice value of the exports. MECIB issues three different types of comprehensive short-term policy applying respectively to ship ments, contracts and services. The first offers protection for exports of goods and commodities wholly or partly produced within Malaysia, provided they are exported on credit terms of not more than 180 days. The contracts policy covers the Malaysian exporter against the risks of non-payment on goods specially manufactured andlor produced for overseas buyers, where credit terms or the manufacturing period do not exceed six or 12 months respectively. The services policy covers Malaysian companies against the risk of non-payment

on export of services, such as technical or professional assistance, repairs, refits, conversions carried out to ships and payments of royalties. A Confirming Bank Policy (CBP) can be issued to cover Malaysian banks, which add their c o n f i a t i o n to irrevoc'able letters of credit issued by foreign banks. In addition, MECIB offers a range of specific policies that cover Malaysian companies against the risks of non-payment for exports of capital or semi-capital goods and/or services with lengthy manufacturing and/or payment periods and high contract values. The credit terms must be for at least two years and the policy is established on a case by case basis. A so-called Pure Specific Policy covers individual contracts for the export of capital or semi-capital goods, usually with minimal or no service element. A specific services policy covers Malaysian companies carrying out services for principals overseas. It applies to all earnings under the individual services contract. Malaysian contractors who undertake construction and engineering works for overseas employers involving a large element of services combined with supply of materials, can apply for a construction works policy. A specific leasing policy covers full pay out on financial leases for all types of Malaysian goods sold on more than six-months credit terms. MECIB also offers several export finance guarantees. The Banker's Export Finance Insurance Policy (BEFIP) is a short-term guarantee facility to protect commercial banks and other financial institutions against default and non-payment of export-related short term pre- and post-shipment loans made by banks to exporters. The premium rate ranges from 0.75% to 1% of the facility limit or the loan amount. A buyer credit guarantee underwrites repayment to Malaysian banks of export finance loans made to foreign buyers in respect of the purchase of Malaysian goods and services. To be eligible, all capital projects or goods and services must satisfy 30% local content and 20% value added criteria. In addition, banks that issue bonds in favour of overseas buyers and principals of capital goods and projects can benefit from MECIB's bond indemnity support facility. Under this arrangement, MECIB unconditionally guarantees to reimburse the bond issuing bank for the amount of the bond call. The commission is 1.25% for tender bonds and 1.5% for other instruments. Finally, MECIB provides an overseas investment guarantee. This programme has been designed to protect investment by Malaysian individuals and companies in foreign counmes. To qualify for coverage, the investment must be either new, or an injection of new, capital into an existing project for expansion or modemisation purposes. In addition, the investment should either utilise Malaysian raw materials or supplies, or provide input to domestic industries in Malaysia. Premium rates vary from 0.5% to 0.75% on an annual basis.

Singapore
Export credit insurance is provided by ECICS credit insurance. This is a subsidiary of a company called ECICS Holdings. Other subsidiaries include International Factors (Singapore) and International Factors Leasing. They can provide financing - including domestic and export factoring - under the Singapore government's Local Entexprise Finance Scheme (LEFS). ECICS provides export credit insurance against both commercial and non-commercial risks. It can also issue both comprehensive and specific policies. The comprehensive cover can apply to exports of all types for credit terms usually not exceeding six months. Specific policies are issued for exports of capital and semicapital goods and services which are non-recurring in nature and that involve medium and long term credits of more than two years. ECICS can guarantee banks directly as well as covering exporters. The company also issues bid bonds, performance bonds, and advance payment bonds. The Monetary Authority of Singapore (MAS) runs a rediscounting scheme. This provides easy accesss for exporters to short term financing of locally manufactured export products. In addition, ECICS provides an insurance linked factoring scheme, the terms of which are supported by the government.

SLECIC - the Sri Lanka Export Credit Insurance Corporation - issues a range of policies for exporters and guarantees for banks involved in export credit operations. The corporation modernised its procedures two or three years ago and has taken steps to boost computerisation of its operations as part of the country's drive to make the current 10 year period the decade of exports. SLECIC issues two broad categories of export payments insurance policies. They are the standard policy and a special policy for new and small scale exporters. The latter offers a much lower premium though with a lower maximum liability limit. Within that limit it also covers a higher percentage of losses than the standard policy. Policies cover both commercial and political risks. In addition, specific cover is available for exporters of consignment stocks and for banks providing credit to such exporters. This procedure has been applied. for example, on Sri Lankan exports to Russia, Ukraine and Kazakhstan. Several other specific policies are also available. Examples are - overseas civil construction works policies, services policies and overseas investment insurance. Under a provision called contract cover, the c o r p ration's standard policy can be extended so that cover is provided from the date of contract. Special areas known as Export Processing Zones and Export Villages have been created in Sri Lanka to assist the international development of the country's economy. Despite their special status, companies located in these areas can benefit from SLECIC cover and in some cases preferential insurance terms are offered. A further important activity is the issue of guarantees to banks that extend credit or provide bank guarantees to exporters. The main purpose of this activity is to facilitate the granting of advances for activities connected with exports on a more liberal basis. Pre-shipment Credit Guarantees (PCG) are issued to commercial banks covering advances granted against letters of credit or confirmed orders, for purchasing manufacturing or packing of goods for export. They are the most popular of the different types of guarantees issued to commercial banks by SLECIC. Post-shipment Credit Guarantees (PSG) cover commercial hanks against advances granted by way of purchase or discount of export bills. Banks are covered up to 75% under the standard scheme and 85% under the extended scheme for new and small scale exporters. The Export Performance Guarantee (EPG) is a counter-guarantee issued against guarantees and bonds provided by banks on behalf of exporters whose importing customers require this form of security. Banks are indemnified up to 75% of default. The above schemes have assisted Sri Lankan exporters to diversify products from traditional to non-traditional products such as motor spares, dry foods, rice and rice flour, books, kitchen utensils and soft toys. Furthermore, the corporation has helped exporters to enter new markets such as Russia, Kenya, Greece, Turkey and Syria. In 1993 SLECIC made a profit of SLRs26.4 million. Outstanding payment claims totalled SLRs12.8 million, whilst SLRs2.7 million were recovered on claims paid.

Sri Lanka

Argentina
The Compania Argentina de Seguros de Credito a la Exportacion SA was originally established in the 1970s by 141 insurance companies active on the Argentinian markets. This was in response to the rising needs of Argentinian exporters of manufactured goods. Both commercial and political risks are covered;. commercial risks are for the account of the Compania, and political risks are undertaken in collaboration with the government. Maximum periods of cover of five years and eight years normally apply to commercial and political or extraordinary risks respectively. Extraordinary risk insurance covers political risk and natural disasters. Premium rates are usually up to 0.6% for cases in which up to one-year's credit is granted, up to 1.1% when up to three-year terms apply, and

up to 2.6% for operations up to eight and a half years. Most policies of this category cover 100% of the credit sum granted. So far as ordinary or commercial risk cover is concerned, both individual and global policies can be obtained. The normal maximum cover is usually 80%. Other policies include cover against public buyer risk, pre-shipment risks, and risks on carrying out construction works abroad.

Jamaica
The National Export-Import Bank (Ex-Im bank) is a limited liability company jointly owned by the govemment of Jamaica and the Bank of Jamaica. The Ex-Im bank was established by the government to provide institutional support to industry with particular emphasis on the non-traditional export sector. Ex-Im bank was created in 1986. It provides short-term export credit insurance and loan financing for the export sector. Credit insurance can be extended to export transactions involving consumer goods and general commodities sold on terms ranging from a sight draft to 90-days open account. The export of capital goods and services may also be insured under special contractual arrangements. Both political and commercial risks are covered and policies may be granted both to exporters and financing institutions. In addition, the bank provides financing under a number of different schemes. For example lines of credit have been established with government backing to facilitate imports that can extend productive capacity in the non-traditional manufacturing sector, and boost exports. Side by side with this, a special Export Development Fund (EDF) facilitates the import of raw materials, spare pans and equipment by Jamaican firms for incorporation into export products. The EDF offers short-term (one year maximum) foreign exchange credit. In addition, a pre-shipment financing facility (PSF) provides exporters with funds to purchase local raw materials and finished goods for export. To qualify, exporters must hold an Ex-Im insurance policy. Financing of up to 65% of the FOB value can be provided for a period of 90-days extendable to a maximum of 360 days. Furthermore, the bank provides two discounting facilities which allow exporters to obtain advances of up to 80% of the price of goods shipped before payment is received from the importer. One of these is referred to as the Bankers Export Credit Facility (BECF) and the other as the Export Credit Faciliry (ECF). The main difference between the two is the method of guarantee. Financial support under the BECF is channelled through commercial financial institutions. Funds from the ECF are disbursed to clients who provide security directly to Ex-Im.

Zimbabwe
Credsure - Credit Insurance Zimbawe - was established in 1965 by a consortium of banks, insurance and reinsurance companies plus the country's industrial development corporation. Its principal objective is to boost the counny's export promotion efforts by providing a range of export credit insurance and guarantee facilities. Since 1983, a range of domestic credit insurance and guarantee facilities has also been available. Credsure offers two main categories of export insurance called respectively, export short-term and export medium-long term. Policies of the first type provide cover againt the non-receipt of payment. Both political and commercial risks are covered. The company offers five basic types of short-term cover. They are pre-shipment, post-shipment, consignment stock, transit risk and guarantees for banks. Consignment stock insurance is important in a number of instances where exporters maintain stocks of goods in other countries. The policy indemnifies the exporter

against confiscation or loss occumng before the goods are released from consignment. Medium or long-term cover can be divided into contract policies and bond. and guarantees. Credsure's contract policies cover the export of capital goods or services on credit terms of more than two years and they include the interest element The policies are available on either a buyer credit or a supplier credit basis and both political and commercial risks are covered. In addition, Credsure can also issue bonds and guarantees as part of a package including the conaact policy.

Cyprus
Credit insurance is provided through a department of the Ministry of Commerce and Industry known as the Export Credit Insurance Service (ECIS). The main product offered is a comprehensive guarantee policy which covers exporters of manufactured goods against losses outside their own control arising from both commercial failure and political risks. Cover is usually effective from shipment of the goods. Exporters are required to undertake to offer ECIS all their eligible goods for cover during the one year period following issue of the policy. In return, the ministry undertakes to cover the seller's exports during that period subject to its right to decline particular buyers or to exclude particular countries if economic conditions deteriorate. To be eligible for insurance, at least 25% of the value of the goods must have been added in Cyprus. A maximum of 90% of the loss is normally covered. A premium at the rate of 10 cents per 100 of annual exports with a minimum of 25 and a maximum of 250 is payable at the time the policy is issued and on each annual renewal. Further premiums are then payable monthly on the basis of a rate per 100 of the value of business carried out. This rate is 30 cents per 100 for cash sales, 50 cents for credit terms not exceeding 90 days, 70 cents for up to 180 days and a further 10 cents if pre-shipment cover is required. Exporters are expected to attempt to recover payment themselves before a claim on the insurance can be honoured. Subject to this, claims are paid four months after the due date of payment. Supporting documentation has to be produced by the exporter.

Israel
The Israel Foreign Trade Risks Insurance Corporation provides export credit guarantees and insurance to both exporters and banks. The corporation's activities are in part guaranteed by the state. In addition to standard short term cover for exports from Israel, the corporation has also set up a special scheme to cover goods sold by Israeli companies from stocks held abroad. This has been designed specifically to assist Isreali businesses that are setting up such stocks as a response to: evolving distribution practices in the US and EU markets. Other policies include cover for the supply of capital goods, services and construction works and equipment as well as Israeli investments abroad. Other policies include cover of buyers' credits and guarantees to banks that finance exporters. A specific policy has also been created to guarantee banks that provide export factoring services.

Chapter 22: Export credit systems in OECD countries Some country examples
Introduction
The export credit and foreign investment insurance schemes operated nationally by mature industrialised countries represent a significant source of funding for countries with emerging economies. In some instances, finance is provided directly by a national export-import bank. In others, funding of trade and projects is made possible by the granting of guarantees. Often large projects call for joinr ventures involving suppliers from several different countries. Such schemes may then benefit from the support of several different countly agencies. Furthermore. export credit agencies from the OECD states are increasingly involved alongside multilateral and regional development banks, and UN agencies in the funding of development projects in the developing world and eastern Europe. Most of the world's advanced industrialised countries belong to the Paris-based Organisation for Economic Cooperation and Development (OECD) which provides them with an international forum for policy discussions. For this reason, these countries are often referred to collectively as the OECD counmes. Some illustrative examples of schemes operated by a number of OECD member states are set out briefly below.

ASIA AND THE PACIFIC

Trade and investment insurance in Japan is managed directly by the Ministry of International Trade and Industry (MITI). The Japan Trade and Investment Insurance Organization (JTIO) supports MITl in the fields of country risk research, agency work for underwriting, claims payment and recovery, publishing and liaison, and coordination between MITI and insured companies. Japan first established an export insurance system in 1950. The system has expanded gradually since then and it is currently governed by legislation known as the Trade and Investment Insurance Law. There are now seven different policy types as follows: General trade insurance. This covers losses caused by the impossibility of shipping cargo and by the postshipment impossibility of collecting charges, proceeds and loans related to the export of equipment. Exchange risk insurance. This covers foreign exchange losses suffered by exporters of industrial plant, machinery and equipment.

Export bill insurance. This covers losses suffered by banks if documentary export bills are dishonoured after shipment has been made. Export bond insurance. This covers bank losses incurred through a foreign government's unfair calling of bonds relating to exported industrial plant, machinery and equipment. Pre-payment import insurance. This covers losses suffered through the failure to recover advance payments made for imports. Overseas investment insurance. This covers losses from expropriation, war, transfer risks, bankruptcy and other risks relating to overseas investments. Overseas untied loan insurance. This covers losses suffered by banks from failure to collect Ion,0 term overseas business loans. The system provides for both specific and comprehensive insurance. Specific insurance relates to individual export contracts and comprehensive insurance provides general cover for a company's overseas business. In addition to comprehensive cover for individual businesses, the ministry's Export-Import Insurance Division (EIDMITI) has negotiated a number of package deals with exporters' associations.

Australia
The Export Finance and Insurance Corporation (EFIC) provides export finance as well as export and overseas investment insurance. Originally created some 40 years ago, EFIC today supports around $5billion worth of export trade annually in more than 100 markets. The normal export credit insurance policy covers an agreed part of the company's export turnover. Usually it applies to cases in which credit terms of up to 180 days are granted. Specific policies cover large individual contracts for goods or services, custom-made products and longer credit terms. Cover is also provided to banks that confirm irrevocable documentary credits. EFIC also provides overseas investment insurance for investments that offer significant net benefits to Australia. This policy covers political risks, including transfer risks, expropriation, war, hostilities and political violence. The declared objective of EFlC's export finance facilities is to enable Australian exporters to match government subsidised credit terms offered by foreign competitors. Medium- to long-term loans are available in connection with exports of capital goods, related sewices and project management. Loans can be made directly to overseas buyers and EFIC also guarantees banks that lend to such buyers. Other products include guarantees for bank financing of exporters' working capital needs, plus the issue of bonds and counter-guarantees of bonds issued by commercial banks.

NORTH AMERICA
America
Two federal government bodies support export and investment pro,mmes. The Export-Import Bank of the United States (Ex-Im Bank) provides both guarantees and funding for US exports. The Overseas Private Investment Corporation (OPIC) provides finance and insurance facilities for US investment projects in devel-

oping countries, eastem Europe and Russia. In its 60 years of operation, Ex-Im Bank has supported around $300 billion worth of American exports of goods and services. Under the bank's short-term insurance policies, American content must be at least 50%. The bank's medium- and long-term programmes require that any foreig content be financed outside of ExIm Bank's own programs. The bank focusses on transactions that the private sector cannot support. Most military programs are excluded from support, whilst special attention is given to small businesses and environmental goods and services. OPIC was established in the early 1970s to provide financing and political risk insurance to US companies investing in the developing world. It now does business in around 140 countries and regions. It is founded on the idea that promoting private enterprise is the key to helping developing nations build their economies. Support is available both for new ventures and expansion or modemisation of existing successful operations. Loan guarantees are provided, typically for larger projects, and most range in size from US$IO million to US$200 million. Direct loans are reserved for small businesses and cooperatives and range from US$2 million to US$30 million. The ceiling for support of any individual project is US$400 million. OPIC guarantees relate to political risks. It can provide project financing on limited recourse terms in countries where banks are often reluctant or unable to lend on this basis. OPIC also uses its guarantees to back private sector funds that target emerging markets around the world. Infrastructure developments involving partnerships with the private sector are one key focus of OPIC's activities. This frequently involves co-financing larger projects with other lenders including multilateral development banks. Power, telecommunications, transportation and distribution, and natural resources are all key areas of activity for OPIC.

Canada
Canada's Export Development Corporation (EDC) was originally established in 1944 as the export credit insurance corporation. The EDC operates as a crown corporation (a state-owned company) under the terms of the 1969 Export Development Act. It carries out its business on commercial principles and is financially selfsupporting. Products offered include short- and medium-term credit insurance, foreign investment insurance and performance related guarantees. Export financing services include lines of credit with foreign banks or other agencies worldwide, note purchase arrangements, direct buyer loans, long-term pre-shipment financing, leveraged lease financing and project risk financing packages. Particular emphasis is given to supporting the export efforts of small- and medium-sized enterprises (SMEs). For example, in 1993 more than 1,600 of the EDC's 2,057 customers for that year were SMEs. A small business insurance programme streamlines procedures by allowing firms to approve credit limits of foreign buyers without having to check with EDC on each occasion, by simplifying claims procedures, and by providing 90% coverage against political risks. Recently, EDC has been making special efforts to boost coverage of Canadian firms selling to emerging markets. In particular, the corporation is now prepared to look at both public and private sector projects and transactions on their individual merits in countries where coverage was previously unavailable or severely limited because of country risk issues. Examples are: Argentina, Brazil, Ghana, Jamaica, Jordan, Kazakhstan, Lebanon, Peru, Romania and Vietnam.

WESTERN EUROPE
The Netherlands
The Netherlands credit guarantee company (NCM) was established in 1925. Today 12 Dutch banks and 17 insurance companies - including two foreign credit insurance companies - are shareholders in NCM. The company is active internationally as well as on the Netherlands market. A re-insurance agreement with the Netherlands government dating back to 1932 makes it possible for NCM to provide cover not only for the commercial risk but also for the political risk inherent in foreign trade. NCM covers both domestic and international transactions for Netherlands customers. Both payment and pre-shipment risk can be covered. For short-term credit business, NCM covers consumer goods, raw materials, semi-finished goods and services. This cover normally applies for credit terms of up to six months, though consumer durables may be covered for up to 12 months. The usual type of cover is a whole turnover policy, and the normal percentage is 75%. This can be increased to 95% in particular cases. Medium-term business covers essentially light and heavy capital goods, construction works and engineering services. Credit periods covered, generally range from three to five years and the percentage cover is usually from 90% to 95%. For transactions with a credit term of over 12 months, a 15% down payment is required and at least 5% of the contract price has to be paid when the contract becomes effective. Companies negotiating a contract in which medium-term cover may be applicable, will want to be certain that they are covered if the contract is signed. Accordingly, NCM may be requested to issue a promise of cover in which all the insurance conditions are laid down. This promise is valid for a period of six months and may be extended. Various forms of cover are available. They include cover for supplier's and buyer's credit risk, operational and financial lease cover, construction works and related equipment, exchange risk, guarantees and investment insurance.

Britain is one of the countries that has developed most in opening up the export credit insurance business to the private sector. Accordingly, the government-run Export Credit Guarantee Department (ECGD) aims at complementing the private sector in supporting British exports and investments. EGCD does not provide finance. Since 1991, the departmant's main activity has been credit insurance support for UK capital goods and project exports, typically sold on medium- or long-terms of payment. Support for short-term exports nevertheless remains important, and ECGD tries to ensure that adequate short term credit insurance is available for exporters by means of reinsurance arrangements with the private sector. ECGD has four project underwriting divisions. Three deal with geographical areas: Asia and Pacific region; the Middle East, North Africa and the Americas; and Subsaharan Africa and Europe. The fourth specialises in defence and aerospace business worldwide. ECGD's Overseas Investment Insurance (OH) scheme is aimed at encouraging new investment in developing economies by covering UK companies against the main political risks - expropriation, war and restriction of remittances back to the UK. The scheme applies to new direct investments in overseas enterprises which may take the form of equity holdings, loans or loan guarantees. In addition, ECGD also provides a number of facilities that are subsidised by the government to assist British exports. One of these is the Interest Support Programme which provides subsidies for bank financing of UK capital goods and project exports sold on terms of two years' credit or more.

Another example is a facility known as the tender to contract/forward exchange supplement scheme. This provides a measure of protection for British exporters tendering in foreign currency against movements in exchange rates between the time their tender is submined, and the date on which they secure the contract.

Germany
Hermes manages official export credit insurance on behalf of the govemment. It provides neither export financing nor interest subsidies. Financing for German exports is offered by both commercial banks and specialised institutions. Cover can be issued in respect of both private and public buyers in favour of German exporters and German credit institutions. The percentage cover generally ranges from 75% to 95% depending on the type of policy issued. The uninsured portion of the risk must not be insured elsewhere. An application fee and an issuing fee are charged for handling applications for export guarantees. Premiums for guarantees are the same for all export markets. There is no classification according to country risk groups (country grading) or the standing of the buyer. However, premiums for public buyer mansactions are lower than those for private sector purchases.

France
Created in 1946, COFACE (Compagnie Franpise d' Assurance pour le Commerce Extkrieur) provides cover for both exports and international investments. Most of COFACE's capital is now held by private sector companies due to the privatisation of several of its shareholders who are large French financial institutions. COFACE acts as an insurer on its own account in the case of risks for which a private sector reinsurance market exists. This is essentially short term cover for the most solvent countries. In other cases, it acts on behalf of and at the expense of the state as part of the French government's strategy towards the promotion of French exports. This applies particularly to medium term cover in developing markets. Overall COFACE insures between 20% and 25% of all French exports. In addition to its insurance business, COFACE is playing a growing role in the credit information business through subsidiaries in France and other counmes.

Italy
Export financing in Italy is provided by commercial banks and by more specialised institutions known as medium term lending institutions. Under the terms of a law passed in 1977, two public bodies deal with aspects of export credits. The first of these (SACE) provides export credit insurance. The second (Medio Credito Centrale) provides funds and interest subsidies in respect of Italian exports. SACE provides a full range of policies including cover for both export credits and Italian investments abroad, provided the latter are Linked to imports of raw material and exports of capital goods. Commitments underwritten by SACE are guaranteed by the government subject to statutory limits. SACE's premium structure is based on a base rate compounded with the principal amount of the credit portion. There are six different rates related to the country risk. For example, for political and transfer risk, premium rates applicable from July 1994 range from 0.37% for a three-year credit for a country in Category 1, to 6.19% for a 10-year loan for a country in Category 6.

The National del Credere Office (or Office National Ducroire) provides both export credit guarantees and insurance of Belgian investments abroad. It operates as an autonomous institution guaranteed by the state. So far as export credit guarantees are concerned, the normal maximum percentage cover is 95% for public debtors and 90% for private debtors. The usual waiting period before an indemnity will be paid is six months. Insurance is also available against the risk of foreign currency fluctuations. Investments insurance covers political and catastrophe risks.

Austria
The export guarantee system is based on the Export Promotion Act which confers a supervisory role on the federal Minister of Finance and provides for administration by the Ostreichische Kontrolbank. Generally speaking, exports of consumer goods can he covered for credit terms of up to 180 days and capital goods for periods of up to five, eight or 10 years. In appropriate cases, economic and political risks may both be covered. The premium rate for covering economic risks is a minimum of 0.5% per annum and a maximum of 2% per annum. The premium rate for political risks is at least 0.5% per annum. Premiums are payable on a quarterly basis. In addition there is a handling fee of 1 8 with a maximum of Sch10,OOO.

Sweden
The Swedish Export Credits Guarantee Board (EKN) is a government body that covers export losses caused by both commercial and political events. Swedish investments abroad can be guaranteed against political risks. Deals with credit terms of up to 10 years or even more may be eligible for insurance by EKN. All policies carry an excess that has to be borne by the policy-holder. This is usually 1 5 8 in the case of commercial risks and 10% for political risks.

Finland
The Finnish Guarantee Board (FGB) is a government agency under the aegis of the Ministry of Trade and Industry. The board does not have its own share capital though it is supposed to become self-sustaining in the long run. FGB handles guarantees only and not funding. Funding banks may be either domestic or foreign institutions. FGB works with other institutions including export guarantee and credit agencies, affiliates of the World Bank such as IFC and MIGA and the EBRD. The Board issues both domestic and export guarantees. Over recent years guarantees of buyer credits have come to play the largest role amongst the export guarantees issued by FGB. Many of these relate to buyers in emerging countries, especially in Asia. FGB has also established a special project financing group within its large customer service unit specifically to handle deals that are being financed on limited recourse terms.

OPIC guarantees: case studies


The US-based Overseas Private Investment Corporation (OPIC) issues guarantees and provides finance for many American investments in emerging countries. The following provide examples:

Indonesian power
Mission Energy Company of Irvine, California contracted to build and operate one of Indonesia's first private power plants. This is a 1.2 gigawatt operation in East Java. The design provides for low asMow sulphur coal burning to reduce pollution emissions and to use local resources. OPIC agreed to provide US$200 million in insurance.

Russian telecommunications
US West obtained a contract to bring new technology to link Russia's cities through inter-city switches, wireless communications and business overlay networks. OPIC helped to develop a special structure for this project, which it also intended to serve as a model for supporting joint ventures through a single loan facility. The structure involved US West contributing its existing Russian investments to a Delaware holding company, the raising of new equity for the holding company via a private placement, and US$125 million in OPIC financing. The project package also featured creative debt pricing, since it was agreed that a portion of the returns would be tied to performance of the company's stock rather than to a fixed interest rate. Finally, OPIC also provided political risk insurance to US West.

Airport renovation
Jamaican authorities launched a project to construct a new airport terminal at Sangster International Airport in Montego Bay, Jamaica, and to carry out related renovation work. Private sector pardcipation was a vital element of the project which aimed at increasing the airport's capacity by 75% in order to boost Jamaica's tourist industry. Citibank NA was given the task of arranging the funding to build and operate the new terminal. The bank then obtained US$90 million of OPIC insurance to mitigate political risks. The deal was structured so that part of the project funding could be obtained through the issue of convertible bonds. This allowed for the privatisation of the airport and permitted the project's lenders to become equity participants in the longer term.

Offshore oil
Two US companies, Walter International and Nuevo Energy, joined forces to acquire and develop an offshore oil producing property off the coast of the Republic of the Congo. Additional funding was needed to enable the project to go forward. The two companies approached OPIC which committed a package of US$50 million in financing and US$100 million in political risk insurance to the project.

Export credit structure in Switzerland


The following text drawn up for customers by UBS (Union Bank of Switzerland ) Ziirich, Switzerland, details one aspect of UBS export finance:Export credits are used to finance capital goods and services earmarked for export, utilizing guarantees or other types of cover suitable for international trade, the most common instrument being the Export Risk Guarantee of an agency. In Switzerland it is the ERG-Swiss Export Risk Guarantee. The classic medium- to long-term ERG-covered export credit is primarily available for Swiss deliveries and services with a limited foreign portion and is granted subject to certain conditions and prerequisites. Lender Either the exporter (supplier's credit) or the financing bank (Union Bank of Switzerland - possibly as lead manager of, or participant in, a bank consortium or syndicate) -acts as lender. Borrower The borrower is either a bank in the import country or the importer. Structure The export credit may be structured as a supplier's credit (the bank purchases and refinances the exporter's receivables) or as a buyer's credit with the additional variation of the bank-to-bank credit (vide 2.2. Export Credit Forms). Credit amount The bank limits its financing to the deferred payments, i.e. to the net amount outstanding after deduction of the advance and interim payments. This credit amount may not exceed 85% of the delivery value. In some cases, banks are prepared to finance advance and interim payments as well. The financing of these amounts depends on the credit standing of the impomng country, the duration of the credit and the security offered.

Duration of credit The duration of the credit depends on the delivery value and ranges from three to five years. Nevertheless, as a result of international competition, the five-year credit Limit, as per the parameters of the OECD consensus agreement, is often exceeded in the case of large-scale orders or contracts. Credit repayment Export credits are generally repaid in equal, consecutive, semi-annual instalrnents. The first instalment falls due six months after delivery/disbursement or six months after commissioning, with a latest clause as stipulated in the credit agreement.
Security The following coverage instruments are prerequisite to the granting of an export credit: a) Assignment in favour of the bank of the exporter's basic claim on the buyer and of the Swissexport risk guarantee (ERG) coverage. b) Assignment of the exporter's claims arising from a payment guarantee, bill guarantee (aval) or documentary credit issued by an acceptable hank in the buyer's country.

Interest rate The determination of the interest rate used in export financing is linked to the refirnancing costs of the bank. The final rate consists of a base reference rate being the SEBR (Swiss Export Base Rate) with the average duration as the credit, plus a margin ranging between 112% to 1 718% p.a. depending on the ERG coverage rate, the quality and the credit duration and the non-ERG covered risk portion of the bank. The interest rate is often set when the credit is disbursed, i.e. the time of utilisation.

Fees
Standard fees are applied in the form of management feeslup-front fees and commitment fees.

Risk sharing Typically, the bank assumes the interest risks not covered by the ERG, whereas the exporter assumes the non-ERG covered risks associated with the principal. Sometimes the bank will assume additional risks and, given sufficient security or guarantees, can assume all risks not covered by the ERG. If the ERG coverage does not include the commercial risk the bank as a rule is prepared to assume the entire commercial risk on condition that adequate security (payment guarantee, bill guarantee or aval, documentary credit) is provided. Deadlines Finance offers normally specify a deadline ranging from one to three months, after which k e offer is no longer valid and can be extended at terms to benewly defined.

Chapter 23: Development banks overview


Introduction
Global and regional development banks have become a familiar feature of the world's economic landscape over the past 50 years. In many cases, their original objective was to channel infrastructure and project finance for public works to governments and state-controlled agencies. Today there is a much bigger and still growing emphasis on hamessing the power of private sector businesses to help achieve development aims in emerging countrieq around the world.

Business opportunities
As a result of this trend, there are now considerably more opportunities than there used to be, for businesses to obtain part of their project financing from one of the official development banks. Foreign equity investors in productive projects may also be able to obtain a guarantee to cover the funds they are investing from one of these official financing bodies. In general terms, loans and guarantees may be available in two different situations. The first is where the supplier or investor itself initiates a deal that falls within the lending institution's development targets. The second is where a supplier submits a successful bid for works sponsored by a development bank or a govemment or public agency falling within the bank's development remit.

Objectives
Within their different spheres of influence, development banks around the world follow a basically similar objective. In simple terms this is to provide and generate finance for business and infrastructure undertakings that can contribute to the improvement of living standards in developins countries. There can also be cooperation between them - for example, in co-financing schemes that are of common interest.

Structures
At the same time, these development banks vary considerably and they do not all follow a single pattern. The organisation with the widest geographic spread is the World Bank group, whose members now include most of the world's nation states. Several regional development banks also exist for Asia, Latin-America and Africa. In Europe, the European Union (EU) provides funding and grants for developing countries with the emphasis on the former colonies of member states. Much of this money is channelled through the

Luxemburg-based EIB (European Investment Bank). The European Bank for Reconstruction and Development (EBRD)is a totally separate structure set up to assist the transition of the eastem European countries from centrally controlled to open market economies. Major member countries of the EBRD include the US and Japan as well as European sponsors. In the Middle East, several Arab development funds and banks were created in the oil boom years of the seventies and eighties. The Gulf War of 1991 brought about a change of approach. There is now a marked preference for bilateral rather than multilateral development lending arrangements. In some cases financing and/or technical assistance for investment projects in developing countries may also be available from specialised United Nations agencies as well as from development banks. One prominent example is the Vienna-based UNIDO (United Nations Industrial Development Organisation) which in some cases can supply technical assistance for complex industrial cooperation agreements.

Trends
Several wider trends underly the changing strategies of the multilateral and regional development banks. Many of these are broadly favourable to business. For example, developing countries in growing numbers are looking to privatisation of state-controlled industries and public utilities, believing this will help them to balance their budgets and improve service quality. It creates new opportunities for foreign investors and it is leading to growth in project financing techniques such as Build. Own, Operate, Transfer (BOOT) procedures. Development banks are often involved in such arrangements as co-financiers and/or guarantors. Partly through the urging of intemational organisations such as the International Monetary Fund (IMF) and the World Trade Organisation (WTO), developing countries have also set about dismantling high tariff walls and protective trade barriers. This encourges expansion in export transactions and related financing techniques. Traditionally development banks' activities havc been aimed at supporting investments and projects in particular countries, rather than international trade between countries. For example. MIGA - the Multilateral Investment Guarantees Agency attached to the World Bank - is specifically authorised by its statutes to g u x antee projects only and not export activities. On the other hand, the EBRD for instance, is now indirectly involved in arranging export and import support in several eastern European countries.

New approaches
In the past, intemational institutions such as the World Bank and the IMF have often been criticised for their top down approach, favouring big projects, big action and big suppliers at the expense of local community interests. Often this has been accompanied by equally trenchant criticism of the harsh effects of IMF-imposed adjustment programmes which are aimed at improving the intemational appeal of the country concerned at the cost of slashing its internal infrastructure and social programmes such as health and education. Partly in response to such criticisms, the language of development banking is now changing. There is a new emphasis on community involvement, the role of women in development, and ways to finance small local businesses, for instance. No glossy brochure would be complete nowadays without its measured references to the need to promote sustainable development and protection of the environment. These changing attitudes are worthy developments, to which businesses have to pay special attention.

Co-financing
The term co-fmancing is employed by development banks to refer to any arrangement under which funds from the development bank are associated with funds provided by other sources outside the borrowing country in the financing of a project or programme. This tec que can play an important catalysing role in promoting the flow of development funds into a developing region from both public and private capital investment and loans. Co-financing can be arranged in various different forms. While terminology and precise usage may vary, individual techniques include the following: Parallel financing The project is divided into specific and identifiable packages of components. Each package is financed separately either by the development bank or by co-financing. This mode is often used when the co-financiers have procurement policies and procedures different from those of the lead development bank, and when they administer their loans themselves. Joint financing The funds of the development bank and co-financiers are pooled to finance a common list of goods and services required for the project in agreed proportions. Under this mode, the development bank's procurement guidelines generally govern the procurement of goods and services. It is suitable only when co-financiers do not tie their assistance or impose any special procurement restrictions and provided that they agree to follow the development bank's procurement guidelies. Umbrella or standby financing The development bank initially finances an entire project but later cancels a portion of its loan when co-financing becomes available. This mode is used when the co-financing is possible but not yet definitely arranged at the time of approval of the loan by the development bank. Channel financing Occasionally co-financiers prefer an indirect rather than a direct financial relationship with the developing country for which the development bank is arranging finance. Generally speaking, this is feasible only if co-financiers accept the development bank's guidelines and procedures on matters such as recruitment of consultants, procurement, loan disbursement and project supervision. The method is often used, for instance, when bilateral sources provide grant funds for development bank technical assistance operations. Participation financing Under this technique a co-financier - normally a commercial bank or other private financial institution -purchases a sub-participation in a loan extended by a development bank or obtains an interest under devices such as complementary financing schemes. Typically the latter involves the development bank in making two loans to the borrower - one from its own resources and the other from the funds provided by the co-financiers. The development bank is the lender of record for both loans.

Development finance in India


In addition to the multilateral and regional development banks, funds for development purposes also exist at national level in many developing countries. The Industrial Credit and Investment Corporation of India (ICICI), whose head office is in Bombay, provides one example. Created in 1955, ICICI provides project financing and related services to encourage and assist industrial development and investment in India. The corporation has half a million shareholders in India and abroad and its shares are listed on the main Indian stock exchange. Specialist services offered by ICICI includes lease finance for domestic and imported equipment, lease syndication and assistance with export development programmes. By 1994 it had provided foreign currency loans of US$300 million to over 250 export-oriented projects under the World Bank Export Projects umbrella. In addition, several ICICl programmes aim at helping Indian companies to bridge the technology gap. Advisoty activities include a project advisory services function which assists foreign companies seeking business relationships in India.

Chapter 24: Development banks - the World Bank group


Introduction
Founded at the end of the Second World War as part of the then new United Nations structure, the World Bank group today comprises a family of multilateral development institutions owned by and accountable to member govemments. Most countries in the world are today represented in the group's membership. Member govemments exercise their ownership functions through boards of governors on which each country is represented individually. Most of the governors' powers have in practice been delegated to a board of executive directors appointed or elected by member governments. The president of the group is appointed by the executive directors.

Separate organisations
The World Bank group comprises five separate international organisations:. The International Bank for Reconstruction and Development (IBRD) The original institution in the group, the IBRD opened its doors for business in 1946. Today, it is the largest source of market-based loans to developing countries and it attracts similar financing from other sources. It lends to governments or to public or private entities with government guarantees. It is funded mainly through borrowing on the international capital markets. The International Finance Corporation (IFC) The IFC was established in 1956 to support private enterprise in the developing world through the provision and mobilisation of loan and equity financing and by way of advisory activities. These relate amongst other things to capital market development and privatisation. IFC also acts to attract local and foreign private investment. Its lending and equity investment activities are based on the principle of undertaking market risk together with private investors. Under the terms of its articles of agreement it cannot accept government guarantees. The International Development Association (IDA) The IDA was created in 1960 to provide finance on concessional terms (also known as soft loans) to low income countries that lack the necessary creditworthiness to obtain loans from the IBRD. IDA is primarily funded from grants that it receives from donors. These are replenished periodically. The Multilateral Investment Guarantee Agency (MIGA) MIGA was created in 1988 to provide non-commercial or political investment risk insurance and technical services and help promote investment flows. It also disseminates information on investment opportunities. Under the terms of its statutes, MIGA cannot provide export credits guarantees but is limited to covering investment projects.

The International Centre for Settlement of Investment Disputes (ICSID) ICSID was added to the World Bank family in 1966. it provides conciliation and arbitration services for disputes between foreign investors and host governments arising directly out of an investment. Under a conciliation procedure the parties are assisted in arriving at an amicable settlement by which they agree to abide. An arbitration procedure leads to a binding award that is legally enforceable in the same way as a court judgment. The commonly-used expression - the World Bank - has arisen out of daily practice as a convenient way of refemng to the institution. It is often used as a catch-all phrase for the group as a whole, though more strictly the World Bank is the International Bank for Reconstruction and Development.

The evolving role


At the outset, the bank concentrated on financing individual development projects. Thus its evaluation procedures were limited to examining the viability of each project in a similar way to a commercial banker who is asked to advance a loan. Since then, the World Bank has taken on a much broader strategic role in which it examines the overall economic and social context in which projects are to be carried out. It has also developed an extensive battery of advisory services for governments and other potential borrowers. In particular, the group has been trying to shift its focus away from its traditional role of funding large infrastructure projects carried out by public sector bodies, towards new priorities such as the promotion of social and environmental initiatives and the development of private sector projects. Critics in developing countries and amongst the many non-governmental organisations (NGOs) that are involved in development issues, complain that the bank is moving too slowly in this direction and that its decisions are too much influenced by the conservative macro-economic policies promoted by the International Monetary Fund (IMF). Against this background, the bank claims that its policies have been adapted to meet five major development challenges over the medium to long term. These involve assisting developing countries to pursue economic reforms aimed at enhancing growth and reducing poverty; investing in people so that they can take advantage of the opportunities offered by growth; protecting the environment; stimulating the private sector and helping governments to re-orient their efforts on their core tasks. This last implies a mixture of strengthening the working of the open market economy and improving access to public services. The World Bank has also undertaken reorganisation of its own procedures, partly through moves to reduce staff numbers and partly through the declaration of a set of six guiding principles aimed at giving greater focus to all its activities. In accordance with these principles, the group says that it will increase the selectivity of its activities, strengthen its partnerships with others, emphasize client orientation, increase results orientation, ensure cost effectiveness and maintain strong commitment to financial integrity.

Private sector
Two of the World Bank bodies, the International Finance Corporation, and the Multilateral Investment Guarantee Agency, are particularly concerned with funding and insuring private sector initiatives. ICSID plays a supporting role in this respect. Accordingly, these three organisations are examined in more detail below.

International Finance Corporation


The IFC shares the primary objective of all the World Bank institutions, namely to improve living standards in developing countries. Its focus is private sector development. According to the IFC's articles of agreement it strives to further economic development by encouraging the srowth of productive private enterprise in member countries. It finances businesses in partnership with private investors and it tries to help governments create conditions that stimulate domestic and foreign private investment. Today IFC is the largest multilateral source of loan and equity financing for private sector projects in the developing world. Since its goal is the establishment of an efficient and competitive private sector in member countries it operates on a commercial basis and shares all risks with partners. In particular it does not accept government guarantees and it prices its finance and services in line with the market. IFC seeks to ensure that the projects that it supports are profitable for investors whilst at the same time benefiting the economy of the host country. Because of IFC's status as a multilateral development institution and its experience in the developing world, it has taken on a special role in mobilising additional capital for companies in developing countries. The means used to achieve this end include co-financing, loan syndications, securities underwriting and guarantees. IFC also provides technical assistance and advice to businesses and governments. For example, it has offered assistance to governments in areas such as capital market development and privatisation. IFC coordinates its activities with the other institutions in the World Bank group but it is legally and financially independent. It has its own articles of agreement, shareholders, financial structure, management and staff. Its share capital is provided by more than 160 member countries and these collectively determine its policies and activities. The corporation enjoys AAA rating in the international financial markets, a fact that allows it to raise most of the funds for its lending activities through international bond issues. Between the date of its creation in 1956 and 1994. IFC provided more than $14 billion in financing for 1,290 companies in 109 developing countries. A further important objective of IFC is to play a catalytic role, thus stimulating private investment in the developing world by demonstrating that investments there can be profitable. For example, IFC played a pioneering role in developing investment funds that target developing countries. It also aims at helping developing countries to mobilise foreign capital and domestic savings for investment through capital markets activities. These include investing in financial institutions and funds and advising governments on the frameworks for stock markets, private pension funds, banks and other institutions. Generally speaking, the adoption of market-based policies by many developing countries is leading to a larger role for IFC in the development process. It has also helped several of the eastern European countries to design and implement privatisation programmes that are now being used as models . IFC uses a variety of instruments in contributing to private sector development. These include loans, equity and quasi-equity financing vehicles, loan syndications, underwriting, guarantees, and private placement for resource mobilisation purposes. Risk management techniques such as currency and interest rate swaps and hedging facilities are also employed. Additionally, IFC undertakes technical assistance and advice in areas such as capital market development, foreign direct investment, privatisation, corporate resuucturing, project preparation and evaluation.

Multilateral Investment Guarantee Agency (MIGA)


MIGA was created in 1988 as an independent self-supporting member of the World Bank Group. Its principal purpose is to encourage foreign direct investment in developing countries by providing political risk insurance (guarantees) against the risks of currency transfer, expropriation, war and civil disturbance and

breach of contract. It also provides member countries with a variety of technical assistance services to improve their ability to attract foreign investment. Initially, MIGA had 49 country members, a figure that has now reached around 150. Significantly, nearly all the countries of eastern Europe and the former Soviet Union have joined the agency. Accordingly, MIGA guarantees are now available in virtually every part of the globe. Its outstanding portfolio now exceeds $1 billion in coverage and its underwriting activities from 1990 to 1994 related to nearly $7 billion of direct investment. Insured projects range from fertiliser manufacture in Bangladesh, Trinidad and Tobago, to gold mines in Ghana, Peru and Uzbekistan plus banking projects in Argentina, Brazil, Tanzania, Pakistan and Turkey. Projects are covered in well over 20 countries and include mining, fishing, power, manufacturing, financial and service sector projects. In addition to issuing insurance cover, MIGA also offers technical assistance. Following an internal reassessment in 1993, its technical assistance efforts have been refacussed. This aims in part at avoiding overlap with services that can be more easily provided by other international organisations. Particular emphasis is now placed on helping countries market themselves, their region, sectors and projects to prospective investors. This activity is managed by MIGA's Investment Marketing Services department (IMS). This marketing assistance is aimed particularly at investment promotion agencies (IPAs) around the world that promote the flow of foreign direct investment to developing countries. MIGA has initiated work on computerised management information systems for lPAs and the creation of a global IPA electronic information exchange network. IMS also continues to support investment promotion efforts though on a more selective basis than in the past. In addition MIGA works on a cooperative basis with other investment insurers on both a reinsurance and co-insurance basis. It also cooperates with other international organisations such as the United Nations Industrial Development Organisation (UNIDO) on technical assistance activities. MIGA is also a full member of the International Union of Credit and Investment Insurers (the Berne Union). This is the international association that brings together the world's major credit and investment insurers. After a slow start in its early years, MIGA is now building up its portfolio more rapidly and is actively canvassing for new business. Project financing provides one specific example. In a number of cases project developers have already bought MIGA coverage both for their own equity investments and on behalf of any commercial banks that may later participate in the project financing. This arrangement offers the risk management benefit of having assignable MIGA coverage in hand. Accordingly, it is a feature that makes it easier for the project developer to attract commercial bank financing. Under MIGA ~ l e the s benefit of the policy can be assigned to cover the bank's loans up to a 4: 1 ratio. Currently MIGA policies can be issued to cover up to $55.6 million of investment (equity and debt combined) per project.

International Centre for Settlement of Investment Disputes (ICSID)


ICSID is a separate intemational organisation within the World Bank group. It was established under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the Convention). This was opened for signature in 1965 and it entered into force the following year. ICSID seeks to encourage greater flows of international investment by providing facilities for the conciliation and arbitration of disputes between governments and foreign investors. In addition ICSID undertakes advisory, research and publications activities in the area of foreign investment law. Around 120 countries have now ratified the Convention thus guaranteeing enforcement of awards in most countries of the world. The Centre deals with a modest number of disputes, typically having around three or four cases pending at any one time. This could illustrate that most disagreements between foreign investors and governments are settled between the parties at an earlier stage.

Appendices

1.

MlGA Guarantees - case studies

2.

IFC Case studies

3.

World Bank speak - a glossary

Appendix 1:

MICA Guarantees - case studies

Offshore banking in the Philippines


In 1994 ING Bank of the Netherlands decided to grant a fifteen year shareholder loan of US$27.8 million to ING Manila Offshore Branch (ING Manila). Before agreeing to make the loan, ING Bank needed security against the risks of currency transfer and expropriation. It was able to obtain this in the form of a MIGA guarantee. Established as an offshore banking unit in 1991, ING Manila has become a leading trader of foreign currency denominated Philippine debt. Its activities also include the underwriting of Eurobond issues, foreign exchange trading, currency swaps, and the placement of international equity offerings by Philippine corporations. The purpose of the shareholder loan was to enable ING Manila to establish a financing facility for local companies. Project privatisation and export financing together with loans for private corporate debt resmcturing figure amongst the lending priorities in this respect.

Machine tools in China


Sunnen Products Company (SPC) turned to MIGA in 1994 in order to obtain coverage for an investment in the Shanghai Sunnen Products Company aimed at assembling and selling machine tools and related products. The project was structured so as to use mainly local manufacturing equipment, contractors and other support services in order to stimulate the local economy. The guarantee contract - which was issued for an amount of US$2.7 million - covers SPC against the risks of expropriation, war and civil disturbance.

Fishing in Uganda
A project enterprise was established to process fish from Lake Victoria and other lakes in Uganda for export to the United States, Europe and the Middle East. For this purpose, a joint venture was set up between Clovergem AG, a Swiss company, and Ticon Bygg AS, a Norwegian building contractor specialising in refrigeration plants. Project financing totalling US3.193 million was provided through the cooperation of several governmental and multilateral institutions. The Norwegian Agency for Development Cooperation loaned US$1.615 million dollars, the United States Export Import Bank US$725,000, and the International Finance Corporation US$853,000. MIGA issued a USS5.4 million guarantee in favour of Clovergem. This provided coverage against the risks of expropriation and war. The project was designed to have a significant development effect on local fishermen, by providing them access to a rich fishing ground whose exploitation had previously been constrained by its remoteness. The project enterprise undertook to provide fishing gear, ice and storage boxes to the fishermen and collect the fish from them directly. The creation of adequate processing, storage and transport facilities were further major elements of the deal.

Mobile phones in Pakistan


Motorola International Development Corporation (MIDC), a subsidiary of Motorola Inc. of the US, and SAIF Telecom, a privately held Pakistani company, formed a joint venture to create Pakistan Mobile Communications Incorporated (PMCO). The aim was to install and operate a nationwide cellular telephone network.

MIGA issued MIDC with a US$24.3 million guarantee against the risks of expropriation, currency transfer problems, war and civil disturbance. The project was designed to service a significant segment of Pakistan's cellular telephone consumers by its fifth year of operation and to create more than 340 new jobs by its tenth year of operation. The deal also included provision for extensive employee training in electronics, computer operation and modem business practices.

Power in Honduras
In 1994, MICA issued its first guarantees in Honduras to W a s i l l Diesel Development Corporation. (WDD). The guarantees totalling US$27 million in maximum liability, related to a 60 MW diesel electric power plant near the Atlantic port of Puerto Cones. MIGA also signed a commmitment letter with WDD regarding coverage of an additional US$23 million maximum liability for commercial banks. The MIGA insurance covered WDD against the risks of currency transfer, expropriation, war and civil disturbance. The deal involved the creation of a joint venture vehicle called Electricidad de Cortes SRL de C.V (ELCOSA). The partners were WDD and the Honduran Electric Corporation (HECO). The latter is a special purpose company formed by a group of local Honduran industrialists. MIGA also worked actively with other bilateral and multilateral institutions to facilitate the financing of the project. Lenders included the International Finance Corporation. The project was designed to relieve chronic power shortages in Honduras where most of the country receives only 12 to 16 hours of electricity a day. The arrangement provided for 90% of the electrical output to be sold to Empresa Nacional de Enegia Electrica, a local govemment-owned utility with the remaining 10 % being sold to HECO member companies.

Vietnam
The agency issued its first contract of guarantee in Vietnam to Citibank in June 1995. Citibank invested US$15 million to open a branch bank ((Xibank Vietnam) in Hanoi. The branch was established to provide banking services in sectors such as trade finance, structured trade, foreign exchange services, project advice and cash management. MIGA's guarantee, which totalled US$13.5 million, covered Citibank's investment against the risks of expropriation, transfer restriction and war and civil disturbance.

Appendix 2:
Asian infrastructure

IFC case studies

Infrastructure systems and services in Asia need to he expanded significantly to keep pace with the region's dynamic growth. Governments and public sector entities are finding it increasingly difficult to fund all the region's infrastructure needs on their own and are turning to the private sector to sponsor and finance part of these investments. A fund called the Asian Infrastructure Fund has been created to help overcome the shortage of loan and equity resources needed to support private sector initiatives in this area. This is a pooled investment vehicle including IFC participation aimed at mobilising USSl billion worth of funds from strategic and institutional investors worldwide. The fund manager is the Asian Infrastructure Fund Management Company. This is a new fund management firm and it is one of the first in Asia to manage a pool of funds that targets the infrastructure sector exclusively. The project sponsor is Peregrine Investments Holdings Limited, a Hong Kong-based merchant hank that is also part of the Peregrine Group. IFC agreed to make an equity investment of $50 million in the fund plus a 10% participation in the equity capital of the fund management company. Other shareholders of the management company include Peregrine Infrastructure Capital, Soros Fund Management, Frank Russel Company and the Asian Development Bank.

Pension funds in Latin America


Private pension plans can make an important contribution to a country's capital markets as they encourage long term savings and generate demand for new long-term instruments. In Argentina and Peru, IFC is supporting the development of private pension systems by helping to establish financially sound pension fund management companies. For example, IFC recently made a $L.lmillion equity investment in a Peruvian pension fund mana,wement company called Horizonte AFP SA. It acted in cooperation with a group of local sponsors and CAF, which is a development institution for the Andean countries. In Argentina, IFC along with Banco Roberts, Deutsche Bank, Banco Quilmes and New York Life - a US insurance company - has promoted a group of pension fund management and insurance companies known as the Maxima SA AFJP Group. In addition to a $15 million equity investment, IFC provided technical assistance in studying the project's feasibility and in developing the structure, management and operational standards for the new companies. New York Life's particular role is to act as technical partner and provide insurance expertise.

African management services


Amsco, a company incorporated in the Netherlands, was founded in May 1989 to carry out the activities of the African Training and Management Services Project. This is a joint initiative by IFC, UNDP (United Nations Development Progam) and the African Development Bank. Amsco's main objective is to help rehabilitate ailing companies in Sub-Saharan Africa and to create a pool of well-qualified African managers. Amsco is supported by its three sponsors and the governments of seven countries. About 70% of its share capital is held by IFC, the African Development Bank and bilateral agencies from seven industrial countries. The remaining 30% is held by more than 50 international private companies with business experience in Africa.

Appendix 3:

World Bank speak - a glossary

Agenda 21 - This is an environmental action plan drawn up by the United Nations Conference on Environment and Development (UNCED). It aims at sustainable development. Brady operations - This is named after one-time US Treasury Secretary, Nicholas Brady. It represents a shift in the international community's debt strategy from supporting adjustment with concerted new lending to supporting adjustment with debt and debt service reduction. Brown environmental agenda - This refers to the main environmental problems immediately facing cities, paricularly energy use and efficiency, urban and industrial pollution control and urban environmental management. Central bank facility - This is a facility used by the IBRD to raise short term US$ debt by offering to central banks and other government oganisations of member countries a one year US$-denominated variable rate instrument. The interest rate is adjusted monthly on the yield of the one year US treasury bill plus a spread. Committee of the whole - This is a committee made up of all executive directors for preliminary discussions and preparatory work. Currency swaps - Currency swaps are used by the World Bank as a liability management tool. Essentially they involve an exchange of a stream of principal and interest payments in one currency for a stream in another currency. In particular the bank uses currency swaps to obtain borrowings in the ultimately desired target currency at below the cost of a market borrowing in that currency. Development committee - This is a committee of mainly ministers of finance that reports to the World Bank and the International Monetary Fund (IMF) on resource transfer to developing countries. Enhanced Toronto terms - These were agreed by the Paris Club (see below) in 1991. They provide additional concessions on debt reductions for low-income countries. Forward foreign exchange market -This allows for the sale or purchase of foreign currency for deferred rather than immediate delivery. G7 countries - The rich man's club comprising Canada, France, Germany, Italy, Japan the United Kingdom and United States. Green environmental agenda - This refers to the promotion of sustainable natural resource management and the reduction of resource degradation. ICOR (Incremental capital-output ratio) - This is an aggregate measure of the efficiency of investment. it shows the amount of investment required to produce an annual income stream of a single US dollar. The lower the ICOR the more efficient the investment. LIBOR (London inter-bank offered rate) - This is the rate at which major banks in London are willing to lend in a specific currency or currency unit to other banks. It is used as a base rate for many international interest rate transactions. Low-income countries - These are countries with a GNP per capita of US$675 or less in 1992 US$ terms.

Mezzanine financing -This has two meanings. In the case of the International Finance Corporation, mezzanine finance funds refer to risk capital made available to unlisted companies to support development and expansion programmes in anticipation of the company's being listed on an organised stock exchange. The term can also be used more generally to refer to a type. of finance. Middle-income countries - These are countries with a GNP per capita of more than USJ675 but less than US$8,356 in 1992 US$ terms. Negative pledge clause - Negative pledge clauses refer to the granting of security interests by a borrower over its assets to its creditors. Under the terms of such a clause the borrower agrees with a creditor or group of creditors to restrictions on its granting or otherwise permitting to exist security interests in favour of other creditors. Generally speaking negative pledge clauses are standard practice in World Bank loans. They may be waived on a case by case basis. Official development assistance (ODA) - This designates financial aid to developing countries and multilateral institutions provided by official agencies. It is concessional in character and contains a grant element of at least 25%. Panel data set - This is composed of both time series and cross-section observations. This procedure provides a richer analytical data base than a cross-sectional obligation on its own. Paris club - The Paris Club is the name given to the ad hoc meetings of creditor governments that arrange renegotation of debi owed to or guaranteed by official creditors. Debts owed to commercial banks are renegotiated with committees of the banks involved. The World Bank is not a member of the Paris Club. Social action programmes and social funds - These consist of multi-sectoral operations mobilising several sources of financing in order to fund action aimed at alleviating the social costs of adjustment and reducing poverty. Spa eligible countries - This term designates a country that is eligible for special concessional funding on the basis of poverty. Special drawing rights (SDR) - The Special Drawing Right is a reserve asset created by the International Monetary Fund in 1968. It can be used by IMF members and designated institutions including multilateral development banks and the Bank for Intemational Settlements (BIS). (The BIS which is based in Basle, Switzerland, groups most of the industrialised world's major national central banks.) The value of the SDR is calculated daily by using a weighted basket of the currencies of the so-called G5 countries (France, Germany, Japan, United Kingdom and the United States). Structured notes - These are notes (commercial paper) for which the returns are linked to interest and/or exchange rate indices. Toronto terms - This expression refers to options that can be chosen to reduce official debt in low-income debt distressed countries. They were originally agreed in Toronto in September 1988. (See also Enhanced Toronto Terms above) Vehicle currency - This is a currency in which the World Bank borrows and simultaneously enters into a currency swap in order to convert the vehicle currency liability into a liability denominated in another currency (target currency).

Chapter 25: Regional development banks


Introduction
This chapter looks at major regional development banks. Such banks provide an intermediate level of development lending and advisory services between the global lending institutions on the one hand and national development banks in individual developing countries on the other. They also frequently cooperate with the other two groups and can act as a catalyst in attracting additional funds to their respective regions.

Asia
Asian Development Bank
The Asian Development Bank was founded at the end of 1966. Its main goal is to promote the social and economic progress of its developing member countries in the region, especially smaller less-developed countries. by lending funds and providing technical assistance. By 1994 the bank could boast 54 member countries. 38 from within and 16 from outside the Asia-Pacific region. The bank's operations are based on country strategy studies which determine the needs and possibilities of the country in question. Following a strategic planning process initiated in 1992, the bank has adopted a medium term strategic framework defining five strategic objectives. These are : Promotion of economic growth Reduction of povery Improvement of the status of women Development of human resources including population planning, sound management of natural resources and the environment. In attempting to achieve these objectives the bank now emphasizes the role of the private sector and efficient public sector management. Support for the development of the private sector in member countries is an important patt of the bank's operational policy. It has made loans to and equity investments in private companies for development-related projects since 1983. The bank's policy in this respect is to lend to private sector entities if the proposed project is developmental and profitable and will create jobs or positively affect the country's economy. Whilst most loans are guaranteed, the bank Will provide direct loans to private companies without government guarantees for projects which produce essential items or provide vital services. As a general rule the bank does not provide majority funds for private sector projects, and it avoids any responsibilities associated with ownership except if this becomes necessary to safeguard its investment. The

bank will try to sell its equity in a company at a fair price as soon as possible. Most financing by the Asian Development Bank is designed to support specific projects, but the bank also provides programme, sector and multi-project loans. Project loans are for individual projects. Sector loans are for a number of sub-projects spread out over a geographical area or a period of time. Programme loans are made to goverments to support a development programme which will include policy reforms, investment programmes or institutional improvement. The two largest shareholders are first Japan and second the United States, followed by the People's Republic of China, India and Australia. At December 31 1993 the authorised capital of the bank was US523.2 billion. In addition to lending, the bank also provides technical assistance to member developing countries. In addition, the bank co-finances development projects with traditional aid donors, aid agencies, export credit institutions and private sources. It also enters into equity investment operations. Member countries and others cooperate in bilateral co-financing operations. Multilateral sources for cofinancing include the World Bank Group and other United nations institutions, such as the International Fund for Agricultural Development, International Telecommunications Union, United Nations Capital Development Fund, United Nations Development Program, United Nations Population Fund, United Nations Childrens Fund, and World Health Organisation. The European Community, the European Investment Bank, the International Finance Corporation, the International Monetary fund, the Islamic Development Bank the Nordic Development Fund, the Nordic Investment Bank, and the OPEC Fund for International Development are also involved.

The Americas Inter-American Development Bank


The Inter-American Development Bank (IDB) is an international financial institution created in 1959 to help accelerate the economic and social development of member counmes in Latin America and the Caribbean. The bank's headquarters are in Washington, D.C., America. Its cumulative lending and technical cooperation amounted to US$65 billion by the end of 1993. The bank's main functions are : To promote the investment of public and private capital in the region. To use its own capital and mobilise funds for high priority economic and social projects. To encourage private investment contributing to economic development and to supplement private investment whenever necessary. To help member countries make better use of their resources while fostering foreign trade. To provide technical cooperation for preparing financing and carrying out development plans.

- are in the Americas, and 18 - known as the non-regional members - are in Europe, Asia and the Middle

The bank is owned by its 46 member countries. Some 28 of these countries -known as the regional members

East. Membership in the bank enables non-regional countries to develop closer relations with Latin-America and to reach many more Latin-American countries than would be possible solely through bilateral programmes. Under a 1994 capital increase scheme known as the Eighth Replenishment the IDB is intensifying its

involvement in five critical areas. These are: social reform including efforts to reduce poverty, productive and technological modernisation, strengthening the private sector, restructuring the state, and support for greater involvement of all members of society in decision-making. The bank gives particular attention to lending through its Fund for Special Operations to the less-developed countries of the region and those with limited markets. It also tries to ensure that 50% of its lending programme directly benefits lower income groups. One of the bank's key functions is to encourage private investment in projects that contribute to economic development and to supplement private investment when it is not available on reasonable terms. The bank accordingly makes loans to countries to help them finance credit programmes aimed at the private sector channelled through national financial institutions. In addition, in accordance with the Eighth Replenishment the IDB can lend up to 5% of its portfolio directly to private firms without government guarantees. In addition, the bank has provided more than US$2.7 million for the transfer and development of science and technology. Projects considered by the IDB are reviewed to determine how the most appropriate low cost technology can be incorporated into the production process. The bank also offers technical cooperation services. In addition, several of the bank's member countries have entrusted the IDB with special funds to finance specific types of development projects.

The Multilateral lnvestment Fund


This fund was founded by several members of the Inter-American Development Bank in 1992 in an effort to promote private investment. The fund was endowed with some US$1.2 billion of resources. Administered by the IDB, the fund has two purposes. These are to support the modemisation process and to ease the human and social costs of economic adjustment. The Multilateral lnvestment Fund (MIF) provides grants for workforce training, small business development and improvements in the investment climate. MIF projects are designed to incorporate social groups that have been operating at the margins, such as youth, women and the unemployed, into the economic mainstream.

Inter-American lnvestment Corporation (IIC)


Founded under the aegis of the Inter-American Development Bank, but operating as a separate organisation for funding and accounting purposes, the IIC encourages the establishment, expansion and modernisation of small and medium scale private enterprises. It also supports enterprises in which public entities have a partial equity interest provided their activities strengthen the private sector. The corporation makes direct investment such as equity participation, loans and purchases of debt instruments. as well as indirect investments through other financial institutions. Through co-financing, loan syndication, joint ventures and other means, the IIC promotes participation of other funding sources. It also provides technical, financial and managerial assistance and it may enter into licensing, marketing or management arrangements with individual countries.

Central American Bank for Economic Integration (Banco Centro Americano de Integraci6n Economica - BCIE)
The BCIE was founded in December 1960 by the republics of Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica with a view to strengthening regional integration.

The bank operates as the financial ann of the Program for Central American Integration (Programa de Integraci6n Central Americana). In this context it handles the need for external resources of both the public and private sector in the region and fosters regional development. The BCIE provides both finance and technical assistance for investment projects, pre-investment procedures and technical cooperation in the manufacturing sector, productive support infrastructure, communications, power generation, transport and agro-fisheries. It also finances housing projects, schemes to protect the environment and projects relating to tourism and social development. In addition, it caters for business sectors in respect of pre-shipment, export and industrial reconversion needs. Countries outside the region covered by the bank's activities are increasingly joining the bank as investing shareholders. China, Mexico and Argentina provide recent examples. During the six-month period up to December 31 1994 the bank lent some $CAI54 million (Central American dollar). It called on SCA107.2 million worth of its lines of credit and borrowed $CA137.7 million from external sources. It registered a profit of $CA42.1 million.

Andean Development Corporation (Corporacibn Andina de Fomento - CAF)


The CAF was founded in 1970 as the financial arm of the Andean Group and it helps to channel funds between the international financial markets and the Andean region. It encourages regional integration by funding projects in both the private and public sectors and providing technical support. The CAF centres its efforts on specific business and investment opportunities and projects. Its activities extend to the Andean region and to neighbouring Latin American and Caribbean countries together with other areas interested in strengthening trade and financial links with the region. One of the bank's principal roles is to act as a catalyst in attracting outside investments to the region. Activities include commercial banking, investment banking, development banking and the indirect financing of small and medium sized businesses through loans to commercial banks and other financial intermediaries. The five Andean group countries -Bolivia, Colombia, Ecuador, Peru and Venezuela - are all members of the CAF. Other major shareholders are Mexico and Chile.

Caribbean Development Bank (CDB)


The bank began operations in 1970. It was founded in order to contribute to economic growth and development amongst member countries in the Caribbean and to promote economic cooperation and integration in the area. Particular attention is paid to the less developed member countties. Apart from the Caribbean countries, the CDB also includes members from outside the region including Canada, France, Germany, and the United Kingdom. It maintains close links with several other regional institutions such as the Commonwealth Caribbean (CARICOM) Organisation, the East Caribbean Central Bank (ECCB), and the Caribbean Group for Economic Development (CGED). This last is a World Bank offshoot.

The Middle East Islamic Development Bank (IDB)


The IDB provides development finance for parties in member countries and other Islamic communities elsewhere. Shar'ia or lslamic legal principles apply to its transactions, and its operations are denominated in Islamic Dinars (ID). One ID is equivalent to one Special Drawing Right (SDR). The bank's activities include project financing and the financing of foreign trade. Trade finance constitutes the largest single activity undertaken by the IDB. Among other matters, the IDB can take equity shares in productive projects in member countries, invest in member states' productive infrastructure and make loans to the public and private sectors. It also provides technical assistance and undertakes research into Islamic financial and banking activities. Generally, the IDB organises loan guarantees on the financing that it extends. It favours projects that combine good profit potential with social objectives such as job creation.

Arab Monetary Fund


The Arab Monetary Fund (AMF) promotes Arab economic integration particularly through the promotion of Arab financial markets. Nearly all members of the Arab League are members of the AMF. The Arab Trade Financing Program (ATFP) is sponsored by tlie AMF. This aims at boosting Inter-Arab trade by providing finance for exports between parties in different Arab countries. Emphasis is placed on local materials and local manufacture. Some re-exports also qualify for help under the scheme.

Arab Fund For Economic and Social Development (AFESD)


The fund provides financing for development activities in Arab League countries. This includes project lending on soft terms to governments and other institutions, encouraging public or private investment in development and providing technical assistance. The AFESD closely supervises projects that it sponsors and it attracts considerable funding from other Arab sources. A major part of AFESD loans is for projects co-financed with other aid agencies such as the World Bank. It has also worked jointly with the United Nations Development hogram.

OPEC Fund for International Development (OFID)


Based in Vienna, OFID extends funds to the governments of less developed countries outside the OPEC area and to international institutions that are active in supporting the developing world. It extends assistance on a concessional basis. The fund has issued procurement guidelines indicating that preference will be given to goods and services provided by the recipient country or other developing nations. The majority of OFID's projects are cofinanced with other multilateral or bilateral aid agencies or with recipient governments.

Arab Investment Company


This company was established in Riyadh in 1974 and it is owned by 15 Arab governments. It promotes Arab businesses by taking equity participations. Emphasis is placed on relatively smaller projects and on trade finance.

Arab Petroleum Investments Corporation (APICORP)


Founded in 1975 by the member states of the Organisation of Arab Petroleum Exporting Countries (OAPEC). APICORP aims at assisting in the financing of the petroleum industry and associated projects in the Arab world.

Arab Gulf Programme for United Nations Development Organisations (AGFUND)


Established in 1981, this organisation has become a major donor to international agencies. These include the World Health Organisation, the International Labour Orsanisation, the Food and Agriculture Organisation, UNICEF. UNESCO, UNDP and the LN Environment Programme.

Africa African Development Bank (AfDB)


The bank was established in 1963 by the members of the Organisation of African Unity (OAU). Membership was later opened to industrialised countries. Agriculture and the social sector provide important targets of the AfDB's activities. In 1992 the AfDB sponsored the formation of an African Export-Import Bank (Afrexirnbank), planned as a continent-wide trade bank. The AfDB structure also includes two special divisions for concessionary lending. These are the African Development Fund (ADF) and the Nigerian Trust Fund (NTF). The A m 6 cooperates closely with other multilateral financial institutions, particularly the World Bank. The bank's operations have been marked over recent years by problems of declining net income and growing loan repayment arrears as well as disputes between members. Traditionally borrowers from the AtDB have been governments or government-owned agencies rather than private companies. This position is now changing in the light of a new strategy aimed at promoting private sector activities.

East African Development Bank (EADB)


The East African Development Bank was established in 1967 by the members of the former East African Community - Kenya, Tanzania and Uganda. In 1980 the EADB became an independent international ogani-

sation with a UN registered charter. Public sector infrastructure lending provides the main focus of the bank's activities. Lending is restricted to projects in the three member states.

La Soci6t6 internationale financiPre pour les lnvestissements et le Dkveloppement en Afrique (SIFIDA)


SIFIDA was founded in 1970. It provides capital for African investment and development projects. SIFIDA provides funding for profitable undertakings and wherever possible it prefers partnership structures involving locally managed private sector enterprises. The organisation's shareholders include banks. trading oganisations and international development agencies.

Arab Bank for Development in Africa (BADEA)


BADEA was established by the members of the Arab League and it covers project finance. technical assistance, and emergency aid. Its main activity is providing concessionary project financing for member countries of the Organisatlon of African Unity.

The West African Development Bank (Banque Ouest Africaine de Developpement - BOAD)
The bank's shareholders are the seven member of the West African Monetary Union. all of which use the CFA franc as their currency. The members are: Benin, Burkina Faso, CBte d'Ivoire, Mali. Niger, Senegal, and Togo.

FOSlDEC
The West African Economic Community (Commautb Economique de I'Afrique de I'Ouest - CEAO) operates a regional fund called the Fonds de Solidaritb et d'Intervention pour la DCveloppement de la Communaute - FOSIDEC).

ECOBANK
Ecobank was established by the 16 members of the Economic Community of West African States (ECOWAS) . Its purpose is to stimulate regional trade.

Europe European Bank for Reconstruction and Development (EBRD)


Set up in 1991, EBRD channels investment capital into eastern Europe and the former Soviet Union. EU countries hold more than 50% of the capital in the bank. The US holds 10% and Japan 8.52%. The EBRD operates both as a merchant bank and as a development bank. It concentrates on lending for specific projects. Restructuring and privatising industries and financing related infrasuuctures constitute its main targets. The bank is particularly keen to take part in joint ventures with foreign sponsors. The bank funds up to 35% of total cost on individual projects. At the same time it insists on significant equity contributions from other investors and debt funding by other co-financiers. Telecommunications and transport infrastructure together with the energy sector are i m p o w t targets for EBRD funding. Since 1994 new guidelines stress the need for the EBRD to become more active in equity investment and to stimulate the growth of financial intermediaries in eastern European countries. The EBRD does not need guarantees from the host country's goverment. In appropriate cases it will fund projects on limited recourse terms, looking to the revenues generated by the completed works for repayment. It is also prepared to look at a wide range of equity investments. Basically, the EBRD looks for a commercial return on its investments. Maturities can be as long as 15 years for some public sector infrastructure projects.

European lnvestment Bank (EIB)


The EIB is the EU's official project investment bank. It lends from its own resources at normal interest rates. The bank focusses on regional development priorities within the EU such as financing trans-European networks. The EIB also provides financing for some projects outside the EU, essentially central and eastern Europe and the African Caribbean and Pacific (ACP) states. In addition, private sector companies can apply for European Investment Bank loans directly.

European Investment Fund (EIF)


The fund was launched in 1994 as an autonomous financial institution under the aegis of the EIB. It aims at improving the provision of long-term guarantees for major investment projects in the EU and at providing finance for investments by small- and medium-sized European enterprises.

European Development Fund (EDF)


The EDF finances long-term development projects in the African Caribbean and Pacific (ACP) group of states under the 1975 Lomi Convention. Under that convention the EU provides aid and trade support to ACP states. The EDF distributes funding to ACP states through grants and highly concessional loans. The Lomi rules include price stabilisation schemes for ACP states that suffer losses on commodity sales through declining world prices. EDF development targets include agriculture, food production, fisheries, shipping and tourism. Preference

is given to ACP companies on most tenders for contracts financed by the fund, with firms from other EU countries also being eligible. Large projects often involve co-financing alongside other agencies.

PHARE and TACK


In addition to the above, various special EU funds and programmes provide funding for specific projects. Examples are the PHARE and TACIS programmes which provide sources of finance for projects in Eastern Europe and the former Soviet Union.

Sao Paulo commuter train system


In 1994 the Inter-American Development Bank agreed to provide a $420 million loan for the Sao Paulo commuter train system in Brazil. The project aims at improving transport for low and middle income populations in the metropolitan Sao Paulo area, reducing travel times, improving the flow of street traffic, and reducing polIution from vehicle fumes. The project comprises three main components. The first is the Eonstruction and operation of a new 9.3km section of Line 5 of the city's metro system. The second relates to the upamding of the South Line managed by the Companhia Paulista de Trens Metropolitanos (CPTM). The final component consists of the strengthening of management structures in the companies involved in administering the city's mass-transit systems. Improvements to the commuter train system aim at accommodating around 450,000 passengers daily. Related moves include the purchase of eight 64-car trains. The scheme also includes a technical cooperation component which is producing studies to identify opportunities for additional private sector participation in the area's high-capacity mass transit system together with a re-evaluation of the CPTM's assets and feasibility of the second stage of Line 5. The project is part of an overall $2.55billion effort to develop an integrated metropolitan transit system covering some 39 separate municipalities with 15 million inhabitants.

Developing projects in Africa


A scheme known as the Africa Project Development Facility (APDF) was established in 1986 under the aegis of the United Nations Development Program (UNDP). APDF provides advice to African entrepreneurs seeking to expand or modemise their businesses or start new ones. It supports projects with investment costs ranging between $250,000 and $7 million. The facility is managed by the International Finance Corporation (IFC), a subsidiary of the World Bank that specialises in financing the private sector. The African Development Bank acts as regional sponsor. Overall funding for APDF's operations is provided by UNDP, the IFC, the African Development Bank and the governments of 15 industrialised countries. In addition Bmzil, Israel and the Export-Import Bank of India provide technical experts for shortterm use. Furthermore, the Danish government has recently established a trust fund with an initial contribution of Dkrl4 million (approximately $2 million) to finance the costs of consultants working on APDF projects in 18 different countries. The facility provides technical assistance to clients in the preparation of bankable investment proposals. It also helps them find local and foreign financial and technical partners, raise debt and equity financing and negotiate reasonable financing terms. APDF also advises African entrepreneurs interested in buying local companies from foreign shareholders or state enterprises scheduled for privatisation. APDF does not provide project financing but it may finance part of the cost of market and feasibility studies. In one recent case APDF advised Angofrangos - an Angolan poultry producer - on a two-phase project aimed at producing poultry meat and doubling egg production. Another instance was the creation of a fleet of industrial fishing boats to enable a Cameroon-based distributor to export shrimp and fin fish to western Europe. Further APDF-projects include the establishment of a new company in the CBte d'Ivoire to perform chemical and bacteriological analyses, and advice on the expansion and rationalisation of a Zimbabwean manufacturer of ball-point pens and related material.

Co-financing trade
The European Bank for Reconstruction and Development (EBRD) operates a scheme known as the Export Credits Loan Arrangement Technique (ECLAT). This enables the bank to co-finance exportimport deals in eastern Europe alongside commercial banks, other international lending institutions (ILIs) and national export credit agencies. One example of this was the launch in May 1995 of an innovative Ecu7.8 million co-financing facility for Bulgaria. This provided part of the funding for an Ecu220 million railways rehabilitation project. Another instance is a power plant rehabilitation scheme in Uzbekistan with a total cost of Ecul30 million. The EBRD agreed to provide some Ecu50 million, or half the cost of the project's main components. Export credit agencies that have expressed a willingness to cooperate with the EBRD in such arrangements include those from Canada, Norway, the US, Germany, Finland, France, Spain and Turkey. Many have signed framework cooperation agreements with the bank.

Appendices

1.

Borrowing from the Inter-American Development Bank

2.

Asian Development Bank - financing private enterprise

Appendix 1:

Borrowing from the Inter-American Development Bank

Both public and private sector entities in the Latin-American member countries are eligible to borrow from the bank. However. it does not finance projects in a member country if the government concerned objects to such financing. Before the bank considers individual project loan applications, staff specialists visit the relevant country on programming missions to review the country's development plans and investment programmes and help identify projects. Individual loan applications are then considered in the context of the findings of these missions. The IDB carries out a series of analyses in evaluating each loan application. These include an institutional analysis, a technical evaluation, a socio-economic evaluation and a study by the bank's environment division to monitor the project's environmental impact. A financial analysis looks at the profitability of the project, the capacity of the borrower to meet the counterpart requirements, and the sustainability of the project. A leg1 evaluation centres on the capacity of the borrower to contnct the loan, assume its obligations and perform the project. Amortization periods of loans provided with ordinary capital resources range from 15 to 25 years. Interest rates charged by the bank on these loans reflect the costs incurred by the bank in borrowing funds on the world's capital markets. Lower rates of up to around 4% apply to loans granted out of the fund for special operations . Loans are disbursed as the project progresses and as actual expenses are incurred by the borrower. Currencies used in loans are those derived from the subscriptions and contributions of the bank's member countries and from its borrowings in the capital markets. The bank supervises loan administration and follows day to day progress of projects through its field offices in Latin-American member countries. The borrower has to provide the bank with an initial schedule of project investment expenditure and submit periodic reports as the project progresses. Generally speaking the bank will finance between 50% and 80% of the total project cost depending on the stage of development of the country concerned. Only businesses from bank member countries are eligible to compete in bidding to provide goods and services for IDB projects. Procurement thresholds above which international competitive bidding is required are determined on a case by case basis. Unless an exemption is granted by the board of executive directors these thresholds will not exceed US$5 million for construction of civil works and US$350,000for supply of goods, for instance. Information on loan approvals, loans under consideration and procurement opportunities can be obtained from a number of sources. These include two of the bank's own publications - a monthly newsletter called The IDB and IDB Projects. The UN's Development Business publication is a further source.

Appendix 2:

Asian Development Bank financing private enterprise

Financing for private enterprises and financial institutions is provided directly by the Asian Development Bank (ADB) and is also made available indirectly through development finance institutions (DFIs). These include development banks, some commercial and merchant banks and leasing and venture capital companies. Advice and assistance services are also available. Direct assistance to private enterprise mainly consists of loans without government guarantee, and underwriting and investment in equity securities. Direct assistance is also provided to privately owned financial institutions. The bank has underwritten the initial offering of several mutual funds for instance. Financial institutions and sponsors of projects involving venture capital, leasing and factoring, investment management and commercial finance among others are eligible for direct assistance. Generally speaking the bank looks for enterprises that are able to undertake financially viable projects which also have significant economic merit and catalyse the flow of domestic and external resources to the projects in question. To be eligible for bank assistance an enterprise should be in the private sector and it may be either locally or foreign owned. Enterprises owned jointly by private interests and the government are also eligible in some circumstances. ADB assistance may be considered in respect of productive activities in sectors such as energy, manufacturing, transport, forestry, fisheries: mining, tourism, health and agriculture. Assistance is also available to infrastructure projects on a BOT /BOO basis in areas such as electric power, telecommunications, roads, bridges, ports and water supply. In addition bank assistance may be granted to member developing countries for efforts to privatise enterprises and financial institutions owned or controlled by the government. Normally, the project should produce or provide essential goods or services and serve national development objectives. Projects to produce non-essential or luxury consumer goods may be eligible provided the products are primarily for export. The bank prefers projects which use domestic raw materials, create jobs, employ modern management techniques and technology and those which are export oriented or lead to efficient import substitution, induce foreign investment and provide wider dispersal of ownership. The total amount of ADB assistance will normally not exceed 25% of the total cost of the project or US$50 milllion, whichever is lower. Bank equity investment will usually not exceed 25% of the value of the enterprise and will not be smaller than US$100,000. The bank will not be the largest single investor in an enterprise. The ADB assists companies in arranging co-financing or syndications to obtain finance from other sources. Before granting assistance the bank undertakes a comprehensive appraisal of the applicant enterprise and the project. The ADB then evaluates the technical feasibility, marketing prospects, financial and economic viability and environmental soundness of the project. It also attaches considerable importance to the integrity, experience and competence of the project sponsors and management. ADB loans must normally be secured. This usually entails a charge on the borrower's assets and may take the form of a guarantee by a financial institution or project sponsors. Fees charged by the bank will normally include a periodic commitment fee. This accrues 60 days after the loan is signed and it is payable to the bank until the loan is fully discharged. Front end fees and expenses may also be asked for. In general the repayment period of a loan may not exceed 12 years including a suitable ,pace period. Longer repayment periods may be considered in cases such as BOTIBOO infrastructure projects. Interest rates charged include a negotiated spread. Loans are made in one or more of the internationally traded currencies used by the bank including US$, Japanese yen, sterling, Deutschmarks and Swiss francs. At the same time the bank operates an exchange risk pooling system (ERPS) which provides some protection against fluctuations in exchange rates. For procurement purposes, ADB funds can be used only to finance procurement of goods and services produced in member countries and from those countries. The ADB requires assisted companies to adopt appropriate accounting systems based on internationally accepted accounting principles. Furthermore, companies obtaining assistance are required to comply with

prevailing environmental regulations and in appropriate cases to submit an environmental impact assessment (EIA) report in connection with the project. The bank does not seek a controlling interest in assisted companies and it will not normally assume any managerial responsibilities. It will retain regular contact with management and may require periodic reports. The basis of any equity financing by the ADB is that the bank will divest its shareholdings at a fair price when the objective of bank investment is considered fully achieved. Furthermore, before approving a loan or an equity investment, the bank requires from the concerned government an indication to the effect that it has no objection to the proposed bank investment. To enable the bank to assess promptly the eligibility of a project for bank assistance, the ADB recommends sponsors to submit a brief project outline including the following information: Description of the project. The sponsors, including financial and managerial background. Project cost estimates. including foreign exchange requirements. Financing plan indicating the amount of Asian Development Bank financing required. Market prospects including proposed marketing arrangements. Implementation plan including status of government approvals.

PART 7
CONCLUSION

Chapter 26: Conclusion


A common experience of business people everywhere is that experts can always answer every question in the world except the one that matters. In the same way, the most lavishly detailed payment instrument, or the most elegantly structured financing vehicle, can do nothing to replace good judgement when it comes to evaluating the party on the other side of the table and the likely profitability of a deal. What such techniques can offer is something quite different. If the basics are sound they can help the deal forward and contribute to maximising the returns. For instance, a guarantee or a buyer credit make it possible to sign a contract otherwise beyond reach. A series of compensation agreements opens new foreign markets to an importer. Specialist arrangements such as leasing, factoring or forfaiting lighten the burden on corporate balance sheets, provide tax advantages and afford companies more room to manoeuvre. As this book has sought to show, a huge selection of financing procedures is available for trade deals and projects in emerging markets. Often, with the assistance of their banks, buyers and sellers will mix together a cocktail of techniques to fit the precise details of their individual case. Yet the range and sophistication of these techniques also presents temptations sometimes best avoided. It may, for instance, be worthwhile restructuring the legal foundation of a deal to gain an extra tax advantage or changing the specifications and sources of supply to reap the benefit of concessional credits. But overall the financing should follow the deal, not the other way round. Otherwise the basic objective might just slip from view, and an overly-clever piece of engineering might just produce unexpected and undesired side effects at a later date. The techniques described in earlier chapters were designed to cater for a diversity of situations. Some have been around for hundreds of years. Others appeared the day before yesterday. All of them, in one way or another, can be adapted to the changing demands of the marketplace. Their details can be comprehensively haggled over before bargains are struck. And more ways of managing the flow of funds and credit will doubtless be added as business technology and the emerging countries evolve in ways that we still only guess at. Our book is ended, but the story carries on.

Some useful addresses


Development banks and corporations
African Development Bank 10- 12 Avenue Joseph Anoma Abidjan. CGte d'Ivoire BP 1387. Abidjan 01 CBte d'Ivoire Tel: 20 4444; 20 4848 Fax: 33 2172; 22 7004 Andean Development Corporation Corporation Andina de Fomento Avenida Luis Roche Edificio Torre Central Altirnira, Caracas, Venezuela Tel: (58-2) 209 21 1 1 Fax: (58-2) 284 5754 (58-2) 284 2553 Asian Development Bank 6 ADB Avenue, Mandaluyong 040 1 Metro Manila P.O. Box 789 0980 Manila Philippines Tel: (63-2) 4444 Fax: (63-2) 741 7961 Banco Centramericano de Integracibn Economica Apartado Postal No 772 Tegucigalpa M.D.C. Honduras CA Tel: (504) 37 2230139 (504) 37 1184188 Fax: (504) 37 0793

Caribbean Development Bank P.O.Box 408 Wildey St Michael Barbados Tel: 809 431 1600 Fax: 809 426 7269 European Bank for Reconstruction and Development One Exchange Square London EC2A 2EH United Kingdom Tel: (44) 171 338 6282 (44) 17 1 338 6252 Fax: (44) 171 3386102 European Investment Bank 100 Boulevard Konrad Adenauer P.O. Box 2005 Luxembour~ - Kirchberg Tel: (352) 43 79 1 Fax: (352) 43 77 04 The Industrial Credit and Investment Corporation of India 163 Backbay Reclamation Bombay 400 020 India Tel: 2022535 Fax: 022 2046582 Inter-American Development Bank 1300 New York Avenue N.W. Washington D.C. 20577 Tel: (1) 202 623 1000 Fax: ( 1 ) 202 623 3906 Islamic Development Bank P.O. Box 2925 Jeddah 21432 Saudi Arabia Tel: (966) 26361 400 Fax: (966) 26368 871 The World Bank 1818 H Street, N.W. Washington D.C.20433 USA Tel: ( 1 ) 202 477 1234 Fax: ( 1) 202 477 639 1

Export credits organisations


International Union of Credit and Investment Insurers (The Berne Union) 35 Old Queen Street London SW 1H 9JA United Kingdom. Tel: (44) 171 799 2990 Fax: (44) 171 799 299 1

Berne Union

- List of members

ARGENTINA (CASC) Compania Argentina de Seguros de Crddito a la Exportation S.A. Conientes 345, 7th Floor 1043 Buenos Aires Tel: (54 1) 313 30481313 2986 313 43031313 2683 313 5071/313 4362 Fax: (54 1) 313 2919 AUSTRALIA (EFIC) Export Finance & Insurance Corporation Level 5, Export House 22 Pitt Street Sydney NSW 2000 Tel: (61 2) 201 21 11 Telex: I21224 EFIC AA Fax: (61 2) 25 1 385 1 AUSTRIA (OeKB) Oesterreichische Kontrollbank Aktiengesellschaft Abteilung Intemationale Verbindungen Am Hof 4 A-I01 l Vienna Tel: (43 1) 53127-0 or Ext Number Telex: 132785 OKBE A Fax: (43 1) 53127-205 or Ext Number

Mailing Address PO Box R65 Royal Exchange NSW 2000

Mailing Address Postfach 70 A- l o l l Vienna

BELGIUM (OND) OFEce National du Ducroire Square de Meefis 40 B-1M0 Brussels Tel: (32 2) 509 42 11 Telex: 2 1147 OND B Fax: (32 2) 5 13 50 59 CANADA (EDC) Export Development Corporation 151 O'Connor Street Ottawa Canada KIA 1K3 Tel: (1 613) 598 2500 Telex: 0534136 EXCREDITCORP OTT Fax: (1 613) 237 2960 CYPRUS (ECIS) Export Credit Insurance Sewice Ministry of Commerce & Industry Nicosia Tel: (357 2) 30 3441 Telex: 2283 MINCOMIND CY Fax: (357 2) 36 6120 DENMARK (EKR) A/S EKR Eksportkredit GI. Kongevej 1 1-13 DK 1610 Copenhagen V Tel: (45) 3 1 3 1 38 25 Fax: (45) 31 31 24 25 FINLAND (FGB) Valtiontakuukeskus Etelaranta 6 SF-00131 Helsinki Tel: (358 0) 134 111 Telex: 121778 VTL SF Fax: (358 0) 651 181 FRANCE (COFACE) Compagnie Franqaise d'Assurance pour le Commerce ExtCrieur 12 Cours Michelet La DCfense 10 92800 Puteaux Tel: (33 1) 4902 2000 Telex: 61 4884 ASEXP F Fax: (33 1) 4906 0988

Mailing Address PO Box 1010 SF-0010 1 Helsinki

Mailing Address CCdex 5 1 F-92065 Paris La Dkfense

FRANCE (SFAC) SociCte Franqaise d'Assurance Crkdit 1 rue Euler 75008 Paris Tel: (33 1) 4070 5050 Telex: 630850 SFAFC F Fax: (33 1 ) 4070 5017 GERMANY (HERMES) Hermos KreditversicherungsAktiengesellschaft Friedensallee 254 22763 Hamburg Tel: (49 40) 8834-0 Fax: (49 40) 8834 9 175 GERMANY (TREUARBEIT) C&L Treuarbeit Deutsche Revision Aktiengesellschaft Winschaftspriifungsgesellschaft S teuerberatungsgesellschaft New-York-Ring 13 22297 Hamburg Tel: (49 40) 63780 Telex:2174118 TAHH D Fax: (49 40) 6378 1510 HONG KONG (HKEC) Hong Kong Export Credit Insurance Corporation South Seas Centre. Tower 1 2nd Floor, 75 Mody Road Tsimshatsui East Kowloon Tel: (852) 2723 3883 Telex: 56200 HKXC HX Fax: (852) 2722 6277 INDIA (ECGC) Export Credit Guarantee Corporation of India Limited loth Floor. Express Towers Nariman Point Bombay 400 02 1 Tel: (91 22) 202 4852 Telex: 118323 1 ECGC IN Fax: (9 1 22) 204 5253

Mailing Address 19x Cedex 10 F-75460 Paris

Mailing Address 22746 Hamburg

Mailing Address Postfach 60 27 20 22237 Hamburg

Mailing Address Box 98548 T.S.T. Post Office Hong Kong

INDONESIA (ASEI) Asuransi Ekspor Indonesia Sarinah Building, 13th Floor JI. M.H. Thamrin No. 11 Jakarta 10350 Tel: (62 21) 3903535 Telex: 69061 ASEI IA 69062 AXINDO IA Fax: (62 2 1 ) 323662f327886 ISRAEL (IFTRIC) The Israel Foreign Trade Risks Insurance Corporation Ltd 65 Petah Tikva Road Tel Aviv 6 1201 Tel: (972 3) 563 1777 Telex: 34 1 179 IFTI IL Fax: (9723)5610313

Mailing Address P.O. Box 20215 65 Petah Tikva Road Tel Aviv 61201

ITALY (SACE) Sezione Speciale per I'Assicurazione Mailing Address del Credito all'Esportazione C.P. 253 Roma Centro Piazza Poli 37 00 100 Rome Tel: (39 6) 67361 Telex: 613160 SACE I Fax: (396) 6736225f6736270 6736359 Research & International Relations Dept. ITALY (SIAC) Societa Italiana Assicurazione Crediti S.p.A. Via Rafaello Matarazzo 19 00139 Rome Tel: (39 6) 87292-1 or Ext.No. Telex:620616 SIACRE I Fax: (39 6) 872922 18 JAMAICA W.I. (EXIM J) National Export-Import Bank of Jamaica Limited 48 Duke Street Kingston Tel: (1 809) 92 2969019 Telex: 3650 EXIMJ JA Fax: (1 809) 92 29184

Mailing Address C.P. 1 11253 Roma - Montesacro

Mailing Address P.O. Box 3 Kingston

JAPAN (EIDIMITI) Export-Import Insurance Division International Trade Administration Bureau Ministry of International Trade and Industry 1-3-1 Kasumigaseki Chiyoda-ku Tokyo 100 Tel: (81 33) 501 1665 Telex: 22916 EIDMITI J 28576 Fax: (8 1 33) 508 2624 EIDMITI - PARIS Export-Import Insurance Division Jetro -Paris Centre d'Affaires le Louvre 2 Place du Palais Royal 75001 PARIS Tel: (33 1 ) 4261 5879 4261 5883 Telex: 213294 Fax: (33 1) 4261 5049 KOREA (KEIC) Korea Export Insurance Corporation 33 Seorin-Dong Chongro-Ku Seoul 110-1 10 Tel: (82 2) 399 6800 Fax: (82 2) 399 6577 KEIC - LONDON Korea Export Insurance Corporation c/o The Export-Import Bank of Korea 3rd Floor Boston House 63 New Broad Street London EC2M 1JJ Tel: (44 71) 638 8124 Telex: 8812140 EXIMBK G Fax: (44 71) 68 9255 MALAYSIA (MECIB) Malaysia Export Credit Insurance Berhad Level 12 & 13, Bangunan Bank Industri Jalan Sultan Ismail 50250 Kuala Lumpur Tel: (60 3) 29 1 0677 Telex: 3 1190 EXCRED MA Fax: (60 3) 291 0353
Mailing Address P.O. Box 11048 50734 Kuala Lumpur Mailing Address Jetro - Paris 2 Place du Palais Royal 75044 Cedex 0 1 Paris

MEXICO (BANCOMEXT) Banco Nacional de Comercio Exterior S.N.C. Camino A Santa Teresa 1679 3a Planta Colonia Jardines del Pedregal C.P. 01900 MEXICO D.F. Tel: (52 5) 327 6000 Telex: 1764393 BNCE ME Fax: (52 5) 327 6 157 3276187 NETHERLANDS (NCM) Nederlandsche Credietvenekering Maatshcappij N.V. Keizergracht 27 1-285 1016 ED Amsterdam Tel: (3 1 20) 553 91 1 1 Telex: 11496 NCM NL Fax: (3 1 20) 553 28 1 1 NEW ZEALAND (EXGO) EXGO I st Floor Norwich Insurance House 3- 1 I Hunter Street Wellington Tel: (64 4) 496 9600 Fax: (64 4) 496 9670 NORWAY (GIEK) Garanti-Instituttet for Eksportkreditt Dronning Mauds gt 15 IV 0250 Oslo Tel: (47) 22837070 Telex: 76783 GIEK N Fax: (47) 22832445 PORTUGAL (COSEC) Companhia d e Seguro de CrCditos, S.A. Avenida da Republica 58 1094 Lisbon Codex Tel: (351 1)7960131 7952143 Telex: 12885 COSEC P Fax: (351 1) 7934614

Mailing Address Postbus 473 NL I000 AL Amsterdam

Mailing Address Norwich Insurance House Box 5037 Wellington

Mailing Address Postboks 1763 Vika N-0 122 Oslo

SINGAPORE (ECICS) ECICS Credit Insurance Ltd. 141 Market Street 10-00 International Factors Building Singapore 0104 Tel: (65) 272 8866 Telex: 21524 ECICS RS Fax: (65) 323 5093 SOUTH AFRICA (CGIC) Credit Guarantee Insurance Corporation of Africa Limited Credit Guarantee House 3 1 Dover Street Randburg 2194 Johannesburg Tel: (27 11) 889 7000 Telex: 4205081426525SA Fax: (27 1 1 ) 886 1027 886 5715 SPAIN (CESCE) Compania Espanola de Seguros de Credito a la Exportacion, S.A. Velazquez, 74 2800 1 - Madrid Tel: (34 1) 577 60 66 577 60 77 Telex:45369/23577 CESCE E Fax: (34 1) 576 5 1 40V SPAIN (CESCC) Compania Espanola de Seguros de Crcidito y Caucion S.A. Madrid Raimundo Femandez Villaverde 61 E-28003 Madrid Tel: (34 1 ) 553 68 00 553 87 04/553 35 02 Telex: 43163 SCYC E Fax: (34 1) 535 33 73

Mailing Address

P.O. Box 125


Randburg 2125

Mailing Address Apartado Correos 524

SRI LANKA (SLECIC) Sri Lanka Export Credit Insurance Corporation Mailing Address P.O. Box 221 3 27815 Union Place Colombo 2 Colombo 2 Tel: (941)4228 15 43 01 61 Telex: 21404 SLECIC CE Fax: (94 1) 44 75 10

SWEDEN (EKN) Exportkreditnamnden Kungsgatan 36 Stockholm Tel: (46 8) 701 00 00 Telex: 17657 EKN S Fax: (46 8) 41 1 8 1 49 SWlTZERLAND (ERG) Geschaftsstellefur die Exportrisikogarantie Kirchenweg 8 CH-8032 Ziirich Tel: (41 1 ) 38447 77 Telex: 815060 ERG CH Fax: (41 1) 384 47 87 SWITZERLAND (FEDERAL) The Federal Insurance Company Limited (Eidgenossische VersichemngsAktiengesellschaft) Flossergasse 3 CH-8039 Ziirich Tel: (41 1) 208 44 22 Telex: 815353 FED CH Fax: (41 1 ) 201 28 04 TURKEY (TURK EXIMBANK) Export Credit Bank of Turkey Miidafaa Cad 20 Bakanliklar 06100 Ankara Tel: (90 312) 417 13 00 417 32 87 425 6502 Telex: 46751 EXMB TR 46106 EXBN TR Fax: (90 3 12)425 78 96 425 75 47 UNITED KINGDOM (ECGD) Export Credits Guarantee Department 2 Exchange Tower Harbour Exchange Square London El4 9GS Tel: (4471)5127000 Telex: 290350 ECGDHQ G Fax: (4471)5127649

Mailing Address Box 3064 S-1103 61 Stockholm

Mailing Address Postfach CH-8032 Zurich

Mailing Address Postfach CH-8039 Zurich

UNITED KINGDOM (TI) Trade Indemnity plc Trade Indemnity House 12/34 Great Eastern Street London EC2A 3AX Tel: (44 171) 7394311 Fax: (44 171) 860 2856 UNITED STATES OF AMERICA (EXIMBANK) Export-Import Bank of the United States 811 Vermont Avenue, N.W. Washington D.C. 20571 Tel: (I 202) 565 3946 Telex: 8946 1 EXIBANK (In-Safe No) 6710607 EXIBANK Fax: (1 202) 565 3380 UNITED STATES OF AMERICA (FCIA) Foreign Credit Insurance Association 40 Rector Street New York N.Y. 10006 Tel: (1 21 2) 306 5000 Fax: ( 1 212) 5134704 UNITED STATES OF AMERICA (OPIC) Overseas Private Inveshnent Corporation I100 New York Avenue, N.W. Washington D.C. 20527 Tel: (1 202) 336 8580 Telex: 4938219 OPIC UI Fax: (1 202) 408 5142 (1 202) 408 9859 ZIMBABWE (CREDSURE) Credit Insurance Zimbabwe Limited 67/69 Second Street Harare Tel: (263 4) 73894417 706 10114 Telex: 24424 CREDSURE ZW ' Fax: (263 4) 706105 OR (M&G for CREDSURE) (263 4) 732945

Mailing Address P.O. Box 1085 Harare

(MIGA) Multilateral Investment Guarantee Agency 1818 H Street, N.W. Washington D.C. 20433 USA Tel: ( 1 202) 473 6168 Fax: ( 1 202) 477 9886)

East and Central European Export Credits Agencies


CZECH REPUBLIC Export Guarantee and Insurance Corporation (EGAP) Janovskeho 2 170 32 Prague 7 Tel: (422) 389 2100 Fax: (422) 374 488 SLOVAK REPUBLIC Export Credit Insurance Corporation (SPE) Krizna 52 832 19 Bratislava Tel: (427) 329 143 Fax: (427) 329 144 HUNGARY Hungarian Export Credit Insurance Ltd. 1065 Budapest Nagyrnezo Utca 44 Tel: (361) 269 1 197 Fax: (361) 269 1198 POLAND Export Credit Insurance Corporation (KUKE) ul. Widok 519 00-023 Warsaw Tel: (4822) 27 35 83 Fax: (4822) 8 1 34 64 ROMANIA Eximbank of Romania 6 Stavropoleos Street 70075 Bucharest Tel: (401) 614 160112326 Fax: (401) 312 135014238

SLOVENIA Slovenian Export Corporation Ltd. UL. Josipine Turnograjske 6 6 1000 Ljubljana Tel: (38661)1762019/036 Fax: (38661)1253015

Other international organisations


International Chamber of commerce 38 Cours Albert ler 75008 Paris France Communications division: Tel: (33) I 49 53 28 23 (33) 1 49 53 29 09 Fax: (33) 1 49 53 29 24 Leaseurope Avenue de Tervuren, 267 1150 Brussels Belgium Tel: (32) 2 771 21 08 Fax: (32) 2 770 75 96 Multilateral Investment Guarantee Agency (MICA) 600 Nineteenth Street, NW Washington DC 20433
USA Tel: (1) 202 473 2060 Fax: (1) 202 477 9886

Organisation for Economic Cooperation and Development (OECD) 2 rue AndrC Pascal 75775 PARIS Cedex 16 France Tel: (33) 1 45 24 82 00 Fax: (33) 1 45 24 85 00 World Trade Organization William Rappard Centre 154 rue de Lausanne CH-1211 Genkve 21 Switzerland Tel: (41) 22 739 5 11 1 Fax: (41) 22 73 1 4206

United Nations Commission on International Trade Law Vienna International Centre P.O.Box 500 A- 1400 Vienna, Austria Tel: (43)211314060 Fax: (43) 237485

Bibliography
Books
Brian W. Clarke (Editor), Handbook of International credit Manageinent. Gower, London, UK, 1989. Tom Clarke (Editor), Leasing Finance. Euromoney, London, UK, 1985. Bernard Colas (Editor), Global Economic Co-operation. Management Books 2000, Didcot, UK, 1994. Anthony N. Cox & John A. Mackenzie, International Factoring. Euromoney, London, U K , 1986. Dick Francis, The Countertrade Handbook. Woodhead-Faulkner, Cambridge, UK, 1987. Charles J. Gmiir (Editor), Trade Financing. Euromoney, London, UK, 1986 Ian Guild & Rhodii Hams, Fogaiting. Woodhead-Faulkner, Cambridge, UK, 1985. Jaime de Melo & Amind Panagariya, The New Regionalism in Trade Policy. World Bank, Centre for Economic Policy Research, 1992. Michael Rowe, Countertrade. Euromoney, London, U K , 1989. Michael Rowe, Guarantees. Euromoney, London, UK, 1987. Michael Rowe. Letters of Credit. Euromoney, London, U K , 1985.

Guides and rules


Banco de A. Edwards. Exponar es ficil : Banco de A. Edwards y Prochile le ayudan. Chile. Banco del Estado de Chile : Guia de criditos y servicios para exportadores e importadores. Banco Santander : Republics Popular China, Spain, 1994. Clifford Chance (international law firm) . Cross-border Aircraft Leasing, London, 1992. Clifford Chance . Project finance, London 1994. Clifford Chance. Offset Investment in Saudi Arabia, Riyadh, 1994.

Cridit Suisse. Documentary credits, documentary collections and bank guarantees. CrCdit Suisse Special Publications. Val. 77. Ziirich, Switzerland. Cyprus, a centre for international business. Central Bank of Cyprus. Third edition, 1994. The Economist Intelligence Unit, London UK. Financing Foreign Operations (Loose-leaf service). The Hong Kong and Shanghai Banking Corporation Limited. The ABC Guide to Trade Services. Group Training and Management Development, Hong Kong, 1994. International Chamber of Commerce. Paris. France Bills of Exchange - a guide to legislation in European countries by Dr. Jur. Uwe Jahn. 1990. Publication n o 476. Incoterms 1990. Publication no 460. Uniform Rules for Collections. Publication no 322. Uniform Customs and Practice for Documentary Credits. Publication no 500, 1993 ICC Guide to Documentary Credit Operations by Charles del Busto. 1994. Publication no 5 15 The New Standard Documentary Credit Forms for the UCP 500. Edited by Charles del Busto. 1993. Publication no 516. UCP 500 & 400 compared. 1993. Publication No 5 1 I . Uniform Rules for Demand Guarantees, 1992. Publication No 458. Guide to the ICC Uniform Rules for Demand Guarantees by Professor Roy Goode. 1992. Publication No 510. ICC Model Forms for Issuing Demand Guarantees. 1994. Publication N o 503. Uniform Rules for Contract Bonds. 1993. Publication No 524. Managing Exchange Rate risks. 1985. Publication No 422. Retention of Title (2nd edition). Publication No 501. The Istanbul Chamber of Commerce. New Practices in the Turkish Finance System. Publication No 1994-22. Abdul Latif Janahi. Islamic Banking Concept Practice & Future. Bahrain Islamic Bank B.S.C. Manama, Bahrain. OECD. The Export Credit Financing Systems in the OECD Member Countries. Fourth Edition. Paris, 1990. UNCITRAL. Legal Guide on International Countertrade Transactions. United Nations, New York, 1993 Union Bank of Switzerland. Documentary Credits, Documentary Collections and Bank Guarantees. 2nd Edition. Switzerland, 1994.

Magazines and newsletters


Project & Trade Finance. Euromoney, London, UK. Inrernational Trade Finance. Financial Times, London, UK

Projecr Finance International. IFR Publishing, London UK. Lower GuffBusiness Law Review. Trowers & Hamlins, London, UK.