The cover of the risks within the framework of the investment and export activities

Financing and insurance of the export activities

Specific financing formulae for international trade

The credit establishments have developed financing tools destined specifically to the international trade. Such instruments allow meeting two essential concerns of the enterprises:

the "counterparty risk": it is the insecurity generated by the fact that an enterprise does not have sufficient knowledge and information allowing it to assess the reliability and solvency of its commercial partners,
the customs formalities: the customs duties add to the price of the good and shipment costs and should be paid prior to the distribution and sale of the goods, which necessitates specific financing.

Irrevocable letter of credit
Acceptance credit
Customs formalities
Credit risks
Risks tied to the exchange
Insurance of the risks linked to investments abroad

Where to insure and / or get financing?

Irrevocable letter of credit

Unlike its name seems to say, the irrevocable letter of credit is more of a guarantee mechanism and means of payment than credit in the strict sense of the word.
Its role is indeed especially to use the banking system in order to reduce the counterparty risk. How can an exporter indeed make sure that his customer will pay him his goods once they have arrived safe and sound.
If he tries to bypass the problem by requiring prior payment before the shipment of the goods, it is the importer who will have to fear a similar risk: he cannot be sure that the exporter will actually ship him the goods once the payment performed.
The mechanism of irrevocable letter of credit allows to use the banking system to get out of this dilemma. Like its name says, it is based on the check and transmittal of documents associated to the commercial transaction.
The irrevocable letter of credit operates as follows:

The importer and the exporter agree on a commercial transaction. They agree that the payment will take place through an irrevocable letter of credit and fix the conditions thereof. The exporter will have to supply a series of documents meant mainly for proving the compliance of the goods with the technical specifications and their shipment according to the agreed conditions.
The importer can so be sure that the payment will be effected only if the exporter has met his obligations, demonstrated by the document to be provided.
The importer asks his bank (bank I) to open an irrevocable letter of credit in favour of the exporter with the bank of the latter (bank E).
After the shipment, the exporter supplies all the necessary documents to his bank (bank E), that checks them and then forwards them to the importer's bank (bank I).

The exporter will be certain to get his payment, as a bank has committed to perform the payment, whereby no objection can be opposed provided the supplied documents correspond scrupulously with the terms of the irrevocable letter of credit. If the documents are complying, the latter will effect the payment according to the agreed terms and conditions.

Acceptance credit

The acceptance credit is meant to "replace" the mechanism of discount credit in order to allow an importing or exporting enterprise to finance its international activities.
The discount credit consists for an enterprise in drawing a draft (certificate of indebtedness) on its customers and to discount it afterwards with its bank, namely to cash the amount of the draft (due by the customer) reduced by the agio (remuneration of the bank).
At the maturity date the customer of the enterprise pays the amount of its debt directly to the bank.
This way to proceed implies that the bank might assess the solvency of the enterprises on which its client draws commercial drafts.
Within the framework of international transactions, this turns often out to be difficult.
The acceptance credit allows remedying this difficulty.
It is a mechanism through which the bank accepts that its own customer draws a commercial draft on it for each import or export invoice, discounts the drafts so created and credits the account of its customer.
The customer pays then to the bank at the maturity date of the draft.

Customs formalities

The European customs administrations require in principle immediate payment of the customs and excise duties on the goods upon their passing the border.
It is however possible to get differed payment on the condition to constitute a surety (amount of money paid to serve as guarantee).
Although technically speaking, an instrument of guarantee, the customs surety can however be considered as a financing means insofar as it allows the enterprise to get terms of payment.

Specific Insurances

Credit risks

The credit risks include the "classical" problems of solvency of the buyer: late payments and default of payment.
The international dimension of the exchange makes however the management of these situations clearly more complicated.
Both commercial partners depend indeed from two distinct jurisdictions, and the cost of settlement of the litigations might turn out to be considerable.
Besides specific techniques like the irrevocable letter of credit, it is hence also possible to insure oneself against the risk of default of payment.

Risks tied to the exchange

Exchange risk

Whenever the commercial transaction concerns partners not using the same currency, there is a risk that the exchange rates develop unfavourably between the conclusion of the transaction and its development, which would disadvantage one of the two parties.
The enterprise wishing to limit such risk can resort to some "cover" techniques on the foreign exchange market.
For instance a Moroccan exporter takes that risk when signing a sales agreement in dollars because the US currency can depreciate with respect to the dirham between now and the sometimes very distant settlement of the invoice. The reverse mechanism prevails for the importer. The entrepreneur can "cover himself" by outright purchase or sale of currencies in counterpart for the initial transaction.
The exchange loss feared by the undertaking can so be totally or partly offset by a gain realised on the covering position.
It is also possible as a supplement to these techniques proposed by most banks, to take out an insurance that will specifically cover the exchange risk.

The risk of inconvertibility

It is possible that an enterprise would incur by the action of the local government, in the impossibility to convert the proceeds of a sale effected in local currency in an international currency.
It is only really possible to protect oneself against the risk by demanding a payment in international currencies, as the risk of inconvertibility is rarely covered for commercial transactions.

Risks linked to the goods

The goods themselves should be insured during their transportation. It is also important to foresee guarantees in case of non-compliance of the goods with the technical specifications.

Insurance of the risks linked to investments abroad

The risks linked to the ownership

The DFI's can in some countries, turn out to be risky for the investor's ownership. The risks incurred can either derive from the actions of the local government, or from the political instability of the country.

Expropriation

The local governments can decide to nationalise, expropriate or confiscate the goods of the enterprises located on their territory.
Insurances allow covering that type of "political risk".

Destruction

In case of civil unrest, coups or riots, the property belonging to the enterprise might be sacked, looted or destroyed.
These losses can be covered by an insurance against political risks.

Risks associated to the repatriation of funds

Some governments may suddenly decide to limit or prevent any repatriation of funds by hindering, limiting or delaying the conversion of local currency in foreign currencies.
Therefore the investor will incur in the incapacity to repatriate his profits, indeed his capital. It is however possible to cover oneself against such risks.

Breach of governmental contracts

Eventually in the politically instable countries, a government might break unilaterally the contract binding it to a foreign investor. That risk can also be insured.

Where to insure and/or get financing?

Banks and private insurances

Various credit formulae for exports and necessary insurances are commercialised by the banks and private insurance companies.
The proposed products are among others the irrevocable letters of credit, the insurances on the transportation of goods, and the insurances against the termination of the contracts.

Public entities of export aid

Most OECD States have established organisations the role of which is to facilitate export activities.
These organisations propose on the one hand additional guarantees or cover extensions associated to existing credit or insurance contracts.
They propose however other products not marketed by the private sector, like for instance the constitution of guarantee to the profit of the customs administration.
Eventually they assist the banks active in export credits by proposing cover and guarantee formulae allowing them to propose some specific products to their customers.