Law Relating to Payment and Trade Finance - Essay Example

?Law Relating to Payment and Trade Finance Introduction Day in an out, efforts are being made by international bodies such as the World Trade Organisation, World Tourism Organisation, Food and Agriculture Organisation among others to make transnational trade and cross-border trade as flexible as possible. Even among stakeholders in various continents, there are such attempts to make the flow of good and services across borders as easy as possible. To this effect, there has been the creation of economic and trade zones such as the European Union and the Economic Community of West African States. Hitherto, investors and other traders who wanted to do cross border or international trading (import and export) had to go through stringent bureaucracies and processes that killed the enthusiasm of most of such investors and traders. Today, the situation is quite different as a lot more people are gaining the interest to go into international trading. The need to make cross border trade and commerce as flexible as possible not withstanding, there are certain basic regulations that remain unchanged and would perhaps remain unchanged for a very long time. One of such regulations is the mode of international trade financing and payment. Though the processes are not as stressful as before, international traders are still required to follow basic international trade financing systems that are governed by law. This write-up therefore seeks to examine the role of some of the most common international trade financing and payment methods in addressing the currency global credit crisis. What is international trade finance and payment? Organisation such as the International Monetary Fund and World Trade Organisation have devised laid down procedures and structures that need to be followed whenever trade and business transactions have to take place across borders. Such trade that take place across borders are referred to as international trade whereas the funding or financing of all forms of products, good and services that are involved in such international trades are referred to as international trade finance or simply put, trade finance. According to the Business Money (2011), “Trade Finance is the science that describes the management of money, banking, credit, investments and assets for international trade transactions.” This means that the financing of trade across borders is just more than giving out monies for goods that one wants to buy. Rather it reaches an extent where the entire process is described as management. Instead of just giving out money to pay for goods and products, one has to device means and follow processes that ensure that the money is managed by taking the payment process through a couple of processes, involving institutions such as banks and insurance. It is therefore in the right direction that the Investopedia (2009) notes that “trade finance looks at banks, credit agencies, insurers, forfaiters, and any other person or institution who enables importers and exporters to trade across borders.” Discussion on the present Global Credit Crisis Closely related to the issue of international trade finance is the availability and access to flexible credit. This is because as mentioned already, trade finance goes beyond paying money in hand to a company to including the involvement of institutions such as banks and insurances. This means that issues on credit plays an important role on the success of world trade finance. However, it is common knowledge that the world has in times past suffered and even today suffers from credit crisis that is not limited to any one country but the world as a whole. Broadly speaking, when a particular nation suffers a breakdown with its credit system, we say credit crisis has hit that country but when the situation expands to include almost all nations of the world – especially the giants like America, China and Germany, we say that there is a global credit crisis. Greewood (2011) explains that global credit crisis arises due to “less credit availability combined with high interest rates leads to reduction in investment and reduced consumer spending.” Simply put, there is global credit crisis when world over, investors and international traders find it extremely difficult to come by credit and even when they come by one, it is accompanied with huge interest. According to the Investopedia (2011), credit crisis is “a crisis that occurs when several financial institutions issue or are sold high-risk loans that start to default. As borrowers default on their loans, the financial institutions that issued the loans stop receiving payments.” This is to say that the real problem associated with global credit crisis starts with the borrower. Forms of international trade finance and payment There are several forms of international trade finance and payment systems that have been discussed in literature. Common among these systems or methods of payment are cash in advance, counter trade, offset, barter, switch-trading and letter of credit. Some of these forms of payment involve the issuance of physical cash whereas others do not. For instance cash in advance involves advance payment for goods. Giovannucci (2008) explains that “Cash in advance clearly is risk-free except for consequences associated with the potential non-delivery of the goods by the seller. It is often preferred because it is speedy and does not bear the danger of the check not being honored.” Letter of credit on the other hand requires the buyer to seek what may best be described as a guarantee or an assurance letter from a bank, stating that the buyer is in a position to make payment via the bank after the transaction goes through. Other forms of payment such as counter trade, offset, barter and switch-trading however do not involve the use of physical cash. Giovannucci (2008) states that “barter is the exchange of goods or services between two parties.” In this case, the value of goods being exchanged must be able to cover or in some cases supersede the actual amount of goods being traded. Touching on counter trade, Raza (2011) notes that “is primarily used when the firm is exporting to countries whose currency is not freely convertible, and who may lack the foreign exchange reserves required to purchase the imports.” With counter trade, both parties have to send products across board. This means that counter trade works with the same principles as barter trade since it does not involve physical cash but exchange of products and goods. Closely related to counter-trade is offset. Meyer (2009) states that “offset, as a form of counter-trade, resembles a compulsory commitment requiring transnational corporations that receive large government contracts to carry out an investment scheme as a prerequisite to a winning contract.” This is to say that offset normally involves larger companies who take up contracts directly from governments. The mode of payment mandated for these companies is the productions of investment schemes. Finally, the Institute for Working Future (2011) writes on switch trading that “a switch trade is used when the products received are of no use to the exporter or cannot be converted to cash. The original exporter may then barter the goods received for other products which may be sold for cash.” This means that with switch trade, there may be money involved but the money does not come from the buyer directly. Rather, the money comes in after the seller sells the products that the buyer exchanged the original goods with. International Trade Payments that address Current Global Credit Crisis Issues With the present global economic meltdown and current global credit crisis, access to credit has generally become very difficult. Access to credit to undertake any form of project or investment seems not to be forthcoming as easily as it did some years past. The pressure and effect of the current global credit crisis is felt everywhere even among inter-national donor and credit funding for weaker economies and underdeveloped and developing countries. This situation puts the investor who wants to buy across borders in a very tight position especially when the business or trade transaction has to do with the payment of physical cash or an assurance of credit. To this effect, investors and buyers have resorted to various means of trade financing that does not involve direct payment of money or even the need to get credit from banks. Some of these means or methods of payment include counter-trade, offset, barter and switch-trading. Investors and international buyers the world over have hailed these options to trade finance and payment because in these instances, there is virtually no need to involve a bank or other credit givers. The first advantage enjoyed with these methods of trade finance has to do with skipping the routine seeking of credit from banks. As a matter of fact, getting credit from any bank, especially for trade purposes is very difficult. This is because most banks doubt the success of any proposed international trading until they concrete evidence that the transactions are going to succeed. For this reason, they are always slow to issuing credits. The current global credit crisis has even come to worsen the faith of banks in investors. For this reason, if investors would skip the tall bureaucracies to getting credits because such a payment form as barter would not demand physical cash, they would hail such opportunities as blessings. Again, with counter-trade, offset, barter and switch-trading systems of international payments, buyers barely have any worries with interest rates. This is of course an advantage in the midst of the current global credit crisis or credit crunch as it is referred in some quarters. This advantage arises because buyers barely have anything to do with seeking credit when they opt for any of these four methods of international trade payment or finance. As noted early on, due to the credit crisis, interest rates on bank credits have generally gone high. This is even apart from the fact that credits are even difficult to come by in the first place. For the success of any business that is into international trading, there is none denying the fact that if interest rates go very high, it reduces the profit margins of investors and the profit margins of goods and products that are bought. This is because most often than not, buyers complete their transactions only to take large portions of the money they make out of their re-selling into paying off their debts and the high interests that come with them. The eventual results have therefore being that such investors either run at a lost or record low profits. However with the forms of barter systems discussed above, because investors do not take any credits from banks, they barely think of paying off any credits or interest. This means that as the current global credit crisis keep pushing interest rates high, counter-trade, offset, barter and switch-trading remain the best and perhaps only options available to investors to ‘calm the storm’. Another advantage of using any of counter-trade, offset, barter and switch-trading in the current global credit crisis has to do with the issue of differences in currency of most world countries. Giovannucci (2008) asserts that any form of barter payment “is most often used when the buyer lacks access to convertible currency or finds that rates are unfavorable or can exchange for products or services desirable to the seller.” This means that despite the fact that the current global economic crisis have relegated the usefulness of most currencies off board and rendered them ‘unusable in international trade, investors from nations with such currencies can still do business without thinking of what their native currencies are, this is because instead of exchange money for goods, these investors would now be exchanging goods for goods, which does not involve currencies in any way. It is worth emphasizing at this point that it is only by the presence of options of trade financing and payments such as counter-trade, offset, barter and switch-trading that investors from certain parts of the world have remained in international business. This is because the currencies of such countries are simply unrecognized in international trade and for these investors to always depend on exchanging their local currencies for popular currencies like the dollar, pound or euro would cost the investors so much because the depreciation value of the currencies of such countries is just so bad. In such situations, using a product in place of money becomes the common yardstick for determining how much goods an investor from such a background described in the scenario can receive and not necessarily how much money such an investor has. Finally, it has been debated that in the midst of the current global credit crisis, the value of most globally recognized and acclaimed currencies have depreciated badly and that the exchange rates of most currencies have become unpredictable. The problem that this situation is an event whereby a buyer pays an item for say $5000 with the hope of selling the item for $5500 to make a profit of $500 only to complete the transaction to realise that the value of $500 as it initially used to be has now dropped to $400. In this situation, the investor losses $100 off the transaction he did because of the drop in exchange rate. However with any of the barter systems, the investor does not really care about the value of money at the time the transaction was started to the time the transaction was completed because there are no currencies involved. Rather, the price of product exchanged; if it would be re-sold is determined only at the end of the transaction and so the price is given in accordance with current exchange rates, inflations and other economic indicators. It is therefore not surprising that the UNZCO (1998) points out some of the risks with other forms of foreign trade finance that involve the use of physical cash saying “one of the risks associated with foreign trade is the uncertainty of the future exchange rates.” Legal challenges the various trade finance systems may pose This section of the write-up is limited to the final set of trade finance discussed above, which deals with the indirect use of physical cash. From all indication, the use of counter-trade, offset, barter and switch-trading instead of letter of credit and cash in advance puts the buyer in a safer position where he or she has very little to worry about as far as global credit crisis and global economic crunch are concerned. However, there are very serious legal concerns and challenges that traders who want to hide in the shades of these forms of international trade financing and payment are likely to face. In the first place, there arises a legal problem with valuation of good or products that are being exchanged. This situation often results because exchanging one set of goods for another may not have the buyer undergoing real valuation of the goods being exchanged. Most often than not, because international trade involves people from different parts of the work, sellers have always complained that buyers give them exchange products of lower value and this has always resulted in litigations. Next, there has been the problem of legal guarantee and legal backing for goods that are used as payment. This is because unlike the use of physical cash where banks can guarantee for buyers and in some cases insure their moneys or save them the use of products as payment is different. Sellers are not presented with the opportunity of having payments secured or guaranteed since banks deal with documents and money and not with products. This situation also results in failures on the part on the part of buyers to produce the agreed products. Finally, elasticity of goods that are used as payment also arises in legal terms. For instance in switch trade where the seller has to sell the exchange product to made up of the payment, there have always been situations where the exchange products loss their value, marketability, demand and in some even expire before they are bought. However, since no laws bind exchangers to produce cash in such situations or it is not even logical to blame the buyer in such situations, this scenario has always caused serious legal problems including court litigations. Conclusion International trade finances are very important because as Robert (2010) notes, “due to the physical distances between buyer and seller, and the fact that the transaction may have taken place without the two parties actually meeting, minimizing exposure to risk is on the minds of both parties.” However, in the heat of the current global credit crisis, it is important that investors and buyers have options for paying for their goods that may still fall under international trade finance but still reduce their dependence on credit from banks. To this effect, counter-trade, offset, barter and switch-trading have been discussed to be some of the best options available to such investors as these would reduce their chances going through the stress that the credit crisis seem to be bringing on each and every business person. REFERENCE LIST Business Money, 2011, ‘Definition of Trade Finance’, Giovannucci D, 2008, ‘Basic Trade Finance Tools’, retrieved May 21, 2011 Greenwood R, 2011, ‘Credit Crunch Explained - What's Caused the Global Credit Crisis?’ retrieved May 21, 2011 Institute for Working Future, 2011, ‘Switch Trade’, retrieved May 12, 2011 International Monetary Fund, 2011, ‘The IMF and the World Trade Organization’, retrieved May 21, 2011 Investopedia, 2011, ‘Credit Crisis’, retrieved May 22, 2011 Meyer B, 2009, ‘Offset Fund Established by NBK Capital’, Raza M.K, 2011, ‘What is Counter Trade?’ retrieved May 21, 2011 Robert S.G, 2010, ‘Popular payment methods in international trading’, retrieved May 22, 2011 The Free Dictionary, 2009, ‘Trade Finance’, Accessed May 20, 2011 UNZCO, 1998, ‘A Basic Guide to Exporting’, retrieved May 20, 2011 Read More