International trade explained
International trade of any kind can be complex, especially without the right knowledge and guidance. This section of the guide aims to provide you with a thorough overview of the terminology and logistical challenges of trading in foreign markets. You will find information on the risks involved and how to manage them, required trade documentation, transportation and payment methods.
An international trade transaction: What is involved?
As an exporter or importer, once you’re convinced that you’ve matched a product to a suitable market, there is a general order of events that you can expect to follow for an international transaction.
All trade involves some element of risk, but international trade introduces some additional elements and complications. There are several ways to manage these risks, but you first need to be aware of what you may be facing. Risks may be related to:
• the country you are trading with
• foreign exchange
• choice of trading partners
• terms of trade
• customs, national controls and licences.
The country you are trading with
Some countries are generally regarded as unstable or have poor credit ratings. It would clearly be unwise for a company to trade with such countries on terms that put goods and payments at risk. Risks may be minimised by the use of Documentary Letters of Credit (L/Cs), which should ideally be confirmed by an independent bank (see this guide).
Additional complications can arise if a country suddenly introduces currency controls, restricting the importer’s ability to pay the exporter; it is sometimes possible to insure against this risk, but this is often not cost-effective.
Exchange rates are volatile. If they move in an unfavourable manner, they can have a negative impact on your finances, the cost of imports and the value gained from exporting goods and services. For many businesses, the main issue is the uncertainty of exchange rate movements and the adverse knock-on effects this may have on profitability and cash flow. This is a large concern for companies doing business abroad.
In The Economist Intelligence Unit’s (EIU) report, titled ‘Risk Radar 2011 – How firms are navigating risk’, currency fluctuations are rated as respondents No. 1 risk for the year ahead.
Financial institutions, such as RBS and other banks, can help organisations of all types and sizes with their foreign exchange requirements. From day-to-day currency needs, such as helping to move money between different currencies at competitive rates, or guaranteeing known exchange rates for future transactions, to helping identify the longer-term foreign exchange risks faced. Specialists can work with organisations to help them quantify and manage these risks, leaving them to focus on what they do best – running their business. RBS was ranked number one for foreign exchange among UK corporates in the Euromoney FX poll, 2011.
Choosing a trading partner
Locating a prospective trading partner may be daunting. Some useful sources of information can be found through the following channels:
• Chambers of Commerce, which may be able to point to a relevant source
• trade consulates of foreign embassies, which are often useful avenues of information in finding buyers
• trade fairs, which offer opportunities to meet potential trading partners: informal contact is sometimes more valuable than formal enquiry
• the UK Government, through UK Trade & Investment, has enormous resources and experience.
Successful international trade requires partners who are trustworthy and solvent, as well as willing, so it is absolutely essential that the trader makes all necessary enquiries about a prospective partner. The precise nature of the enquiries depends on the expected value of trade and on the relationship envisaged, but the enquiries should cover the central issues:
• the partner’s integrity, trustworthiness, and reputation
• the length of time the trader has been in business
• whether your trading partner may be considered good for the amount of money involved and the terms of payment.
Terms of trade (Incoterms® 2010)
Trade terms set out the rights and obligations of the parties to a sales contract with respect to the delivery of goods. They define, amongst other things, whether the importer or the exporter will be responsible for arranging the transport and insurance necessary for the delivery of goods. The most commonly used terms, accepted by international practice since 1936, are published by the International Chamber of Commerce (ICC) as “Incoterms®”. The current edition is Incoterms® 2010. Incoterms® are not law and have no direct force of law, but by incorporating them in sales contracts exporters and importers give them legal effect. More can be found on Incoterms®, 2010 in this article.
Non-payment is a problem in any kind of trade, but the problem is worse in export trade because:
• the buyer and seller are in different countries
• the goods end up in a different country from the seller
• it is difficult for the seller to get the goods back again.
Four main payment methods are used in export trade. They overcome these problems to varying degrees and in different ways, and each has implications for the movement of:
• goods and services
• documents connected with the goods or services
• the money due on the sale of goods or services.
The four main methods are:
• advance payment
• open account trading
• documentary collections (or collections)
• Documentary Credits or Letters of Credit.
For each of these four methods, advantages (in terms of mitigating risk) accrue either to the exporter or to the importer. Documentary Credits offer the best balance for both sides of the transaction – for more information on this see this article.
Losses as a result of fraud may potentially harm your business if you are duped into transactions based on fraudulent commercial Letters of Credit and Standby Credits (see Standby Credits in this article).
Fraudsters are always plausible and often seem to come from impeccable backgrounds. You should therefore always be wary about offers of large amounts of business from unknown parties, especially when presented as urgent enquiries requiring instant agreement or lose a once-in-a-lifetime chance of an enormous return. The International Chamber of Commerce’s Commercial Crime Bureau is actively involved in combating this type of fraud and has issued many warnings and publications.
At a transactional level, traders should take advice from their banks and should ensure that the authenticity of L/Cs is verified. All unusual business offers should also be referred to the bank, which should have up-to-date information on such activities.
Customs, national controls and licences
Customs monitor the passage of goods across international borders for a number of reasons, including:
• controlling payment, repayment and remission of any duties or taxes, such as VAT
• checking on licensable, prohibited or restricted goods
• making sure that requirements for transit documentation are met, and
• compiling national and international trade statistics.
Customs also administer special duty schemes, e.g. several countries give preferential treatment to exports of certain goods that originate in the EU, so that an exporter’s customers can pay less import duty or none at all.
Some transactions are controlled in line with the exporting country’s national and strategic interests, and with commitments entered into with the UN and the international community. Controlled goods typically include military goods and equipment, nuclear materials, artefacts that are important to the national heritage, animals and animal products and goods that are subject to international sanctions and embargoes.
A large category of controlled goods in the UK and the EU is goods which have dual uses, i.e. goods that are meant for civil use but that could also be used in developing weapons of mass destruction and missiles to deliver such weapons. The use to which exported goods will (or can) be put, heavily influences the need to control them. For UK exports, all goods linked to weapons of mass destruction programmes are subject to the end-use control, which has a very broad scope. In some cases, exports are also controlled because specific destinations are involved.
Export controls may completely forbid the export of certain goods, or may permit them in defined circumstances, subject to licence. There are different kinds of licences available:
• some licences must be applied for and are subject to individual detailed consideration and to a specific decision that permits or forbids the intended export
• other licences are general permits that allow exporters, in circumstances that the licences prescribe, to make the intended export. For most licences of this kind, exporters must register in advance their intention to use the licence.
On the whole, exports to other EU Member States of highly sensitive dual-use goods are likely to require a specific individual licence. Exports to other Member States of most dualuse goods are likely to be covered by a general licence, for which the exporter must register in advance and keep prescribed records.
UK Government Support
Supported by the UK government, the following schemes can help to add value to your export requirements:
Letters of Credit Guarantee Scheme (provided by ECGD) – When a foreign buyer pays a UK exporter via a Letter Of Credit, the exporter may ask a local bank to ‘Confirm’ (effectively guarantee) the payment. In certain circumstances the bank may not be happy to accept the full risk. Under the Letter of Credit Guarantee Scheme, ECGD will consider guaranteeing up to 90% of the risk, enabling the bank to provide the Confirmation.
Supplier Credit Financing Facility (provided by ECGD) – Under this scheme, the Export Credits Guarantee Department provides a bank with a guarantee against credit or political risks when exporters are required to provide a buyer with an extended period of credit. This could make it easier to obtain credit and may have a positive effect on credit pricing.
Buyer Credit Facility (provided by ECGD) – The Buyer Credit facility is aimed at exporters of capital goods or services. ECGD provides a guarantee to cover a loan issued by a bank to an overseas buyer to finance their UK capital goods/services purchase. The minimum contract value should usually be £5m.
Bonds Support Scheme (provided by ECGD) – Export Credits Guarantee Department assists here by providing a guarantee up to 50% of the value of the bond and up to 80% for advance payment and progress payment bonds.
Export Working Capital Scheme (provided by ECGD) – This scheme is meant to facilitate exporters’ access to working capital finance for specific export contracts by sharing risks with the banks on loans above £1 million.
Enterprise Finance Guarantee Scheme (provided by the Department for Business, Innovation and Skills) – This provides over half of the £1.1 billion paid out nationally. The scheme is designed to provide a government-backed guarantee for up to 75% of a bank loan, but has up until recently excluded loans for export related activity. This has now changed, and will assist exporters by providing a partial guarantee on certain trade finance products.
Export Enterprise Finance Guarantee Scheme (provided by the Department for Business, Innovation and Skills) – The ExEFG is a new loan guarantee scheme, based on the above EFG, but aimed specifically at viable SMEs seeking short term export finance facilities. ExEFG is available to viable SMEs that lack the security to obtain normal commercial export facilities.
These are just some examples of support schemes offered by the government, and you can find out more about government support by contacting either the Export Credits Guarantee Department or the Department for Business, Innovation, and Skills. These schemes are subject to certain conditions.
The UK Government offers several support schemes to help add value to your export requirements