One of the most important elements in international commercial transaction is the currency used for invoicing. Choosing an invoicing currency involves comparing the amount of the invoice billed directly in domestic currency with the domestic currency equivalent of the amount of the invoice billed in foreign currency. Making the comparison is not a straightforward operation. Since payment will be made some time in the future, the spot rate cannot be used in making the comparison because the spot rate can, and probably will, change in the meantime. The forward rate is the obvious solution. In practice, however, the forward rate is not always directly applicable. Take the case where deliveries and invoices will occur several times over year. Applying the appropriate forward rate to each separate invoice implies a different price for each delivery. In this case, an average forward rate would probably be better.
The problem is the same for both the buyer and the seller. If the buyer agrees to be billed in foreign currency, the amount he owes will be exposed to foreign exchange risk. If the seller agrees to bill in foreign currency, the amount he receives will be exposed to foreign exchange risk. One or the other is going to have to cover his foreign exchange risk and they will both have recourse to the same financial intermediaries offering the same products. If markets were completely efficient, the choice of the invoicing currency would be completely neutral. In fact, it is not neutral at all. In the first place, not all companies have access to the same financial products at the same prices. Smaller companies are limited in the products they can use and often pay higher prices for the ones that are available to them. Furthermore, rules and regulations imposed by the monetary and tax authorities can create barriers and supplementary costs. Finally, all companies are not equally endowed with the knowledge and expertise to deal with problems associated with foreign exchange transactions. Thus, companies with the required know-how can offer the financial service of billing in their client’s domestic currency along with the merchandise they are selling and make a profit on both ends.
There can also be speculative element involved in pricing and billing in foreign currency. A professional that follows the foreign exchange market closely is going to form opinions on how different currencies will do. He may feel that some currencies are strong and are likely to appreciate. Others, he may feel, are weak and likely o depreciate. If he has any confidence in his opinions, he will try to take advantage of them by selling in strong currencies and purchasing in weak ones. A word of caution is in order. Most corporate treasures agree that multicurrency invoicing should exclude exotic currencies with narrow markets where financial services are costly or non-existent. Questions
1. Why is an average forward price better than spot rate and forward rate?
2. How do the seller and the buyer avoid to be exposed to foreign exchange risk?
Methods of Making Payments
For international payments, the traditional means of settling debts in a domestic economy such as cash, credit cards and traveler’s cheques, are only relevant for tourism. Bank transfers are probably the fastest and most efficient means of settling international debts. In a bank transfer, the importer instructs his bank to debit his account and credit the exporter’s account at the exporter’s bank. The transfer is made by telex, or SWIFT, which guarantees its speedy execution. The disadvantage of a bank transfer is that it is generated at the initiative of the importer and the exporter and has no guarantee in the cost of non-payment. Consequently, except for cash payments in advance, bank transfers are appropriate only for the most trustworthy relationships.
Checks are another instrument generated at the initiative of the importer. Unlike the bank transfer, however, they are not rapid. First of all, they have to be sent, which takes time, and could get lost in the mail. Furthermore, banks credit foreign cheques only after a long delay due to difficulties in processing and clearing them.
A promissory note is written promise by the importer to pay a given sum on a given date in the future. They play a small role in international trade but are often used as a support to financing operations as in bridge loans, for example.
A draft or bill of exchange is the most common means of payment in international trade. A draft is an unconditional order in writing issued by the exporter, ordering the importer to pay on demand or at a given future date a given sum of money. A draft is usually addressed to the importer or the importer’s agent. It can be payable to a particular beneficiary or to bearer. Bearer drafts are negotiable. When it is paid on demand it is called a sight draft. When it is payable at a future date it is called a time draft.
In most cases three parties involved in the draft. The drawer is the party that draws up the draft, sighs it and sends it to the second party called drawee. The drawer is usually the exporter and the drawee is usually the importer or importer’s agent, or a bank under L/C. The beneficiary of the draft is called the payee. Normally the drawer and the payee are the same.
When the drawee receives the draft, he writes “accepted” on its face, followed by the date and his signature. When this has been done, the draft becomes an acceptance and the party that does the accepting has the obligation to pay at maturity. If the accepting party is a commercial enterprise, it is known as a trade acceptance. If a bank accepts the draft, it is known as a banker’s acceptance. Questions
1. What are the commonly used means of settling debts in international payments according to the passage?
2. What are trade acceptance and banker’s acceptance?
Arbitration
Among the available dispute resolution alternatives, arbitration is by far the most commonly used internationally.
Arbitral award is considered final and binding. While several mechanisms can help parties reach an amicable settlement---for example through conciliation under the ICC Rules of Conciliation---all of then depend, ultimately, on the goodwill and cooperation of the parties. A final and enforceable decision can generally be obtained only by recourse to the courts or by arbitration. As arbitral awards are not subject to appeal, they are much more likely to be final than the judgments of courts of first instance. Although arbitral awards may be subject to challenges, the grounds of challenge available against arbitral awards are limited.
Arbitral award enjoy much greater international recognition than judgments of national courts. About 120 countries have signed The 1958 United National Convention on the Recognition and Enforcement of Foreign Arbitral Awards, known as The New York Convention. The Convention facilitates enforcement of awards in all contracting states. There are several other multilateral and bilateral arbitration conventions that may also help enforcement.
Arbitration is also noted for its neutrality. In arbitral proceedings, parties can place themselves on an equal footing in five key respects: (1) place of arbitration; (2) language used; (3) procedures or rules of law applied; (4) nationality; (5) legal representation.
Arbitration may take place in any country, in any language and with arbitrators of any nationality. With this flexibility, it is generally possible to structure a neutral procedure offering no undue advantage to any party.
Judicial systems do not allow the parties to a dispute to choose their own judges. In contract, arbitration offers the parties the unique opportunity to designate persons of their choice as arbitrators, providing they are independent. This enables the parties to have their disputes resolved by people who have specialized competence in the relevant field.
Arbitration is faster and less expensive than litigation in the courts. Although a complex international dispute may sometimes take a great deal of time and money to resolve, even by arbitration, the limited scope for challenge against arbitral awards, as compared with court judgments, offers a clear advantage. Above all, it helps to ensure that the parties will not subsequently be entangled in a prolonged and costly series of appeals. Furthermore, arbitration offers the parties the flexibility to set up proceedings that can be conducted as quickly and economically as the circumstances allow. Questions
1. What advantages does arbitration enjoy as a means of settling disputes according to the passage?
2. What is The New York Convention, what role does it play in the development of arbitration? 3. According to the article, what factors have helped ensure the impartiality of arbitration?
Letter of Credit Transaction
There may be some uncertainty under L/C payment. Exporters can never totally control the payment process. Documents which are required to be presented under an L/C are frequently prepared by other people, and may not meet the strict compliance standards required by the banking community for payment. Sometimes banks which have not properly ensured they will be adequately reimbursed by their customer, have very narrowly applied L/C principles to deny payment. They have been regularly upheld by courts on grounds that the seller has not strictly complied with the terms of the L/C.
To maximize the chance for payment under an L/C, a seller/beneficiary must know the rules of the game. The rules are codified in a publication sponsored by the International Chamber of Commerce (ICC), known as the Uniform Customs and Practice for Documentary Credits. The latest version of the rules is ICC Publication No. 600, 2006 Revision (the UCP 600).
The rules in the UCP 600 are drafted by and for the banking community. One of the major purposes is to protect the banks from liability in L/C transactions. The banks are providing a service---the financing of the transaction---and they expect to be protected from getting involved in disputes between the parties as to the terms of the sales contract. For this reason, “the independence principle” is a very important concept in L/C transactions. This means that the L/C, and the documents required under the L/C for payment, is completely independent from the underlying transaction between the buyer and the seller.
The bank is not concerned with whether the contract between the buyer and the seller is being performed according to its terms. The bank’s only concern is whether the documents presented by the seller conform to the documents required under the L/C, and whether the documents are presented within the required time periods. The bank employees who examine documents presented under the L/C are essentially clerks. Their job is not to make judgment calls, but simply to see if the documents presented by the seller/beneficiary comply strictly with the documents required by the L/C. It is therefore very important to assist clients in understanding the rules, because a lack of knowledge will only work to their detriment. Questions
1. Why is it difficult for the seller to have total control on L/C?
2. What institution sets the rules governing letter of credit and what is the name of the rules? 3. What is the bank concerned with in letter of credit transactions?
Ocean Bill of Lading
Ocean freight is the most widely used form of transportation in international trade. It still has the attraction of being a cheap mode of transport for delivering large quantities of goods over long distances.
The ocean bill of lading is an extremely important document that serves three purposes. It is a cargo receipt issued by the shipping company to the shipper; it is also a document of title of the goods; finally, it forms the evidence of a contract by the shipping company to carry the goods from the port of shipment to the port of destination.
The exporter obtains the bill of lading from the shipping company and completes it himself or gets his freight forwarder to do it. It is then returned to the shipping company. Bills of lading are usually made out in sets, which consist a number of originals (usually three) and a number of copies.
The originals are signed by the shipping company and therefore become the negotiable title to the goods that the bill of lading covers. Each original is negotiable, but once one has been negotiated the others are void.
When the goods are loading on board the vessel, the shipping company checks the details on the bill and hands it to the exporter. As soon as the bill of lading is received by an exporter, he must
arrange it to be sent to his customer. The exporter can mail the bill to the customer---either direct or through a bank, depending on the method of payment.
If the handling over of the bill of lading is linked with a term of payment, it is important that all originals are kept together. When payment is arranged under a documentary credit, the terms of credit usually state that the bill of lading must be clean, shipped, in order and blank endorsed. This means that the goods must be in apparent good order, be loaded on board the stated vessel and that the bill gives title to any bearer. Great care must be taken to see that this legal document is made out in the proper way. Questions
1. What are the three purposes that an ocean bill of lading serves?
2. Once an original copy of bill of lading has been negotiated, what will happen to other originals? 3. Please briefly describe the process of using the bill of lading.
4. What kind of bill of lading is generally required by the bank for negotiation?
Principles of Insurance
It is important that insured should have a basic understanding of some of the underpinning principles of insurance generally, and particularly their implications to cargo insurance. Insurable interests
The principle of insurable interest is a vital one to all forms of insurance. In order to take out a policy the policy holder must have an insurable interest in the insured matter. In the case of cargo insurance this means that they must benefit from the safe arrival of the goods or be prejudiced by their loss. Without such a principle it would be possible for any individual to take out an insurance policy on any eventuality they could think of. It is also necessary to prove insurable interest in order to make a claim against a policy and this can pose a problem if the claim is actually made by a non-policy holder. Indemnity
Most insurance is based on the fact that the insurers promise to indemnity the insured. That is, they promise to put them back into the situation they were in before the loss. It is obviously not a principle of life insurance. In practice the indemnity on cargo insurance policies is expressed as an amount of money, the insured value of the goods. Utmost good faith
Once again this is a principle which applies to all forms of insurance. The insurers are almost totally dependent on the insured to disclose any relevant information regarding the insured risks. Subrogation
In the event that loss or damage occurs due to an insured risk then a claim will be made on the insurance company. If we assume that the claim is successful then the insured will regard the matter as closed. However, if nothing else happens but we have a carrier, who may well be liable for the loss or damage, who has apparently avoided any liability. It is the principle of subrogation which avoids this, in that it allows the insurance company to take action against liable carriers in the name of the insured. The exporter, or the importer, must maintain any rights of action against carriers, by avoiding giving clean receipts and advising loss or damages as soon as possible, but these rights are subrogated to the insurance company once the claim has been paid. It is very fair to the insured in that the claim must be paid first. The insurance company cannot make a claim on the carrier and only pay the insured if the action against the carrier is successful. The insured will have a valid claim irrespective of the carrier’s liability. Also, in the unlikely event that the insurers actually receive more in their claim on the carrier than they have paid to the insured, then the insured receives the difference. Proximate cause
It is perfectly reasonable for insurance companies to prefer that claims are made for loss or damage due to risks which are actually covered by the policy. In fact many claims fail simply because the cause of the loss is not an insured risk. When a loss occurs it is often the result of not one clear event but of a series of events which, cumulatively, lead to a loss. What the insurers must do is to