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Trade Finance InfrastructureDevelopment Handbook forEconomies in TransitionUnited NationsESCAP

Trade Finance InfrastructureDevelopment Handbook forEconomies in TransitionUnited NationsNew York, 2005

Trade Finance Infrastructure DevelopmentHandbook for Economies in TransitionUnited Nations publicationSales No. E.05.II.F.30Copyright United Nations 2005All rights reservedManufactured in ThailandISBN: 92-1-120443-7ISSN: 1020-3516ST/ESCAP/2374The opinions, figures and estimates set forth in this publication are the responsibilityof the authors and should not necessarily be considered as reflecting the views or carryingthe endorsement of the United Nations.The designations employed and the presentation of the material do not imply theexpression of any opinion whatsoever on the part of the Secretariat of the United Nationsconcerning the legal status of any country, territory, city or area, or of its authorities, orconcerning the delimitation of its frontiers or boundaries.Mention of firm names and commercial products does not imply endorsement bythe United Nations.Bibliographic and other references have, wherever possible, been verified.

iiiForewordThis Handbook is one of the products developed under a three-year project fundedthrough the United Nations Development Account and aimed at building the capacity ofselected ESCAP member countries with economies in transition in the area of trade andinvestment, with a view to enabling them to respond more effectively to the challenges andopportunities emerging from the globalization process.As part of this project, a series of eight national training workshops on tradefinance infrastructure development were held in Central Asia, the South Caucasus andMongolia. Most of the training material developed for these workshops is summarized inthis Handbook and an accompanying CD-ROM.The Handbook is targeted mainly at officials from ministries in charge of trade whoneed to acquire a basic understanding of trade finance and the importance of tradefinance infrastructure development. Information provided in the Handbook may help tostrengthen the trade finance aspects of national trade development strategies and tofoster a better understanding of the issues and mechanisms that may need to be discussedwith officials in charge of financial sector regulation and supervision.On the other hand, the Handbook may also provide a platform for financial systemregulators to better understand the point of view of trade officials and traders and theirneeds. Selected chapters may also be of interest to officials from ministries or agencies incharge of information and communication technology with the main responsibilities ofdeveloping e-commerce, online banking and e-payment systems.The first a chapter provides a general introduction to trade finance and tradefinance infrastructure development, and an overview of trade finance methods and instrumentsis given in chapter II. Legal issues and conventions related to the main trade financeinstruments are discussed in chapter III, and chapter IV is dedicated to structured tradeand commodity finance. The relationship between trade finance and the macroeconomicenvironment is examined in chapter V and the importance of institutions for trade financedevelopment is highlighted in chapters VI. Issues related to international payment systemsand e-trade finance development are addressed in chapters VII and VIII. The Handbookconcludes with a proposed trade finance infrastructure development framework based onITC trade finance pointers methodology and inspired by the ESCAP Trade FacilitationFramework.This Handbook is the result of close collaboration between ESCAP and a numberof international organizations that provided relevant expertise and knowledge. Mr. LeeYow Jinn, ESCAP consultant and Senior Adviser at the International Trade Institute ofSingapore contributed most of the two introductory chapters as well as the chapters onpayment system development and e-trade finance. Mr. Carlo Cattani, Senior Trade FinanceAdviser, and Mr. George Mills, Consultant, both from the International Trade Centre UNCTAD/WTO contributed most of the material presented in chapters III and IV. Mr. Lamon Rutten

ivand Ms. Frida Youssef, both from the Division on International Trade in Goods and Services,and Commodities of the United Nations Conference on Trade and Development, contributedthe chapter on structured trade and commodity financing. Finally, Mr. Yann Duval, ESCAPTrade and Investment Division, provided overall coordination and guidance for the preparationof the Handbook and contributed chapter VI.

vCONTENTSPageFOREWORD .I.AN INTRODUCTION TO TRADE FINANCE .A.B.C.D.E.F.II.III.1Introduction .Trade finance and trade development strategy .Importance and benefits of trade finance .Trade finance infrastructure development .Trade finance and international organizations .For further reading .1134610TRADE FINANCE METHODS AND INSTRUMENTS: AN OVERVIEW11A.B.C.D.E.Introduction .Methods and instruments to raise capital .Methods and instruments to manage risks .Terms of payment .For further reading .1112131621TRADE FINANCE METHODS AND INSTRUMENTS: LEGAL ISSUESAND CONVENTIONS .23A.B.C.D.E.F.G.H.I.J.IV.iiiIntroduction .Trade credit legal issues .Documentary credit legal issues .Documentary collection legal issues .Leasing legal issues .Legal issues related to the assignment of receivables, factoringand forfaiting .Legal issues related to financial risk management instruments .Legal issues related to international payment terms andmodalities .Conclusion .For further reading .23232425262729313636STRUCTURED TRADE AND COMMODITY FINANCING .37A.B.C.D.E.F.G.37373840454747Introduction .What is structured trade and commodity financing? .Export receivables-backed financing .Inventory/warehouse receipt financing .Pre-payment financing .Conclusion .For further reading .

viCONTENTS (continued)PageV.VI.TRADE FINANCE AND THE MACROECONOMIC ENVIRONMENT:POINTERS .49A.Introduction .B.Determinants of trade finance availability and development .C.ITC Trade Finance Pointers: an overview .D.Conclusion .E.For further reading .Annex ITC trade finance survey questionnaire .494954595960INSTITUTIONS FOR TRADE FINANCE DEVELOPMENT .69A.B.C.D.Introduction .A national trade finance institutional structure model .Financial sector dynamics in newly independent States .A favourable macroeconomic environment as a prerequisiteto the implementation of the TFIS model .Conclusions and recommendations .For further reading .696978PAYMENT SYSTEM DEVELOPMENT .85A.B.C.D.E.F.G.Introduction .Delivery channels .Payment methods .Clearing house and bank-to-bank payment .Payment system legislation .Conclusion .For further reading .85868992959696E-TRADE FINANCE INFRASTRUCTURE DEVELOPMENT ion .Main features of e-trade finance systems .Benefits of e-trade finance .E-trade finance models .Phases in e-trade finance infrastructure development .E-trade finance development challenges .Conclusion .For further reading .979899100102105109110TOWARDS A FRAMEWORK FOR TRADE FINANCEINFRASTRUCTURE DEVELOPMENT .111

viiCONTENTS (continued)PageLIST OF BOXES1. Islamic Development Bank .ADB programmes for SME trade finance development in Pakistan .The Asian Clearing Union .79102. transaction with credit guarantee: An example .Some best practices for advance payment .Some best practices for open accounts .Some best practices for collections .Some best practices for letters of credit .15161718203.1.3.2.Areas not covered by the UCP 500 .Risk transfer and Incoterms 1990 .25344. finance for Kazakhstan’s Food Contract Corporation .Public vs. private warehouses .Reserve-based lending facility in Turkmenistan .3942456. Bank of India and Trade Finance .Facts about COFACE, EFIC and ECGC .The EXIM Bank of Thailand .7274757. electronic funds transfer services of the Tunisian Post .OCBC Bank’s Velocity online banking service .NETS, an electronic payment service provider in Singapore .SWIFT messaging system .Purchasing cards for the United Kingdom .Using debit cards for warehouse receipt financing in India .Singapore Automated Clearing House .Laws and by-laws in Singapore on payment systems .86878889909194958. loan services for SMEs in Hong Kong, China .DBS Bank – IDEAL .NETS and China Union Pay linkup .Certification authorities: the experience of Singapore .100101105108

viiiCONTENTS (continued)PageLIST OF TABLE9.1.Diagnosis of the financial sector for trade finance .112LIST OF FIGURES1.1.Trade development strategy . .Trade cycle and trade finance methods and instruments .Risks in international trade and mitigation methods .Documentary collection process .Letters of credit .Comparison between various terms of payment .11131919214.1.Warehouse receipt mode of operation .415. .Macroeconomic environment and trade finance .Ten determinants of trade finance access and availability .Kazakhstan 2002 Trade Finance Pointers chart .Long-term debt as a percentage of gross national income .Kazakhstan 2002 ready reckoner chart .50505557586. structure of the financial sector in Malaysia .Proposed national trade finance institutional structure model .Stages in the development of banking sector and trade financeinstitutions in transition economies .70717. .Payment system infrastructure overview .A typical clearing house scheme overview .Typical SWIFT payment using correspondence banking .8593938.1.Stages in e-enabling financial services .10379

ixLIST OF ABBREVIATIONSACUADBAFTAASEANAsian Clearing UnionAsian Development BankASEAN Free Trade AreaAssociation of Southeast Asian NationsB2Bbusiness-to-businessCISCommonwealth of Independent StatesD/AD/Pdocuments against acceptancedocuments against paymentEBRDECGFECIEDCEDIEFTPOSESCAPEXIM BankEuropean Bank for Reconstruction and Developmentexport credit and guarantee facilityexport credit insuranceenterprise development corporationelectronic data interchangeelectronic fund transfer at point of saleEconomic and Social Commission for Asia and the Pacificexport-import bankFDIFIDICForeign direct investmentInternational Federation of Consulting EngineersGDPGNIgross domestic productgross national incomeICCICTIMFIOBISDAISPITCInternational Chamber of Commerceinformation and communication technologyInternational Monetary FundInternet-only bankInternational Swaps and Derivatives AssociationInternational Standby PracticesInternational Trade Centre UNCTAD/WTOL/CLIBORletter of creditLondon Inter-Bank Offer RateMASMonetary Authority of SingaporePKIpublic key infrastructure

xSMESOESTCFSTESWIFTsmall and medium-sized enterprisestate owned enterprisestructured trade and commodity financingstate trading enterpriseSociety for Worldwide Interbank Financial TelecommunicationTFISTPOtrade finance institutional structuretrade promotion iform Customs and Practice for Documentary CreditsUnited Nations Commission on International Trade LawUnited Nations Conference on Trade and DevelopmentInternational Institute for the Unification of Private LawUniform Rules for CollectionUniform Rules for Contract BondsUniform Rules for Demand GuaranteesWTOWorld Trade Organization

1An introduction to trade financeI. AN INTRODUCTION TO TRADE FINANCEA. IntroductionInternational trade, the cross-border exchange of goods and services, is now widelyacknowledged as an important engine of growth in most developing and transition economies.The recent ministerial meetings of WTO have further demonstrated the importance ofinternational trade and investment flows, with many developing economies joining handsto vigorously defend their interests in this area. While countries need to actively engage innegotiations with others to create a favourable international environment, each must alsoensure that its domestic environment is favourable to trade development.Whether the domestic environment is favourable can ultimately be measured bythe economic cost of importing or exporting specific goods and services into or from thedomestic market. In most economies, major transaction cost factors would includetransportation and financing (including insurance) as well as red tape. Unpredictable and/or uncompetitive transportation, financing or procedurals and documentation costs can allbe formidable barriers to trade for SMEs.The financing of trade and investment has long been identified as one of the mostchallenging issues faced by new enterprises and SMEs in developing or transition economies.The issue of financing is particularly important, as financing is needed not only during theexport process itself, but also for the production of the goods and services to be exported,which may include imports of raw material or intermediate goods. Lack of financing at anytime during the production and/or the export process will result in a failed transaction.B. Trade finance and trade development strategyTo understand the significance of trade finance, it is important to view it in thecontext of an overall trade development strategy whose purpose is to develop and expandsustainable trade flows to support the country’s economic development.Figure 1.1. Trade development strategyTRADE DEVELOPMENT EDEVELOPMENTTRADEPROMOTIONTRADE RELATIONSMANAGEMENT

2Trade Finance Infrastructure Development Handbook for Economies in TransitionFigure 1.1 suggests that a comprehensive trade development strategy includesfour main components, with trade finance issues being addressed as part of trade facilitationand infrastructure development. Key elements of the strategy are discussed below.Trade relations managementInternational trade relations management involves developing cordial trade relationswith other countries to safeguard a country’s trade interests and to ensure market accessfor its products and services. It also involves responding to restrictions placed on productsby importing countries. Trade negotiations may be conducted at three levels, namelybilateral, regional (e.g., ASEAN free trade area, AFTA) and multilateral (i.e., WTO).Trade promotionTrade promotion consists of pro

and e-trade finance development are addressed in chapters VII and VIII. The Handbook concludes with a proposed trade finance infrastructure development framework based on ITC trade finance pointers methodology and inspired by the ESCAP Trade Facilitation Framework. This Handbook is the result of close collaboration between ESCAP and a number

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