<http://blogs.officialexportguide.com/special/?p=11> April 2008

### 

### Tips for Competitive Payment Terms in Global Markets: The U.S. Small Business Administration Has Help for Small Exporters *by Inga Fisher Williams* 

When the Monte dei Paschi Bank of Sienna, the fourth largest bank in
Italy today, issued the first Letter of Credit in 1646, it could not
have anticipated the role that this financial instrument would come to
play in global trade. According to the World Trade Organization (WTO),
the dollar volume of trade has doubled in the last decade and quadrupled
over the past 20 years. The volume of international payment advisories
routed through banks is now around one and a half billion a year and
growing.Letters of Credit (LC) have evolved and adapted over hundreds of
years; they are a recognized and well-known tool in processing
international payments. Their importance is undisputed, although today
they are no longer the only method for settling international accounts
and often may not even be the one best-suited. As technology and
competitive factors erode the volume of their use, letters of credit are
nevertheless known even to the most unseasoned small exporter. Small
exporters' contribution to U.S. trade is around 30 percent of total U.S.
exports, which reached \$1.6 trillion in 2007. With around \$500 billion
worth of annual exports, small U.S. businesses are players in the global
market. They may not have at their command all the details of the UCP
600 (revised rules for letters of credit that became effective January
2006). Nor may they be knowledgeable in how to structure an LC properly
so that risk is truly mitigated. But after open account terms, the LC is
their favorite means of getting paid for export sales. Lacking
information about alternatives, how can small firms adapt their
practices to the modern market?

To be fair, the knowledge related to established practices and
terminology of export financing is not integrated in the United States
in nearly the same degree and at all levels of business as it is in
European countries, where exporting has been practiced for profit ---
and as a survival technique --- for decades. Globalization, however, has
thrown small businesses into this arena for good. It's sink or swim,
and, thanks to the Small Business Administration (SBA) export finance
staff distributed across the country in regional [U.S. Export Assistance
Centers](http://www.sba.gov/aboutsba/sbaprograms/internationaltrade/useac/index.html),
there is a life preserver. Small exporters can get help from SBA in
learning about [key
ingredients](http://www.sba.gov/idc/groups/public/documents/or_portland/or_exportfaqs.pdf)
for success in international trade and what ***is*** important in the
practice of using a 350-year old convention for settling international
accounts.

### How To Get Paid

It is not uncommon for small businesses to begin exporting in response
to an unsolicited inquiry, not by any design or plan. How to get paid is
one of the central, immediate questions for start-up exporters. Because
they are inexperienced in export practices and risk-averse, they
frequently opt for getting paid in advance. But there are other options.

Trade transactions are usually divided into traditional (LC, documentary
collections, etc.) and open account terms. The LC, formally a
"documentary Letter of Credit," is estimated to be used today in 10-12%
of international settlements arranged through banks. When an LC is used,
the buyer's bank steps into the place of the payment risk of the
importer and promises payment, if the exporter abides by the terms and
conditions of the Letter of Credit. Since it is essentially a
bank-to-bank transaction, the LC language is designed and formed by
bankers. Knowing how to "read" an LC and how to advise the buyer on the
preferred structure and language is a technical skill that used to be
provided by the international trade services division of major
banks.However, amid the consolidation of the banking industry, pressures
for market share and profitability, and the centralization of services,
the formerly customary "call-your-local-banker" method for finding this
information is likely to fail. Small businesses' access to LC guidance
from the international divisions of trade banks has largely disappeared.
But SBA's export finance staff in the Export Assistance Centers are able
to fill this advice gap. Aside from the technical aspects of using an
LC, SBA staff can also help an export business focus its use of LCs on
suitable customers and current country risk. As a traditional risk
mitigation tool, LCs are a payment method well-suited to first-time
customers, sizeable transactions, and markets with a less-developed
platform for credit checks or payment infrastructure.

### LCs in the Digital Age

LCs' diminishing share of international payments is a trend that still
continues. In early 2007, SWIFT ([Society for Worldwide Interbank
Financial Telecommunication](http://www.swift.com/)**,** which provides
a bank platform for secure communications) trade volumes overall
increased 15%, while the SWIFT trade volume for LCs rose only 2.4%. As a
bank-to-bank process, LCs are subject to the need for cost savings in
operations, which drives the move toward digitization and high-speed
telecommunication. In the last decade a great variety of "e-tools" has
emerged to adapt LCs and international payment methods to the new
high-tech world:

-   *Bolero.net* built an infrastructure for the exchange of documents,
    aiming to eliminate the bane of LCs: discrepancies. It has also
    added some functionality for payments to its service.

-   *Actrade*, the oldest of the innovators, started in 1987 by selling
    electronic trade acceptance drafts, targeting buyers who need trade
    credit.

-   *Avantrust* began in 2001 as a joint venture of Dun & Bradstreet and
    AIG Insurance. It focused on providing credit approvals and
    assurance of payment in the electronic marketplace by offering a
    search for credit scores and combined that information with
    proprietary formulas for underwriting.

-   *TradeCard,* with its strategic partner, Coface, and an alliance
    with MasterCard, began with a focus on trade between North America
    and Asia, expanding its global trade to Europe. Both the buyer and
    seller must be registered as users, and, as for many of the other
    tools, they must have invested in the necessary infrastructure to
    have access to the electronic platforms.

-   *LC Connect* is also betting on the survival of the LC with its
    electronic process for soliciting bids and pricing from bank groups.
    LC Connect functions as a gateway and matchmaker to link companies
    with banks.

As banks embrace browser technology, the use of the LC may undergo
continued makeovers. At this stage, the market is fragmented, and no
clear winner for a standardized adaptation has emerged. For most small
businesses, these innovations are not suitable or cost-effective due to
the large up-front investment required to establish access to the
proprietary platforms. The banking system itself will continue to
undergo changes globally as market and regulatory mandates impact how it
is structured. One European development to watch is SEPA (the Single
European Payment Area), which took effect in January 2008 and will
facilitate standardized payment instructions within 31 countries in the
European region.

The move to open account terms has left banks with no real product and
with shrinking opportunities for generating revenues. If it were
possible to begin with a clean slate, how might process, platforms, and
customs for payment tools and flows be designed today? Major issues of
flexibility, security, regulatory compliance, efficiency, and speed may
determine the shape of payment flows in the future. One use of the LC is
certain to continue, if for no other reason than lack of an alternative.
Standby Letters of Credit (SBLCs) remain very useful for down-payment
guarantees and performance or bid bonds. There also is a trend to use
LCs in the form of SBLCs in support of open account supply chain
financing, mostly on the import side.

### A Nuanced Credit Policy Is a Must

Estimates in the industry are that 80 % of global trade is today
conducted on open account terms. Evidence of the shift from letters of
credit to open account is provided by the volume of messages in the
SWIFT system. According to BAFT ([Bankers Association for Finance and
Trade](http://www.baft.org/jsps/)), SWIFT payment volumes increased
almost 75% in the 5 years from 2001 to 2006, from 929 million to nearly
1.6 billion, while SWIFT volumes tracking Letters of Credit remained
relatively flat, growing by 10%, from around 43 million messages in 2001
to about 47 million in 2006.

Small businesses can leave much business on the table if they insist on
Letters of Credit. In many emerging markets, their best trading partners
may be too small or too new as a business to be able to muster the
financial strength that LCs require. In well developed markets,
furthermore, it is a distinct disadvantage to require an LC when the
competition is offering open account terms. Even in markets where
previously it was unthinkable to use anything but LCs (i.e., China),
open account transactions are growing in popularity.

Exporters who use this trend to their advantage will open up their trade
terms as a competitive sales strategy, while export companies that rely
on one single payment term will find their sales prospects limited. A
nuanced credit policy is a must. Its development needs to take into
account internal factors, i.e., the financial strength of the company,
its appetite for sales growth and risk exposure, and profit margins, and
it should include parameters for offering extended terms that help sales
staff in making appropriate offers. Ideally, the entire management team
should be included in producing a set of standards for extending credit.
Among external considerations, the company's global strategic position,
competitive industry standards, buyers' preferences, regional standards,
cost comparisons and convenience need to be factored in as well.

The role of credit risk insurance cannot be overlooked in this context.
Foreign receivable insurance (see
[www.sba.gov/idc/groups/public/documents/or_portland/or_exportcreditins.pdf](http://www.sba.gov/idc/groups/public/documents/or_portland/or_exportcreditins.pdf)),
long accepted in Europe, has generally not been much used by U.S.
companies in the past. Estimates are that over 40% of European
exporters, but only 5--10% of U.S. exporters, utilize it. This lack of
use can in part be attributed to the past dominance of U.S. traders in
global markets and their ability to dictate terms. For the most part,
however, it is simply not well known that credit insurance can mitigate
the commercial and political risks of non-payment in export sales. This
is beginning to change**:** the Export-Import Bank of the United States
has reported that its Small Business Credit Policy is one of its fastest
growing products. Available to SBA-defined small businesses with up to
\$5 million in annual export credit sales, the Ex-Im Bank
[policy](http://www.exim.gov/products/special/smallbus.cfm) offers
insurance for multiple buyers at very competitive rates. When it is
combined with an SBA export working capital loan, Ex-Im Bank will
discount the insurance premium by 25%, reducing the fee from 65 b.p. to
49 b.p. on the invoiced amount. The insurance industry's private sector
providers, such as Coface, Atradius, AON, Euler Hermes, etc., have
adapted to global market demands with modified, customized products that
allow streamlined models for efficient mitigation of commercial and
political risk. Lists of the specialized brokers for these products can
be obtained from the SBA export finance staff in Export Assistance
Centers.

Added benefits for the small businesses that use credit insurance come
in the form of increased liquidity and competitiveness. The exclusion of
foreign receivables from a firm's borrowing base --- a long-established
practice of banks in the United States --- presents a handicap that many
small exporters may not even be aware exists. They typically rely on a
line of credit for working capital that may not be adequate to support
the longer payment cycles of international transactions. Given current
bank practices, the more the exporter's foreign sales grow, the greater
the percentage of its receivables are deducted from what is often its
principal business asset. Risk insurance turns receivables into a
valuable asset, since banks are willing to lend against insured export
receivables. Moreover, the competitive business posture of being able to
meet industry terms is likely to play itself out in increased sales
opportunities and volume for the small business.

### Financing Growing Export Sales

Access to financing consistently shows up among the top three obstacles
to exporting, in nearly every survey of small businesses that could
export but do not do so yet, or of firms that are in the early stages of
their export development. The most common error of start-up exporters is
to look for export financing in the international division of a bank.
This intuitive approach runs counter to the evolution of U.S. banking
structures, where these days the international divisions provide mainly
trade service, i.e., services related to Letters of Credit, foreign
exchange, hedging, etc. Although some of the larger banks still offer
export / import lending in their international divisions, their customer
focus is largely corporate and the preferred transactions typically on
the larger side.

Loan-making for international transactions has largely shifted to the
domestic side of the house in regional banks and, at community banks
which lack an international division, that is where it has been all
along, assuming the bank is willing to consider lending on transactions
that are not domestic. The SBA has a well-developed distribution system
of SBA lenders to aid early-stage exporters in finding a banking
relationship that will support their expanding export sales. Moreover,
with two export loan programs, the SBA has added capacity to its
[financing
support](http://www.sba.gov/aboutsba/sbaprograms/internationaltrade/index.html)
of small businesses in the start-up and expansion stages.

Adequate working capital, a critical need for small emerging exporters,
is frequently not considered until they are ready to sign the export
contract. The demands of a longer cash cycle, inadequate supplier terms,
and limited cash from earnings or a line of credit, especially when
combined with an insufficient track record to qualify for bank
financing, will make the cash crunch apparent. The SBA [Export Working
Capital (EWCP) loan
program](http://www.sba.gov/services/financialassistance/SpecialPurposeLoans/ewcp/index.html)
is designed for just such a scenario. Whether needed as supplier
financing, for the production of goods, or as working capital to support
extended payment terms, these SBA guaranteed loans can provide up to \$2
million in financing for export sales. For smaller transactions or
export expansion costs that are not eligible for EWCP financing, SBA is
piloting its [EXPORT EXPRESS loan
program](http://www.sba.gov/services/financialassistance/SpecialPurposeLoans/exportexpress/index.html),
which has a \$250,000 loan maximum and has the advantage that its loans
can be approved directly by participating SBA Express lenders.

### SBA Offers Export Finance Expertise

Touted as a One-Stop Shop for U.S. exporters, the U.S. Export Assistance
Center network built on the platform of the offices of the [Commercial
Service](http://www.buyusa.gov/), U.S. Department of Commerce (DOC), has
integrated SBA export finance specialists in 19 regional locations. For
more than a decade, this joint venture of federal agencies has linked
the marketing expertise of DOC trade specialists with the finance savvy
of highly specialized SBA export finance staff. The infusion of finance
expertise works on multiple levels: in integrated customer service to
U.S. exporters, in inter-agency cross training and collaborative
seminars, and in advocacy with community banks that have SBA divisions
but are not yet offering export financing in their menu of SBA loans for
small business customers.

A central aim of the Export Assistance Centers is to demystify
international market entry, logistics, shipment documentation, and
payment conventions. It is in the financial aspects of exporting that
SBA staff make the difference. They not only are able to guide exporters
through the SBA loan application process, if their internal working
capital is not adequate, but are able to function like consultants to
advise, teach, and pass on knowledge of emerging trends that help a
small business position itself for success in global markets. Together
with DOC colleagues and industry speakers, SBA export finance staff
teach seminars where they share information regarding credit policy, due
diligence practices and strategic consideration for negotiating terms,
etc. --- in short, all those tools that increase a company's expertise
and expand its options in the decision-making process toward export
expansion.

To find the SBA export finance staff for your state, consult the SBA's
online [list of Export Assistance
Centers](http://www.sba.gov/aboutsba/sbaprograms/internationaltrade/useac/index.html).

![](media/image1.jpeg){width="0.75in" height="0.75in"}

*Inga Fisher Williams is the Regional Export Finance Manager of the U.S.
Small Business Administration, based in the Portland Export Assistance
Center. She can be reached at <inga.fisherwilliams@mail.doc.gov> or
503.326.5498.*

> See also an online library for exporters in Idaho at
> http://www.sba.gov/localresources/district/id/ID_ITRESOURCES.html