Risk and Insurance

TFG Risk and Insurance Guide

Trade Finance Global / Risk and Insurance

Risk and Insurance

Transactions across international borders are fraught with risk and complexity. Faced with this, many firms and investors can baulk at engaging in such transactions, even when they know them to be profitable, valuable enterprises. Through its array of insurance and guarantee products, Trade Finance Global can secure international commercial contracts and mitigate risks to investment.

Featured Insights

PODCAST: U-shaped recovery – ICISA’s Richard Wulff on trade credit insurance and its bounce back from the pandemic Like many products within trade finance, trade credit insurance has endured serious volatility during the last 12-18 months, thanks to the COVID-19 pandemic.
Video Paul Coles FT Im ITFA market practice update- Structured LCs, MRPAs, the LIBOR transition VIDEO: ITFA market practice update – Structured LCs, MRPAs, the LIBOR transition The world’s most important number is changing, and traders need to be aware of its implications.
ICC Trade Register ICC Trade Register 2021 – 6 top takeaways and the low-risk nature of trade finance as an asset class The 2021 ICC Trade Register summary, on the credit risk profiles of trade finance, supply chain finance and export finance transactions. Read our summary on 38m transactions representing USD $19.2t exposures, and 28% of global trade flows.

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Risk & Insurance – Frequently Asked Questions

What are the most popular risk & insurance products
  • Guarantees – binding financial agreements between contracting parties and a third party which guarantee that contractual obligations will be met, and that financial penalties will be incurred if not.
  • Bonds – Flexible financial products underpinned by guarantees which ensure financial reparations to the bond holder if contractual obligations are not met.
  • Credit Insurance – A core financial product underpinning the import and export of goods across international borders whilst mitigating financial risk to both buyer and seller.
  • Sureties – A guarantee to protect investors against direct loss of investment in the event of a complete failure to fulfil contractual obligations (such as insolvency).
  • Claim Management – The process by which any claim against an insurance or guarantee product is handled by a bank or third party agent.
What is trade credit insurance?

Companies engaged in international trade of goods often use trade credit insurance to protect the receivables involved in their transactions from credit risks such as non-payment of goods, invoices and other debts. When working across international jurisdictions with new suppliers, these risks can be exacerbated. As such, trade credit insurance helps protect and mitigate risk for exporters of credit loss and non-payment.

What is political risk insurance?

Political risk insurance is a specialist type of insurance which provides financial protection to investors and businesses in the event of losses incurred as a result of action by a government against them, or by events deemed “political” in nature. Simple political risk insurance protects against direct government activity which proves harmful, such as intervention against a business to expropriate or nationalise assets owned by that business in their territory, or refusal to convert or repatriate local currency. More complex political risk products can insure companies against losses incurred by more general political events, such as political violence, civil wars, or sovereign debt defaults.

How does insurance facilitate trade and trade finance?

International trade across national borders creates numerous risks and complexities for exporters and importers. In particular, operating across geographic distances between two separate legal, trade and political jurisdictions can make investors, lenders and traders nervous about the risks posed to their investments. In a domestic transaction, if one contracting party fails to fulfil their obligations – they take payment without producing goods, they deliver late or faulty goods, or declare insolvency – the other contracting party can pursue matters through the domestic court system. However, in international transactions, this can be much more complex. Moreover, the value of international trade transactions tends to be much greater than domestic trades.

Insurance and guarantees can mitigate against these risks by using a trade finance partner (such as a bank) as a broker and agent between the contracting parties to ensure these risks do not become issues, and to resolve issues when they arise. In doing so, these products provide the buyer certainty that when issues occur, their investments, money and business are safe. Moreover, in their role as facilitators, trade financiers can help facilitate trade finance by managing payments and documents between parties to ensure secure, trust-based transactions are conducted.

How does credit issuance work?

Credit issuance is the process by which importers guarantee to exporters that they will pay them in full once the conditions of the contractual agreement between them are fulfilled.

Commonly, the actual issuance of credit is made to and from third party banks or trade financiers assisting the two transacting parties, using a financial instrument known as a letter of credit.

For example, UK toy trader Party A wishes to buy $1m of toy cars from Chinese toy car maker Party B. Party A does not want to pay $1m until it is proven that the toy cars have been made to the correct standards and shipped to the UK. Party B does not want to make the toy cars without assurance of payment from Party B.

Using two third party banks, a credit issuance can be made to Party B guaranteeing that Party A will pay Party B once the toys are made and shipped. Once Party B ships the toys and provides the appropriate documentation (such as a Bill of Lading), Party A makes their payment to their trade financier, who passes the money through Party B’s trade financier to Party B.

For more information, visit our Credit Issuance page.

How does a surety bond work?

A surety bond is a specific type of guarantee used by contracting parties to provide surety in the event of one party entering insolvency. If two parties agree a contract underpinned by a bank providing a surety, then that bank guarantees to pay one party if the other party fails to fulfil their contractual terms, usually due to them ceasing trading.

For example, UK toy trader Party A wishes to buy $1m of toy cars from Chinese toy car maker Party B. Party B asks for the payment up front, which Party A is apprehensive about as they are not based in China and do not know the supplier or the Chinese legal system well. As such, Party A purchases a surety on their contract; if Party B is to become insolvent whilst the toys are being produced, the bank providing the surety will pay Party A their $1m. The bank will then pursue Party B for the $1m reparations payment.

For more information, visit our Surety page.

What is a guarantee?

A financial guarantee is a non-cancellable ‘promise’ backed by a bank, insurer or other third party. The guarantee underwrites a contract by guaranteeing to make payments to one party in it if the terms of the contract are not met by the other party.

Guarantees can take many forms depending on the nature of the contract. They can support contractors bidding for work; buyers required to make advance payments; importers needing performance guarantees; and even maintenance or warranty periods on purchased goods (such as machinery). However, all guarantees work as separate agreements to a contract, and are strictly focused on the compliance or non-compliance with the terms of that contract.

For more information, visit our Guarantee page.

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About the Author

Trade Finance Global (TFG) assists companies with raising debt finance. While we can access many traditional forms of finance, we specialise in alternative finance and complex funding solutions related to international trade. We help companies to raise finance in ways that is sometimes out of reach for mainstream lenders.

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