Trade bonds are a globally accepted mechanism of trade financing which help to drastically reduce the risks of international trade. In particular, bonds are frequently used by exporters to guarantee their business activities when working with trade partners abroad. To secure the transaction detailed in the parties export contract, trade financiers will issue a bond on behalf of the exporter to their international buyer or, where appropriate, a counter guarantee to a bank in the buyers country. If the contract is not fulfilled to the standards detailed in its terms, the buyer can call the bond and receive compensation.

Bond Products

Although their names vary, bonds are generally used in four commercial situations to guarantee the performance of one party in a transaction according to the terms of the contract underpinning it.

First, bid bonds can be used in tendering processes to assure importers that any bidders will take up the contract they are bidding for if the importer awards it to them. These bonds usually reflect 2-5% of the value of the contract under tender; if the contract is not taken up, the bank providing the bond will provide the importer with compensation to the value of the bond and recover the amount from the exporter. This reassures importers that all exporters tendering for a piece of work are genuinely interested in taking on the work at the price they bid, and protects them from any loss should they fail to do so.

Second, bonds can be used to guarantee the quality of products purchased under contract. Called performance bonds, these bonds impose penalties of a stated percentage of the total contract price (often around 10%) on exporters who fail to export the right quantity or quality of goods purchased by an importer. However, these bonds are financial guarantees on the terms negotiated; whilst they provide the importer with a level of finance from the exporter, they do not guarantee that the bank will fulfil the contract (for example, by locating an alternative supplier) if the exporter fails to do so.

Third, importers are often requested to provide advanced payment to exporters prior to the completion of a contract to secure the exporters financial position or to provide cashflow for the firm to fulfil the order. If so, an advance payment bond can protect importers by undertaking that the exporter will refund any advance payment made by the importer in the event that the product is not delivered to the terms of the contract. Rather than a percentage, the value of these bonds are usually agreed in advance and paid immediately on demand if called.

Finally, once a transaction has been completed, importers sometimes wish to withhold full payment of the contracted amount for a given period of time. These are often required when an exporter has sold an importer some machinery, either to provide a warranty period to assure the purchased goods’ effectiveness, or to ensure that the exporter fulfils a promise to maintain or service the good for an agreed period. If so, warranty bonds or maintenance bonds can guarantee these obligations.

Guarantees insights