The key to fulfilling a successful trade transaction is to understand and mitigate the associated risks. Not all risks may be applicable to an individual trade transaction but it is important to have an awareness of the possibilities.
Operational - Political - Credit - Regulatory
Currency - Sanctions - Legal - Money Laundering
Fraud - Disputes - Cultural - Time Zone
Language - Infrastructure - Transport
As noted above, there are a number of risks that entities involved in international trade need to be aware of. Thorough research will help to identify and alleviate many of these risks and a number of avenues are available for access to such information.
For instance, when entering into an international trade transaction, the overseas entity may be unknown to the domestic party. Status enquiries and credit references can be obtained from various sources, which will provide information in respect of the counter-party, based on historical trading data.
The first step to alleviating risk is to understand the business of a customer and applying KYC (Know Your Customer) principles. The extent of such KYC may also depend on national and regional banking regulations. At a minimum it should include an awareness of sourcing of funds, purpose of transactions, compliance checks and regular on-going reviews. Know Your Customer ‘KYC' is the initial gathering of information to verify identity on the basis of independent information, and to understand the nature of the underlying business.
There exist certain features in trade finance transactions that may provide a warning sign (referred to as "red flags") that closer attention is required. The list below is not exhaustive and each bank should ensure it has its own comprehensive list and guidelines, that is disseminated to all appropriate staff.
A very simple acronym DAVEGARY will provide you with most of the information required to handle the risk elements of a trade transaction.
DEAL KNOWLEDGE - It is not always necessary to understand a deal in its entire complexity. If one is dealing with a simple documentary collection, a basis awareness of the deal is sufficient. However, if one is involved in a risk participation agreement with a number of other banks in a commodity financing transaction, it is far more important to consider all aspects of the deal.
ASSESS THE RISK - An obvious assumption, but one that is, all too often, not applied sufficiently to enhance the security available. Risk mitigation is, essentially, an amalgamation of many factors. This is an on-going process and includes elements such as keeping up-to-date with worldwide developments by reading appropriate industry publications, attendance and participation in relevant seminars, and regular contact with others involved in trade - not just bankers, but cross-industry: importers, exporters, carriers, forwarders, insurers, inspection agencies, etc.
VARIOUS TYPES OF RISK - There are varying types and levels of risk. These can be sovereign, bank, corporate, documentary, legal, commodity, pricing, delivery, performance, political, and in many instances, a combination of most if not all of these.
EDUCATION - An element that unfortunately is all too often neglected. It takes time to train a person to a level whereby he or she can be expected to have an optimum level of expertise allowing them to understand the various elements that can make up a trade finance transaction. A commitment is initially required to this type of business.
GO THROUGH THE TRANSACTION- A deal cannot be left alone once it has been obtained and booked. Constant monitoring is required, and factors of a political or legal nature may impact on the transaction.
AWARENESS OF FRAUD - Unfortunately, since time immemorial, fraud has been, and will continue to be, with us. There have been some quite spectacular frauds in the trade finance area over the last few years, but the majority is still discovered at a very early stage before any damage can be done. Many of the successful frauds are successful for one reason only - greed. Experienced staff will virtually always ensure that you are not defrauded.
RELATIONSHIP MAINTENANCE - Know your customer, meet your customer, and develop a relationship. You will come across many counterparties in trade deals, be they bank or corporate. Obviously you cannot meet them all, but relationships can be maintained and supported even by telephone contact. The more you learn about your clients, and the more trust developed with your specific contacts, will improve your knowledge and understanding of companies involved in trade financing.
YOUR ULTIMATE PROTECTION - Ensure the documentation is right. Whether the deal is a letter of credit or a syndicated pre-shipment financing, this is where you ensure that your protection and rights of recourse are recorded.