Trade Finance Introduction

What is Trade Finance?

Trade finance is an all-encompassing term used to describe funding provided to companies to help them carry out their day-to-day business. As implied in the name, “Trade Finance” differs from conventional bank lending in that it is specifically focused upon financing transactions.

Why would a corporate choose trade finance instead of borrowing from a conventional lender?

Typically, a corporate can choose from a wide range of financing types. A normal, secured term loan involves the company allowing the funder to take a legal charge over a particular asset, with property being the most common example. An unsecured loan requires no security but generally investors are nervous about making large advances without taking security.

However, for a company that has a turnover that is disproportionately large compared with their asset base, these two solutions don’t work. If a company is trying to complete a transaction and has the following characteristics:

1. They involve commercial transactions that have a defined and natural end-point (the sale of the oil, clothes and tobacco)
2. The assets in the transaction have a tangible and realisable value

A conventional lender may decline to finance these transactions. However, the fact that they are “self-liquidating” and “asset-backed” means that they are a perfect example of transactions that trade finance teams would look at.

What are the different parts of Trade Finance?

The trade finance company looks at the transaction very differently to a bank. Whilst they are likely to present the funding as a single package, it is actually composed of several different parts:

1. Pre-Production Finance - a loan to buy goods that are as yet unproduced. It is the riskiest part of trade finance lending because there is always the possibility that the goods may not actually be created
2. Inventory Finance - lending to a company and taking security over their stock
3. Structured Trade Finance - funding for goods being moved from the seller to the purchaser
4. Receivables Finance - funding provided based upon the debt owed by the purchaser to the seller

The risks are actually very different in all of these components. A trade finance house has to be sensitive to all of the elements of the transaction in order to protect its own position and provide the right solution to the client.