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Trade Finance

Trade Finance refers to the set of financial instruments and mechanisms that support international trade. Unlike a simple FX operation for payment, its purpose is twofold: Mitigate the inherent risks of transactions between parties in different countries and Finance the production and sales cycle, providing working capital for exporters and importers. It structures the transaction to ensure that the exporter is paid and the importer receives the goods.

Main Instruments

Trade Finance instruments are the tools that banks and financial institutions use to provide security and liquidity to operations. The most common are:

  • L/C (Letter of Credit): A payment guarantee issued by a bank on behalf of the importer. The bank undertakes to pay the exporter a specified amount, provided that, within a deadline, the exporter presents a set of documents strictly in accordance with the agreed terms. Its main function is to eliminate the risk of non-payment for the exporter, replacing the buyer's credit risk with that of the bank.

  • ACC (Advance on Exchange Contract): A pre-shipment financing. The exporter, already with a closed sales contract, obtains an advance in Reais (BRL) to cover the production or purchase of the goods to be exported. The loan is settled with the foreign currency received from the export itself, serving as working capital for the production phase.

  • ACE (Advance on Delivered Exchange): A post-shipment financing. It occurs when the exporter has already shipped the goods and delivered the export documents to the bank. The financial institution then advances the sale amount to the exporter, who does not need to wait for the payment term (e.g., 60, 90 days) granted to the importer. It anticipates the receipt of an already completed sale.

Case Study - Exporting Metal Company

A medium-sized metal company in Minas Gerais ("MetalMinas") closes an export contract for auto parts worth US$ 2 million to a car manufacturer in Mexico—the payment term is 120 days after shipment.

  • Challenges:

    • Credit Risk: MetalMinas has never sold to this client and is not comfortable waiting 120 days for payment without a solid guarantee.
    • Working Capital: The company needs R$ 4 million immediately to buy steel and pay labor, but its cash is allocated to other projects.

  • Application of the Trade Finance Solution

    • Risk Mitigation: MetalMinas requires the transaction to be backed by an Irrevocable Letter of Credit. The buyer's bank in Mexico issues the L/C, guaranteeing payment of US$ 2 million upon presentation of the correct shipping documents. The risk of non-payment is eliminated.

    • Cycle Financing: With the L/C (a high-security instrument) in hand, MetalMinas' CFO goes to its bank in Brazil and requests an ACC. The bank, using the L/C as collateral, approves the advance of R$ 4 million. The working capital problem is solved.

In the end, MetalMinas used the bank's capital to finance its production. After shipment, it presented the documents, its bank paid it in dollars and settled the ACC. The company managed to make a large sale to a new market without compromising its cash and without taking on the buyer's credit risk.