RISKS AND INSURANCE IN INTERNATIONALISATION
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Internationalisation entails additional risks that we need to be aware of and mitigate where possible with insurance or other measures. We list the most frequent risks and the insurance available to mitigate them.
EXCHANGE RATE RISKS
The exchange rate risk arises when prices are set. From that moment onwards possible exchange rate fluctuations alter the expected benefit of the transaction, to a greater or lesser extent, and in a favourable or unfavourable direction.
- If your company has debts or future receivables and those financial commitments are in another currency, the company may be exposed to losses due to exchange rate fluctuations.
- If your business is conducted in a foreign currency, it is possible that the value of the currency may change from the time the agreement is made until the settlement date of the transaction.
You can eliminate risk by trading, thus transferring the risk to your customer. However, if your competitors are trading in local currency, you may have to do so as well.
Fortunately, mechanisms exist to hedge this risk, such as exchange rate insurance or currency options..
MECHANISMS TO COVER RISKS
EXCHANGE RATE INSURANCE
There are a number of financial products on the market to minimise the risk of working with local currencies. The main hedging mechanism for foreign exchange risk is the exchange rate insurance.
The exchange rate insurance consists of a forward foreign exchange purchase or sale contract that allows the settlement price of the contracted currency to be known in advance for a given amount and for a fixed future date. Exchange rate insurance is a firm sale and purchase with a future date, so that both parties are obliged to fulfil the contract, whatever the market price of the contracted currency on the maturity date.
The foreign exchange insurance contract therefore incorporates a right, but also an obligation!!!
WHAT DO I DO IF I CANNOT COMPLY WITH THE EXCHANGE RATE INSURANCE?
As it is a firm but deferred sale and purchase, the breach of an exchange rate insurance entails a reverse sale and purchase transaction and, therefore, possible differences - for or against - between the initial prices and the prices at the time of the breach. These differences will be in favour or against the customer.
If necessary, an exchange rate hedge can be rolled over to a new maturity, used early or even defaulted on before maturity. It should be borne in mind that, as it is a purchase and sale involving interest rates, a default leads to price differences that will have to be recognised, and a shift in time leads to an update in interest rates.
FOREIGN CURRENCY OPTION
An alternative to exchange rate insurance that incorporates the right but does not entail an obligation is the foreign currency option. One option in foreign currency is a a contract that gives its holder the right but not the obligation to buy or sell a certain amount of foreign exchange at a fixed rate of exchange called the strike price, or strike priceagainst payment of a premium to the writer of the option.
There are also exchange rate risk elimination or control mechanisms that are formed from combinations of options. This makes it possible to benefit from favourable exchange rate movements without paying a premium. Due to their characteristics, these alternatives are not widely used. Among these combinations, we can mention the tunnel, the mixed option and the forward plus.
Always do a thorough investigation of your clients to check that they are creditworthy. Even in countries considered low risk, it is quite possible to encounter high-risk customers.It is therefore always worth doing an additional check in order to negotiate with absolute peace of mind.
In order to minimise the payment risk, it is advisable to take out a export credit insurance. In the area of foreign trade, difficulties in obtaining adequate and sufficient information from the customer, different business customs and the diversity of legal environments significantly increase commercial risks.
DEPENDING ON THE STAGE OF THE OPERATION AND THE PART AFFECTED, WE CAN DISTINGUISH BETWEEN:
- Unilateral cancellation of the contract. The risk incurred by the seller, prior to delivery of the goods, in the event that the buyer is unwilling or unable to accept delivery of the goods.
- Non-payment. This is the commercial risk par excellence, which the seller incurs when the buyer, to whom the ordered goods have been delivered, does not fulfil his payment obligation.
- Delivery. The buyer must consider the possibility that the goods received do not meet the contractual requirements: do not conform to the expected quality, are not delivered on time or not delivered at all.
The distance from late payment to non-payment is short and sometimes easy to travel.
NOT TO FORGET
- Request full business reports from prospective customers or suppliers.
- Include in the contract provisions on applicable law, competent courts and arbitration.
- Have guarantees of payment or contractual performance appropriate to the contract envisaged.
- Include the Incoterms condition, with express reference to Incoterms 2020.
- Take out insurance with sufficient cover and in accordance with the actual risk incurred.
- Ensure that the contract of carriage corresponds to the shipment made and is complete and acceptable according to the means of payment.
EXPORT CREDIT INSURANCE
Export credit insurance is a useful instrument for exporting by covering the risks inherent in international trade transactions. These can be risks of contract termination, risks of non-payment, risks arising from investments abroad or improper execution of guarantees.
The leading company in the Spanish market (in terms of commercial risk as well as political and extraordinary risks) is the Compañía Española de Seguros de Crédito a la Exportación (Spanish Export Credit Insurance Company). CESCE offers a wide range of products on its own account or on behalf of the State (exclusively in this case), but always in its own name. The institutions that carry out this activity in the different countries, such as CESCE in Spain, are known internationally as ECAs (export credit agencies), export credit agencies), and collectively constitute one of the primary sources of international trade finance in the world.
To protect your company against non-payment, it is important to insure your export operations, even if your customer is a trusted acquaintance or company in a low-risk country. Your chosen insurance company will cover payment risks in international trade.
INSURANCE OF GOODS
As a result of export, our goods will spend a number of days in transit with the consequent risk of damage, loss or delay. Although the goods are legally protected, this is often not enough. Risks should be minimised by taking out goods insurance to cover the value of physical loss or damage to goods during transit.
- Risk that the goods that the seller makes available to the buyer do not meet the contractual requirements of quality, time and manner of delivery, or that they do not arrive at all.
- Transport risk, logistics: International trade involves greater distances between the point of departure and arrival of the goods, and therefore a significant increase in risk. For this reason, it is important to have reliable logistics companies, experts in the market(s) to which we are going to export or import. Forwarding companies, if possible with their own structure, that are capable of managing our operations, both conventional and triangular if necessary.
The very nature of the export and import process means that goods may be in transit for many days, with the risk of damage, loss or delay. The most international companies have very careful in the handling of goods to minimise such risks.
However, it is wise to insure your assets according to their value, so that you are sufficiently covered in case something goes wrong. Freight insurance covers physical loss or damage to goods during transit and covers transport by air, road, rail and sea..
The Incoterms® of the operation will determine who is responsible for taking out the insurance. As an exporter, you are obliged to take out an insurance policy for Incoterms® CIF and CIP. And in these cases you must take these costs into account in your budget.
The term "country risk" is usually used to refer to the joint assessment of the dangers posed to international business by a particular country. Some firms now use the spread between the yield on a country's bonds and US Treasury bonds or bills as an indicator of country risk.
Local factors that may affect the business:
- Foreign exchange controls preventing the release and transfer of funds.
- Import restrictions imposed after the signature of the contract.
- Political events or economic measures that prevent or delay the transfer of payment.
- The instability of the local banking system.
- War, civil unrest and natural disasters.
The risk associated with variations in the economic cycle of a given country. The danger posed by an unfavourable economic downturn in the economy, as well as the impact of social problems.
RISK OF FRAUD
The risk of fraud that exists in international business relationships. It can increase when we are starting out inexperienced. This is a genuine premeditated deception with the intention of illicit enrichment, and not merely a more or less intentional commercial disagreement.
This is associated with the actions of a country's governmental bodies that, due to their interventionism, negatively affect companies. This is the case of changes in regulations, changes in their application. In short, the actions of public administrations that are detrimental to your business.
Instability of the government or political regime, caused by socio-economic problems (poverty, unemployment and labour disputes, low per capita income, industrial or economic recession, high levels of inflation, etc.); political (factional or party political strife, armed subversion, violence or civil war, coup attempts, etc.).
Adoption of certain policies by constituted governments that directly affect the operation of companies, such as nationalisation of sectors of the economy: expropriation of assets; limitation or substantial variation in the rights to remit profits abroad or repatriate capital; unilateral revocation by the state of contracts with foreign companies, among others.
Differences in legal systems and their potential impact on the success of the transaction should be analysed when engaging in foreign trade relations. The applicable laws, the existence of international conventions on certain matters or the economic cost of litigation abroad are aspects to be taken into account.In some cases they may be minor and in other cases they may make the operation inadvisable.
It is therefore advisable, include an arbitration clause in international contracts and trade agreements, It is customary to submit to the International Court of Arbitration of the International Chamber of Commerce. It is also advisable, include a reference to the applicable jurisdiction. It is desirable to include an arbitration clause in international contracts or, in its absence, in the documentation exchanged reflecting the commercial agreement.
One of the most commonly used clauses is the one that submits the arbitration process to the ICC International Court of Arbitration, whose standard is: "All disputes arising in connection with the present contract shall be finally settled under the Rules of Conciliation and Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the said Rules". In addition, it may also be appropriate to include a reference to the applicable jurisdiction.
Documentary risk is the risk that occurs as a result of difficulties in the clearance or dispatch of goods due to a lack of or insufficient customs documentation required.
If we are Europeans and we start our internationalisation by country in the European UnionIn the EU, some of these risks disappear or are minimised. The common market, which allows for the free movement of citizens (workers), goods, services and capital across the 28 EU countries, is a key element of the common market. EUThe political stability of the environment, the absence of customs barriers, and the fact that we share regulations and currency (the euro is used in 19 countries) make it infinitely easier to approach any EU market than that of a third country.
TYPES OF GUARANTEE USED IN INTERNATIONALISATION
Its purpose is to ensure that a bidder will not withdraw or alter its bid until the final award and that, if awarded the contract, it will accept and sign the contract in accordance with the terms offered. - Performance guarantee. It ensures a payment to the buyer in the event that the seller fails to perform adequately, or in full, or within the stipulated time, its contractual obligations.
It covers the contractually agreed maintenance period during which the supplier remains responsible for the proper functioning of the machine.
ADVANCE PAYMENT GUARANTEE
It guarantees repayment of the full amount advanced and, if applicable, interest.
GUARANTEE OF PAYMENT
Guarantees can be used as a mechanism to secure payment obligations arising from a sale or purchase or the provision of services. Payment guarantees are an alternative to documentary credit.
GUARANTEES VIS-À-VIS CUSTOMS AUTHORITIES OR COMMUNITY BODIES
These include customs guarantees, ATA carnets for the temporary export of commercially valuable samples, Community transit guarantees, etc.
LETTER OF GUARANTEE
It has no specific meaning. However, it often appears in connection with documents of sale and transport of goods, when these are missing or defective.
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