Trade Finance Interview Questions | Succeed with confidence

Payment methods:

Open Account: The seller supplies goods, and all original shipping documents are sent directly to the buyer. The buyer makes payment at a later date, as per the contract. This method carries high risk for the seller.

Advance Payment: The buyer makes payment to the seller before the goods are shipped. Once the goods are shipped, the seller will send all original shipping documents directly to the buyer. This method carries high risk for the buyer.

Documentary Collections: The seller ships the goods and presents all original shipping documents to their bank, with a request to forward the documents to the buyer’s bank. The documents are released against payment (Documents against Payment – DP) or acceptance of a bill of exchange (Documents against Acceptance – DA). This method carries moderate risk for the seller.

Documentary Credit: The buyer arranges to issue a Letter of Credit (LC) in favor of the seller. Once the goods are shipped, the seller presents the documents to a nominated bank named in the credit. Upon receipt of the documents from the nominated bank, the issuing bank honors the complying presentation and releases the documents to the applicant. This method offers a balanced risk for both parties.

INCOTERMS 2020

There are 11 INCOTERMS defined under INCOTERMS 2020.

Any Mode of Transport (Seven Terms):

1. Ex Works (EXW): The seller delivers when the goods are made available for pickup at the seller’s premises or another agreed location (named place). The seller is not responsible for loading the goods onto any vehicle nor for clearing the goods for export. The seller has the least responsibility and the buyer has most responsibility.
2. Free Carrier (FCA): The seller delivers the goods to the carrier nominated by the buyer at the named place ready for unloading. The seller is responsible for clearing the goods for export.
3. Carriage Paid To (CPT): The seller delivers the goods to the carrier and pays the transport charges to the named destination. The seller is responsible for clearing the goods for export, but the risk transfers to the buyer once the goods are handed over to the carrier.
4. Carriage and Insurance Paid To (CIP): The seller delivers the goods to the carrier and pays the transport charges to the named destination. The seller also arranges and pays for insurance to cover under Institute Cargo Clauses-A. The risk transfers to the buyer once the goods are handed over to the carrier. However, The seller is responsible for clearing the goods for export
5. Delivered at Place (DAP): The seller delivers when the goods are made available for unloading at the named place of destination. The seller is responsible for the costs and risks associated with transporting the goods to the destination, but the buyer is responsible for clearing the goods for import.
6. Delivered at Place Unloaded (DPU): The seller delivers when the goods are unloaded from the arriving means of transport and placed at the disposal of the buyer at a terminal or another agreed place at the named port or place. The seller bears all the risks and costs associated with transporting the goods to the named destination, including unloading. The buyer is responsible for clearing the goods for import.
7. Delivered Duty Paid (DDP): The seller delivers when the goods are made available for unloading at the named destination after clearing the goods for import and paying all duties and taxes. The seller assumes all risks and costs, including import duties, taxes, and other charges. The seller has the most responsibility and the buyer has the least responsibility.

Sea & Inland Waterways (Four Terms)

1. Free Alongside Ship (FAS): The seller delivers when the goods are placed alongside the ship nominated by the buyer at the named port of loading after clearing the goods for export. The risk transfers to the buyer once the goods are placed alongside the ship.
2. Free On Board (FOB): The seller delivers when the goods are loaded onboard the ship nominated by the buyer at the named port of loading after clearing the goods for export. The risk transfers to the buyer once the goods are loaded on board the ship.
3. Cost and Freight (CFR): The seller delivers when the goods are loaded onboard the ship at the port of loading after clearing the goods for export. The seller is responsible for paying the freight charges up to the named port of discharge. The risk transfers to the buyer once the goods are loaded onboard the ship.
4. Cost, Insurance, and Freight (CIF): The seller delivers when the goods are loaded onboard the ship at the port of loading after clearing the goods for export. The seller is responsible for paying the freight charges up to the named port of discharge and also arranges and pays for insurance to cover the goods at least under the minimum coverage (Institute Cargo Clauses – C). The risk transfers to the buyer once the goods are loaded onboard the ship.

Trade Cycle:

1. Sales/ Purchase Contract:
   Once the seller’s offer is accepted by the buyer, either the exporter creates a sales contract, or the buyer creates a purchase contract.
2. Export Clearance:
   Once the goods are ready for shipment, export clearance must be obtained from the customs authorities.
   Export clearance involves:
   • Filing of shipping bills, invoice, packing list, and the export order.
   • Paying the necessary duties and taxes.
   • Offering goods for inspection as required by the customs authorities.
3. Contract of Carriage:
   The seller or buyer shall enter into a contract of carriage depending on the chosen Incoterms.
4. Cargo Insurance:
   Cargo insurance to cover the risk of damage to the goods is arranged depending on the Incoterms. The seller or buyer may be responsible for insuring the goods.
5. Shipping Documents:
   Once the goods are shipped, the seller must obtain the relevant shipping documents. These typically include:
   • Transport document (e.g., Bill of Lading or Airway Bill).
   • Insurance document (if applicable, e.g., insurance policy or certificate).
   • Certificate of origin.
   • Other documents required by the contract.
6. Document Presentation:
   Depending on the terms of payment, the documents are presented either to the bank or dispatched directly to the buyer:
   • In the case of Open Account or Advance Payment, documents are sent directly to the buyer.
   • In the case of Documentary Collections or Letter of Credit (LC), the documents are sent to the remitting bank or nominated bank respectively.
7. Buyer’s Responsibilities:
   The buyer will receive the documents either directly or through the collecting bank (in case of documentary collection) or the issuing bank (in case of LC).
   The buyer must:
   • Arrange import clearance with the local customs authorities.
   • Take delivery of the goods from the carrier once the clearance is completed.

Letter of Credit Cycle:

1. Buyer and Seller Contract:
   If the buyer and seller enter into a contract with payment under a Letter of Credit (LC), the buyer requests their bank to open a Letter of Credit in favor of the seller.
2. Issuing the Letter of Credit:
   The issuing bank opens the LC in favor of the seller after securing a cash deposit or blocking the credit limit of the buyer.
3. Parties Involved:
   • Since the LC is established at the request of the buyer, the buyer is referred to as the applicant.
   • The buyer’s bank is known as the issuing bank.
   • The seller is referred to as the beneficiary.
4. Advising Bank:
   The issuing bank may engage a corresponding bank in the seller’s country to advise the LC to the seller. This bank is known as the advising bank.
5. Document Presentation:
   The beneficiary (seller) presents the required documents to the nominated bank stipulated in the LC or to the issuing bank for payment or acceptance.
6. Nominated Bank’s Obligations:
   The nominated bank is not obligated to pay unless it is a confirming bank. If the LC is confirmed by the nominated bank, it is obliged to honour in accordance with the LC terms. 
7. Document Compliance:
   If the documents are complying, the issuing bank shall honor and release the documents to the applicant after debiting the applicant’s account.
8. Non-complying Presentation:
   In the case of a non-complying presentation, the issuing bank must send a Notice of Refusal to the presenter within five banking days following the day of receipt of the documents.
9. Contents of the Notice of Refusal:
   The Notice of Refusal must contain:
   • A statement that the bank refuses to honor/ negotiate the documents.
   • A description of each discrepancy.
   • Holding instructions of the documents as per Article 16 of UCP 600:
     • a) The bank is holding the documents pending further instructions from the presenter.
     • b) The issuing bank is holding the documents until it receives a waiver from the applicant and agrees to accept it, or receives further instructions from the presenter prior to agreeing to accept a waiver.
     • c) The bank is returning the documents to the presenter.
     • d) The bank is acting in accordance with instructions previously received from the presenter.

Definitions:

1. Credit:
   An irrevocable undertaking of the issuing bank to honor a complying presentation
2. Advising Bank:
   The bank that advises the credit to the beneficiary at the request of the issuing bank.
3. Applicant:
   The party on whose request the credit is issued.
4. Banking Day:
   A day on which a bank is regularly open for business at the place where the act subject to these rules is to be performed.
5. Beneficiary:
   The party in whose favor a credit is issued.
6. Complying Presentation:
   Presentation of documents that conform to the terms and conditions of the credit and applicable rules of UCP 600 and International Standard Banking Practice (ISBP).
7. Confirmation:
   A definite undertaking by the confirming bank, in addition to the undertaking of the issuing bank, to honor or negotiate a complying presentation.
8. Confirming Bank:
   The bank that adds its confirmation to a credit at the request or authorization of the issuing bank. 
9. Honour:
   a. To pay at sight if the credit is available by sight payment.
   b. To incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment.
   c. To accept a bill of exchange drawn by the beneficiary and pay at maturity if the credit is available by acceptance.
10. Issuing Bank:
    The bank that issues the credit at the request of the applicant or on its own behalf..
11. Negotiation:
    The purchase by the nominated bank of drafts and/or documents under a complying presentation by advancing or agreeing to advance funds to the beneficiary before reimbursement is due to the nominated bank.
12. Nominated Bank:
    The bank with which the credit is available (known as restricted credit), or any other bank if the credit is available with any bank (known as freely available credit). 

Special Types of LCs

• Red Clause Credit: A letter of credit that allows the drawing of advance money before shipment, against a simple receipt or demand.
• Green Clause Credit: A letter of credit that allows the drawing of money before shipment, against a warehouse receipt.
• Standby Credit: Standby credits are primarily used to cover non-performance risk. The beneficiary may present a claim under a standby credit in the event of non-performance by the applicant.
• Evergreen Credit: These types of credits are issued for a longer period, typically over 1 year, and are automatically extendable unless cancelled before expiry, with sufficient notice in advance. Evergreen credits are typically used for Standby (SB) credits.
• Revolving LC: A credit that allows the revolving of the face value on a time or value basis. If time-based revolving, the number of revolutions will be indicated in the credit and whether it is cumulative or non-cumulative will be specified. In such cases, Article 32 of UCP 600  “Instalment Drawings or Shipments” must be excluded in the LC. If value-based revolving, the maximum value that can be drawn must be provided.  For automatic revolving credit, reinstatement will be done by the issuing   bank upon each utilization. Non-automatic revolving LCs require a separate amendment for each reinstatement and credit limit is blocked only to the extent of the face value of the credit.
• Back-to-Back Letters of Credit
  A Back-to-Back Letter of Credit (LC) is a financing arrangement involving two separate LCs to facilitate a trade transaction. It is particularly useful for an intermediary trader (the seller) who receives an LC from the ultimate buyer and uses it as collateral to issue another LC in favor of the supplier of goods.
• Transferable Letters of Credit
  When an LC is designated as transferable, the beneficiary (the intermediary) may request the transfer of the credit in favor of the actual supplier of the goods, known as the second beneficiary. This arrangement is commonly used in transactions where intermediaries rely on suppliers to fulfill their obligations to the ultimate buyer.
• Assignment of the Proceeds Under LC: When a buyer issues a standard Letter of Credit (LC) in favor of the intermediary (the beneficiary), rather than a Transferable LC, and the intermediary cannot arrange a back-to-back LC with their bank to the actual supplier of the goods, the assignment of LC proceeds provides an alternative solution to manage payment risk for the supplier. The beneficiary may request a nominated bank to assign the LC proceeds to the supplier. The assignment of proceeds is irrevocable, and the assignee gains the right to the proceeds of the LC but does not acquire the right to perform under the LC.

Short notes:

• Parties to documentary credit are Issuing bank, Confirming Bank (if any) and the Beneficiary. Applicant is not a party to documentary credit.
• The primary difference between a credit available by deferred payment and acceptance is that, in the case of acceptance, a bill of exchange must be presented, whereas no draft is required under deferred payment.
• Inoperative LC: If an LC depends on another event to become operative, it may require further amendment. For example, “This LC is operative only upon issuance of a performance guarantee.”
• SWIFT: Society for Worldwide Interbank Financial Telecommunication.
• Transhipment: The unloading of goods from one means of conveyance and reloading onto another during the journey.
• Straight Bill of Lading: A bill of lading consigned to a named party, which is not a negotiable document.
• Short Form or Blank Back Bill of Lading: A Bill of Lading that does not explicitly show the terms and conditions of carriage but includes a reference to the source of those terms and conditions, such as the shipping company’s official website
• Non-Documentary Conditions: Conditions in a credit that do not stipulate the document required to indicate compliance with the condition.
• Negotiable Document: A document of title that can be transferred by endorsement and delivery. (Example: “To Order” bill of lading)
• Transport Documents Issued in Negotiable Form: Bill of lading, charter party bill of lading, and multimodal transport document (if the last leg of the journey is by sea).
• Transport Documents Defined under UCP 600 Articles 19 to 25:
  • Multimodal Transport Document
  • Bill of Lading
  • Non-Negotiable Seaway Bill
  • Charter Party Bill of Lading
  • Air Transport Document
  • Road, Rail, Inland Waterways Transport Document
  • Courier/Postal Receipt

• Freight Forwarder/House Bill of Lading is Acceptable: A transport document may be signed by a freight forwarder in their own capacity without the need to identify the carrier’s name. (This rule also applies to other types of transport documents.)
• “Notify Column” in a Transport Document: This information is provided to facilitate the shipping company in notifying the arrival of goods to the party stated in this column at the port of discharge.
• Shipping Documents: All documents required by the credit, except drafts, teletransmission reports, and courier receipts evidencing the sending of documents.
• Stale Documents Acceptable: Documents may be presented later than 21 calendar days after the date of shipment, but before the expiry date of the credit.
• Third-Party Documents Acceptable: All documents for which the credit or UCP 600 do not indicate an issuer, except drafts, may be issued by a named person or entity.
• Exporting Country: The beneficiary’s country, the country of origin of the goods, the country of receipt by the carrier, or the country from which shipment or dispatch is made.
• Article 30 a of UCP 600, the words ”About or Approximately”, used in connection with quantity, unit price, or value allows  10% +/-.
• As per Article 30 b, 5% +/- Tolerance for the quantity is allowed provided quantity is not expressed in stipulated packing units or individual items
• As per article 30 c, Even when Partial Drawings are Not Allowed,  drawing up to 5% less in value is allowed.
• Documents to which UCP 600 transport articles do not apply:
  • Delivery note
  • Delivery order
  • Cargo receipt
  • Forwarder’s certificate of receipt (FCR)
  • Forwarder’s certificate of shipment
  • Forwarder’s cargo receipt (FCR)
  • Mate’s receipt

Transferable Credits:

When an LC is designated as transferable, at the request of the first beneficiary, the nominated bank may transfer the credit to one or more second beneficiaries. In the case of a freely available credit, the credit must specify the name of the transferring bank.

• The second beneficiary cannot request the transfer to a subsequent beneficiary. However, the second beneficiary may return the transfer to the first beneficiary.
• While transferring the credit, the transferring bank may allow the following reductions:
  • Amount
  • Unit price
  • Expiry date
  • Period for presentation
  • Shipment date
• The percentage of insurance coverage may be increased to match the amount of cover stipulated in the credit.
• The first beneficiary may request to have the honor or negotiation carried out at the second beneficiary’s bank, up to the expiry date of the credit.

Characteristics of Bill of Exchange / Draft:

• An unconditional order by the drawer to the drawee to pay a sum on the due date.
• Must be drawn by the beneficiary on a bank (drawee) named in the credit.
• Must be dated.
• Tenor must align with the terms of the LC.

Characteristics of Invoice:

• Must be issued by the beneficiary.
• Must be made out in the name of the applicant.
• Must be in the same currency as the credit.
• Need not be signed or dated unless required by the L/C.
• Description of goods must match the description stated in the L/C.
• Invoice titled as “provisional invoice” or “pro-forma invoice” is not acceptable.
• Trade terms (Incoterms) must be stated as per the L/C, with source if shown.
• Should not include merchandise not covered by the credit, even if marked as “free of cost.”
• Must show any deduction of advance or discount as stated in the credit.
• May also show deductions not mentioned in the credit.

Bill of Lading:

• A transport document used for port-to-port shipments, serving as a document of title and capable of transfer by endorsement and delivery.
• The name of the carrier must be identified.
• To be signed by the carrier or master, or their agents, clearly identifying the capacity of the parties involved.
• When an agent signs the Bill of Lading on behalf of the master, the master’s name is not required.
• Port of loading and port of discharge must match those specified in the L/C.
• If the Bill of Lading is not in shipped form, an “on board” notation must be included, with the date and evidence of shipment.
• If “pre-carriage” is shown, the “on board” notation must include the vessel name and port of loading.
• If the term “intended” or similar is used for the vessel name, the “on board” notation must include the actual vessel name.
• If the term “intended” or similar is used for the port of loading, the “on board” notation must include both the actual vessel name and port of loading.
• The number of originals issued must be stated.
• If the L/C prohibits cost additions to freight, any cost additions (such as FI, FIOS, etc.) are not acceptable, though charges for late return of containers are allowed.
• Any reference to a charter party is not allowed.
• If issued “to order” or “to order of shipper,” it must be endorsed by the shipper.

Non-Negotiable Sea Way Bill:

• A transport document used for port-to-port shipments, typically for short voyages.
• Not a document of title (pre-printed text does not require surrender of at least one original to release the goods by the carrier at port of discharge)
• The rules under UCP 600 for Sea Way Bill are the same as those for a Bill of Lading.

Charter Party Bill of Lading:

• A transport document used for port-to-port shipments, issued subject to a charter party agreement which is considered as quasi negotiable document
• The charter party agreement is made between the charterer and the owner.
• There are two types of charters: Time Charter and Voyage Charter.

Basic features of Charter Party Bill of Lading:

• Must be signed by the master, owner, or charterer, or their agents, clearly identifying the capacity of the parties.
• When an agent signs the Bill of Lading on behalf of the master, the master’s name is not required.
• There must be reference of Charter Party 
• The port of loading and port of discharge must be as per the Letter of Credit (L/C).
• The port of discharge can be shown as a geographical area, as stated in the credit.
• The date of issuance of the Bill of Lading will be deemed the date of shipment unless there is a separate dated on-board notation.
• The number of originals issued must be specified.
• Must be endorsed by the shipper if issued “to order” or “to order of shipper.”

Air Waybill:

• A transport document used for air shipments, but NOT a document of title.

Basic features of an Air Waybill:

• The name of the carrier must be clearly identified as the carrier. Using only the IATA airline code for the carrier name is not acceptable.
• Must be signed by the carrier or their agent, clearly identifying the capacity of the parties.
• Airport of departure and airport of destination must be as per the Letter of Credit (L/C).
• Must indicate that goods have been accepted for carriage.
• The original air waybill must be provided to the shipper or consignor, even if the L/C requires a full set of originals.
• Transshipment is acceptable even if the credit prohibits it.
• IATA codes (International Air Transport Association) can be used to indicate the airport of departure or destination

Insurance Document:

• An insurance document is required when the trade term is CIF (Cost, Insurance, and Freight) or CIP (Carriage and Insurance Paid to).

Basic requirements for the insurance document:

• The document must be signed by the insurance company, underwriters, or their agents or proxies (a proxy is a power of attorney holder).
• The document must be dated on or before the date of shipment. If it is dated after shipment, it must indicate that the coverage is effective from a date that is on or before the shipment date.
• The risks to be covered must align with the terms specified in the Letter of Credit (L/C).
• The coverage must be at least from the place of receipt to the place of delivery as stated in the L/C.
• Minimum coverage should be 110% of the goods’ value. There is no maximum limit for coverage.
• Insurance certificates are not acceptable if the L/C requires an insurance policy.

Franchise or Excess Deductible Clause under Insurance Document:

• Basic principle of insurance is to compensate abnormal loss. Insurance document may show minimum percentage of loss (that is considered as normal loss depending upon the nature of the product), to lodge a claim under policy.

In case of an “Excess Deductible” clause:

• Claims are settled after deducting the normal loss amount from the total claim.

In case of a “Franchise” clause:

• Claims are settled for the full claim amount, regardless of the normal loss amount.

Important Note:

• If the L/C stipulates claims to be settled “irrespective of percentage”, neither the Franchise nor Excess Deductible clause are allowed. However, there is no need to mention “irrespective of percentage” in the document

Uniform Rules for Bank to Bank Reimbursements:

Reimbursement Authorization:

• When the credit text includes details of the reimbursement bank, the issuing bank must send a Reimbursement Authorization to the reimbursing bank named in the credit.

• The Reimbursement Authorization:
  • Should not be subject to an expiry date, unless the reimbursing bank is authorized to issue a Reimbursement Undertaking.
  • Should not require a certificate of compliance with the terms and conditions of the credit from the claiming bank.
  • It is revocable, unless it contains authorization to issue a Reimbursement Undertaking.
  • The L/C should not require sight drafts to be drawn on the reimbursing bank.

• Key details included in the Reimbursement Authorization:
  • L/C number and date
  • Currency and amount
  • Nominated bank (Claiming bank name), if known
  • Parties responsible for charges

Reimbursement Undertaking (Irrevocable):

• Key details included in the Reimbursement Undertaking:
  • Issuing bank name
  • L/C number and date
  • Currency and amount
  • Expiry date for presentation of a claim
  • Parties responsible for charges

Claim:

• Key details included in the claim:
  • Issuing bank name
  • L/C number and date
  • Currency and amount
• When time drafts are required to be drawn on the reimbursing bank, the claiming bank must forward the draft along with the reimbursement claim to the reimbursing bank. The following must be included:
  • Goods description
  • Origin of goods
  • Place of shipment and destination
  • Date of shipment
• In the case of a maturity bill, the claim should not be sent more than 10 days before the maturity date.

Reimbursing Bank:

• The reimbursing bank must process the claim within 3 banking days following the day of receipt of the claim.

Important SWIFT Formats for Letters of Credit (LC) and Reimbursement:

1. MT 700 – LC Issuance:
   This is used for issuing a Letter of Credit. It includes all the necessary details of the LC such as the beneficiary, applicant, terms of the credit, and conditions under which the credit can be honored.
2. MT 707 – LC Amendment:
   This is used to amend an existing Letter of Credit. The amendment could include changes to the amount, expiry date, or any other details specified in the original credit.
3. MT 720 – Transfer of LC:
   This format is used when a transferable Letter of Credit is transferred to a second beneficiary. It communicates the transfer of credit details to the second beneficiary.
4. MT 734 – Notice of Refusal:
   This message is used when a bank refuses to accept or honor a document under an LC. It provides reasons for refusal based on discrepancies found in the documents presented.
5. MT 740 – Reimbursement Authorization:
   This format is used to authorize the reimbursing bank to pay or negotiate a reimbursement claim. It includes details such as the L/C number, currency, amount, and any other instructions for the reimbursement.
6. MT 742 – Reimbursement Claim:
   This is used by the claiming bank to submit a reimbursement request to the reimbursing bank under the terms of the LC. It includes details about the documents presented and the amount to be reimbursed.
7. MT 756 – Advice of Reimbursement or Payment:
   This message is used to advise the originating bank or party that a reimbursement has been made or a payment has been processed under the LC.

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