In international trade one of the most established ways used to procure supplies from far-away places is by settlement of cash against documents (CAD). What this means is that importers only pay when presented with the documents that give them ownership of the goods in transit. CAD is a much cheaper way to settle in international trade compared to the use of LoCs – and also much simpler, as banks can make the issue of an LoC a cumbersome process (see earlier case studies, but just to recap: the key differences between CAD and LoCs are that with Letters of Credit, the process is initiated by the importer, whereas exporters initiate the process when it comes to CAD. When LoCs are used, banks are much more involved in the process, as they are responsible for checking the conditions before importers make any payment, rather than merely holding cash for payment. This makes CAD more affordable for both parties than LoCs. The bank has less to do, takes less risk and hence demands lower fees). However, if we look at security, how secure is CAD really?
The CAD is really a compromise, the documents are usually offered at a late stage in the transaction, meaning following transport when the goods are offered to the buyer for settlement. There is hence no guarantee that the importer will actually pay. If the importer refuses to pay, the transaction has to be reversed and the exporter will have to pay for the costs. If it concerns an item that was specifically manufactured for the buyer, the exporter will lose money on both the extra transportation costs for repatriation and the fact the goods cannot easily be (re)sold to a third party.
Having established these ‘holes’ in the security CAD is still promoted as a method to protect the seller when he does not have a history with the buyer, the order is very large, or the buyer’s credit standing is poor. A way of settling transactions in international trade that is not or hardly ever used, and could offer an alternative is escrow. This is probably because escrow is mostly associated with old-fashioned, manually driven, processes. Escrow is a settlement method whereby the seller pays cash in advance, like in the picture above, but not to the seller. Instead, he pays to an independent third party, the escrow agent. Upon arrival of the goods, the Escrow agent is served with a notice that the goods have arrived at the agreed place of destination. Only then the monies are released to the seller. The escrow settlement method allows for the inclusion of milestones. For example,the parties can agree that a quality check is built into the process. A confirmation of safe arrival must in that case be accompanied with a report confirming the quality of the goods as agreed (a ‘milestone’). If confirmed, settlement will take place.
A completely digitalised and user friendly escrow process, whereby parties can agree everything on-line from behind their desks, thus avoids the administrative burden of an LoC, whilst giving more security than CAD settlement. This more secure, easier and better alternative for CAD can be found at www.mercuriontrade.com . If you recognise the situation as described in this briefing note, why not check it out today?