[co-author: Talal Khan, trainee]
In the latest edition of Sullivan’s webinar series, Geoffrey Wynne, Head of Trade and Export Finance at Sullivan’s London office, discussed key aspects of structuring trade finance transactions, including the best ones. practices and risk mitigation. Geoff was joined by Jacqueline Cook, Of Counsel and Senior Knowledge Development Lawyer, who provided an informative overview of key aspects of security used in trade finance structures. Here are some of the main areas covered.
A risk-based approach?
The recent Wolfsberg Group report on “Demonstrating Effectiveness” felt that a “risk-based” approach might be best when it comes to trade finance. This would require parties to initially focus on the risks inherent in a transaction and assess them to determine whether a risk should be eliminated, reduced, mitigated or spread. Such considerations underscore the importance for financiers and their counterparts to discuss how to balance their expectations against their needs.
What are the risks ?
The Financial Conduct Authority (FCA) has named four key areas that trade finance practitioners should focus on with particular emphasis on risk assessment:
- Financial crime risk factors (e.g. dual-use goods)
- Risk mitigation
- Due diligence
- Holistic Financial Crime Risk Assessment
The FCA stressed the need for (i) a credit analysis of all trade finance counterparties, including all parties interested in the transaction; and (ii) due diligence vis-à-vis other parties interested in the transaction, if applicable, with a view to identifying fraudulent activity. When it comes to approving transactions, financiers should focus on both the financial and non-financial risks posed by end buyers, as well as transaction payments (in particular, the need for management more effective risk with regard to end buyers, credit insurance and security arrangements).
Security in a trade finance transaction
Security plays a key role in trade finance transactions and relates to the commodity itself, the proceeds of the sale, and the cash flow. As the nature of an asset can change during the lifecycle of a transaction, the question of how to protect that asset, its value and its cash flow is a critical part of structuring the security package.
A typical security package would include an assignment of receivables, a charge on a bank account, and a pledge on property and title deeds, depending on the commodity at the heart of the transaction. Key characteristics, such as when to notify an assignment, can be a decision based on legal and business considerations. While this is a legal requirement of perfection to create a legal assignment, there is also the business question of when and whether to give notice and until then rely on a fair assignment.
A key feature of a pledge of property, delivery, actual or deemed, is required for possession to pass to the secured creditor. Of course, English law is being reformed to remove the blocker which currently means English law does not recognize possession of intangibles. With regard to fixed and floating charges, financiers seeking to take collateral should be aware of two key points in particular: (i) the actions of the parties can affect a fixed charge, effectively making a floating charge; and (ii) that a floating charge falls behind a fixed charge and therefore under English law at the time of insolvency is subject to the claims of the lien claimants and to the prescribed portion of the floating charge assets available for unsecured creditors, the latter up to a maximum threshold.
The international nature of the trade means that parties seeking a guarantee should consider legal advice on any local legal requirement to perfect the guarantee, for example any requirement of perfection or additional registration, such as notarization, legalization or translations.
What can go wrong and how to avoid it
The main objective of a financier may not be to take security and execution, but rather to ensure the return of the money advanced in connection with a transaction. One solution is to ensure that there are sufficient controls throughout the lifecycle of a business transaction, for example on the goods themselves. Was the claim correctly created and paid? Are there any safeguards in place to ensure that it is not sold or billed to someone else? Security taking is not conceived as an alternative to these controls, especially since the application of security takes time and often poses its own problems. Furthermore, it should be borne in mind that trade finance is not immune to the risk of fraud. Financiers who exercise adequate due diligence should be more likely to avoid fraud.
Potential solutions and the future of trade finance
Some fintechs try to solve document duplication using platforms. The World Blockchain Trade Consortium has focused its efforts on creating a decentralized multi-jurisdictional ledger for invoices. This would allow financiers to cross an invoice on the ledger before financing it. Open banking can be useful with the ability for financiers to integrate third-party solutions into their internal systems. The success or failure of these projects will depend in part on the regulatory environment in which they operate. Data protection laws, confidentiality obligations and the approach taken by regulators to protect financiers are also important.
Ultimately, the extent to which trade finance practitioners can protect asset, cash flow and asset value and avoid the pitfalls discussed will depend on their ability to perform due diligence checks and effectively structure trade finance transactions.
Please click here for a link to a video of the webinar.
 See Law and Consultation Commission website and Electronic Business Documents Bill https://www.lawcom.gov.uk/project/electronic-trade-documents/