Keys to internationalisation

The increase in risks involved in international trade makes coverage instruments necessary. The activity of the company and the country in which you are going to operate influences to a great extent the type of coverage you should contract.

Basically: know the risks, evaluate their impact on your project, decide to cover or assume them.

Spain offers companies a set of public mechanisms to help them promote their internationalisation. One of the mainstays of this help are the mechanisms available to companies to cover risks in international trade. In addition to the public, but there are also personal mechanisms for risk coverage. byGalicia recommends that you take a look at them. Lets go:

There are a multitude of insurance companies that offer insurance policies to cover trade risks. As in any other insurance policy, you can pay a fairly expensive policy and be covered from the risk of default payment or failure to fulfil contract obligations of the other party, etc. Premiums are normally calculated depending on the risk in the country in question, on the amount of the operation, of the solvency reports of your partners, etc.

JEVs (joint European ventures of public capital) have very competitive offers for companies. Public insurance companies are normally the only ones who cover political risk. Insurance with a private insurance company may be very expensive due to the level of uncertainty arising in some markets. What private company would bear the risks in a country with a high degree of conflict? Only the State, via the JEVs assure this type of operation given that international trade is the fulcrum to achieve greater competitiveness.

CESCE (Compañía Española de Seguros de Crédito a la Exportación/Spanish Company for Export Credit Insurance) operates under this context. It is an entity with public capital whose objective is to cover foreign trade risks. In consequence, it contributes to the promotion of competitiveness of Spanish companies abroad. CESCE provides exporters with a wide range of policies designed for different types of projects.

CESCE has many policies available each one of them orientated towards an operation type. As a public entity, a portion of its operations are covered by the State. The other portion is covered privately. Political risks are always covered by the State. In this way, CESCE similar to other JEVs, is one of the mechanisms that the State makes available to companies, with the objective of promoting international competitiveness via risk coverage mechanisms that are not covered by private insurance companies. The net result is that the companies have sufficient guarantees to launch their operations in all types of countries.

As exporter, you have policies that provide a direct coverage to your company:

• Policy 100
  Is a policy designed for SMEs, with an export volume of less than 1.2 million euros. Covers 85% of the trade risks and 99% of political risks. Provides global coverage on all exports.
• Individual public or private buyer policy
  A policy designed for specific operations. An export contract for the odd occasions when you operate abroad. Covers 99% of political risks and 85% trade risks.
• Individual policy to resolve contracts
  Covers the unilateral resolution of contract, CESCE offers this policy for those projects in which the exporter company has to invest heavily to fulfil a contract, for example, the bespoke manufacture of specific equipment. If before delivering the merchandise there is a unilateral cancellation of the contract you are covered for political and trade risks.
• Supplier credit policy
  As exporters, you need to cover the losses derived from default in instalment payments for operations longer than 3 years. Trade risk coverage is up to 94% and political risk up to 99%.
• Foreign site and work insurance
  You can contract this type of policy if you are carrying out work abroad. You are indemnified for work stoppage, contract resolution and damage to or loss of equipment. You are covered for up to 94% of trade risks and up to 99% for political risks.
• Insurance against loss of financial security
  This policy can be contracted to cover against the loss of security. You are covered for up to 99% of political risks and up to 85% of trade risks for projects with a duration of less than 3 years and 94% for those more than 3 years in length.
• Project-Finance operations insurance
  Depending on the nature of the project, you can contract an insurance policy covering trade and political risks CESCE evaluates the coverage levels.
• Foreign investment insurance
  CESCE has a policy that covers the political risks involved in foreign investment with a coverage percentage of 99%. Situations such as the lack of transfer, expropriation or confiscation for political reasons, revolutions or war, or the breach in fulfilment of advance agreements or breakdown in commitment of authorities of the country, can be covered by this policy.

Following the logic that there are no exports without financing and no financing without insurance, CESCE has a set of policies destined to cover the risks of the bank entities that finance you or the buyer. In this way, under OECD directives, better competitiveness abroad can be achieved.

The most common include:

• Global confirming insurance policy
  Another policy that covers the bank entities from possible loss due to the payment management contract signed  by the debtor policyholder.
• Global and individual insurance policy confirming credit notes
  In this policy the policyholder is the bank entity confirming the credit note. In this way, the bank remains covered of risks inherent to credit note confirmation. It covers up to 99% of political risks. It can be global, with a yearly limit for countries and bank entities, or individual, with coverage for only one credit note.
• Global factoring and forfaiting policy
  The policyholder is also the financial entity that, via this policy, considers insured the losses incurred as a consequence of total or partial default in payment of credits acquired on factoring or forfaiting operations.
• Buyer's credit policy
  In this type of financial model the party who is covered is the financial entity financing the buyer deferred price of an export. It covers a possible default in payment of the credit. Covering commercial risks of up to 94% and political risks of up to 99%.
• Policy of bank guarantees
  With this policy, the financial entity is covered for up to 94% of commercial risks if the importer does not pay the pre-financed credit or financing that normally exists in help-related models.

Currency exchange is the main financial risk. When an operation involves more than one currency there is a currency exchange risk. This risk occurs because currencies do not have fixed rates; rather their exchange rate varies from one day to another dependent on a multitude of factors: supply, demand, monetary interest variations, the political-economic situation, speculative movements, etc. Predicting the future exchange rate of currency is an impossible task. You can make estimates based on evolution of interest rates, but you cannot predict speculative market movements nor environmental conditions.

The introduction of the Euro has supposedly eliminated exchange rate risks in the Euro zone, the main destination of Galician exports. However, the growing tendencies of globalisation and the presence in more and more markets brings with it other currency risks.

The exchange rate risk is a factor that impacts the business trading account that is the result of the same as a consequence of the positive or negative factor of the real currency change of a currency at the moment in which payment is made. The exchange rate risk in a transaction in which two currencies are involved is eliminated if, at the moment in which the operation is closed, there is a cash payment, if your currency is used for the transaction or you open a foreign exchange account. If this is not the case and you are still at risk, byGalicia recommends that you evaluate exchange rate risk for your operations and decide whether you need cover, or not. Exchange insurance and currency options are the two main mechanisms of cover offered by financial entities.

Exchange insurance is an agreement to buy or sell foreign currency to be delivered on a future date at a pre-set exchange rate. This is an agreement with the financial entity to assure an exchange rate on a set date.

There are two types of currency exchange involved in exchange insurance:

• Spot rate: is the cash rate, with a maximum validity period of two days.
• Forward rate: is a futures rate. That is, the prediction of the currency rate in a set period of time. The main factor intervening in its calculation is the evolution of the currency interest rate.

The characteristic of exchange rate insurance is that on expiry of the insurance term the exchange rate stipulated in the insurance is applied, regardless what of the spot market rate at that moment in time. It could be that the exchange rate agreed in the insurance is favourable, or not. What is clear is that an exchange rate insurance reduces the uncertainty of an operation; from the first moment you know what your profit will be. Not insuring the exchange rate could imply extra income derived from a favourable variation in exchange rate. What, however, would happen if the variation was negative? The profit margin of the operation would be reduced. The decision depends on each company.

Another important instrument for risk coverage is currency options. It gives you the right to buy or sell a currency amount on a certain date at a pre-established rate. If you purchase a right to buy the currency, this is known as a call option adversely if it is the right to sell the currency, it is called a put option.

Options are available to companies and private individuals from financial organisations. The buyer of the option has the right to fix the exchange rate to be applied when the period expires. In exchange, the financial organisation will charge a premium that is calculated using factors such as the exchange rate, volatility of the currency involved, the amount, term and interest rates.

The main difference between option and exchange rate insurance is that when the term ends, the exchange rate insurance is always exercised. However, currency options, as its name implies, can be exercised, or not. A call option is exercised if the spot rate is higher than the fixed exchange rate plus the stipulated premium. It is recommended that call options are exercised if the spot market rate is lower than the option plus the paid premium.

The use of options is recommended for currencies that have high volatile indices and whose evolution is impossible to predict. In this way, if the exchange rate is very favourable you can opt to exercise the option, or not, always taking into account the premium you have to pay for the option. For more stable currencies, the exchange rate insurance is the most appropriate.

Pay attention to the preparation of commercial offers. Remember the validity period of the offer should always be included, the currency of the prices, the conditions and terms of payment.

To avoid misunderstandings or possible disputes, use an Incoterm in the contract.

• Risks in international commerce
• Hedging instruments
• Commercial reports