Counter Trading Arrangements

Vitally I. CherenkovVitally I. Cherenkov

Graduate School of Graduate School of ManagementManagement

Methods of Methods of International International

Operations [ Operations [ IIOIIO ]: ]:

COUNTERTRADING COUNTERTRADING ARRANGEMENTSARRANGEMENTSOctober 25,2010


CountertradeCountertrade AA generic term that describes various techniques generic term that describes various techniques

for the conditional exchange of goods and/or for the conditional exchange of goods and/or services between seller and buyer.services between seller and buyer.

Countertrade provides a means of trade with Countertrade provides a means of trade with countries using a countries using a blocked currencyblocked currency---currency ---currency that is not readily convertible into other that is not readily convertible into other currencies---or lacking the foreign exchange, thus currencies---or lacking the foreign exchange, thus removing the difficulties and risks in a trade removing the difficulties and risks in a trade financing and paving the way for a successful deal financing and paving the way for a successful deal that otherwise would fail. that otherwise would fail.

Countertrade also provides a Countertrade also provides a means to preserve means to preserve foreign exchange reservesforeign exchange reserves by eliminating the by eliminating the use of hard currency. use of hard currency.


CountertradeCountertrade CountertradeCountertrade is an alternative means of is an alternative means of

structuring an international sale when structuring an international sale when conventional means of paymentconventional means of payment are are difficult, costly, or nonexistent. difficult, costly, or nonexistent.

Countertrade denotes a whole Countertrade denotes a whole range of range of barterlike agreementsbarterlike agreements; its principle is ; its principle is to trade goods and services for other to trade goods and services for other goods and services when they cannot be goods and services when they cannot be traded for money traded for money


CountertradeCountertrade Countertrade is thriving in modern Countertrade is thriving in modern

international trade. In early 1970's, international trade. In early 1970's, countertrade was used by about 20 countertrade was used by about 20 countries and countries and after the Soviel blok crushafter the Soviel blok crush, , more than 1more than 1110 countries are using it. 0 countries are using it.

A wide range of goods and services are A wide range of goods and services are transacted on countertrade, for example, transacted on countertrade, for example, oil, airplanes, automobiles, mineral, oil, airplanes, automobiles, mineral, machinery, agricultural products, shoes, machinery, agricultural products, shoes, wine, and advertising time.wine, and advertising time.


CountertradeCountertrade

Classification Classification of of

Forms Forms of of

CountertradeCountertrade


Does the transaction reciprocal involve Does the transaction reciprocal involve commitments ? (other than cash commitments ? (other than cash

payments)payments)

YESYES

COUNTERTRADECOUNTERTRADE

NONO

STRAIGHT SALES STRAIGHT SALES (CASH OR CREDIT)(CASH OR CREDIT)


Does the transaction involve the Does the transaction involve the use of money?use of money?

YESYES

COUNTERPURCHASCOUNTERPURCHASE, BUYBACK OR E, BUYBACK OR OFFSETOFFSET

NONO

BARTER-TYPEBARTER-TYPE


BARTER-TYPEBARTER-TYPE Does the transaction extend over Does the transaction extend over

long time periods and involve a long time periods and involve a basket of goods?basket of goods?

YESYES

CLEARING CLEARING ARRANGEMENTARRANGEMENT

NONO

SIMPLE BARTERSIMPLE BARTER

X*A = Y*B


SIMPLE BARTERSIMPLE BARTER BarterBarter is the direct exchange of goods and/or is the direct exchange of goods and/or

services, of approximately equivalent value, services, of approximately equivalent value, between parties without the use of money or credit. between parties without the use of money or credit.

Country B

Company B

Страна А

Компания А

Товар А

Product B


““Non-Pure” BarterNon-Pure” Barter

Country B

Company B

Страна А

Компания А

Товар А

Product B

€, £, ¥, $


BarterBarter – Some – Some ProblemsProblems

FirstFirst, if goods are not exchanged , if goods are not exchanged simultaneously, one party ends up simultaneously, one party ends up financing the other for a period financing the other for a period

SecondSecond, firms engaged in barter run , firms engaged in barter run the the riskrisk of having to accept goods of having to accept goods they do not want, cannot use, or they do not want, cannot use, or have difficulty reselling at a have difficulty reselling at a reasonable price. reasonable price.



Are third parties involved?Are third parties involved?

YESYES

SWITCH TRADING,SWITCH TRADING,Or Or TRIANGLE DEALS

NONO




($)($){X{Xii} } ↔↔ {Y {Yjj} } ((€€))

i i ≠ j≠ j


Country B

Company B

Страна А

Компания А

Товары по Списку А

Products from the List B

Взаимное сальдирование €, £, ¥, $

Неконвертиру

емое денежное

сальдо

Товары в счет сальдо


Non-Convertible Balance(NCB) Delivery at the expense of NCB

Reciprocal Balancing


Clearing Clearing AgreementAgreement

Two countriesTwo countries (companies) (companies) agree to buy agree to buy particular types and quantities of each other's particular types and quantities of each other's goods within a period of time, using a goods within a period of time, using a designated designated clearing currencyclearing currency. .

At the end of the period, the country At the end of the period, the country (company) (company) that buys more that buys more may settle the shortfall may settle the shortfall either in hard currency and/or goodseither in hard currency and/or goods, or , or issue a creditissue a credit to the other country to the other country (company) (company) in the subsequent clearing agreement, if any. in the subsequent clearing agreement, if any.


ClearinghousesClearinghouses BalancingBalancing export sales and export sales and

counterpurchase obligations on a deal-by-counterpurchase obligations on a deal-by-deal basis is often deal basis is often cumbersomecumbersome. .

To To facilitate countertradefacilitate countertrade, firms may , firms may agree to establish agree to establish clearinghouse clearinghouse accountsaccounts. .

Using this approach, as a firm exports Using this approach, as a firm exports goods and services to another, it incurs a goods and services to another, it incurs a counterpurchase obligationcounterpurchase obligation of an of an equivalent value, which is recorded in its equivalent value, which is recorded in its clearinghouse account. clearinghouse account.


ClearinghousesClearinghouses When the firm When the firm buysbuys goods from its goods from its

partner, partner, its clearinghouse its clearinghouse obligation is reduced. obligation is reduced.

Thus a firm does not need to balance Thus a firm does not need to balance any single countertrade transaction, any single countertrade transaction, although it must honor its cumulative although it must honor its cumulative set of obligations by the time its set of obligations by the time its clearinghouse accountclearinghouse account expires. expires.


Switch TradingSwitch Trading Switch trading refers to the use of a Switch trading refers to the use of a

specialized thirdparty specialized thirdparty trading housetrading house in a in a countertrade arrangement. countertrade arrangement.

When a firm enters a When a firm enters a counterpurchasecounterpurchase or or offset agreementoffset agreement with a country, it often with a country, it often ends up with what are called ends up with what are called counterpurchase creditscounterpurchase credits, which can be , which can be used to purchase goods from that country. used to purchase goods from that country.

Switch trading occurs when a third-party Switch trading occurs when a third-party trading house buys the trading house buys the firm's firm's counterpurchase creditscounterpurchase credits and sells them and sells them to another firmto another firm that can better use them. that can better use them.


PRODUCT PRODUCT SWITCHSWITCH

UK EXPORTER

SRI LANKA IMPORTER

RUSSIAN IMPORTER

TEA PA

CK

AG

ING

EQU

IPMEN

T

TEA DELIVERY

₤

Hard Currency

Hard Liquid Product


Triangle Trade Triangle Trade ProcedureProcedure



1 - 1 - Buyer and seller concludes a sales contract.Buyer and seller concludes a sales contract. Buyer applies to his issuing bank for a Buyer applies to his issuing bank for a

transferable letter of credit in favor of the seller in favor of the seller (first beneficiary). (first beneficiary).

The letter of credit (L/C) provides for shipment The letter of credit (L/C) provides for shipment FROMFROM named port of shipment (i.e., named port of shipment (i.e., Hong KongHong Kong, , China) China) TOTO named port of destination (i.e., named port of destination (i.e., New New YorkYork, U.S.A.) and the , U.S.A.) and the third party's bill of lading third party's bill of lading is acceptableis acceptable..

The letter of credit does not stipulate the consignor The letter of credit does not stipulate the consignor of goods.of goods.

http://www.export911.com/e911/export/transfer.htm#xTransferableLC



2 - 2 - Seller transfers the letter of credit to the Seller transfers the letter of credit to the third party (second beneficiary) in a third party (second beneficiary) in a transferred credit. .

The credit stipulates the consignor of goods.The credit stipulates the consignor of goods. Other credit terms being same as the original Other credit terms being same as the original

transferable L/C, transferable L/C, with the exception of the with the exception of the L/C amountL/C amount, any unit price of goods, time of , any unit price of goods, time of shipment, last date for presentation of shipment, last date for presentation of documents, and expiry date.documents, and expiry date.

http://www.export911.com/e911/export/transfer.htm#xTransferred



3 - 3 - Third party Third party ships the goodsships the goods directly directly to the buyer.to the buyer.

4 - 4 - Third party presents the Third party presents the draft (bill of exchange) and documents and documents to the negotiating bank for L/C to the negotiating bank for L/C negotiation. negotiation.

Documents reach the seller through the Documents reach the seller through the seller's seller's transferring bank..

http://www.export911.com/e911/export/bill.htm

http://www.export911.com/e911/export/partyLC.htm#xTransferBank



5 - 5 - Seller substitutes his draft and Seller substitutes his draft and documents for those presented by the documents for those presented by the third party, but third party, but uses the same bill of uses the same bill of ladinglading. .

Seller presents the draft and Seller presents the draft and documents to the negotiating bank for documents to the negotiating bank for L/C negotiation.L/C negotiation.

Documents reach the buyer through Documents reach the buyer through the buyer's issuing bank.the buyer's issuing bank.


FINANCIAL FINANCIAL SWITCHSWITCH

U.S. EXPORTER

CHILI EXPORTER

MIN

ING

EQU

IPMEN

T

UKRANIAN IMPORTER

SWITH TRADEROr

CLEARING BROKER

$$$$$$$$$$$$$$$$$$$$$$$$$$

GRIVNA

LOW LIQUIDITY PRODUCT (Cu Ore)

$$$$$$$$$$$$$


COUNTERPURCHASE, COUNTERPURCHASE, BUYBACK OR OFFSETBUYBACK OR OFFSET

Reciprocal commitment limited to Reciprocal commitment limited to purchase of goods?purchase of goods?

•YESYES

BUY BACK AND BUY BACK AND COUNTERPURCHASECOUNTERPURCHASE

•NONO

OFFSET


OFFSETOFFSET Offset is found most often in the large-scale Offset is found most often in the large-scale

capital goods, such as commercial aircrafts and capital goods, such as commercial aircrafts and military hardwares. military hardwares.

In a In a direct offsetdirect offset, part of the cost of the export , part of the cost of the export product is offset by buying the agreed amount product is offset by buying the agreed amount of goods---components or materials---from the of goods---components or materials---from the importing country, which the exporter importing country, which the exporter incorporates in the export product. incorporates in the export product. Other direct offsets include Other direct offsets include coproduction, coproduction,

licensing, subcontractinglicensing, subcontracting, and , and joint venturesjoint ventures.. In an In an indirect offsetindirect offset, the import goods are not , the import goods are not

used in the export product.used in the export product.


OFFSETOFFSET

Country B

Government B or

Company B

Страна А

Правительство А

или Компания А

Экспорт по основному контракту А→В

Договоренность сторон

Услуги/льготы

Offset Delivery

Offset Investments

Результат: снижение выплат по основному контракту А→В

Offset Investments

Relevant Services

Non-Contractual Agreement

MAIN CONTRACT: EXPORT DELIVERY A→B

OFFSET RESULT: Diminishing Payments in accordance with the main contract A→B


Offset with Triangular Offset with Triangular Full CompensationFull Compensation

Country B

Company B

Страна А

Компания А

Поставка по контракту А→В

Согласованная оценка обмениваемых товаров

Contract В→А Delivery

Завершение взаиморасчетов

Company C

Company B


Компенсационное

обязательство

disagio

Compensation

DutyFinal Settlement

Export Contract A→B Delivery

Assessment of Products to be

Exchanged


Offset with Triangular Offset with Triangular Partial CompensationPartial Compensation

Country B

Company B

Страна А

Компания А

Поставка по контракту А→В

Согласованная оценка обмениваемых товаров

Contract В→А Partial Delivery

Завершение взаиморасчетов

Company C

Company B


Компенсационное

обязательство

Partial Payment forContract В→А

Final Settlement

Assessment of Products to be

Exchanged


Compensation

Duty

$$


BUY BACK AND BUY BACK AND COUNTERPURCHACOUNTERPURCHA

SESE Are the goods taken back by the Are the goods taken back by the

exporter the resultant output of exporter the resultant output of the equipment sold?the equipment sold?

•YESYES

BUY BACKBUY BACK

•NONO

COUNTERPURCHASECOUNTERPURCHASE


COUNTERPURCHACOUNTERPURCHASESE

The seller is obliged to The seller is obliged to buy from the buy from the buyer goods and/or servicesbuyer goods and/or services that that are usually unrelated to the goods are usually unrelated to the goods and/or services sold by the seller. and/or services sold by the seller.

The counterpurchase involves The counterpurchase involves two two separate contractsseparate contracts and the and the deliveries can take place within a deliveries can take place within a period of one to five years. period of one to five years.


Paralleled DealParalleled Deal

Country B

Government B or

Страна А

Правительство А

или Компания А

Экспорт по основному контракту А→В

Контракт на встречную закупку (А←В)

Importing as Counterpurchase

Основной экспортный контракт (А→В)

Соглашение о встречной закупке (А↔В)

t = T

Company C

Company B

Передача исполнения контракта

(А←В) третьей стороне

t = T + τ


Counterpurchasing Contract

Main Export Contract A→B

Duty Transfer to the

Third PartyAgreement on Counterpurchasing


Advanced Advanced PurchasingPurchasing

Exporter from Country A

Importer from Country B

Goods from

B to A

as compensation

Export Delivery (Equipm

ent)from

A to B

BANK(acceptable for the both Parties)

ESCROW ACCOUNT

Revenue as a result of

Goods selling

3rd PARTYOption B

ank Transfer to Pay Export D

elivery

Threshhold – up to 100%


BuybackBuyback or or Production Production

CompensationCompensation Compensation or buyback is normally Compensation or buyback is normally

found in the exports of plants, found in the exports of plants, machinery or technology, where the machinery or technology, where the exporter is compensated by, or exporter is compensated by, or obliged to buy from the importer, obliged to buy from the importer, the goods producedthe goods produced by such plants, by such plants, machinery or technology. machinery or technology.


BuybackBuyback

Country B

Company B (Contractor)

Страна А

Компания А (Генподрядчик)

[3] Экспорт товаров и услуг по контракту А→В

[1] Контракт А→В на условиях «под ключ» (turnkey) с оплатой проекта по схеме

«байбэк»

Product Deliveries [4], [5]

Constructed Plant

СУБПОДРЯДЧИКИ (SUBCONTRACTEES)

[2]

[3] [3]

Рынки, на которых маркетируется товар, производимый на производственном объекте, сооруженном для Компании В по

контракту А→В

[5]

Производтвенное

потребление товара

от Компании

В

ИНВЕСТОРЫ (INVESTORS) $, ¥, £, €

Markets where the product produced on the Constructed Plant is to be marketed

Turnkey Project to be paid by Buyback Arrangement

GOODS/SERVICES DELIVERIES

Production Consumption of

Goods Produced on the Constructed Plant


Seller’s Seller’s ObjectivesObjectives

Increase Increase profitsprofits Help countertrade partner conceal a Help countertrade partner conceal a price cutprice cut SignalSignal a high quality product a high quality product Increase Increase sales volumesales volume and and market sharemarket share Establish Establish long-term relationshipslong-term relationships with new with new

trading partners trading partners Secure Secure government contractsgovernment contracts Gain entry into Gain entry into new or difficult marketsnew or difficult markets Fuller use of Fuller use of production capacityproduction capacity Generate Generate customer goodwillcustomer goodwill Gain access to Gain access to newnew marketing networksmarketing networks

and and expertiseexpertise


Buyer’s Buyer’s ObjectivesObjectives

Generate Generate goodwillgoodwill Acquire Acquire badly neededbadly needed products and technology products and technology Help conceal Help conceal price cutprice cut Secure Secure accessaccess to critical sources of supply to critical sources of supply FreeFree blocked funds blocked funds Make purchases without deteriorating the Make purchases without deteriorating the balance of trade balance of trade Conserve hard currencies Conserve hard currencies Reduce heavy Reduce heavy debt burdensdebt burdens Bypass Bypass trade restrictions trade restrictions Establish long-term Establish long-term relationshipsrelationships with new trading partners with new trading partners Secure low cost Secure low cost sources of production or raw materialssources of production or raw materials CollectionCollection of existing debts of existing debts


Shortcomings of Shortcomings of Countertrade Countertrade

No "in-house" use for goods offered by No "in-house" use for goods offered by customers.customers. Exporters often face the problem of Exporters often face the problem of what to do with the goods they are offered. what to do with the goods they are offered. Goods that cannot be used in-house need to be resold.Goods that cannot be used in-house need to be resold. Some firms will rely on Some firms will rely on specialist brokersspecialist brokers to sell to sell

their goods.their goods. Timely and costly negotiations.Timely and costly negotiations. Arranging a Arranging a

countertrade deal requires a time-consuming and countertrade deal requires a time-consuming and complex bargaining process. A prospective complex bargaining process. A prospective customer with a long track record usually has a customer with a long track record usually has a tremendous edge over an exporter with little tremendous edge over an exporter with little negotiation skills. negotiation skills.


Shortcomings of Shortcomings of CountertradeCountertrade

Uncertainty and lack of information on future Uncertainty and lack of information on future prices.prices. When part of the traded goods involve When part of the traded goods involve commodities, firms run the risk that the price sinks commodities, firms run the risk that the price sinks before the goods can be sold. Apart from price before the goods can be sold. Apart from price uncertainty, there is uncertainty, there is uncertainty about the qualityuncertainty about the quality of the goods.of the goods.

Transaction costs.Transaction costs. Costs flowing from countertrade Costs flowing from countertrade quickly add up: quickly add up:

cost of finding buyerscost of finding buyers for the goods (if there is no in- for the goods (if there is no in-house use),house use),

commissions to middlemen (if any), commissions to middlemen (if any), insurance costsinsurance costs to cover risk of faulty or nondelivery, to cover risk of faulty or nondelivery, hedging costshedging costs to protect against sinking commodity to protect against sinking commodity

prices. prices.


a few words of a few words of adviceadvice

Always Always evaluate the pros and consevaluate the pros and cons of of countertrade against other options.countertrade against other options.

MinimizeMinimize the ratio of compensation goods to the ratio of compensation goods to cash.cash.

Strive for goodsStrive for goods that can be used in-house. that can be used in-house. AssessAssess the relative merits of relying on the relative merits of relying on

middlemen versus an in-house staff.middlemen versus an in-house staff. Check whether the goods are subject to any Check whether the goods are subject to any

import restrictions.import restrictions. Assess the Assess the qualityquality of the goods. of the goods.


QUESTIONS FOR QUESTIONS FOR DISCUSSIONDISCUSSION

Explain why countertrade is often viewed as Explain why countertrade is often viewed as a a necessary evilnecessary evil..

Compare and contrast the alternative Compare and contrast the alternative techniques for countertrade. Is there techniques for countertrade. Is there one one best formbest form for a seller and one best form for a seller and one best form for a buyer? Explain.for a buyer? Explain.

To what extent are the objectives of sellers To what extent are the objectives of sellers and buyers in countertrade transactions in and buyers in countertrade transactions in conflictconflict with each other and to what extent with each other and to what extent are they in are they in harmonyharmony with each other? with each other?

Counter Trading Arrangements

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