Trade Finance in International Trade: Legal Guide in Russia

October 31, 2023

BRACE Law Firm ©

As a rule, international trade transactions involve the performance of financial obligations. However, it is not always possible to perform a financial obligation immediately, and the counterparty often must wait for payment under a foreign trade contract, frequently for a significant period.

At the same time, the financial market is continuously evolving and offers foreign partners various financial products capable of accelerating the performance of financial obligations, such as loans, letters of credit, discounted letters of credit, international factoring, preferential financing instruments from the export center and EXIAR coverage, derivatives, currency swaps, and others. All these financial instruments fall under the single umbrella concept of trade finance, which represents a complex of financial and intermediary services provided for making payments and protecting against risks arising during the performance of contracts.

The following parties generally participate in trade finance within the sphere of international trade:

• banks and credit institutions, including those engaged in trade finance;
• exporters and importers;
• insurance companies;
• export credit agencies.

Considering that both suppliers and buyers bear the risks associated with foreign trade contracts, situations frequently arise where the buyer pays for the goods but does not receive the shipment, and vice versa, when the supplier ships the goods but the funds for the sent goods are not received. To avoid misunderstandings and reduce potential risks during the performance of a foreign trade contract, parties to an international transaction resort to various trade finance methods, allowing them, for example, to receive payment immediately after the delivery of goods and not wait a long time for payment from the buyer.

Trade Finance in International Trade Operations

Trade finance represents financial services of banks and other financial organizations through which foreign partners conduct payments under foreign trade contracts, and protection is provided for export and import operations. Such services may also be used for domestic trade. Trade finance can be divided into several directions:

• financing domestic transactions within the country (e.g., bank guarantees, letters of credit);
• financing imports and exports (loans from a bank under the insurance coverage of an export credit agency, loans from a foreign bank, forfaiting, etc.);
• conducting settlements for foreign trade transactions (covered and uncovered letters of credit, collections).

The primary function of trade finance is the involvement of a third party in an international transaction to reduce the risk of non-performance of obligations under a foreign trade contract, such as receiving funds or performing delivery obligations, currency exchange rate fluctuations, etc.

Trade interaction with foreign partners allows importers to enter new markets and expand their capabilities, for the implementation of which trade finance instruments are used, possessing a number of advantages:

• increased turnover and profit;
• the ability not to use one's own funds for contract performance;
• reduction of risks in receiving payments;
• simplification of business operations with foreign partners;
• the possibility of obtaining a payment deferral under a foreign trade contract.

Methods of Financing International Trade Transactions

To resolve tasks within the framework of interaction under foreign trade contracts, foreign partners resort to various trade finance methods. Financial instruments in the sphere of trade finance include such instruments as:

• Credit represents a transaction in which a bank or other credit institution (the "creditor") undertakes to provide funds (the "credit") to the borrower in the amount and on the terms provided for by the agreement, and the borrower undertakes to return the received monetary sum and pay interest for using it, as well as other payments provided for by the credit agreement, including those related to the provision of the credit.[1] At the same time, measures for supporting credit institutions are adopted at the state level for the development of foreign trade activity in order to compensate for lost income.[2] Credit lines from banks can be provided to both importers and exporters.
• When settling by letter of credit, [3] the issuing bank, acting on the instructions of the payer, undertakes to the recipient of funds to make payments or to accept and pay a bill of exchange issued by the recipient of funds, or to perform other actions for the performance of the letter of credit upon the presentation of the documents provided for by the letter of credit and in accordance with its terms by the recipient of funds. [4] A letter of credit protects the parties from potential non-performance of obligations under a foreign trade contract; the buyer's bank guarantees payment, for example, for delivered goods, while if the seller does not fulfill their obligations under the letter of credit, payment will not be made. The United Nations Convention on Independent Guarantees and Stand-by Letters of Credit [5] applies to an international obligation, which means an independent obligation, understood in international practice as an independent guarantee or a stand-by letter of credit, and which is issued by a bank or other institution or person (the "guarantor / issuer") to pay the beneficiary a certain or determinable sum upon simple demand or demand with the presentation of other documents in accordance with any documentary conditions of the obligation, indicating or from which it follows that payment is due by reason of non-performance of some obligation or the occurrence of another circumstance, or in payment for borrowed or advanced funds, or as payment in repayment of any matured debt of the principal/applicant or another person. An obligation is international if the commercial enterprises of any two of the following persons specified in the obligation are located in different states: guarantor/issuer, beneficiary, principal/applicant, instructing party, confirming party. In this regard, if more than one commercial enterprise of a given person is specified in the obligation, the relevant commercial enterprise is the one that has the closest connection with the obligation. At the same time, if no commercial enterprise of a given person is specified in the obligation but its permanent residence is specified, this residence is considered sufficient for determining the international character of the obligation. [6]
• A discounted letter of credit represents a procedure where the bank buys the letter of credit from the seller (the exporter) and immediately pays the sum without waiting for the actual receipt of payment from the buyer (the importer); however, the cost of such a purchase is often lower.
• Under a financing agreement against the assignment of a monetary claim (factoring agreement), [7] one party undertakes to assign to the other party—the financial agent (the "factor") — monetary claims against a third party (the "debtor") and to pay for the services rendered, and the financial agent (the "factor") undertakes to perform at least two of the following actions related to the monetary claims being the subject of the assignment: [8]
• transfer funds to the client against the monetary claims, including in the form of a loan or an advance payment;
• maintain accounting for the client's monetary claims against third parties (debtors);
• exercise rights under the client's monetary claims, including presenting monetary claims to debtors for payment, receiving payments from debtors, and conducting settlements related to monetary claims;
• exercise rights under agreements on securing the performance of the debtors' obligations.

For factoring, according to international norms, the UNIDROIT Convention on International Factoring[9] applies, which regulates the relations arising when using factoring agreements and during the assignment of a right of claim. The Convention applies whenever the rights of claim assigned under a factoring agreement arise from a contract for the sale of goods concluded between a supplier and a debtor who are residents of different states and:

• these states, as well as the state in which the factor is located, are contracting states to the Convention;
• the contract for the sale of goods and the factoring agreement are governed by the law of a contracting state to the Convention.

In the event that one of the parties conducts activity in more than one state, the state that has the greatest relationship to the specific contract and its performance, in accordance with the circumstances known to the parties or provided for by them at any time before or during the conclusion of this contract, should be considered the location of this party.

• Derivatives or a derivative financial instrument represent an agreement between parties on the purchase (sale) of a specific asset at a specific time. The underlying assets of derivative financial instruments are securities, goods, currency, interest rates, the inflation level, official statistical information, physical, biological, and/or chemical indicators of the state of the environment, agreements that are derivative financial instruments, and values calculated on the basis of one or a combination of several indicators specified in this paragraph, on the prices (values) of which the obligations of the party or parties to the agreement being a derivative financial instrument depend.
• A bank guarantee represents an independent guarantee issued by a bank or other credit institution. Under an independent guarantee, the guarantor assumes, at the request of another person (the "principal"), an obligation to pay a specified sum of money to a third person (the "beneficiary") in accordance with the terms of the obligation given by the guarantor, regardless of the validity of the obligation secured by such a guarantee.[10] The requirement for a specific monetary sum is considered met if the terms of the independent guarantee allow for the establishment of the monetary sum to be paid at the time of the guarantor's performance of the obligation. In the international field, actions with a bank guarantee are regulated by the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit, the Uniform Rules for Demand Guarantees, and other regulatory documents. Within the framework of the Eurasian Economic Union, the Agreement on Mutual Recognition of Bank Guarantees in State (Municipal) Procurement[11] and regulatory documents adopted in accordance with this agreement have been made public.
• Credit insurance is used for insurance against the non-payment of credit obligations upon the occurrence of unforeseen circumstances (currency exchange rate fluctuations, changes in the political or economic situation, etc.).
• When settling by collection, the bank (the "issuing bank") undertakes, on the instructions of the client, to perform actions at the client's expense to receive payment and/or acceptance of payment from the payer.[12] An issuing bank that has received a client's instruction is entitled to involve another bank (the "collecting bank") for its fulfillment. In the international legal field, the Uniform Rules for Collections[13] also apply, according to which collection means operations carried out by banks on the basis of instructions received with documents for the purpose of receiving payment and/or acceptance, transferring documents against payment and/or against acceptance, or transferring documents on other terms.
• EXIAR insurance coverage represents part of the system of state support for Russian exports and is used for protection against entrepreneurial and political risks. State guarantees of the Russian Federation for the obligations of the Joint-Stock Company "Russian Agency for Export Credit and Investment Insurance," which provides insurance support for imports, are regulated by Government Decree of Russia No. 1672 dated September 22, 2022, On the State Guarantee of the Russian Federation for the Obligations of the Joint-Stock Company "Russian Agency for Export Credit and Investment Insurance" Providing Insurance Support for Imports.... The guarantee is provided in favor of Russian policyholders, reinsurers, and other beneficiaries meeting the requirements established by the Budget Code of the Russian Federation to ensure the performance of the principal's obligations to pay insurance compensation (within the limits of the insurance amounts) (in the currency of the Russian Federation) upon the occurrence of insured events under insurance and reinsurance agreements concluded by the principal (acting as the insurer and reinsurer, respectively) in accordance with the acts on the performance of the principal's activity from the date of the guarantee's entry into force during the principal's performance of insurance support for imports.
• A currency swap represents a double transaction, and in accordance with Bank of Russia Directive No. 3565-U dated February 16, 2015, On the Types of Derivative Financial Instruments (the "Directive No. 3565-U"), a swap agreement is recognized as:

• An agreement providing for the obligation of a party or parties to the agreement periodically and/or once to pay monetary sums depending on changes in the prices (values) of the underlying asset and/or the occurrence of a circumstance being the underlying asset. If such an obligation is established for each of the parties, it is determined on the basis of different underlying assets or different values of the underlying asset (rules for determining the values of the underlying asset). In this regard, the obligation of a party to the agreement to pay monetary sums may be determined on the basis of a fixed value of the underlying asset established by the agreement;
• An agreement (with the exception of a repo agreement) providing for the obligation of one party to transfer currency, securities, or goods into the ownership of the second party and the obligation of the second party to accept and pay for the currency, securities, or goods, as well as the obligation of the second party to transfer currency, securities, or goods into the ownership of the first party no earlier than the third day after the day of concluding the agreement and the obligation of the first party to accept and pay for the currency, securities, or goods. This agreement must contain an indication that it is a derivative financial instrument, or provide for the obligation of the party or parties to the agreement periodically and/or once to pay monetary sums depending on changes in the prices (values) of the underlying asset and/or the occurrence of a circumstance being the underlying asset, and/or on fixed prices (values) of the underlying asset in the agreement. In this regard, the determination of the obligation of each of the parties to the agreement to pay monetary sums is carried out in accordance with the terms of the agreement on the basis of different underlying assets or different values of the underlying asset (rules for determining the values of the underlying asset);
• An agreement providing for the obligation of a party or parties to the agreement periodically and/or once to pay monetary sums depending on the occurrence of a circumstance being a credit event.

A swap agreement, in addition to the established conditions, may also provide for one of the following conditions:

• the obligation of the parties or a party to the swap agreement to transfer, including on a periodic basis, to the other party securities, currency, or goods being the underlying asset, or other securities, or rights (claims), including through the conclusion of a contract for the purchase and sale of securities, a contract for the purchase and sale of foreign currency, a contract for the supply of goods, or a contract for the assignment of rights (claims) by the party (parties) to the swap agreement and/or the person (persons) in whose interests the swap agreement was concluded;
• the obligation of the parties to the swap agreement to conclude an agreement that is a derivative financial instrument and constitutes the underlying asset.

• A futures contract[14] is recognized as an agreement concluded at exchange trades providing for the obligation of each of the parties to the agreement periodically to pay monetary sums depending on changes in the prices (values) of the underlying asset and/or the occurrence of a circumstance being the underlying asset.[15] A futures contract, in addition to the established conditions, may also provide for one of the following obligations:

• the obligation of one party to the agreement to transfer securities, currency, or goods being the underlying asset into the ownership of the other party or a person (persons) in whose interests the futures contract was concluded, including through the conclusion of a contract for the purchase and sale of securities, a contract for the purchase and sale of foreign currency, or a contract for the supply of goods by the party (parties) to the futures contract and/or the person (persons) in whose interests the futures contract was concluded;
• the obligation of the parties to the futures contract to conclude an agreement that is a derivative financial instrument and constitutes the underlying asset.

• A forward contract [16] is recognized as an agreement providing for one of the following obligations: [17]

• the obligation of one party to the agreement to transfer securities, currency, or goods being the underlying asset into the ownership of the other party no earlier than the third day after the day of concluding the agreement, the obligation of the other party to accept and pay for such property, and an indication that the agreement is a derivative financial instrument;
• the obligation of the parties or a party to the agreement to pay monetary sums depending on changes in the prices (values) of the underlying asset and/or the occurrence of a circumstance being the underlying asset.

• An option contract [18] is recognized as: [19]
  1. An agreement providing for the obligation of a party to the agreement in the event of a demand by the other party periodically and/or once to pay monetary sums depending on changes in the prices (values) of the underlying asset and/or the occurrence of a circumstance being the underlying asset;
  2. An agreement providing for one of the following obligations:
• the obligation of a party to the agreement on terms determined at its conclusion, in the event of a demand by the other party, to buy or sell securities, currency, or goods being the underlying asset, including through the conclusion of a contract for the purchase and sale of securities, a contract for the purchase and sale of foreign currency, or a contract for the supply of goods by the party (parties) and/or the person (persons) in whose interests the option contract was concluded;
• the obligation of the party to the agreement, in the event of a demand by the other party, to conclude an agreement being a derivative financial instrument and constituting the underlying asset.

The underlying assets of derivative financial instruments are securities, goods, currency, interest rates, the inflation level, official statistical information, physical, biological, and/or chemical indicators of the state of the environment, agreements that are derivative financial instruments, and values calculated on the basis of one or a combination of several indicators specified in this paragraph, on the prices (values) of which the obligations of the party or parties to the agreement being a derivative financial instrument depend.

In accordance with paragraph 7 of Directive No. 3565-U, an agreement that is a derivative financial instrument containing conditions of several types of derivative financial instruments represents a mixed agreement.

Financing in Foreign Banks During International Trade

In addition to the designated financial services, entrepreneurs may need additional financing when concluding foreign trade transactions, including financing in a foreign bank. In accordance with Article 1 of Federal Law No. 395-1 dated December 2, 1990, On Banks and Banking Activities, a foreign bank is recognized as a bank recognized as such under the legislation of the foreign state in the territory of which it is registered.

Sources of financing in foreign banks may include:

• Foreign bank loans. These are provided to non-residents in the currency of the state in which the loan is formalized for use in the territory of another state. Often, especially in modern political and economic conditions, such financing may be limited at the state level. Advantages of loans in foreign banks include a lower interest rate, long terms for raising funds, the possibility of using accounts receivable or proceeds under export contracts as collateral, as well as a low formalization cost compared to other forms of raising foreign financing. Disadvantages include fairly strict requirements for the borrower and the security for the loan, the need to receive at least part of the proceeds in the currency of the loan, numerous conditions and covenants, the non-fulfillment of which leads to the early calling of the loan, the occurrence of currency risk, compliance with the legal norms of the foreign state, etc.
• Obtaining foreign bond financing. In this case, the issuance of the company's bonds is placed on a foreign capital market in the local currency. Foreign issuances, as a rule, face additional established restrictions compared to issuances of local companies.
• Placement of company shares on foreign markets. The goal of such financing is the diversification of financing sources, which represents the distribution of capital to minimize risks. Such an action allows for reducing the influence of national market fluctuations. At the same time, the sale of shares on a foreign market attracts new shareholders from other countries, which can positively influence the value of the shares.
• Creation of joint ventures. In this case, foreign investments are partially used to create the enterprise. Frequently, at the state level, the regulation of the activity of joint companies occurs; as a rule, such a regulator is the restriction of the foreign investor's share in the capital of the joint venture at the level of 49%.
• Issuance of Euro-shares and Euro-bonds represents the issuance of securities with the goal of placing them among foreign investors. There are special international syndicates that issue and place such securities. A Euro-bond is generally an issuance of bonds sold in another country. The issuance of Euro-bonds has a single currency as its nominal value, although it is usually sold to investors in a number of countries.
• Commercial bill of exchange or draft. This represents a written statement by the exporter instructing the importer to pay a certain sum of money by a specific deadline. A draft can be either a sight bill of exchange or a time bill of exchange. A sight bill of exchange is paid upon its presentation to the party to whom it is addressed, the drawee. If the drawee, or the importer, does not pay the specified sum upon presentation of the bill of exchange, they refuse payment, and reimbursement is carried out by means of a letter of credit.
• Forfaiting operations. Forfaiting represents the provision of credit to an exporter by purchasing bills of exchange accepted by the importer. Advantages of forfaiting include the improvement of liquidity, and currency, credit, and interest rate risks are excluded; forfaiting does not influence another credit provided by the bank. Disadvantages of forfaiting are high cost and the difficulty for the exporter in finding a bank wishing to act as a forfaiter.

The variety of trade finance opportunities allows foreign trade participants to analyze the offered types of financing, make an optimal decision, and choose the trade finance suitable for a specific company. In this regard, one should not forget that in the case of trade finance with the involvement of foreign capital, it is necessary to comply with the requirements of not only international and Russian legislation but also the legislation of the country from which the foreign financing will be received. At the same time, it is necessary to note that a significant condition for using trade finance is compliance not only with the norms of national legislation but also the rules of international law, which in the sphere of trade finance include:

• the UNIDROIT Convention on International Factoring;[20]
• the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit;[21]
• the Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600, approved by the International Chamber of Commerce;
• the Uniform Rules for Demand Guarantees [22], etc.

The performance of national and international legislation allows participants in foreign trade transactions to carry out interaction with each other with minimal risks, and simultaneously with comfortable conditions for full-fledged cooperation.

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References

[1] Civil Code of the Russian Federation (Civil Code) Art. 819(1).

[2] Government Decree No. 1628 dated October 2, 2023, On Approval of the Rules for Providing Subsidies from the Federal Budget to Credit Institutions to Compensate for Lost Income on Loans or Other Financial Instruments Economically Similar to Credit, Issued within the Framework of Supporting the Acquisition of Merchant Ships for the Development of Foreign Trade Activities.

[3] Resolution of the Arbitration Court of the Far Eastern District dated May 12, 2016, No. F03-1820/2016 in Case No. A51-11536/2014, On the Recovery of Damages and a Fine Related to Improper Performance of the Terms of a Coal Supply Contract. Having not received payment for delivered goods, the supplier suffered losses related to the price difference specified in the contract and its realization. Under the contract terms, a fine was charged for violating payment deadlines and a claim was sent, which remained unsatisfied. Since the supplier's obligation to deliver goods was fulfilled and the defendant's breach confirmed, damages were recognized as justified in the form of the difference between the contract value and the price of realization to a third party, storage costs, and other fees until the moment of realization; the claim was partially satisfied.

[4] Civil Code Art. 867(1).

[5] The Convention was approved by the UN General Assembly on December 11, 1995. The Convention does not apply to Russia.

[6] Article 4 of the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit.

[7] Resolution of the Arbitration Court of the North-Western District dated April 25, 2023, No. F07-3882/2023 in Case No. A56-16911/2021, On the Inclusion of the Bank's Claim in the Amount of Debt under Financing Agreements 1 and 2 Against the Assignment of a Monetary Claim (Factoring) into the Register of Creditors' Claims. The bank's performance of any services for the debtor under factoring agreement-1 was not confirmed; therefore, the applicant's claim was partially satisfied.

[8] Civil Code Art. 824.

[9] Russia joined the Convention in accordance with Federal Law No. 86-FZ dated May 5, 2014, On the Accession of the Russian Federation to the UNIDROIT Convention on International Factoring.

[10] Civil Code Art. 368(1).

[11] Concluded in Moscow on August 29, 2023. It enters into force on the date the depositary receives through diplomatic channels the last written notification of the completion by the member states of the internal procedures necessary for the entry into force of the Agreement.

[12] Civil Code Art. 874.

[13] Approved by the International Chamber of Commerce and entered into force on January 1, 1996.

[14] Resolution of the Arbitration Court of the West Siberian District dated February 21, 2022, No. F04-8229/2021 in Case No. A45-518/2021, On Recognizing as Unlawful Actions (Inaction) to Not Provide the Opportunity to Withdraw Active Orders for Oil Futures Contracts, Not Changing the Lower Price Limit for Contracts, Expiration of Contracts, and Recovering Damages in the Amount of Losses from Executing Contracts at a Negative Price. According to the case materials, the Exchange stopped trading and forcibly closed positions at a negative price, which, in the plaintiff's opinion, caused the loss of the invested amounts. There are no prohibitions on negative prices for futures contracts in Russian legislation, and considering the plaintiff's losses — this is a realization of risk when entering into legal relations with brokers; the claim was denied.

[15] Paragraph 3 of Directive No. 3565-U.

[16] Resolution of the Arbitration Court of the Central District dated November 16, 2022, No. F10-5035/2022 in Case No. A54-10276/2021, On Recovering Compensation for Metal Racks Transferred under a Forward Contract for the Provision of Glass Transportation Services. In filing the claim, the customer cited the carrier's failure to return reusable packaging — racks for transporting cargo — which were provided in accordance with the contract terms. Evidence of the return of the racks was not provided; the claim for compensation for the reusable packaging was satisfied.

[17] Paragraph 4 of Directive No. 3565-U.

[18] Resolution of the Arbitration Court of the Moscow District dated February 19, 2019, No. F05-292/2019 in Case No. A40-207820/17, On Compelling the Conclusion of a Contract for the Sale of a Share in the Authorized Capital of a Company. A counterclaim was filed to recognize the agreement on the granting of an option to conclude a contract for the sale of a share in the authorized capital as unexecuted. The claim to compel the conclusion of the sales contract was denied. Since the terms of the option agreement did not allow for the determination of the specific size of the share to be transferred or the price of the share, the counterclaim was satisfied.

[19] Paragraph 2 of Directive No. 3565-U.

[20] The Convention was adopted in Ottawa on May 28, 1988.

[21] The Convention was approved by the UN General Assembly on December 11, 1995. It entered into force on January 1, 2000. Russia does not participate in this Convention.

[22] Approved by the International Chamber of Commerce.