There are many different types of risk arising from International Trade. There is also a wide range of solutions available to mitigate these risks, see Figure.
Financial Risks Arising from International Trade
Minimising Counter-party and Credit Risks
The financial crisis has shown how important it is for companies to minimise counter-party and credit risk from banks, as well as from trading partners and country risk. Previously, it was all too easy to assume the large banks and countries were 'sound' and represented little counter-party risk, but not any more. All counter-parties represent some level of credit risk and operational risk, no counter-party is risk free. Each counter-party risk has to be recognized and managed.
There are three stages in managing and mitigating counter-party risk: 1) obtaining full information about each counter-party, 2) analyzing this information consistently, and then 3) using appropriate products and services to manage this risk.
Obtaining Counter-party Information and Assessments
The annual report and accounts from companies and banks are the first source of information, but these are by definition out of date and can hide the true position. More up-to-date information is available from trading statements, press releases together with quarterly statements, and issuance prospectuses for fund raising programmes. It is a full time task to collect this information. Few companies carryout this task themselves, instead they use credit scoring companies and/or credit rating agencies to analyze and collect this information and make the assessments of risk.
The credit scoring companies work through all the published sources including bankruptcies and records of directors' interests, cross-check this against general and country industry trends, and then provide a credit score for the company or country. The large global credit scorers have millions of companies on their databases. There are also regional credit scorers.
The credit rating agencies have a much higher profile as their research is publicly available, but there has been much criticism because they 1) gave the derivatives securities (repackaged mortgages and credit card receivables) a far too high rating, and 2) failed to detect the worsening of the financial market conditions and change their ratings to reflect this. The rating assessments need to be treated with care. They should be used just one assessment, not the whole truth on which key decisions are made.
Managing and Mitigating Bank and Customer Risk
Every bank and customer represent some level of counter-party risk. The question is to assess how much risk and then to limit the trading credit, and operational exposure to an 'acceptable' level. The decision as to what level of exposure to each bank or customer is acceptable is normally made by the finance/treasury committee. The operational risk from each bank should also be considered and managed.
An important indicator of what the market thinks about a bank's prospects is their Credit Default Swaps price. Many corporate treasurers now monitor banks' CDS price as part of their assessment of bank counter-party risk.
Export credit insurance provides protection against commercial losses—default, insolvency, bankruptcy, and political losses—war, nationalization, currency inconvertibility, etc. It allows exporters to increase sales by offering liberal open account terms to new and existing customers. Insurance also provides security for banks providing working capital and export financing.
The screening of customers and trading parties has become a major problem. The United States has eight different agencies and departments, which issue lists of sanctioned companies and organisations, and other countries' governments do the same. There are now a range of databases and services to screen companies as to whether they have been approved by governments or not.
Managing and Mitigating Country Risk
Sovereign risk is a growing problem world-wide and needs to be assessed and managed. The ability of the government and the private sector in each country to pay for their imports is assessed by the rating agencies, but this should clearly be just one the inputs to your company's assessment of the overall risk.