12 December 2007

Risks mitigation

The question arises why contract parties are willing to pay so much money for bank commissions instead of paying directly to the other contract party. To give an answer to this question, it is first necessary to take a look at the risks of worldwide trade today.

Risks associated with trade

“The truth is that risk is a derivative, and essentially negative, concept – an elliptical way of saying that either or both of the primary obligations of one party shall be enforceable, and that those of the other party shall be deemed to have been discharged, even though the normally prerequisite conditions have not been satisfied.” (goode)

Business outside of the home country bears greater risks than inside; wide distance, different law and business practices, different currencies, different political systems and communication problems caused by different languages and technical standards are typical problems in international business. If contracts are ruled by foreign law, it is often hard to estimate the legal situation of the foreign contract party. Another problem is the performance of the contract; matching payment with physical delivery is not possible, therefore also no control. To take a party to court can be difficult because of foreign language, foreign law, foreign process law or the need of a foreign solicitor. There are mainly four risks to face when trading worldwide: economic risks, political risks, payment risks and transport risks.

Economic risks

Economic risks results from a lack of quality, solvency or credit-worthiness of a contract party. Exporter’s risks are the manufacturing risk, that means that the importer could get insolvent or breaches the contract while producing the goods; the risk that the importer do not take the goods delivered, and the delcredere risk, which means that the importer do not pay, for example because of delay or unwillingness or incapability to pay. In a wider sense, economic exporter risks are includes the risk of bankruptcy of the importer, the risk of arbitrary cancellation of the contract, the risk of compositions / arbitration or the risk that an execution does not compensate a payment claim. But there are also importer´s risks: the order risk, that means that the exporter cannot deliver promised goods, and the delivery risk, which means that the exporter fails in performance caused by delay or lacks in kind, quality or quantity of the goods.

Political risks

Political risks, also called “state risks”, are caused by measures of governments or authorities or are results of war, rebellion or revolution. These risks can concern goods, which can be confiscated, expropriated, destroyed or damaged, or can concern assets or payments caused by confiscation, prohibition of payment, a moratorium or restrictions of conversion or transfer of money. Perhaps each party wants to perform, but caused by such political circumstances that is impossible. In some cases, for example war, the whole contract is regarded as being frustrated if one of the parties acquiring the status of an enemy. Or the performance can be disturbed by war.

A contract can also regarded as frustrated if legislation of one country after conclusion of it prohibits its performance by placing an embargo. An important and usual risk is the risk of a moratory; a state prohibits payments because of the incapability of the state to pay.

Currency risks

Currency risks are caused by floating exchange rates of the home currencies of each party and generally include the danger of losses. The exporter who signs a contract which includes payment in foreign currency bears the risk that he receives less money than he has calculated. The importer who has to pay in foreign currency bears the risk that he has to pay more money for buying foreign currency than he has calculated. Such currency risks can be caused by economical and / or political reasons. Another risk occurs if the currency of a state is not convertible or payments in this currency are not allowed. Even this is more a political risk, caused by measures of a state, it can also include a currency risk if the payment was said to be made in this currency.

Transport risks

Import and Exports include a transport risk; goods can get lost or damaged on the transport way. The question arises from which point on the importer has to bear a risk and has to pay even he never received goods. Another problem occurs if the property in the goods has passed, but the buyer justifiably rejects the goods; it is then not always clear who has to bear the risk of any loss, damage or deterioration of the goods if they must be stored or transported back.

Letters of credit can be used for risk-minimization of some, but not all of the above mentioned risks.

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