Canada & Iran Trade Transaction
Wednesday, September 16, 2009
Canadian/Iranian wheat sales express a trade finance structure that begins with the Iranian buyer, who is the importer, asking the Canadian Wheat Board for an order of wheat. Once the Canadian Wheat Board accepts the contract and negotiated price have been agreed upon, the Iranian buyer will apply to an Iranian bank for a letter of credit to be issued in favor of the Canadian Wheat Board for the merchandise. Now that the Iranian bank has issued the L/C, they will send it to the Canadian Wheat Board’s bank; the Royal Bank of Canada. After the appropriate documentation has been sent to RBC, the Canadian Wheat Board will export their product, which is financed under L/C requiring a bill of lading to Iran. Next, the Canadian Wheat Board will give RBC their time draft with the required documents, including the bill of lading. RBC will present the draft and documents to the Iranian Bank, who will promise to pay the draft at maturity. Once the accepted draft is sent back from the Iranian Bank to RBC, they have the option to sell it to the open market or hold the acceptance in its own portfolio. If RBC decided to keep the accepted draft, they can pay the proceeds to the Canadian Wheat Board, less commission.
The primary risks involved are as follows:
- The political situation in Iran points to the possibility of another revolution as young people rise up against the clerics who took power in 1979. Any politically instability may disrupt payments due by Iran to international creditors.
- Iran’s government budget will be in deficit if the price of oil dips below $US 18.00. Recently the price of oil has been between $US 15 and $US 20.
- Iran does not have a country rating from a recognized rating agency, therefore, the Canadian bank must rely, largely, on internal expertise to assess the political and economic risks of doing business in Iran.
- The Canadian bank views country credit limits as a scarce resource and any limit in excess of $Cdn 75 million must be reported, immediately to the Board of Directors. As such, there is a question in the minds of risk managers as to how much the country limit for Iran should be, especially given the potential amount of the wheat sales. Further, there is a question about whether the limit should permit business other than wheat transactions; for example, spare parts for the oil and gas industry.
To start, one of the documents required to support this transaction is the bills of lading. These will be issued to Canada with the common carrier that transports the merchandise. They will need the commercial invoice, which will be issued by Canada and contain a precise description of the merchandise (wheat) that will be exported. They will need the insurance documents, which have to be issued by insurance companies or their agents. The last documentation that is required is the consular invoices, which would be issued in Canada by the consulate of Iran to provide customs information and statistics from Iran to help prevent false declaration of value.
Difficult finance transactions should have formal written corporate policies and procedures to identify, evaluate, and control risks associated with such deals; with an emphasis on those that present elevated levels of legal or reputational risk to the institution. Given the risks of this transaction, the return on capital the Canadian Bank should require from the Iranian government should be relatively high. Assuming that the average interest rate on a similar transaction between banks is 7%, the interest rate the Canadian bank should entail from the Iranian government should be close to 10%. Iran is experiencing serious issues that need to be solved. In this case, it is important that Canadian Bank guarantees a high return from this transaction. The risk of the Iranian government to fail to pay back due to the different issues they have undergone is significant.
Considering all these facts it could be a ”go” with the 10% interest rate taking the risk in consideration, however there is no guarantee that the 10% will be paid. Therefore, we say it’s too risky and a “no go”. If this case was today rather than 1996 it would still be a “no go” having the information today which we did not have back then. Today’s country rating for Iran clearly states that is unstable and not a suitable trading partner, also Canada couldn’t support this transaction considering the political ties with the US.