What is a verification letter?
A verification letter is a short letter referring to one or more commercial invoices, signed by the buyer and addressed to the trade financier.
The letter confirms the buyer’s confidence and satisfaction with his chosen supplier and the performance of the trade, and also acknowledges that the trade financier is involved.
- By signing a verification letter, the buyer enables a trade finance company like PrimaDollar to provide low cost, collateral free finance to the exporter; the letter significantly reduces the amount of credit risk that the financier takes on the exporter.
- If a buyer decides not to sign a verification letter, this can mean that the cost finance is higher and the amount of finance available is lower, or can mean that no finance can be provided.
Why is a verification letter important?
The supply of goods between an exporter and his buyer involves a variety of risks.
A trade financier like PrimaDollar pays the exporter in cash at shipment and then relies upon the buyer to pay the invoice later. Typically, the exporter is weaker credit and the buyer is a stronger credit.
- Ideally, the risk on the exporter is mitigated because the buyer verifies the trade by signing a verification letter upfront with the trade financier.
- If the buyer does not sign such a letter, then the trade financier may have material credit risk on the exporter which has to be assessed, priced into the transaction and then managed.
The role of the verification letter in the transaction is to determine the allocation of risk between the buyer, the exporter and the financier.
Why should a buyer sign a verification letter?
By signing a verification letter, the buyer is confirming his level of confidence and satisfaction with his chosen supplier and the performance of the trade.
There are good reasons why signing a verification letter is sensible for buyers to do:
- The buyer has chosen the supplier and has the expertise to determine if the supplier is performing.
- The financier is not in a position to assess whether goods are supplied correctly or not; without a confirmation, the financier has to structure and price the trade on the basis of worst-case assumptions.
- This means that the advance rate will be low and the cost will be high, and the buyer finally pays these costs. It is a zero-sum game. In the end, all of the costs of the supply chain end up in the cost of goods that are supplied to the buyer.
Moreover, if there are issues with the supply, it is the buyer not the financier who has the leverage and knowledge to resolves issues that may arise. When buyers sign a verification letter, they do not give up any of these rights.
Times are changing
Many years ago, many buyers may well have taken a strong position and would not normally have signed verification letters.
- But in recent years, larger buyers have set up supply chain finance programs. Supply chain finance programs operate identically to the verification letter system.
- As sourcing moves to lower cost locations, buyers have found an increasing need to provide letters of credit, down-payments and payments at shipment to exporters. The verification letter system allocates risk no differently to these arrangements.
- Buyers generally have also begun to value their supply chain as an asset, and have been prepared to provide support it, knowing that all the finance costs in the supply chain inevitably end up in the cost of goods.
This means that most buyers now have the expertise to evaluate the best way to support their supply chain with trade finance.
Moreover, as banks have retreated from trade finance, funding gaps are opening especially between emerging market exporters and their international buyers. These funding gaps are creating problems in supply chains which require new solutions.
Verified trade finance from PrimaDollar is the lowest cost and simplest way to get exporters paid at shipment, allowing buyers to pay later.
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