Bill of exchange: A safe pair of hands for global trade

In the 13th century ‘The Book of the Marvels of the World’ heralded a new era. Marco Polo's tales of his travels to China ignited Europe's interest in opening the Silk Road between East and West. This fostered a spirit of adventure and economic expansion that would shape the future of global trade. Northern Italian merchants, key players in exploring these new opportunities, popularised a new payment method to support trade credit. Centuries later, the bill of exchange still plays a crucial part in international commerce.

What is a bill of exchange?

A bill of exchange is a commercial document in which the debtor (drawee) agrees to pay a specific sum to the creditor (drawer) on a given date. Once this agreement is made it is legally binding. The drawer can transfer the bill to a third party (payee or beneficiary). This makes it a useful tool for circulating commercial debt.

How a bill of exchange works

The process begins when the drawer issues the bill. The drawee then accepts the bill, agreeing to pay the specified amount to the payee. The amount must be clearly indicated and the date agreed between the parties. The bill of exchange may be payable on demand, immediately when presented,  or on a specific date, if commercial credit is to be granted. Its main feature is that once signed, it’s an unconditional order, so payment must be made, regardless of any other event or condition.

Types of bills of exchange

Understanding the different bills of exchange is crucial for international trade. Here are the main types:

• Trade draft: Issued by individuals or businesses for commercial transactions.
• Bank draft: Issued by a bank, guaranteeing payment.
• Sight draft: Requires immediate payment on presentation.
• Time draft: Specifies a future payment date, allowing time to arrange funds.

Bills of Exchange Act 1882

The oldest legal regulation in force of this means of payment is the UK’s Bills of Exchange Act 1882. This act cemented the rules related to bills of exchange, cheques and promissory notes. This created a clear legal framework that’s just as important today. Many countries have adopted the principles outlined in the United Nations Convention on International Bills of Exchange and International Promissory Notes. However, the legal regulations vary in different jurisdictions, in terms of requirements, enforcement and transferability.

Bills of exchange vs. other financial instruments

There are, of course, other financial instruments to consider but how do these compare to bills of exchange? Below are some alternatives:

• Letters of credit: Offer greater guarantees but are more expensive and complex.
• Promissory notes: Not negotiable and used for straightforward loans.
• Cheques: Less formal and used for smaller, domestic transactions, while bills of exchange are better suited to international trade.

Importance of the bill of exchange in international trade

The bill of exchange enables trade and financial security. It’s a formal, legally binding commitment to pay. This is crucial in international trade, where trust and creditworthiness are so important. And it’s negotiable, so can be transferred or discounted, giving businesses liquidity and flexibility. This combination of security, enforceability and flexibility makes a bill of exchange an invaluable tool for global commerce.

Markets where a bill of exchange is commonly used typically have the following characteristics:

• High volatility: In markets that often see significant fluctuations in their economic conditions, a bill of exchange is useful for securing future payments.
• Trust in traditional instruments: In regions that prefer traditional payment methods, the bill of exchange remains popular, due to its long history and reliability.
• Strict regulation: In markets with strong legal frameworks regulating bills of exchange, they provide security and clarity in transactions.
• Active international trade: Countries with high levels of exports and imports use the bill of exchange to facilitate the flow of goods and services across borders.
• Limited access to modern technologies: Where digitalisation and electronic payment systems aren’t fully developed, a bill of exchange remains a reliable option.

Benefits of using bills of exchange

A bill of exchange benefits both sellers and buyers in B2B transactions. Sellers gain secure payment and can discount the bill for immediate cash flow. Buyers benefit from deferred payment terms, allowing time to sell goods before payment. As mentioned above, this financial instrument provides a legally binding commitment to pay. Its negotiable nature allows for transfer or discounting, offering liquidity and flexibility. However, the main risk is the possibility that the drawee may not pay.

How credit insurance mitigates the risks of using bills of exchange

Although this means of payment offers more security than others, there is still the risk of non-payment. Credit insurers play a vital role in mitigating these risks. They conduct thorough analyses of the debtor's financial health, assessing their ability to meet payment obligations. This pre-emptive evaluation helps identify potential risks before transactions take place.

Additionally, credit insurers provide guarantees against non-payment, so the seller is compensated if the buyer defaults. Where recovery is needed in distant markets, insurers employ various mechanisms, including legal and amicable recovery processes, to secure payment. This comprehensive approach makes bills of exchange even more reliable and secure, giving business greater certainty and peace of mind.

Future of the bill of exchange in international trade

Since its popularisation in northern Italy nine centuries ago, the bill of exchange has become a safe pair of hands for global trade. Other means of payment have emerged, such as documentary credit. This instrument provides greater guarantees of payment but is far more expensive and complicated.

Despite its age, the bill of exchange remains a cost-effective option for many companies in the 21st century. Its future will, of course, be influenced by digitalisation and new technologies. Electronic bills of exchange are already becoming more common, offering greater efficiency and security. But trends suggest that while paper bills may decline, the use of electronic bills will continue to grow, especially when supported by credit insurance to mitigate risks.

To explore how our insights can strengthen your credit risk strategy, get in touch to see how we can help you stay ahead.