Using an escrow account is nothing new in most industries. Often used in real estate or in consumer-to-consumer transactions, escrow accounts are used to offset the counterparty risk for both buyers & sellers.
What is an escrow account?
Escrow is a legal concept describing a financial agreement between a buyer and a seller where a third neutral party will be mandated to hold the funds on their behalf until certain rules or steps are reached in a commercial transaction.
To keep it simple, an escrow account is a temporary pass-through account held by a neutral third party in a transaction. This trusted third party – the escrow agent, will hold the funds until the completion of a transaction process, which is implemented after all conditions between the buyer and seller are settled.
In essence, companies use escrow services when two parties take part in a transaction and there is uncertainty about the fulfillment of their obligations. Escrow services respond to trust issues between both parties.
In International Trade, trust is a key pillar for trading businesses but how do you make sure that the counterparty will hold its position if you send the goods in advance or payment? Escrow services respond to this question by securing both buyer and seller.
How can an escrow account be used for international trading business to offset risk?
To answer this question, it is important to understand the mechanism of an escrow service.
Consider a company that is buying goods internationally. The company needs assurance that it will receive the goods after making a payment. The risk here is that the supplier vanishes after receiving the payment.
To offset that risk the transaction can be made using escrow services:
- Buyer & seller will mandate an escrow agent to hold the fund until pre-determined key rules are reached: validation of shipping documents for example.
- Buyer transfers the funds to the escrow account that is determined for the transaction.
- Escrow agent notifies the seller that the money is held into the account. The sellers now has the assurance that he will receive payment when pre-determided rules are respected.
- Sellers shipped the goods and send the shipping document to the escrow agent.
- Escrow agent verifies the authenticity of the shipping documents.
- Escrow agent release the payment to the seller after validation of the pre-determined documents.
In this transaction example both buyers and sellers have the assurance that the other party will fulfill their obligations :
- Sellers know that he will receive the payment from the seller if he completes his obligations.
- Buyer knows that the funds will only be released if the seller complete his obligation before receiving the payment.
In international trade, escrow services offset the international counterparty risk and the fear of the unknown of both parties while mitigating the financial engagement of their respected companies.
Tulyp is a FinTech specialized in Trade Finance. The Tulyp solution supports international trade actors on their payment guarantees, financing, and liquidity issues. If you have any questions you can contact us, one of our experts will contact you within 24 hours.