Standby letters of Credit: A Comprehensive Guide

This authoritative reference book gives thorough, practical guidance for anyone who needs to deal with standby letters of credit either professionally or academically. 

Augmented with examples of numerous real-life cases, the book addresses the exact procedures undertaken by global banks in handling letters of credit transactions whilst incisively providing an article by article interpretation of the ISP98.

Furthermore, the book explains the credit operation cycle, the various parties to the credit transaction, types, uses -with special emphasis on tender and performance standby letters of credit– roles, responsibilities of the parties to the transaction, risk management and fraud prevention. 

The book literally provides all the tools needed to deal not only with routine problems but also with unforeseen difficulties whether at clerical, middle management or senior management level. 

Commercial/Financial fraud detection and prevention is an issue that is decisively addressed in Chapter 15 which tackles the types of fraud the bank frequently encounters whilst conducting its trade finance operations.

The Author quotes several examples of fraudulent transactions and pinpoints the operational gaps the fraudsters often use to penetrate the bank’s safeguards and execute their crimes. 

The Author also tackles “organized crime” in banking operations whilst precisely explaining the techniques the banks must follow and safeguards they must place in order to detect and prevent these destructive fraud crimes. Risk Management in trade finance operations is another major concern of the international banking community. 

This concern is comprehensively addressed in Chapter 14 which warns that the methods commonly used by banks to effectively manage risks vary from one country to another according to the specificities of the socio-political environment; methods of trade finance risk mitigation described in general texts could turn to be invariably useless and any attempt to apply abstract theories and academic discussion can be not only a value destroyer but also a dangerous process.

The chapter then proceeds to emphasize the importance of understanding the bank’s specific operational environment and base its risk management approach on the operational history of the bank and its working environment.

It continues by identifying the exact risks the bank faces in a standby letter of credit transaction and finally, the Chapter tackles the three approaches banks follow in managing their operational trade finance risks, namely “Operational Risks Correlated to Volume”, “Value at Risk Analysis (VAR)” and “The Distribution of Loss Measure".

Fraud Watch: Reef International, Sialkot, Pakistan

A few days ago, Mr. Bruce Morrison from Alabama, USA informed me about a trade fraud involving his company, KYM Industries Inc and the seller in Pakistan, Reef International.

According to Morrison, he came across Reef International on the internet and interested to purchase some quantity of leather glove. He was assured by the Reef International that the goods will be shipped to him upon receipt of 30% upfront payment. Without suspecting any dishonesty, Morrison remitted the payment in USD via Telegraphic transfer to the seller in Pakistan.

He was shocked to find out that the 125 cartons of leather glove which he paid for were not in the container. The container is empty. Morrison tried to contact Reef International to get further clarification, but failed to speak with anyone from the Reef International.

The transport document used in this trade is a multimodal transport document. However, I believe that the document is also forged as there are few important data not indicated such as the place of taking charge and freight charges.

Please avoid from dealing with this company. For your information, here are details of the company:

Name:
Reef International

Address:
P.O. Box 2094 Sialkot Mailing Address
Along With Muslim League Office
Amin Abad Road, Sialkot, Pakistan
Production Unit – B.2 Sector Korongi Ind Area, Karachi.

Tel Numbers:
92 52 8101 732
92 52 8105 469

Fax:
92 52 3258 302

Mobile:
92 300 616 5600
92 334 800 8118

Email:
reef@haat.net.pk
reef@gjr.paknet.com.pk

Website:
http://www.refint.com/

Other information:
Export number 006583
NTN number 19-06-TR-7219

The information above is extracted from the invoice sent to me by Morrison. I believe some information may be fabricated by the seller.

Strict Compliance: Need not be identical to, but must not conflict with

The expression ‘…to ascertain whether or not they appear, on their face, to be in compliance with the terms and conditions of the credit’ as stated in article 13 of the UCP 500 has been clearly explained in article 14 of UCP 600.

What is written in an invoice for example, need not be identical to what is written in other documents. This is because each document serves a different function and therefore the content or data contained in each of the document differs with each other.

The invoice serves as the accounting document. Packing list on the other hand provides information of the number of packages, weight, mark and numbers. Bill of lading is an evidence of contract of carriage as well as a title to the goods. As such, the content or data in each and every document called for under the letter of credit bound to differ. However, these differences must not conflict with each other and most importantly must not conflict with the data contained in the letter of credit within the context of international standard banking practice (ISBP).

This non-identical allowance suggested by article 14 of UCP 600 is clearly practical in the case where the term Ex-Work is used by the trading parties. Under the term Ex-Work, point of delivery of the goods can either be at the seller’s premise, workplace or factory. To accommodate to the possibility of making a delivery different from the original point as stated in the letter of credit, article 14 (j) allows the invoice issued by the seller to state a different address. For example, if the letter of credit expressly stated the address of the seller as follow:

59: Beneficiary
+Commercial Direct TV
340 Commerce Avenue,

Suite 20 Southern Pines N.C. 28387
United States of America

The invoice may bear a different address which can be the factory or workplace of Commercial Direct TV within the United States of America.

The same is also applicable to the applicant or the buyer. For example, if the letter of credit expressly stated the address of the applicant as follow:

50: Applicant
+Direct TV Business
132 Bangsar Park, Kuala Lumpur
59200 Malaysia

The seller that is Commercial Direct TV may issue an invoice to a different address within Malaysia which may be a branch or workplace of the applicant or buyer that is Direct TV Business.

However, when the applicant or buyer appears as a notifying party or part of the consignee on a transport document, the details of the applicant or buyer must be as stated in the letter of credit. Referring to the above example, the detail of the applicant should read as ‘Direct T V Business, 132 Bangsar Park, Kuala Lumpur, 59200 Malaysia’.

Collections: Collection Instructions

When the seller presents the relative documents to the remitting bank for collection of proceeds, the documents are invariably accompanied by a covering schedule in which the seller fills the relevant details as to the name of the drawee, nature/type of documents and instructions on the disposal of the documents and collection of the proceeds, known as a Collection Instruction. For standardization and ease of reference, and to prevent misunderstanding, thereby leading to inconvenience and complications, the seller is required to complete the standard Collection Instruction furnished by the remitting bank.

The seller is required to give full and clear instructions in the Collection instruction to the remitting bank to avoid unnecessary misinterpretation, inconveniences and enquiry which would result in delays. The following points should be noted:

1. The full name and address of the buyer/drawee should be correctly stated
2. The seller should correctly stipulate the following in the Collection instruction:
a. The tenure (Sight/Acceptance), the reference number, date and value of the Bill of Exchange
b. The nature and number of copies of the relative documents in the form of commercial invoice, insurance policy, certificate of origin, bill of lading or multimodal transport document or etc
c. How the documents to be released to the buyer/drawee that is whether against payment or upon acceptance of the bill of exchange
d. The name of the presenting bank in the country of the buyer to present the documents, other than the remitting bank’s correspondent/agent bank, if it is so required by the seller or buyer

Besides the above mentioned, generally the Collection instruction contains a set of standard instructions with appropriate boxes for the seller to mark and with extra boxes for the seller to include other additional specific instructions, where appropriate. Listed below is a typical list of such instructions:

1. Release documents against payment
2. Release documents against acceptance
3. Payment may be deferred until arrival of goods
4. Acceptance may be deferred until arrival of the goods
5. Collect all charges and expenses from drawee
6. Waive charges/expenses if refused by drawee
7. Collect interest at the rate of…….% from the drawee from…….until………
8. Advise Acceptance and due date by airmail/telex/SWIFT
9. Advise Non-Acceptance by airmail/telex/SWIFT
10. Remit proceeds by airmail/telex/SWIFT
11. Advise Non-Payment by airmail/telex/SWIFT
12. If dishonoured by non-acceptance/non-payment, please protest
13. If dishonoured by non-acceptance/non-payment, please do not protest
14. In case of need, refer to…………, who will assist in securing payment, but who has no authority to amend the bill or terms of payment
15. If documents are not taken up on arrival of carrying steamer, please arrange for goods to be stored in bond and insured, under advise by airmail/telex/SWIFT to us
16. Other specific instructions, where deemed appropriate.

Letter of Credit In Electronic Trade Transaction

Somewhere in 1990s some 40 bankers, carriers and multinational companies have joined together in the BOLERO project. BOLERO aims at providing an electronic Bill of Lading for use in export transactions. Banking software packages and specialized telecommunications networks such as SWIFT have already taken a lot of paperwork out of the business of preparing and transmitting letter of credit details. eUCP has been introduced by the ICC to focus on the presentation of electronic or partial electronic documents.

Internet, undoubtedly has become an important medium for business community to get connected and to carry out their business transactions safely with the help of digital signature authentication system. The internet facility also makes buying a large business abroad possible through the internet franchise service. This electronic medium has also made the status inquiry and the due diligent process completed much faster without exchanging papers back and forth. By clicking on computer franchise for example, buyer or seller can obtain information and get connected. Internet franchise or computer franchise provides a focal point for trading community in search for business diversification.

When the idea of electronic trade transaction takes a full swing, the quality of the evidence provided by the seller with regard to the goods is very important. The buyer, in his instructions to the bank, specifies what the bank is to accept as evidence. In practice, this is a set of documents issued by the seller and by the independent parties.

A letter of credit consists of a series of flows; instructions, money, evidence regarding the goods and the title to the goods. Most of the flows are already dematerialized, or could be. For example, instructions with regard to the letter of credit can be passed from buyer to bank, and from bank to seller by electronic means and many banks have implemented systems to allow this to happen. Indeed, there is even a North American Bank which is prepared to accept applications for letter of credit over the World Wide Web. Within the banking system, this type of instruction can be handled through SWIFT, using its MT700 message format.

The issues seem to be concentrated in the field of evidence and of title to the goods. If we concentrate on the evidence, there seems to be no reason why a buyer could not call for the bank to accept a certain set of electronic messages instead of the equivalent set of documents. There exist internationally accepted standard EDIFACT messages, which can carry all the data the buyer may require, and which correspond in every way to the documents normally used.

Collections: Documents against acceptance (D/A)

Under the documents against acceptance (D/A) the buyer does not have to pay immediately. The buyer is given a credit period. He only pays on the maturity date of the accepted Bill of Exchange, which may be 30 days, 60 days, 90 days later or even longer. This method offers greater flexibility to the buyer in his cash flow and liquidity management as by the time he is required to pay, he should be able to sell the goods and secure payment from his debtors.

Under this method, the seller is required to ship the goods first to the buyer. Upon shipment, the seller will obtain all the necessary documents like Bill of Exchange, Invoice, Bill of Lading (or other transport documents), Insurance Policy, Certificate of Origin and etc. He is also need to complete a collection order (furnished by his bank) with the appropriate instruction.

The documents then will be presented to his banker (Remitting bank) where the documents will be checked to ensure they tally with the collection order. These documents will be air couriered to the buyer’s bank (Collecting bank).

Upon receipt of the said documents, the collecting bank will present the Bill of Exchange to the buyer for acceptance. Acceptance means the buyer has to endorse on the back of the Bill of Exchange with a company seal. Upon acceptance, the Bill of Exchange will be returned to the collecting bank for safe keeping and the rest of the documents are delivered to the buyer to take possession of the goods.

The collecting bank will notify the remitting bank of the acceptance as well as the maturity date. On maturity, the collecting bank shall debit the buyer’s account and remit the proceeds via MT202 to the remitting bank.

What if the buyer fails to pay on maturity? In the first place, can the buyer refuse to pay under documents against acceptance? This is in fact the biggest risk faced by the seller under this method of payment. When the buyer refused to pay, the collecting bank will not pay the remitting bank which means that the seller will not receive his payment.

In this case, the seller has to resolve the problem with the buyer. The remitting bank and the collecting bank are only acting as an agent and can not enforce any legal avenue to obtain payment from the buyer. Collections is not governed by the UCP but by another set of rules known as Uniform Rules for Collections (URC).

SWIFT Confusion

The issuing bank is responsible to ensure not only completeness of the Letter of Credit but the most important is to make sure all the data which forms the terms and conditions of the Letter of Credit is correct, clear and does not open to multiple interpretation before it is advised to the beneficiary. Legally speaking, Letter of Credit is in fact a form of a contract that is a contract of payment. Therefore, the terms and conditions laid out in an LC should be precise and clear.

Recently, a question came from one of the readers asking about the following problem. He received an LC with the following conditions:

44E: Port of loading/Airport of departure

+Bangkok Port, Thailand

45A: Description of goods and/or services

+400metric ton abc. FOB Thailand

He wants to know whether the information in field 44E and field 45A above is correctly indicated.

Field 44E (Port of loading/Airport of departure) and field 44A (Place of Taking in Charge/Dispatch from.../Place of Receipt) are fields specifically to indicate the point of delivery. This is the point where the seller technically delivers the goods to the buyer and the buyer accepts the said delivery. At this point, the delivery by the seller is said to have been completed. In other words, the seller must ensure the point of delivery by referring to field 44E only.

Is it necessary to indicate the point of delivery in field 45A? In the above example, name of the port that is “Bangkok Port” is not indicated. Is this ambiguous?

Field 45A is specifically to describe the goods or services and to indicate the trade term agreed upon by both parties. Therefore, the name of the port need not appear again in this field. Nevertheless, it is not wrong if the buyer wish to indicate again the name of the port in this field. However, it makes no difference whether it is indicated or not as information in field 44E is already conclusive.