1. Page 1CreditCraft Letters of Credit a.k.a. Documentary Credits The way to win-win Presented by Brian Ward MICM, CICP
2. Page 2 CreditCraftSeller Buyer In an ideal world - prepayment Seller perspective
3. Page 3CreditCraft Seller Buyer In an ideal world – open account 180 days Buyer perspective
4. Page 4CreditCraft Seller BuyerIn the real world – letter of credit at 60 days Compromise needed
5. Page 5 CreditCraft Why ask your buyer for a letter of credit?» The buyer country risk is higher risk than supports open account terms» Buyer’s creditworthiness is unknown to the seller – Country filing requirements are inadequate to support credit decisions» You move the credit risk from buyer to buyer’s bank
6. Page 6 CreditCraft Why do letters of credit work?» Regulation – Documentary Credits ( Letters of Credit) are covered by ICC Uniform Customs & Practice (UCP600) (International Chamber of Commerce)» They are irrevocable unless specifically stated as otherwise (revocable) – One party in the transaction cannot unilaterally change any term or condition of the LC. – The exporter must specifically accept any amendment.
7. Page 7 CreditCraft What is a letter of credit?» A letter of credit is a written undertaking from the importer’s bank to pay for the exporter’s goods or services, provided the exporter presents documents as stipulated by the credit.
8. Page 8 CreditCraft How is a letter of credit communicated?» A letter of credit is communicated by the Issuing (overseas bank) to the U.K.(advising bank) via SWIFT.» Society for Worldwide Interbank Financial Telecommunication supplies secure messaging services and interface software to wholesale financial entities.» Once received and validated by the Advising bank, that bank forwards the full text of the LC by mail and/or email to the Exporter (Beneficiary)
9. Page 9 CreditCraft Stipulations Which? Where? When?» Which documents to present – Invoice and transport documents etc.» Where the documents should be presented – The bank to which the exporter delivers the documents» When to present the documents – Deadline to present the documents These conditions/stipulations will all be stated on the LC
10. Page 10 CreditCraft When do Letters of Credit work best?» The overseas bank is a strong bank» Seller and buyer agree mutually acceptable terms and conditions for the LC in advance» The Letter of Credit calls for an Ocean Bill of Lading to be produced» Documents for presentation are kept to a minimum
11. Page 11 CreditCraft Basics» If you don’t get your documentation absolutely consistent with the conditions of the letter of credit and if you don’t present your documents within the time limits laid down, you will not get paid under the terms of the credit» Banks are required to check your documents for exact compliance with the terms of the credit» Banks are required to check your documents for consistency between documents
13. Page 13CreditCraft Documentary Credits / Letters of Credit Routing Issuing bank Buyer sends details forwards original Customer/Buyer to issuing bank documents to buyer 1 9 Issuing bank check documents if Issuing bank clean authorise opens LC and payment to advising sends to Issuing bank Advising bank bank 8 2 Advising bank checks documents & Advising bank Pays if nominated or checks details & forwards LC to seller forwards to issuing (may add Advising bank confirmation) or 7 3 confirming bank Seller forwards Seller ships order documents to as per LC details advising bank 4 6 Seller B/Ls, Invoices, Bills of Exchange, packing lists, insurance certs, certs of analysis, legalisation etc 5
14. Page 14 CreditCraft Certainties» Your bank cannot advise a Letter of Credit to you unless they have first authenticated the swift message» Your customer does not want discrepancies on presentation – Buyer has already paid for the LC (in cash or credit) and he wants the material
15. Page 15 CreditCraft Why add confirmation? Belt and braces» Political and/or banking stability is in question – We may ask a “first class Western bank” to add their confirmation to a letter of credit issued by another bank • This moves risk from an unknown bank to a known party» Default on payment would be catastrophic to seller
16. Page 16 CreditCraft Other forms of letters of credit– Standby letter of credit- this can be used to underwrite open account business so that we are not bound by onerous conditions in a letter of credit
17. Page 17 CreditCraft Other forms of letters of credit– Revolving letter of credit –– this is suited to repetitive business where the letter of credit may be renewed in relation to time or value • Where an importer needs repetitive shipments of similar or same value they can open a revolving credit which replenishes the value of the credit as it pays out, in this way the importer caps his utilisation of his credit line at his bank • The exporter should benefit from easier compliance on presentations as the documents required will be very similar each time
18. Page 18 CreditCraft Other forms of letters of credit» Red clause/advance payment — – Red clause DCs contain a clause (traditionally written in red ink) authorising the nominated bank to advance a proportion of the value of the DC to the beneficiary before shipping documents are presented. This enables the beneficiary to purchase raw materials or to pay other costs (eg, transportation) prior to receiving full payment, once conforming documents have been presented.
19. Page 19 CreditCraft Other forms of letters of credit» Back-to-Back – This is where a DC is issued on the back of, and against the security of, another DC (the Master DC) on the understanding that reimbursement will stem from the documents presented under the Master DC. Both DC’s cover the shipment of the same goods. You will need to arrange for a DC facility with your bank if you are planning to use Back-to-Back DCs.
20. Page 20 CreditCraft Other features of letters of credit» Confirmation – The seller can arrange to have a first class bank to add their confirmation to a letter of credit moving risk from buyers bank to a U.K. Bank.» Silent confirmation – The seller can arrange to have a first class bank to add their confirmation to a letter of credit without the buyer’s knowledge» Discounted LC – Letters of credit may be discounted or sold for settlement by the bank today although the term of payment is long e.g. 180 days
21. Page 21 CreditCraft Who normally pays the bank charges on LCsBuyer (Applicant) Seller (Beneficiary)» Costs in buyers country » Costs outside buyer’s – Opening charge country – LC Commission – Advising costs – Amendment costs – Confirmation costs – Discrepancy fees – Discounting fees (if used)
22. Page 22 CreditCraft Why and when a win-win with LCsSeller Buyer» Security of a bank underwriting » Access to credit where it may the trade not otherwise be available» Security of a Western bank » Confidence that goods have underwriting the trade if been shipped as per contract required » The higher the LC value the» Can give seller advantage over lower the cost versus cash competition calling for pre- interest payments payment » The longer the credit period» Cash planning with confidence the lower the cost versus cash» Where credit term is long LC interest payment can be discounted for early » Benefit from interest rate payment differentials between buyer’s country and U.K.