Letters of Credit

Documentary LCs

- require presentation of documents that comply w the terms and conditions set out in the LC before it can be negotiated - provides protection to the buyer and the issuing bank

Reimbursing bank

a final party commonly involved once a negotiation is completed - will claim reimbursement

Nominated bank

might be a local branch of the same name intended to accept a draft/bill or negotiate an LC

Parties that could be involved in a L/C

1. issuing bank 2. beneficiary 3. reimbursing bank 4. Beneficiary 5. Applicant 6. Advising bank 7. confirming bank 8. negotiating bank 9. nominated bank

Revocable vs **irrevocable LCs

1. revocable LCs - can be amended or cancelled by the issuing bank at any time without giving prior notice. provdes little protection so it is rarely used 2. irrecovable LCs - cant be amended or canceled without the agreement of the issuing bank, the confirming bank, and the seller. provides more protection to sellers as changes cant be made without their agreement

Types of risk sharing arrangements

1. syndications 2. club deals 3. risk sharing agreements

Full vs partial negotiations

Full: goods are shipped by the seller and the LC is negotiated once only, after which the issuing banks liability is canceled even if the full amt is not paid partial: where more than 1 shipment is made, an LC is partially negotiated each time a shipment takes place

Who is the beneficiary of an irrevocable sight LC?

Seller

What is a complying presentation

a presentation that is in accordance w the terms and conditions of the LC

D/A terms

documents against acceptance terms

What are letters of credit

long established payment method used for trade transactions particularly for international trade - secure but expensive - guarantee from issuing bank to the seller guaranteeing payment - doesnt necessarily mean the buyer will receive the goods

UCP definition of an L/C

- "any arrangement that is irrevocable and thereby constitutes a definitie undertaking of the issuing bank to honor a complying presentation

Clean L/Cs

- doesnt require documentation other than a draft in order for it to be negotiated - little protection for the buyer or issuing bank - issued infrequently

Red vs Green clause LCs

- red clause: authorizes an advance to be made to the beneficiary - green clause: allows an advance to be made only against warehouse recipients or similar documents

Give a circumstance where an irrevocable LC would not be paid

- the seller doesnt present the correct documents

Advantages of LC from Sellers point of view

1 .Safety - a safe payment means that open account trading 2. Amendments: an irrevocable LC cant be amended without the seller's permission 3. Confirmation: to mitigate credit risk on the issuing bank, and any risks the seller can request an LC to be confirmed 4. Ownership: if not paid, the seller retains title to the goods 5. established payment means 6. Obtaining funding: once a draft is accepted by a bank, a seller can easily discount it if funds are required before date

Lifecycle of an LC

1. Contract of Sale: describes goods to be delivered, specifies letters of credit as means of payment 2. LC issuance: buyer requests its bank to open LC in favor of seller. Will check for availability and terms and conditions 3. LC advising and confirmation: LC is forwarded to advising bank. confirms authenticity of credit and forwards to seller. 4. Shipment: seller arranges shipment of goods 5. negotiation: seller submits documents to negotiating bank who checks that the documents are in order. 6. payment: negotiating bank to make payment to seller

Risks that banks involved in an LC are exposed to

1. Credit risk 2. Operational Risk 3. Country Risk 4. Market Risk 5. Reputational Risk

Disadvantages of LC from sellers point of view

1. Discrepancies: buyers might use small discrepancies as an excuse to delay or not make a payment 2. Credit: granding DA terms means the seller doesnt receive payment until a later date 3. Credit risk 4. country risk 5. costs - bank fees accumulate 6. exchange rates 7. ST credit

Advantages of an LC from buyers perspective

1. LCs are aligned to a contractural agreement 2. Established payment means: they are a long established payment means and subject to UCP 600 3. Documentary proof: provide proof that goods have been shipped 4. negotiation: only possible once the required documents have been submitted by the seller 5. discrepancies: buyer can delay payment or acceptance if there are any discrepancies 6. Credit: terms provide the buyer w time to process/sell the goods before payment is due

Disadvantages of LC from buyers perspective

1. goods shipped might not be the same as ordered 2. Delays can result 3. exchange rate differences 4. costs: buyer incurs costs of issuing an LC 5. Locked in: no amendments or cancelations once issued

why would a seller be prepared to accept payments to be made on DA terms?

1. if the buyer is large it can usually set the terms on which it does business 2. If there are little sellers and product differentiation, a business may only be able to make sales by offering attractive terms of trade to buyers 3. Sales on DA terms are more attractive to sellers if they can obtain a higher price than if they sell of DP terms

Once issued LCs may be confirmed or unconfirmed

Confirmed: one that a bank has added its confirmation. Usually done by the advising bank but can be added by a different bank. means the confirmed bank will make payment Unconfirmed: hasnt been confirmed. Seller relies on the issuing bank to make payment where a valid submission is made

Back to back LCs

act as collateral and a source of repayment for a second LC issued by another bank many banks are reluctant to issue these bc of the level of risk theyre exposed to

Transferable LCs

allows the beneficiary to transfer its rights to one or more second beneficiaries only once w limited changes in terms and conditions

Revolving LCs

credits that are automatically renewed or reinstated after negotiation. lifecycle becomes extended for many years

Standby Letter of credit

demand guarantees. - differ from documentary credits: issuance isnt reliant on underlying movemnt of goods, claim is only made when applicant is in default - used to provide an alternative to issuing of bonds and guarantees, support open account arrangements, or enable a bank to provide credit facilities to a customer - doesnt involve confirmation or negotiation - issued to international standby practices

D/P terms

documents against payment terms

Sight LCs

enable the making of payment to the seller once the LC is negotiated - documents against payment transaction

Deferred Payment LCs

payment doesnt need to be made until a specified future date - used where the market is competitive

Confirming Bank

provides confirmation to the issuing bank

Advising bank

responsible for checking the authenticity of an LC and advising it to the beneficiary at the request of the issuing bank

Usance or term LCs

result in payment being made some time after negotiation

Difference btween transferable LC and back to back LC

rights are transferred under a transferable LC but not w a back to back LC

Negotiating bank

the bank that receives and checks the documents submitted by the beneficiaries

Who bears the cost of opening an LC?

the buyer

Issuing Bank

the party that issues an LC - usually an LC is a contract btwn the issuing bank and the beneficiary

Applicant

the party that requests an LC to be issued by its bank. responsible for the costs of issuing an LC

Beneficiary

the party whose favor an L/C is issued