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Certificate in International Trade and Finance (CITF®)CITF provides trade, export and commodity executives with a thorough understanding of the key international trade procedures, practices and legislation.

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W elcome to this handy collection of TFR Fundamentals articles. Written by examiners, practitioners and lecturers in trade finance, they guide students and those in need of a spot of revision through

the main principles of trade finance – whether it be a letter of c redit or the basics of what to look out for if you are exporting for the first time.

At TFR, we are grateful to our partner, The London Institute of Banking & Finance. In their own words:

“We exist for a very simple reason – to advance banking and finance by providing outstanding education and thinking, tailored to the needs of business, individuals, and society. Our focus is on lifelong learning; equipping individuals with the knowledge, skills and qualifications to achieve what they want throughout their career and life.

“We advance careers by equipping people with the skills and capability the sector demands, so they can perform more effectively and responsibly. The result is better professionals and corporations, performing better for customers.

“Our trade finance qualifications are worldwide benchmarks in the industry. Studied in over 90 countries worldwide, the topics of International Trade & Finance, Documentary Credits and Demand Guarantees provide specialist knowledge to display capability, aid efficiency and enable progression in the workplace.

“The qualifications have been developed in close partnership with the International Chamber of Commerce (ICC), the world’s authority on international trade policy and practice. They encompass the most current industry standards and regulation.

“We are The London Institute of Banking & Finance, lifelong partners for financial education.

Clarissa Dann ,Editor in Chief

Back to basics

Welcome | From the editor

TFREditorialEditor in chief Clarissa Dann MBA+44 (0) 20 7324 [email protected]

Deputy editor Binyamin Ali+44 (0) 20 7566 [email protected]

ContributorsDavid Bischof, Peter Brinsley, Gary Collyer, Simon Cook, Sean Edwards, David Meynell, David Morrish, Donald Smith

Design and production Design and production manager Richard WilcoxDesigner Amber TreadwellProduction controller Natalia Rebow

Contact +44 (0) 20 7324 2367 [email protected]

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Articles published in Trade & Forfaiting Review are the opinion of the authors. The views reflected do not necessarily reflect the views and opinions of the publishers. ©ARK Conferences Limited 2016, a part of Wilmington plc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written permission of ARK Conferences Limited.

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4 TFR Fundamentals 2015/16

Contents | TFR Fundamentals 2015/16

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Go forth, and export!David Morrish sets out the practicalities UK exporters need to think about when making that first sale overseas

Without recourseSimon Cook explains the legal fundamentals of three types of supply chain finance structures

Change of creditorFactoring is a staple of open account trade and is a popular solution for sellers facing working capital problems. Peter Brinsley explains how it works

Present and correctDavid Meynell and Gary Collyer offer some practical tips on getting paid under a letter of credit.

Hook, line and sinkerHow can a letter of credit improve the working capital management of a small British seafood importer? David Morrish explains how even when the cost of the discount is factored in, this trade finance tool is a good solution

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www.libf.ac.uk/trade-finance 5

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Trade’s first advocateAs businesses and countries across the world look to overseas markets to support their growth, David Bischof offers a lesson in using one of the oldest trade facilitation tools

Tainted tradeDavid Morrish offers an insight into the array of tricks employed by fraudsters in trade finance and what investors can do to protect themselves

Not just a one-trick ponyDonald Smith explains how standby letters of credit can be deployed in a variety of scenarios to achieve a whole host of commonly overlooked purposes

Money TodayForfaiting has huge potential as a set of principles and techniques that can be applied to a wide range of receivables. Sean Edwards explains how

Full of flavourDavid Morrish celebrates the beauty of standby letters of credit in keeping trade simple and mitigating the risks of non-compliant document presentation

The London Institute of Banking & Finance | TFR Fundamentals

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David Morrish sets out the practicalities UK exporters need to think about when making that first sale overseas


Go forth, and export!

Trade and commodity finance | Trade principles

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So, it’s great news for your business - the overseas marketing campaign has made its return on investment and your first order has been received. Surely it can’t be that

different from selling to UK customers? It’s understandable if you decide to simply log it with the other orders and fulfil it in the normal way.

But this would be very unwise. In reality there are a number of aspects companies new to selling overseas need to consider. The ‘hope for the best’ approach simply incurs unnecessary risk and could cost you more than the value of the order you have just landed. What is so different about exporting compared with the method in domestic business?

ICC Model International Sales ContractFirst of all, is it clear as to who is responsible for what, and are the consequences of non-performance understood? Companies will have their standard contract terms which may be amended or expanded, but it is worth taking a look at the International Chamber of Commerce (ICC) Model International Sale Contract which has been designed to cover all aspects of cross-border sales transactions.

It applies primarily to manufactured goods but can also be an excellent start point for other types of products too.

Responsibilities of buyer and sellerIncluded in the Model Sales Contract is reference to Incoterms® 2010. For those not familiar with this, Incoterms is a form of ‘shorthand’ which sets out the responsibilities of both seller and buyer, specifically regarding the costs and risks in transporting and delivering goods.

For example, CIF (cost Insurance and freight) means that the seller is responsible for everything to the point where the goods are unloaded. FOB (free on board) means that the seller is responsible for getting the goods on board the vessel. The buyer is responsible for everything else, which includes insurance.

InsuranceInsurance is an important consideration. While it might be tempting, and in many instances perfectly acceptable, for the buyer

to take responsibility, sellers may prefer the cautious approach and make their own arrangements. They may even be able to negotiate better terms through their brokers. Getting it wrong can be expensive: imagine the potential consequences of a shipment being jettisoned with each party thinking that the other has arranged for marine cargo insurance.

CurrencyOne aspect that will affect every sale overseas is the decision on which currency to invoice in. Choosing your own domestic currency removes the foreign exchange risk, but it may make you uncompetitive. Invoice in the buyers currency and you may be at risk from adverse movements in the exchange rate. The important thing is to understand what the risks may be and decide on a strategy to manage those risks.

Should the strategy be to invoice in the buyer’s currency but limit or hedge the foreign exchange risk, then there are various mechanisms available.

These include forward contracts where the exchange rate may be effectively ‘locked’ for a given amount and future date and pure currency options where for a fee or ‘premium’ an exchange rate may be protected, but not used if the exchange rate moves favourably.

Method of paymentThe method of payment is clearly another key consideration. Initial credit checks may be made through your bank but even a good response is unlikely to make a material impact on your decision. So what are the principal options? • Open account – this is where goods are

shipped in the expectation that payment will be received with the agreed period, say 30 days; much the same as trading domestically. This is ideal where exporters are confident in the buyer’s ability and willingness to pay.

• Payment up front – where there is no trading history or if the seller has doubts and doesn’t want to risk it: so cleared funds are insisted on first, before shipment of goods. The risk is then entirely the buyer’s.

It is worth adding that it really is worth considering how much exposure there is likely to be at any one time as this may well affect the decision process. In other words as a seller, how much are you prepared to put at risk with a new buyer, and for that

www.tfreview.com 7



buyer how much do they want to risk in the event that goods prove to be sub-standard or don’t arrive at all? If it is a modest amount then, either way, it may be worth just taking a view.

Documentary letter of creditFor more substantial amounts, and particularly in relation to orders from buyers in new markets, sellers will want more than just a good bank status report. In these situations a documentary letter of credit (LC) may be the answer. This is an irrevocable undertaking by a bank to make payment to the named beneficiary, provided the documents stipulated in the LC are presented exactly as called for and in good time. In short the ability and willingness of the buyer to pay is substituted by an irrevocable undertaking from their bank.

Whilst it sounds simple enough, complying with the terms and conditions to ensure payment can prove challenging. Within the industry the general view is that around 60-70% of documents first presented to banks for checking are wrong in some way.

Caveat vendorOnce again the first essential task of a seller receiving an LC in its favour is to check the terms and conditions to see if there is any aspect that it cannot comply with. Do not assume that a slight change in shipment date or document will be acceptable; it won’t. If there is any element of the credit that cannot be complied with, however trivial, you should contact the buyer and ask for an amendment to the credit. And don’t ship before the bank advises the amendment properly.

DiscrepanciesRemember the documents presented must be exactly as called for in the LC. If latest shipment is 30 October, 31 October won’t do. Documents must also comply with each other; if goods are shipped on 30 October but the insurance certificate is dated 31 October, that would be another discrepancy to negotiate.

If the documents are wrong then what does this mean in practice? At best there will be a delay in payment while either new documents are prepared (where this is possible) or the issuing bank plus usually the end buyer are contacted to establish whether the documents may be accepted as presented. It can happen that the buyer uses the opportunity to reduce the amount payable as a condition of acceptance. In extreme circumstances the buyer may reject the documents completely.

The key point to emphasise is that for sellers that do not take the time and trouble to present complying documentation, LCs can be an expensive luxury.

Credit insuranceIf LCs are not a realistic option then, just as in domestic business, credit insurance on the buyer may be a possibility. Insurers usually like to see all buyers included of course, by this they don’t want just the risky ones singled out, but taking such insurance cover may provide benefits in selling at home as well as overseas.

A listening bankIf financing is an issue (and when isn’t it?) there may be alternatives to traditional finance available. This is something you should talk to your bank about and if you do not feel that you are getting the right answer, it may be worth contacting other banks (and increasingly non-banks such as specialist financial institutions) more active in trade finance and perhaps with greater knowledge of the markets that you are selling into. Factoring and invoice discounting are options well worth exploring for the right organisation both internationally and domestically.

Having read this far, you may wonder whether selling overseas is really worth the effort. For organisations new to selling to, or buying from, companies overseas help and guidance is available from a number of helpful sources.

Most banks will have specialists in overseas trade who will be willing to discuss your international business with you. Of course it is worth checking at first, but initial meetings with a bank’s trade specialist are usually free of charge and a few publish useful guides, often online, which you should get hold of if you can.

A good freight forwarder can provide an invaluable service not just in arranging shipment but also in ensuring that the relative documents are prepared to the right standard. There are also government agencies that may also be able to give technical assistance and practical support where appropriate. In the UK this is provided by UK Export Finance. Your local Chamber of Commerce can also be an invaluable source of information.

Worth the effortThe important point of all this is that although selling overseas is certainly different and requires a new approach to logistics; do not let that deter you. New markets can be opened up and longstanding partnerships developed safely and profitably. So, when you receive that first order, yes, take full on board the new challenges that this will bring and make sure that they are managed appropriately; but also think of what this means for the growth of your business.

David Morrish is relationship director of international trade finance qualifications at The London Institute of Banking & Finance

References1. www.iccwbo.org/

products-and-services/trade-facilitation/model-contracts-and-clauses/sale-of-goods/

2. See www.export.gov/faq/eg_main_023922.asp for a helpful set of definitions

3. See David Morrish’s blog on currency at www.tfreview.com/12397

4. See the UKEF guidance for exporters at https://www.gov.uk/government/organisations/uk-export-finance. The British Exporters Association also provides some practical tips and a downloadable guide.

5. See www.bexa.co.uk/

Trade and commodity finance | Trade principles

“Within the industry the

general view is that around 60–70%

of documents first presented to banks

for checking are wrong in some way”



A letter of credit (LC) is defined in UCP 600,1 as the international set of rules that are applicable to LCs, as “any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying

presentation”.The key words for every beneficiary of a LC are “complying

presentation”. UCP 600 defines this as a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of UCP 600 and international standard banking practice.

The aim for you, as beneficiary of a LC, is how to consistently achieve a complying presentation?

BackgroundHistory and available statistics tell us that a complying presentation is not always possible. For some time now, it has been widely reported that between 60–75% of documents are refused by banks on first presentation. Some, relatively good news, is that this figure does not seem to be increasing. The ICC Banking Commission global trade finance survey (7th edition): Rethinking Trade & Finance2 indicates that in 2014, there was no reported increase in refusal rates on first presentation of documents.

It should be noted that a refusal of documents does not necessarily mean that you will never be paid for your shipment of goods, or for services or performance you have provided. At the very least, it will mean a delay in receiving settlement or financing, and the incurring of additional bank fees.

One aspect that is not to be overlooked is that once documents are found to be discrepant and where such discrepancies cannot be corrected, the undertaking of the issuing bank will no longer exist for

that drawing. Even if the applicant subsequently provides a waiver of the noted discrepancies, the issuing bank is under no obligation to accept it.

Attention to detail when preparing documents clearly becomes crucial to the entire process.

The sale agreementWhether it is a formal contract, a proforma invoice or purchase order that is agreed between you and the applicant, it should indicate some basic information that will shape the content of the LC. For example, and in addition to the amount and description of the goods, it should indicate the terms of payment (sight or tenor), routing of the goods, the applicable Incoterm (which will determine who is responsible for arranging insurance and payment of freight costs), whether partial shipments are to be permitted, the expiry and shipment periods that are required, etc. It is in your interest to guide the applicant with some of the requirements you expect to see in the LC when issued.

Receipt of the LCUpon its receipt, you should review the text to ensure that it meets your interpretation of the conditions of the sale agreement. Also to confirm that it is in a form that allows you to prepare, collate and present the stipulated documents within the stated expiry date and latest date for presentation (which is often to be within 21 days after the date of shipment, but in any event within the expiry date).

At this time, a copy should be made available to the freight forwarder that will be handling the shipment so that it may assess whether the requirements for the transport document and insurance document, if applicable, can be met. If any other document, for example, an inspection certificate, is to be issued by a named entity, contact should be made to ensure that it will be able to comply with the conditions stated, if any.


David Meynell and Gary Collyer offer some practical tips on getting paid under a letter of credit.

Trade and commodity finance | Letter of credit The London Institute of Banking & Finance | TFR Fundamentals


If one or more of the LC’s terms and conditions are incorrect or cannot be met, you should contact the applicant and request that a suitable amendment is issued.

Continual monitoringIn addition to a review at the time of receipt, the LC should thereafter be reviewed periodically to ensure that the production, manufacture and shipment of the goods could still be achieved within the stated timescales. If there is any slippage or chance thereof, an amendment should be requested to extend the shipment and expiry dates.

Goods should not be shipped without any requested amendment(s) being received. Promises that an amendment will follow after the shipment or the applicant agreeing to accept discrepant documents (rather than amending the LC) should not be entertained.

Document preparation The LC will indicate the documents that are to be presented for honour or negotiation to occur. In addition to those requirements, UCP 600 also contains specific rules for transport documents (articles 19-27 and 31) and insurance documents (article 28) such as permitted issuers, parties that may sign such documents and their data content.

Data content of documents should be kept to the bare minimum required by the LC or UCP 600. Adding information that is not required often leads to data being re-keyed incorrectly and banks refusing documents due to a conflict of data within the same document, between stipulated documents or with the LC. Today, conflict of data is one of the most common discrepancies identified by banks.

If the applicant separately requests some extensive detail, consider sending this information directly and providing the bank with only the data required by the LC. For example, where a LC calls for a document without stating its content e.g., “Packing List”, the document must simply appear to fulfil the function of the document. In this example, it should contain some details of the packing.

This does not mean detail such as what is in each crate, box or parcel, or the gross and net weights of each crate, box or parcel. If the applicant required this kind of data to be produced it should have been stated in the LC, instead of merely saying “Packing List”. In effect, a packing list that indicates, “All goods covered by invoice number 1234 are packed in container number ABCD1234567”, would comply with a LC requesting the presentation of a “Packing List” with no requirements specified for its content.

Once documents have been prepared and collated, they are sent to a bank for examination in order to ascertain whether or not they comply with the terms and conditions of the LC. The first bank to which documents will normally be presented is

the nominated bank, which may also be the advising and/or confirming bank. In turn, the documents will ultimately be presented to the issuing bank for examination and honour.

At a time of any global, regional or country specific financial crisis, the slightest opportunity to either opt out of a transaction or, from an applicant perspective, to re-negotiate the terms of payment will be taken up. Discrepancies in documents will often afford an applicant this opportunity.

Presentation to the bank (nominated bank)In most cases, you will be able to present your documents to a bank located in your country e.g., the nominated bank. This bank is nominated to offer honour or negotiation upon a complying presentation being made. UCP 600 sub-article 14 (a) states that a nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation.

Banks are not required to take note of any information apart from that included on the presented documents. The concept of “on the basis of the documents alone” reinforces the position that the examination process is limited to the data appearing on the documents and not from a website or information provided from sources outside the data appearing on the documents. The exception today is where banks are required to complete checks for the purpose of sanction regulations.

Options when discrepancies are identifiedIf your presentation is refused due to discrepancies, there are three options available to secure payment under the LC. In order of suggested preference:• Correct the discrepancies, at least as far as is

possible.• Request the nominated bank contact at

the issuing bank for its agreement that the documents may be honoured or negotiated despite the noted discrepancies. The documents will be held with the nominated bank until the issuing bank responds, indicating that the applicant has provided an acceptable waiver of the discrepancies.

• Request that the nominated bank forward the documents to the issuing bank for settlement. The documents are sent to the issuing bank as a presentation under the LC and honoured following the applicant issuing an acceptable waiver of the discrepancies.

David Meynell and Gary Collyer are co-owners of the trade finance training website - www.tradefinance.training

The ICC’s UCP 600

References1. UCP 600 – the Uniform

Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600

2. See the content of ICC Global Trade Finance Survey 2015 at http://bit.ly/1N059mg


Trade and commodity finance | Letter of credit


F actoring is a receivables finance technique where trade is on open account terms and there is no negotiable payment instrument associated with the transaction. The tenor of

the transaction is typically no more than 90 days from invoice date.

Open account trade is attractive to buyers because payment is made up to three months after the goods or services are received. The seller may see it as high risk because there is no instrument guaranteeing the payment obligation. The seller may also find his own suppliers need paying before his receivable is paid by the buyers, hence a classic cash flow gap.1

Addressing the cash flow gapFactoring can bridge that gap. The financier advances funds to the seller when sales invoices are raised. The amount advanced is directly related to the value of the invoice and therefore the amount of finance available through factoring reflects the growth of the revenues of the seller. More invoices raised means more finance available.

In factoring, the financier takes ownership of the receivable with the transfer of ownership done through the seller assigning the receivable to the factor. The factor wants ownership of the receivable because repayment of any finance advanced comes from the buyers, the entities who owe the receivable as represented by the sales invoices. Following assignment of that receivable the debt is owed to the factor rather than to the seller. The factor is therefore interested in the ability and willingness of the buyer to make payment.

Factoring offers at least two of the following services:• finance to the supplier;• maintenance of accounts relating to the

receivables;• collection of payment from the buyer; and• protection against default in payment by the

buyer.

Factoring is a staple of open account trade and is a popular solution for sellers facing working capital problems. Peter Brinsley explains how it works

www.tfreview.com 11

The London Institute of Banking & Finance | TFR FundamentalsReceivables finance | Factoring principles


Product variationsThe umbrella term ‘factoring’ covers many products, each one offering variations on the above list.

In non-recourse factoring, the factor provides all four of the above services including taking the risk of the buyer not making payment.

By contrast, recourse factoring is where the risk of the buyer not paying is borne by the seller. When one of the services is the factor collecting payment from the buyer, the face of the invoice will state that it’s been assigned to ‘ABC Factor’ and to clear the debt the buyer must make payment to them, and the factor’s bank details are shown.

Another variant is confidential invoice discounting where only the first two services on the list of four are provided. It’s confidential because there’s no notice of assignment on the invoice and therefore the buyer does not know that his supplier has factoring. Also, collections are handled by the seller who holds buyer payments in trust for the factor or in some jurisdictions payment goes to a bank account controlled by the factor but in the name of the seller, thus maintaining confidentiality.

FinancingWhere finance is one of the services being offered – the seller almost always wants to improve cash flow – an advance payment by the factor to the seller of around 80% to 90% of the face value of the sales invoice is made as soon as it is raised and assigned to the factor.

After the initial advance the balance of the invoice value is paid to the seller when the buyer makes payment on or after the invoice maturity date. At this stage a fee for the factor’s services is charged to the seller.

Laws and regulations differ around the world, and there may be specific local requirements if you want to operate as a factor. Often a banking licence is needed to do factoring; in some countries non-banking financial institutions (NBFIs) are also eligible. A financier’s decision to set up a factoring operation should also consider the following questions:• Is there a specific law on transfer of

receivables in your legal environment? You want the comfort of knowing that the local legal system – both legislation and the courts – defines transfer of receivables, understands factoring, and will support your claim over the receivables and the right to receive payment.

• What third-party rights may affect assigned receivables? Can other parties who hold security over assets of the seller challenge your claim over the receivable?

• Is ban on assignment valid? Do such clauses prevent transfer of ownership of the receivable?

• What is the position of the financier in the case of insolvency of the seller? You’ll want clarity over your rights to the receivable particularly when an insolvency practitioner has been appointed.

• Is there a central registry of interests over the receivable? To guard against double assignment of the receivable to different financiers.

In some countries, these issues may not have been clarified. It doesn’t mean to say you cannot practise factoring but the risks will be challenging and possibly unacceptable to shareholders and backers.

Whole turnoverIn most markets factoring is ‘whole turnover’, which is where the seller assigns all its current and future sales invoices. The attraction to the factor is that his risk (i.e. the risk of not getting his money back through buyer payments) is not concentrated in one buyer or a small group of them. However, single invoice factoring has developed, and with this type of factoring, there is no spread of risk.

The factor might mitigate the risk by verifying every receivable with the buyer and obtaining written acknowledgement that the goods or services have been delivered or performed correctly, and that payment will be made.

Quality of receivable and buyerIt is vital that the factor understands the ability and willingness of the buyer to make payment. Why? Because this is how factoring is repaid.

“The factor wants ownership of the

receivable because repayment of any finance advanced comes from the

buyer”

Receivables finance | Factoring principles



The factor must also fully understand the receivable and any impairments to its quality which reduce its value, otherwise known as dilution. Examples include sale-or-return, settlement discounts, reciprocal trading, retentions and post-sale contractual obligations.

Impairment issues will come from close examination of documentation and processes around the sales contract, purchase order, order acknowledgement, invoice and proof-of-delivery. A factor should also form a view on concentration of receivables.

Here are the questions they need to ask:• Are there only a few buyers?• Should the risk be spread more widely?

As part of assessing the quality of buyers, a factor will determine the legal status of the buyers (limited company, partnership or sole trader), obtain credit agency reports, analyse the buyer’s financial accounts and understand the buyer-seller trading relationship.

In some countries credit and financial information on businesses varies in quality or is unreliable. It may simply not be available to begin with. In such circumstances, direct contact with buyers may be the best or the only way to begin your assessment.

The factor may seek to mitigate risk by taking out credit insurance on the buyer, if it is available, but you nevertheless still need to understand the quality of the receivable.

Fee structureThere are two standard fees in factoring:• a service fee; and• a discount fee.A service fee is a percentage of the value of the receivable, and a discount fee expressed as a percentage over base rate and applied daily to the balance of the finance advanced to the seller. The discount fee is the same irrespective of the factoring product and, like an overdraft, is expressed as x% over base.

Service feeThe service fee covers the costs of the factor for the type of factoring being offered, plus a margin. For example in non-recourse factoring the service fee will reflect the workload required as a direct result of the number of buyers, the number of new buyers added each month, and the number of invoices and credit notes raised on average in the year.

The service fee in confidential invoice discounting is lower than in ‘full service’ factoring because the above criteria is largely irrelevant since there is no detailed, invoice-by-invoice record of the buyer accounts kept by the factor, and collections are done by the seller.

Receivables purchase agreement Any type of factoring facility should be based on a receivables purchase agreement (RPA) between the factor and the seller. This stipulates that the seller agrees to transfer all rights in relation to present and/or future receivables to the factor, and the factor accepts those rights without necessarily obtaining the consent of the buyer.

Depending on local laws and accounting rules, when the transfer of ownership of the receivable in factoring is a true sale, the seller may be able to remove the receivable from the balance sheet and show the advance from the factor as cash. Since it is not a loan there is no liability. The attraction for the seller of this off-balance-sheet finance is an improvement in liquidity while avoiding additional leverage. An RPA typically includes: • maximum buyer concentration percentage:

this limits the factor’s exposure to any one receivable to x% of the gross receivable;

• excluded receivables – e.g. inter-company receivable, and cash sales;

• advance percentage; • dilution and performance covenants – e.g. the

factor might reserve the right to reduce the advance percentage if credit notes exceed, say, 3% of receivables (by value) or days sales outstanding exceeds the yearly average; and

• Recourse period is typically 90 days.

Peter Brinsley is the managing director of Point Forward consultancy firm in the UK

Reference1. See also Peter Brinsley's

article on factoring in sub-Saharan Africa at www.tfreview.com/node/11385




Hook, line and sinker

How can a letter of credit improve the working capital management of a small British seafood importer? David Morrish explains how even when the cost of the discount is factored in, this trade finance tool is a good solution


A s Dave Meynell and Gary Collyer pointed out in their October TFR article ‘Present and correct’, letters of credit (LCs)1 provide sellers

with some certainty of payment. And, used imaginatively, they can also facilitate release of much-needed working capital. In some instances this will depend on how sympathetic the seller’s bankers are; and that is one issue I develop further in this article.

Firm orderAt its simplest, the receipt of a firm order for the supply of goods or services in the form of a letter of credit, confirmed by a bank in the seller’s country if appropriate, may give the seller’s bankers confidence to increase credit facilities with them. But if not the bank, or other banks or specialist export finance providers, may be prepared to look at the letter of credit on a stand-alone basis.

The key questions banks will want answering include:• Does the seller have the ability to fulfil

the terms of the LC? Are the terms straightforward or unduly complex?

• Is this the seller’s normal business activity?

• What is known of the buyers? Are they reputable?

• What is the standing of the issuing bank? If the LC has been confirmed what is the standing of the confirming bank?

• Is there a potential market for the goods in the event that the terms of the LC cannot be met and the original buyer walks away?

This is not an exhaustive list, and there is no doubt other factors that will need to be considered, but it should give an indication of what level of comfort lenders are looking for.

It is worth adding that, while there are exceptions, when buyers request their bankers to issue an LC, this will usually be at their expense, and will use up some of their credit line. In other words, if buyers apply for an LC to be issued on their behalf, then it is reasonable to assume that they want the goods. So even if the seller fails to meet all of the terms and conditions of an LC, as long as the underlying goods or services are delivered, in the vast majority of cases payment will still be forthcoming. What has been lost is the certainty of payment that a complying presentation provides.

“By changing the wording of the LC it is still possible to give the seller payment ‘at sight’ while obtaining

credit from them”


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Transfer, assignment and back-to-back LCsFor transactions in favour of sellers that are sourcing some, or all, of the goods or services from third parties, there are other options available. Asking for an LC to be ‘transferable’ (under LC Uniform Rules UCP 6002) allows the beneficiary of an LC to transfer all, or part of, the LC to one or more suppliers. The terms of the LC are, for the most part, replicated, but the amount and unit price of the goods may be reduced so that the beneficiary of the original LC can make its turn.

Importantly, the beneficiary of a transferrable LC needs no additional credit facilities although it will need to pay the banks transfer fees. On the down side, the buyer will almost certainly learn the identity of the ultimate supplier and may subsequently deal direct.

Back-to-back LCs are not recognised by UCP 600 but work in a similar way to transferrable credits, i.e. with the terms and conditions in favour of a seller being replicated in LCs issued ‘on the back’ of LCs issued to third party suppliers. These need very close monitoring by the bank if risks are to be minimised, which is why not every bank will offer this facility. But, as with transferable LCs, it does allow the original beneficiary to use an LC received in its favour effectively as security, in whole or in part, to source goods or services.

As another variation the beneficiary of an LC may assign the proceeds of successful presentations of documents to third parties (as defined in UCP 600). Third party suppliers may therefore be sufficiently confident of a beneficiary’s ability to present complying documents to accept an assignment of a given percentage of proceeds under LC presentations in lieu of payment in advance for goods supplied.

Where it is recognised by a buyer that the beneficiary of an LC may require working capital to allow a contract to be fulfilled, an advance payment or red clause may be inserted into the terms of the LC. This allows the beneficiary to draw down a given percentage ahead of shipment of the underlying goods, with the amount drawn being deducted from the amount due on presentation of complying documents.

Buyer supportOf course, it is not only sellers that may need finance; buyers may also need support.

In a new relationship, it would be not unusual for the seller to call for an LC with payment at sight, i.e. on presentation of complying documents. That will often put pressure on the buyer’s cash flow as there will be a funding gap pending delivery of the goods and their subsequent sale. If the seller can be convinced to accept, say 60-day terms, this will give the buyer breathing space before payment is due. However the seller will either have to wait for

payment as a consequence, or obtain finance against the deferred payment at cost to them. However by changing the wording of the LC it is still possible to give the seller payment ‘at sight’ while obtaining credit from them. The case study illustrates how this could work in practice.

There is not necessarily a finance solution for every situation, but with a little thought, there are ways in which buyers and sellers can help each other and if necessary can obtain support from their banks. If however that support is not forthcoming, companies should not hesitate to look elsewhere. Potentially, this could be other banks with connections in the countries where those companies operate or increasingly to specialist export finance houses. In turn, banks need to look more imaginatively at the way they assess credit risk regarding international trade transactions. Analysis undertaken by the ICC suggests that financing trade is considerably less risky than traditional lending against security or the strength of the balance sheet. And with particular reference to LCs, some of the associated risks have already been removed.

The message, therefore, for both potential buyers and sellers, and also their banks, is to look at the options, understand and mitigate the risks, and reap the rewards.


Case study: seafood import/exports

Seafood Importers (UK) are a fast expanding business in the south of England, specialising in supplying seafood imported from Hong Kong to wholesalers. Typically, sales from Seafood Importers (UK) to the wholesalers are on 90-day terms allowing the wholesalers to then sell to supermarkets and restaurants before payment is due.

Eastern Seafood Exporters (Hong Kong), their principal supplier, would like to increase sales. However, pressure for payment from the predominantly small fishing fleets in Hong Kong, where crews are paid in cash at the end of each voyage, means that Eastern Seafood Exporters must insist on documentary LCs to provide certainty with payment in full at sight.

The current requirement for Seafood Importers (UK) to pay their suppliers at sight, while granting their buyers 90 days credit, has created strong pressure on their cash flow which has slowed the company’s growth significantly as a consequence.

Seafood Importers (UK) needed to find a mechanism that would allow them to grow the business but maintain existing arrangements with their suppliers.

The answer was to change the payment terms to Eastern Seaford Exporters from sight to 120 days sight but include a clause in the LC that would allow the face value of documents presented to be paid immediately against complying documents with the cost of discount more than 120 days to be met by Seafood Importers (UK).

The benefits of this were twofold:• Eastern Seafood Exporters would continue to receive payment in full on

presentation of documents at no additional cost to them.• Seafood Importers (UK) would gain 120 days credit (at cost of discount) giving them

a positive cash flow of 30 days.

References1. See www.tfreview.com/

node/128582. See http://bit.ly/1RZRrlv on

www.iccwbo.org


Supply chain finance structures cover the purchase of receivables by way of assignment without recourse to the seller and usually form two categories: buyer-led transactions and supplier-led transactions, distinguished by the

engagement of the financer or service provider with the debtor of the receivables.

This article sets out the framework of these structures along with their legal implications.

Buyer-led structuresThe main features of these are:• the buyer (the contractual debtor) is the

financer’s client;• there is a contractual nexus between financer

and buyer; • the buyer has accepted liability to make payment

to the financer on the due date (thus mitigating the performance risk on the supplier); and

• the structures are often implemented over an electronic platform, but not a prerequisite.

The rationale for the parties is that:• the supplier obtains earlier payment;• the buyer gets better commercial terms and

Without recourseSimon Cook explains the legal fundamentals of three types of supply chain finance structures

Supply chain finance | Legal structures

maintains a stronger relationship with its supplier; and

• the financer makes its margin.

Both buyer and supplier have accounting treatment requirements, with the buyer wanting a trade payable on its books rather than a debt and the supplier wanting the receivable off its balance sheet.

In Figure 1, there are three contracts:• a sales contract between the buyer and the

supplier; • a payable services agreement (PSA) between

the financer and the buyer; and• a receivables purchase agreement (RPA)

between the supplier and the financer. Under the PSA, the financer acts as paying agent and this agreement sets out the terms on which the buyer uses the platform. Under the RPA, the receivable is transferred from the supplier to the financer and, in some cases, this agreement includes terms allowing the supplier to access the platform (this can be separately documented).

The process is that the purchase order is submitted following which the supplier supplies the goods and services and the invoice is sent out.





Figure 3: Third party structures – other contractual structures

Figure 1: Buyer-led structure

Figure 2: Supplier-led structure

Debtor (buyer)

Service provider/ financer

Supplier (seller)

1. Purchase order

2. Supplies goods/services and invoice

Supply contract

Payable services agreement Receivables purchase agreement

3. Details of accepted invoice/receivable uploaded to platform

4. Notification of upload accepted receivable (manual discount only)

7. Notice of assignment of receivable

5. Request for financer to purchase receivable (manual discount only)

8. Payment of face value of receivable on maturity date

6. Payment of discounted purchase price in exchange for assignment of

receivable

Supply contract Receivables purchase agreement

1. Purchase order

2. Supplies goods/services and invoice

3. Acknowledgement/acceptance of invoice (confirmed structure only)

4. Details of accepted invoice/receivable and request for financer to purchase

5a. Notice of assignment (disclosed structure or supplier default only)

5. Payment of discounted purchase price in exchange for assignment of receivable

6. Payment of face value of receivable on maturity date

7. On-payment of face value of receivable on maturity date

Deb

tor (

buye

r)

Supp

lier (

selle

r)

Fina

ncer

Debtor (buyer) Financer

Supplier (seller)

Third party platform provider

Supply contract Receivables purchase agreement

Financer agreementPayable services agreement

Platform services agreement


Supply chain finance | Legal structures

If the buyer wants to put the invoice into the structure, it uploads details of the invoice onto the platform (including at least the name of the supplier, the amount, the maturity date and a reference linking it to the right transaction) automatically notifying the supplier. The supplier decides either to retain the receivables or to offer them for sale to the financer. If offered, the financer has the choice to either buy the receivable or not. If instead there was an automatic sell down process, as soon as the buyer uploads the invoice the financer is bound to buy the asset.

Payment of the purchase price by the financer triggers assignment of the receivable to the financer and notice being issued to the buyer confirming the purchase. From then on, the buyer will only be able to discharge its obligations by payment to the financer in accordance with its instructions.

The buyer will put the financer in funds prior to the receivable’s due date and then, on the due date, if the receivable was purchased by the financer, the financer retains the funds itself. If not purchased, the financer makes payment on behalf of the buyer to the supplier.

Supplier-led structuresThese structures are more varied but generally the supplier is the financer’s main client. There are contractual arrangements in place between the supplier and the financer but the financer has no contractual relationship with the buyer. These are the main differences from a buyer-led structure:• supplier-led structures can have confirmed or

unconfirmed receivables with the consequence (in the latter case) that there is still seller performance risk;

• the assignment of the receivable may be disclosed or undisclosed to the buyer (no legal assignment in the latter case);

• the supplier commonly acts as collection agent for the receivables;

• if an issue arises with the supplier or the buyer or there is a default, then the financer would serve notice at that point on the buyer if the assignment was undisclosed; and

• the accounting treatment is generally only relevant to the supplier who still requires the receivables to be off balance sheet.

In Figure 2, there are two of the same main contracts as with buyer-led structures. These are: a sales contract between the buyer and the supplier (though there may also be multiple sales contracts/buyers with different protections and different pricing); and an RPA.

The commercial processes are generally the same as for buyer-led structures. There is the potential for variation following issuance of the invoice depending on whether you have the confirmed or the unconfirmed receivable’s structure

and the receivables purchase process may be automatic or discretionary as with the buyer-led structures.

Third party structuresThese are structures involving an electronic third party platform and their main features are:• buyers and suppliers have access to a wider

group of financers;• financers can participate in transactions they

might not otherwise be able to participate in because they do not have their own platform nor do they have the ability to do a whole programme for a customer;

• these structures might be disclosed or undisclosed; and

• the third party platform provider will provide the paying and collection agent’s services.

In Figure 3 there are separate commercial arrangements between the supplier, the financer and the platform provider (these could also be done by way of a tripartite agreement) and the financer still has to sign up to the terms of the platform. In terms of how the commercial structure works, this is very similar to the structures set out in Figures 1 and 2 and, again, the financer purchase arrangements can be automatic or discretionary. Some of the differences to the previous two structures are:• the way in which the financer obtains its rights

against the buyer: there is no contractual relationship but , assuming the documentation has been drafted properly, the PSA should give third party rights to the financer (separate from the financer’s rights under the RPA);

• the important point in these structures is to make sure the drafting works and rights flow through to the financer; and

• in Figure 3, the cash flows go directly from the buyer to either the supplier or the financer rather than through the platform. If the cash flows go through the platform and the platform provider’s accounts, a financer should ensure it is not taking insolvency risk on the platform provider as well as the buyer (buyer funds should be segregated and subject to a trust until payment is actually made down to the financer).

If things go wrong, if the systems fail, if the platform provider pays to the wrong party or it just does not pay at all, a financer’s rights will very much depend on the terms of the documents so it is critical to understand exactly what the buyer’s obligations are and how to enforce against it.

Simon Cook is a partner in Sullivan & Worcester’s Trade & Export Finance Group, based in London

“The financer purchase

arrangements can be automatic or discretionary”



T he widespread use of forfaiting has not always been apparent in recent years. This is in large part due to perception rather than substance as the employment of forfaiting

techniques has continued without abatement and found fresh applications. The following definition of forfaiting from the recently published ICC supply chain finance definitions contributed by the International Trade & Forfaiting Association (ITFA) shows why these techniques offer solutions and opportunities for practitioners of trade finance.

Forfaiting is a form of receivables purchase, consisting of the without recourse purchase of future payment obligations represented by financial instruments or payment obligations (normally in negotiable or transferable form), at a discount or at face value in return for a financing charge.1

Tenors are flexible and the range of forfaitable instruments is wide and always capable of being added to.

Raison d’être of forfaitingThere are other good indicators of the vitality of forfaiting:• the size of the forfaiting market has increased

considerably over the last decade in the largest export markets and is especially popular in Asia, where Bank of China estimates the value of forfaited receivables in China alone at well over US$30bn in 2012;

• new payment instruments have been forfaited, for example the bank payment obligation (BPO) introduced by SWIFT and the range of forfaitable receivables is extremely wide;2

• rules in the form of the Uniform Rules for Forfaiting (URF800), published by the ICC in partnership with the ITFA have for the first time provided standardised global rules in the same way as documentary credits. The recognition accorded by the ICC to forfaiting is evidenced in its ‘Standard Definitions for Techniques of Supply Chain Finance’.3

Many institutions offer forfaiting as a product without necessarily using that label or, in some cases, being aware that they are in fact acting as forfaiters. This can, over time, lead to a dilution of expertise and a lack of awareness of solutions to issues which have been developed and tested. Furthermore, possible new users or potential entrants to the industry may simply be unaware of how forfaiting can be used to their and their customers’ benefit. By focusing on concepts and concrete problems faced by exporters, importers, and financers alike, rather than labels, this article tries to show the value of employing forfaiting techniques.

For exporters the advantages of forfaiting their receivables are as follows:• eliminates a number of risks;• provides financing for 100% of contract value;• protects against risks of interest rate increase

and exchange rate fluctuation;• enhances competitive advantage;• enables sellers to offer credit to their customers,

making their products more attractive;• helps sellers to do business in countries where

the risk of non-payment would otherwise be too high;

• improves cash flow;• enables sellers to receive cash payment while

Forfaiting has huge potential as a set of principles and techniques that can be applied to a wide range of receivables. Sean Edwards explains how

Receivables finance | Forfaiting

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todayMoney


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offering credit terms to their customers;• removes accounts receivable, bank loans, or

contingent liabilities from the balance sheet;• increases speed and simplicity of transactions;• fast, tailor-made financing solutions;• financing commitments can be issued quickly;• documentation is typically concise and

straightforward; and• relieves seller of the administration and

collection burden.

What makes a payment instrument forfaitable?Payment instruments, or payment claims, are the hook on which forfaiting transactions are hung. This does not imply, however, a narrow range of options. There is no longer any slavish adherence to any particular type of instrument and it is best to think of a payment instrument as serving a means to an end rather than being an end in itself.

While not all forfaiters will agree that the following list is exhaustive, most practitioners would agree that a payment instrument should attempt to satisfy at least some if not all of the following criteria:• be independent from the transactions they

finance, i.e. be ‘autonomous and abstract’;• benefit from legal certainty;• be as legally straightforward as possible, but

capable of some flexibility;• be tradable;• enjoy best possible capital treatment; and• enjoy favourable trade status in sovereign and

private debt restructurings.

Instruments traditionally associated with forfaiting, such as bills of exchange and promissory notes, display a number but not all of these characteristics as some features have little to do with the legal nature of the instrument itself.

For example, negotiable instruments are not, per se, trade debt for the purposes of sovereign restructurings; their status will be derived from the underlying purpose for which they have been issued which could, of course, be for raising working capital. Such instruments can also, in some circumstances, give inadequate rights to their holders, e.g. the lack of an ability to accelerate payment, as in a loan, although this can sometimes be overcome by the use of side-letters or other collateral agreements. Legal certainty and tradability are, however, close to the ideal.

The BPO benefits from a set of specific rules published by the ICC (the URBPO),4 which give certainty and provide for instrument autonomy in the same way as letters of credit. Similar issues with trade status would, however, arise as above. The assignability of BPOs is currently limited to the banks within the closed BPO system

which precludes them from being traded unless additional contractual rights are granted.

Book receivables are forfaitable. Here the principal issues tend to be dependence on, and vulnerability to, the underlying transaction and legal certainty. Contractual wording can, to some extent, overcome this.

In short, ‘traditional’ forfaiting has always accepted some commercial and legal limitations to the instruments it deals in and there is, consequently, no reason in principle why more recent instruments cannot be forfaited.

URF800The Uniform Rules for Forfaiting (ICC Publication No 8005) are published by the ICC and are the fruit of a four-year collaboration with the ITFA. The drafting group consisted of experienced professionals from the forfaiting, documentary credit, and wider trade finance community, as well as leading trade finance lawyers.

The URF was implemented on 1 January 2013, but must be incorporated into relevant contracts to have effect and govern the transaction in question. Its vocation is to serve the same purpose in the forfaiting industry as the Uniform Customs and Practice for Documentary Credits serves in the documentary credit industry.

The URF contains 14 clauses or articles and deals with important issues such as the determination of what is satisfactory documentation and the degree of recourse to sellers.

The meaning of ‘without recourse’It is considered to be a fundamental characteristic of forfaiting that the buyer will not have any recourse to the seller. Indeed, this is the origin of the word ‘forfaiting’. Given the liability of endorsers of negotiable instruments, this principle resulted in the practice of qualifying endorsement with the words ‘without recourse’ or ‘sans recours’.

It is not, however, literally true that there is never any recourse to a seller. There would always be recourse for fraud, for example, and it has long been believed in the market that forfaiters originating a transaction (so-called ‘primary forfaiters’) have a duty to ensure that the paper they introduce is legally valid, binding, and enforceable. The precise limits and constituents of this duty have never been legally tested, which is a testament to the integrity of the market, but lack of clarity on this fundamental point is not desirable.

The URF has therefore introduced a ‘liability cascade’ in its Article 13, which sets out the grounds for recourse to different parties. Some grounds, e.g. that the party has authority to enter

“The URF must be incorporated

into relevant contracts to have effect and govern the transaction in

question”

Receivables finance | Forfaiting



into the transaction, are common to all parties, but thereafter Article 13 sets out specific grounds of recourse against each party. The party selling the transaction to the primary forfaiter (called the ‘initial seller’ in the URF) has the greatest liability since it is typically the closest to the obligor, e.g. the exporter. The URF makes the initial seller liable in the following circumstances:• it has not passed on information which it

knew or ought to have known would affect the existence of the payment claim or any credit support documents;

• it is not the sole legal and beneficial owner of the claim being sold free of any third party rights;

• it has not irrevocably and unconditionally transferred the claim;

• it has breached any of the terms of the payment claim or the underlying transaction; and

• fraud in the underlying transaction, for example.

Primary forfaiters have a duty generally to take appropriate steps ‘in accordance with market practice’ to ensure a transaction is valid. Thereafter, subsequent sellers only have a duty to pass on such information as they have available to them.

Recourse is not, of course, simply a legal issue, but will have important implications for determining whether or not a ‘true sale’ has been achieved under applicable accounting standards. In the US, these standards are set out in FAS 125 while the applicable standards for IFRS are set out in IAS 39.

The US standard is stricter and requires legal transfer to have been achieved, while IFRS looks to the transfer of risks and rewards in

the underlying instrument. Generally speaking, recourse is possible for matters which are within the control of the relevant seller, and Article 13 has been drafted in order to achieve this. Figure 1 shows the essential steps in any primary market forfaiting transaction:• the agreement between the forfaiter and the

seller of the payment claim;• the delivery of documents relating to the

payment claim and the underlying trade transaction, and the forfaiter’s examination of those documents;

• calculation of the purchase price and payment ‘without recourse’ to the seller; and

• collection by the forfaiter from the underlying obligor who may be the avalising bank as above or the importer directly.

Set of principlesIt is best to think of forfaiting not as a single product, but instead as a set of principles and techniques that can be applied to sell a wide variety of financial receivables. While this also means that it can be difficult to precisely define forfaiting, it draws attention not just to the accumulated wisdom that the industry possesses, but to an ability to grasp, integrate, and render tradable receivables that could not otherwise be monetised safely and securely.

Sean Edwards is chairman of the International Trade & Forfaiting Association and head of legal, Sumitomo Mitsui Banking Corporation Europe Limited, and. This article is an amended extract from Chapter 7, A guide to Receivables Finance, 2nd edition, published by ARK Group

Figure 1: The essential steps in a primary market forfaiting transaction

References1. See www.forfaiters.

org/forfaiting/what-is-forfaiting

2. Full information on the BPO can be found in TFR’s digital supplement at http://bit.ly/1qUKise

3. www.iccwbo.org/News/Articles/2016/Cross-industry-initiative-establishes-Standard-Definitions-for-Techniques-of-Supply-Chain-Finance/

4. http://store.iccwbo.org/uniform-rules-for-bank-payment-obligations

5. http://store.iccwbo.org/icc-uniform-rules-for-forfaiting-urf-800




L etters of credit (LC) are like apples – they are available in many varieties. “Commercial” credits are typically used to pay for merchandise and normally require presentation of

commercial documents such as invoices, packing lists, transport and insurance documents. In some parts of the world, they are called “documentary credits”, but since all LCs are payable against documents, we will use the term “commercial” for these, and “standby” for those LCs that are typically payable against a simple demand, or a demand plus a statement from the beneficiary.

Standby letters of credit (SBLCs) rarely contain the above types of documents. Both commercial and standbys are independent undertakings, they are in favour of named beneficiaries, are payable against documents, contain expiry dates, and state currency and amounts, etc. In fact, they look a lot like demand guarantees, which some readers will be more comfortable with and will be discussed later.

Babylonian beginnings Legend, and perhaps fact, has it that SBLC originated in the United States. Henry Harfield’s book on the matter, Bank Credits and Acceptances,1 relates the history of the SBLC in the US, going back to the National Bank Act of 1864. Other authors have noted the existence of clay tablets

from the Babylonian times, inscribed with promises from well-known merchant traders to make payment. Regardless of the origination, the current SBLC product known around the world by trade finance professionals is a relatively recent product, which arose following the end of World War II when SBLCs were used instead of bank guarantees, as bid bond and performance bonds.

SBLCs have further evolved in more recent decades to include explosive growth in counter standbys, leading to its recognition in article 1 of the UCP 400 (Uniform Customs and Practices for Documentary Credits):

“These articles apply to all documentary credits, including, to the extent to which they may be applicable, stand-by letters of credit, and are binding on all parties thereto unless otherwise expressly agreed. They shall be incorporated into each documentary credit by wording in the credit indicating that such credit is issued subject to Uniform Customs and Practice for Documentary Credits, 1983 revision, ICC Publication No. 400”.2

The most recent development in the practice of SBLCs occurred with the creation of a set of rules designed specifically for standbys: the International Standby Practices (ISP) 19983. In less than 20 years, this set of rules has achieved global recognition and acceptance. US banks alone had more than US$365bn outstanding at the end of 20154 and US branches of foreign banks had over US$178bn at the end of 2014. Estimates by knowledgeable US bankers are that around 60% of this reflects SBLCs issued subject to ISP98.

Donald Smith explains how standby letters of credit can be deployed in a variety of scenarios to achieve a whole host of commonly overlooked purposes

“Like the different varieties of apples, it is used for many

purposes”

Trade and commodity finance | Standby LCs


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More than a Yankee single purpose product The SBLC is not merely an American product; it is used globally. Further, like the different varieties of apples, it is used for many purposes, not simply as a product to guarantee payment if an applicant defaults in their obligations to the beneficiary.

Some of the more common uses are as advance payment guarantees, bid bonds and performance bonds, progress payments, release of retention amounts, performance guarantees, recurring scheduled payments, primary payment mechanism, escrow arrangements, purchase or sale of securities, protection for a surety company’s undertaking or bond, periodic payments, reinsurance, protection for another bank’s local undertaking (counter standby) with or without an automatic extension clause, warranty, customs duties, property or equipment leases, loan repayment, industrial revenue bonds, commercial paper placement, overdraft facilities, release of cargo guarantees, open account shipments, and the list goes on.

Helpfully, the banking industry has grouped these descriptively based on their function. The preface to the ISP98 lists these groupings and provides additional helpful explanations. The list of groups is as follows: performance, advance payment, bid bond/tender bond, counter, financial, direct pay, insurance and commercial.

SBLCs and demand guarantees (DG) share many similarities. Both have ICC rules in the form of ISP98 and URDG 758 respectively, if they are issued subject to the rules are irrevocable unless otherwise explicitly stated, are payable against documents, have applicants and beneficiaries, issuers (usually banks), currency and amounts, expirations, amendments, and many more similarities.

With all of these parallels, how is a party to know which to choose? That discussion starts (or should start) between the applicant and beneficiary early in the formation of the transaction. What are the parties to the transaction really looking for? What protections does each party need, for what period of time, for what purpose, who will issue the SBLC or DG, will it be “confirmed” (SBLC) or will there be a counter SBLC or counter DG, with an institution local to the beneficiary issuing an undertaking subject to local law, custom and practice, etc. Unfortunately, this discussion rarely involves all of the necessary parties before the contract is executed. The bank issuing the actual undertaking is usually left of these discussions.

It is a disappointing reality that parties to the contract typically think only of their own interests, forgetting to consider whether the bank may be able to issue such an instrument as they have described. Wise applicants and beneficiaries

(those who wish their SBLC or DG to be issued quickly and seamlessly) involve their bankers in the discussions at an early date, to ensure their proposed contractual protections can be achieved in a manner satisfactory to all parties – buyer, seller, and the banks involved.

Hurdles and due diligence Who can issue a SBLC or DG? Must it be issued by a bank or can it be issued by another company, such as an insurance or bonding company? This really is a question for the parties and the answer will likely be found in the law governing the transaction. Governing Law – should you be concerned with that? Absolutely, especially if the transaction is going to involve a counter standby or counter guarantee. This is because the counter standby or guarantee may be issued subject to the law of the state where the issuer is located, and the local undertaking will likely be issued subject to the law of the local issuer.

This can become a problem if there is an issue in the completion of the transaction, or a different treatment of the expiry date, or if the counter undertaking expires prior to the expiry of the local undertaking, etc. Early involvement of both the issuer of the counter undertaking and the local undertaking is critical to addressing these problems and resolving them before they become an issue.

There are a series of checks that can be used to identify whether a SBLC or a DG should be used. You should know the transaction, the applicable rules to each type of instrument, what is acceptable to your counterparty and to the issuing bank, what is recognised under the law of the country in which the transaction will occur, and how do the rules handle a failure to specify governing law and forum?

When attempting to find the bottom line, the KISS principle works well – Keep It Simple, Sam: • Keep the language clear and simple;• Keep the language of the SBLC or DG

separate from the language of the contract;• Understand the law in the countries you do

business; and• Guard against logistical problems by early

involvement of the issuing bank and local bank (if any).

Donald R Smith is president of Global Trade Advisory, Ltd., a consulting firm located in the United States. He is retired from Citibank New York, led the US delegation to the ICC Banking Commission for 12 years and remains a member of the delegation, was appointed to the role of technical Adviser to the ICC Banking Commission in July 2013. In addition to training in the trade products, Mr. Smith is designated as a DOCDEX expert and serves as an expert witness

References 1. Harfield, H. (5th ed)

(1974) Bank Credits and Acceptances, United States: The Ronald Press Company.

2. See the United Nations Commission on International Trade Law, 1984, Volume XV: http://bit.ly/1Teke4f

3. See ISP98 from the Institute of International Banking Law & Practice, Inc: http://bit.ly/1s50EOT

4. Documentary Credit World, April 2016 (subscription required): http://bit.ly/1XovFtm

TFR Fundamentals 19-07.indd 23 26/09/2016 17:07:21

I n his excellent article in the May TFR Fundamentals section Don Smith compared the many different ways in which standby letters of credit

(LCs) may be compared to varieties of apples.1 In this article I want to focu s on the practical application of just one of the varieties that he touched on, the commercial standby: crisp, long lasting and full of flavour…

For those companies new to exporting and uncertain about the creditworthiness of their potential buyers – not to mention the political risks of being associated with the country in which their buyer is located – the consistent, sound advice is usually to insist on a documentary LC. Provided they comply precisely with the terms and conditions then payment will be assured. Of course this is not always as easy as it sounds. But once the relationship has been established for a while and the experience has been a good one, is there a way of simplifying the process without losing the protection provided?

One option is to use commercial standby LC.

Practical functionalityFor those not familiar with how the documentary LC works in practice, the following summary sets out the main points:• Importers apply to their bank for an LC

to be raised for each shipment or series of shipments.

• Banks will then issue the LC to be advised and potentially confirmed by a bank in the exporter’s country.

• On receipt, exporters carefully examine the LC to ensure that they are able to meet the terms and conditions. If they are not then the onus is on them to contact their buyers immediately

and arrange for the LC to be amended.• Post shipment exporters must meticulously

prepare and present the required documentation within the stipulated dates.

• On receipt of complying documents the paying bank will make payment to the exporter.

So, exporters have some certainty of payment and, in return, importers have control over documentation and timing.

This is very much a simplified view but should give a flavour of the roles and responsibilities of each party. And while, for the right transaction, a documentary LC can be the perfect method of payment, there is an increased operational burden placed in particular on the exporter. To reap the full benefit of certainty of payment, documents have to be right (not a bit right or mostly right but exactly right) and I am still hearing that on first presentation 60%-70% do not comply. However, it is good to see that in the ICC Banking Commission’s annual survey, Rethinking Trade and Finance, the 2015 report noted that these high levels of document discrepancy rates are, at least, not increasing any further and respondents to the survey anticipate a reduction because of the “evolution of the International Standard Banking Practices of the ICC, whereas others contend that the main driver is that export beneficiaries are becoming more professional”.2

Definition and benefitsSo, what is a commercial standby LC (standby) and how may it help?

In this context a standby effectively acts to ensure payment is received in the event that the prime method of payment has failed. Unlike a

Full of flavourDavid Morrish celebrates the beauty of standby letters of credit in keeping trade simple and mitigating the risks of non-compliant document presentation

Trade and commodity finance | Standby LCs


“To reap the full benefit of certainty of payment,

documents have to be right”


documentary LC, which is the prime means of settlement of a transaction, the standby allows exporter and importer to trade on simple open account terms, the exporter having the protection of the standby ‘guarantee’ in the background secure in the knowledge that if the importer defaults it will be able to trigger payment.

Case study To see how this may work in practice let’s look at a case study

Birmingham Widgets plc (BW) has been exporting to Johannesburg Buyers Ltd (JB) in South Africa for the last two years on 30 days sight terms supported by unconfirmed letters of credit. The value of each LC is for a maximum of £150,000 with stipulated part shipments of £50,000 per month. To ensure that there is no break in supply four LCs have therefore been issued each year. Payment experience has been good although at times BW has struggled to present complying documents and occasionally two shipments have made in the same month.

JB has asked BW if it will relax the LC terms of payment but, while BW would like to respond positively, it is reluctant to abandon the protection that an LC provides. At the same time BW would welcome the chance to simplify the process.

BW has discussed this with their bankers who have suggested the following:• In place of the existing documentary credits

calling for presentations of documents against individual shipments JB could ask its bankers in South Africa to issue a standby in favour of BW.

• The amount of the standby could be for the maximum value of shipments outstanding at any one time. With 30 days payment terms allowing for shipments to be delivered and be at least two, potentially three consignments, outstanding at any one time, the standby would therefore be opened for £150,000.

• BW however may feel that 100% protection is unnecessary given their experience of working with JB and therefore be comfortable with protection for just two shipments i.e. £100,000.

• The proposal is accepted following discussions between JB and its bankers.

This arrangement has these benefits for both BW and JB:• BW has the protection of an LC but does

not have to present complying documents to be confident of certainty of payment of its shipments. BW has frequently had documents rejected on first presentation in the past which, as a minimum, has adversely affected cash flow and potentially put payment at risk.

• As there are no documents to present under

the standby (except in default of course) there are no presentation fees.

• The terms of the standby will typically be very simple. BW must ensure that it understands and be able to comply with its terms immediately on receipt. Thereafter the standby stays in the background. The beneficiary need only ensure that it remains valid i.e. it is within its expiry date.

• In the event of default of payment by JB, BW need only make a simple declaration of non-payment as defined in the standby credit to obtain payment.

• JB will lose the protection of being able to stipulate documents and must be aware that BW has only to make a simple statement of default to obtain payment

• But in the example, JB has been able to reduce the value of the standby to £100,000 thereby reducing the overall risk, the liability to the bank and consequently the fee.

• As shipping documents are being sent direct from BW to JB this should reduce the possibility of demurrage where the vessel arrives before the documents.

Standards and rulesCommercial standbys may be issued subject to Uniform Customs and Practice for Documentary Credits (UCP 600) or they may be subject to International Standby Practices (ISP98). Both are ‘fit for purpose’ and both sets of rules are published by the ICC. Standbys are still routinely issued subject to UCP 600 even though many clauses will not be applicable. As the name suggests, ISP98 was created specifically for the various types of standbys, the above example being just one. If at all in doubt as to which set of rules would be most appropriate then I would suggest discussing this with your bankers.

In conclusion, the standby provides a small, but potentially worthwhile, step away from documentary credits whilst still providing exporters with the protection they seek. They are particularly useful where a level of trust between exporters and importers has been established and sales are regular or even frequent as illustrated in the case study. And both parties can benefit if they understand what standbys do and don’t do and are prepared to make concessions.

Are standbys beautiful? That may be overstating it but in the right circumstances they can be a very attractive option. And using Don’s KISS principle – Keep it Simple, Sam – a well drafted, one-page commercial standby can tick all the boxes.



References1. www.tfreview.com/

node/136622. See page 44 of the 2015

survey, downloadable from www.tfreview.com/node/12718



I n an era where globalisation and technology are contributing to an unprecedentedly rapid evolution of trade, opening doors to new markets all

over the world, one trade finance tool remains crucial: the letter of credit (LC). The LC dates (in some form or other) almost as far back as trade itself, and while other – perhaps more sophisticated – trade finance instruments have emerged, it is important that we don’t forget the LC.

The basics The LC possesses a rich and varied history. While it can be dated back to ancient Egypt, many attribute the introduction of the LC into Europe to the Venetian explorer, Marco Polo, whose journey to China along the Silk Road opened up a complex network of trading routes between Asia and Europe.

Today, the LC – also known as a documentary credit – is a key financial instrument, typically issued by a bank or non-bank trade finance institution. A legally binding contract, it assures an exporter of their payment, providing that they meet the LC’s specified terms.

In the event of a default, the bank will settle the outstanding debt. From the days of the Roman Empire to today’s complex global economy, the LC has functioned as a steadfast and effective payment method, and is now distinguished by different types of use. Indeed, some LCs provide more security, while others have greater structural flexibility. The most widely-used types fall into five categories: • Irrevocable – perhaps one of the most secure

types, the irrevocable LC cannot be amended or cancelled unless all parties agree.

• Confirmed – serves as second guarantee (or extra security) and is typically used when the seller has doubts over the creditworthiness of the issuing bank.

• Transferable – can be passed from seller to seller. This type is commonly used when there

are multiple parties involved in a transaction. • Revolving – this type of LC is able to cover

several transactions between the same seller and buyer.

• Standby – often used as a ‘payment of last resort’. Standby LCs can be used should the buyer fail to provide payment.

More specifically, an LC is a commitment given by a buyer’s bank to pay a supplier on the former’s behalf by employing a pre-agreed credit facility. Payment for the goods is only made if the buyer’s bank receives specific documents detailing the transaction from their supplier. The LC will also set out the terms and conditions of delivery.

A trusted instrument The term ‘letter of credit’ has its origins in French etymology, specifically, accréditation – the power to do something. Accréditation, in turn, derives from the Latin accreditivus, meaning trust.

And trusted it is. The LC is one of the oldest and longest-standing trade finance products in history.

With a proven track record of security, LCs are one of the most secure and versatile methods of engaging in international trade. An import LC is essential if a business is purchasing from overseas and wants assurances that it will receive the goods before paying.

Similarly, an export LC is beneficial to businesses selling abroad that want to make sure they receive payment. Indeed, LCs are a critical aspect of trade, especially when dealing with a new market, region or trading partner.

What’s more, the LC boasts low default rates. The results of the International Chamber of Commerce (ICC) Banking Commission’s Trade Register report1 confirm the low risk nature of traditional documentary trade finance products.

The LC fares particularly well on multiple levels, including when weighted by exposure. The transaction default rate for short term (ST) export

Trade’s first advocateAs businesses and countries across the world look to overseas markets to support their growth, David Bischof offers a lesson in using one of the oldest trade facilitation tools

“LCs are a critical aspect of trade, especially when

dealing with a new market, region or trading partner”




www.tfreview.com 27

LCs was 0.01% between 2008 and 2014, which compares to a Moody’s rating between Aaa and Aa.

Figures for medium- to long-term trade finance (MLT) products also inspire confidence, with the annual loss rate from 2007 to 2014 lower than the loss rate reported by Moody’s for Aa rated bonds. In fact, the corporate default rate of 0.88% for MLTs, in all asset classes, compares very favourably with the Moody’s default rate of 1.9% for all rated corporates.

And while ST and MLT trade finance instruments have different characteristics, the ICC’s trade register results indicate that both have relatively low default rates. In fact, the default rate for all trade transactions is less than 50% of the default rate of a comparable Moody’s corporate credit portfolio.

Finally, even in the event of default, trade finance instruments evidence high recovery rates. The median result for all ST products is close to 100%. Even with prudent assumptions, the average expected loss for ST trade finance is lower for all products than that of typical corporate exposures.

Governing the LCOne reason LCs are so trusted and secure is that they follow a clear set of rules and regulations. In order to standardise and promote best practice, the ICC published the Uniform Customs and Practice for Documentary Credits (UCP) – a set of universally accepted rules and guidelines for international banking practice rule – in 1933.

A key distinguishing feature of the UCP is that it is not designed by governments, but by bankers and merchants and therefore represents the needs and processes of business. It is regularly developed and updated, and the latest edition (UCP 600) came into effect in 20072.

Today, the UCP 600 is used by LC practitioners worldwide and serves as the basis of US$2trn worth of trade transactions every year. The standards contained in the UCP provide definitions of LC key terms and phrases, as well as setting out the standard practices for the handing of LCs. It means LCs are standardised with little variation in the way they are used or even understood. Indeed, as most commercial LCs are governed by the UCP, banks and specialist financial institutions will often employ UCP definitions – making them language agnostic, despite their international use.

It certainly goes without saying that the LC is one of the most widely used and understood trade finance instruments in the world today, bridging the gap between buyer and seller without the need for explanation or translation.

The future of the LC Of course, just because the LC dates back to ancient times, that doesn’t mean it is drafted on

papyrus; the simplicity of the LC makes it ripe for adaptation.

The digitisation of the financial services industry has led to significant changes for both businesses and banks, completely transforming the ways in which market participants along the supply chain interact with each other.

Since undergoing criticisms for being expensive, time-consuming and error-prone, the LC has evolved beyond its original paper-based practice to an electronic format. Not only has digitisation greatly streamlined the LC process while retaining its classic structure, it has enabled efficiency gains and cost savings by consolidating all relevant information in one place.

Digitisation has also enhanced the security of the LC as transactions can now be tracked in real-time. As a result, opportunities for fraud and other criminal activity have been significantly mitigated.

It is commonly claimed that the LC is a key feature in nearly half of all import and export trade finance. And with more and more businesses looking to expand their horizons, the popularity of the LC is unlikely to fade anytime soon. The LC plays a vital role in encouraging trade, minimising risk and allowing businesses to trade safely in unfamiliar territory.

The trade landscape is complex and very often, new technologies and products are the most appropriate instruments. But where the LC fits, it would be foolish to reject it in favour of its shinier peers – the LC will continue to be a mainstay of international trade finance transactions for decades to come.

David Bischof is policy manager at the International Chamber of Commerce Banking Commission

Figure 1: Steps taken between LC issuance and payment for a customer classified in default

References1. See the ICC Banking

Commission’s Trade Register report: http://bit.ly/1TyVeSH

2. See the ICC’s 2007 UCP (UCP 600): http://bit.ly/29YXiVs

Are documents presented?

Exposures expire

unutilised

Exposures expire

unutilised

Loss incurred by the bank

No loss incurrred on the

Trade facility

Are the presented

documents compliant?

Are the documents

accepted even if discrepant?

Are liabilities under the

import line exposures

paid?

Y

N

N

N

N

Y

Y

Y



F raud is a fascinating subject; just as long as you are not the victim. There are an infinite number of variations that make fraud difficult to prevent or even identify, and while trade finance is

certainly not immune to the problem, the added complexities may hinder rather than help detection.

The skilled fraudster is often knowledgeable and plausible. However, that does not mean to say that losses through fraud are unavoidable. Greater awareness and some sensible precautions should help mitigate the risks. The following examples, mostly drawn from my own experience, help to illustrate how the unwary may be deceived, with a few suggestions added on precautions.

If it looks too good to be true…It’s an old maxim but nevertheless a good one. If offered an opportunity to buy a few million barrels of oil at a 20% discount to the Rotterdam spot market price, I suspect that most would like a plausible explanation as to why the seller was being so generous. But in this case, the story was well spun and was taken at face value. The oil, of course, was never for sale but the fraudster managed to convince the victim that parting with £100,000 in up-front fees would ‘prime the pump’: just one example of an advance fee fraud. There are almost innumerable variations of this but the sting is always the same: the promise of great riches in exchange for a modest fee.

In another situation, a shipment of scrap aluminium was ordered at a price well below the current market rate. The timing of the shipment meant that presentation of documents under the letter of credit was required well before the

vessel was scheduled to arrive. Documents were in order and the payment duly made. The shipment, however, was found to contain a significant proportion of scrap-aluminium-coated plastic.

Why me?In a similar vein, but with a slight twist, is when someone is invited to participate in something that is completely outside their normal business activity. A company with a successful business in refurbishing and exporting used electrical equipment to third world countries was sounded out on a deal involving a private placement of a substantial amount of gold. Neither the company, nor anyone connected with it, had any history of ever trading in precious metals and there was never a rational explanation as to why this company had been selected: nor was it clear what the scam was.

But it was a scam and, thankfully, the company backed away before any damage was done. It did take longer than it should have for the company to realise that gold was most definitely not part of its normal business but the potential to make a large, easy profit had undoubtedly clouded its otherwise sound judgement.

There is no riskAs an ex-banker, this one was always one of my favourites. If there is no risk, why would you want a bank involved, or any other organisation for that matter? In reality, having a bank’s name added to any documentation, even something as simple as an email chain, however carefully worded, helps to add credibility.

Container loads of branded cigarettes on the high seas, without health warnings linking them to a particular country, were popular for a while but then disappeared as the phantom shipments they undoubtedly were. One company got as far

Trade and commodity finance | Fraud

David Morrish offers an insight into the array of tricks employed by fraudsters in trade finance and what investors can do to protect themselves

Tainted trade




“The shipment, however, was

found to contain a significant

proportion of scrap-aluminium coated-plastic”

volume. If that is a concern, the goods should be inspected by a well-known independent inspection company (i.e. not one recommended by the seller) as a condition of payment prior to shipment.

The authorities may also become interested where goods are seemingly too cheap or too expensive: is the transaction being used as a vehicle for money laundering? It would be easy for the unwary to be drawn into this, however innocently. However tempting the opportunity may seem, if there is an unusual element to it, this has to be investigated and if a satisfactory answer is not forthcoming it is time to walk away.

But what if the goods don’t exist at all and the evidence offered in the form of authentic looking documentation has been falsified as in the cigarettes scenario? In these situations, reference can be made to the ICC’s International Maritime Bureau (IMB). The IMB provides an authentication service for trade finance documentation and also investigates and reports on a number of other topics, notably documentary credit fraud, cargo theft and ship deviation.

Role of the banksOver recent years the banks have been put under increasing pressure to look out for unusual transactions that may be fraud related. Money laundering is one consequence of fraud and the additional requirements placed on banks by regulators around the world have helped in making life tougher for the fraudster. A significant investment in additional training has meant that client facing and operations staff are much more aware of the signals that may indicate something is not quite right. While this has put an additional burden of responsibility on the banks, it is absolutely directionally correct.

It would be wrong to go into detail as to what these signals might be and how they are dealt with, but the fact that there is an extra line of defence to make successful fraud more challenging has to be the way forward.

I don’t believe for a moment that international trade is inherently prone to risk, indeed all the research tends to suggest the opposite. But the potential risk of fraud needs to be managed along with the mitigation of other risks including credit, operational and foreign exchange. Like everything else, the best defence is well-trained empowered staff working to clearly defined processes and procedures.

But if there is one simple takeaway from all this, it is to really know who you are dealing with and always remember, if it looks too good to be true then it probably is.



as raising a letter of credit on the strength of such documentation but had the foresight to make it revocable. Thankfully it was revoked before any damage had been done. On the plus side, buying thousands of cartons of non-existent cigarettes should help anyone kick the habit.

I must have an answer today…This is a classic ‘bully boy’ tactic to push the unwary into making a hasty decision. The underlying implied threat is that if you can’t make a decision there and then, the deal will fall through and large profits lost to another (fictitious) willing partner. The answer the fraudster is looking for is naturally a ‘Yes’, but a response along the lines of, ‘If you want an answer today it’s No’, will suddenly remove the urgency and will act as a warning that the transaction should be looked at more closely.

Some fraudsters will favour the proposition that is structured in such a way that it is impossible to unravel. It will have been designed specifically to make the recipient feel ill-informed and financially illiterate. But that is the point. The fraudster will be expecting that the unnecessary complexity will put the recipient on the defensive and as a consequence, make them reluctant to question the detail. Close questioning must be a critical next step. If the deal then starts to fall apart, it will have been worth the effort.

Be especially wary of unfamiliar terminology. This will have been created to give an air of spurious credibility. As an example, every time I see the phrase ‘fresh cut’ in the context of bank guarantees and standby letters of credit, I get concerned. If at all in doubt, it is worth referring to a third party such as trade finance specialists or other trusted professional advisers.

There are, of course, very practical steps that should be taken to avoid these pitfalls right at the outset.

Do you know your customer?This really goes back to basics, but probably the single most important action to take is that you have to know who you are dealing with, however trustworthy the source of the original introduction, and be ready to ask probing questions. Who controls the company? What is their reputation in the market? Is this their normal course of business? (Is it yours?) If the suggested transaction is outside of your typical business norms it does not mean that it should be turned away, but however attractive the potential benefit, it’s important to look at all aspects objectively.

Is the profit margin realistic? If the goods are seemingly just too cheap, is there a reason? As in the aluminium scrap example, it may be that the goods being shipped do not meet the required specification either in terms of quality and/or

