What’s Behind a Name, or Why Documentary Credits are so Modern
Under this title – the latest LCM Newsletter (Volume 16, Issue 4, October - December 2014) presented an article co-written by Radek Dobáš, Andreu Vilà and myself. For starters I must say (almost in envy) that the idea to this was not mine. It is in envy because the basic idea is to right – and so “forgotten” in all of the “hypes” to create something new to replace the LC.
Ever since I started working with LCs its demise has been predicted – and perhaps for that reason that has been the premise. I.e. people (not least the TF managers all over the world) have had this at the back of their heads. Perhaps it has been in the back of the heads of the UCP 600 drafters. Perhaps that is the main reason for the lack of innovation of the LC as such; both in terms of technology and rules. Surely the rules have been revised – but just try to compare UCP 600 to ICC Brochure 83 (dated 1933) – and you will be surprised how similar they actually are. Technology wise some innovation has taken place – but that is mainly related to the communication between the banks and the applicants/beneficiaries; i.e. sharing information and presenting documents. All very fine … but really not much in 80 years!
I really hope that this article will be a paradigm changer in this respect, and that the Trade Finance industry will say:
Yes – we need to find new products like the BPO … but we ALSO need to innovate the LC … because she will stay with us for a long time, so she really deserves it ….
With said – here is the full article – should you not have read it already:
What’s Behind a Name, or Why Documentary Credits are so Modern
According to ICC (ICC Response to Basel Committee Consultation, issued in April 2010) best estimates suggest that the bank-intermediated trade finance underpins around 30 per cent of world trade. Trade finance facilities would include banking commitments, such as letters of credit and bank guarantees, and banking finance of trade documentation. Thus, considering that world trade is about 18.000 billion USD in a year, the volumes object of trade finance are huge. And a good third of that sum is handled by documentary credits.
Documentary credits are therefore an important portion of world trade, reaching every year an aggregate amount roughly the size of the Italian or Russian GDP. They play a central role as an internationally accepted mechanism for debt settlement, and also as a means for trade finance facilitation, where the creditworthiness of the buyer is offered to the seller. Moreover, documentary credits are a risk mitigant for banks. International sales contracts, in particular high value contracts, involve a request for bank guarantees. Any bank financing the buyer would face the risk of an unfair call under such guarantee, whereas a documentary credit would allow for satisfactory evidence of the delivery.
But letters of credit also enjoy a very singular position in trade that turns them into a perfect platform of knowledge for trade specialists, and particularly for bankers. A documentary credit offers every banker a magnificent window to take a look and understand the business of their clients (in fact they offer a view over international business in general), and therefore empower the banker with knowledge and tools to better manage their relationship, enhancing profitability for both parties.
The documentary credit stands in a central position of the business and is shaped with components related to the sales contract, to the transport contract, to general logistics, to insurance of goods, to customs and market compliance, to legal barriers or international sanctions. In sum, the documentary credit practitioner is in a privileged position to see and understand how international commerce works, and thus what the needs of the customer are beyond the documentary credit itself.
A banker that deals with documentary credits needs to have a very good command of the basic sets of rules, mainly UCP, but also URDG and ISP. He or she needs full familiarity with international standards, mainly contained in ISBP, but also in many old or unpublished opinions of the ICC Banking Commission. But beyond that technical know-how, the curious (or only the diligent) banker will expand its knowledge into the international sales law, such as the Vienna Convention, the difference between property and possession, the concept of applicable law or the different dispute resolution schemes.
Incoterms will probably be a must, together with the understanding of the main transport documents related to international transport conventions, such as Hague-Visby, Hamburg, Rotterdam, CMR or Montreal. Some understanding about logistics or different container techniques, such as the difference between an FCL and an LCL load is expected. What are the different types of freight, or when a charter party is required would also be of practical use.
The banker may have a look also at the insurance of goods, and understand the difference with the carrier liabilities. To be knowledgeable in international transport of goods insurance means probably some insight into the British Marine Insurance Act, or the Institute Cargo Clauses of the Lloyd’s Market Association.
Very often a certain understanding of the way customs work is welcomed: how and when VAT or other taxes are applied, or what is a tariff and how a system of preferences work. Let it alone some familiarity with the way market barriers and protections work, or the impact of sanctions in international trade.
Documentary credits are therefore not only an important means of payment, but also a guide for bankers to understand their clients’ international business (be it conducted under a trade finance scheme or not), and makes it easier for that banker to be in a better position to become a true advisor and partner to that business. When banks want to be something more than a distributor of financial products on demand, it should be welcomed as good news getting to know that the report of documentary credits’ death (like that of Mr. Twain) was an exaggeration.
Head of Documentary Business Team
Česká spořitelna, a.s.
Prague, Czech Republic
International Trade Development Manager
That’s it – I hope you enjoyed it. The LCM Newsletter is available – for the next 2 months – here:
Take care of each other and the LC – she deserves it!
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