TFPD_05: The LC is an old fashioned instrument that must be replaced by more up to date instruments


Trade Finance Paradigm #5: The LC is an old fashioned instrument that must be replaced by more up to date instruments

 

The next of the eight Trade Finance Paradigms is: The LC is an old fashioned instrument that must be replaced by more up to date instruments

 

Since the day I started working with LC’s its demise has been predicted many times, and I must admit that looking at the LC from a distance, it looks like the bumblebee that can't fly – but does not know it! There are so many reasons why the LC should be dead and buried long ago. It is from a time with no computers, no Internet – and above all: only paper documents. It is so “yesterday” that you can only imagine. But still it is there – alive and kicking. But of course it should “die” – right? It should be replaced by new – and more up-to-date instruments – build upon today’s technology – right? The TSU/BPO is the answer that will finally take the LC instrument out of its misery – and bury it deep down in an unmarked grave – right?

 

Hmmm most likely not! It seems to me that even though the LC is from another time, it has “features” and qualities that have proven impossible to fully “transfer” into an electronic environment. Many things have been said about the TSU/BPO – so I will not address this here. I will only mention that the TSU/BPO is NOT a 1:1 replacement of the LC.

 

Still – as mentioned above using the LC instrument is NOT hassle-free: I cannot count the times exporters have told me about “impossible to comply requirements” – about nitty-gritty banker raising silly discrepancies.

The UCP 600 has been in force for almost 6 years now – and the level of queries presented to the ICC Banking Commission seems NOT the reduce. And the LC discussions in the market seem only to be increasing. I manage the LCM Newsletter editorial board – and I can share with you that the beginning of this year so far has been a constant flow of discussions between the editors.

 

So surely – using the LC instrument is not necessarily smooth and easy …

 

But what is the problem? Is the problem really that it is an old – out of date – instrument?

 

My answer would be: No! there is nothing wrong with a Maxibon (http://www.youtube.com/watch?vC2qJODr43P0) - or with the LC for that matter!

 

The LC instrument has some really unique features – which I have not seen duplicated as effective anywhere:

 

* It combines in a unique way a payment, a guarantee and a financing.

* It is based on a guarantee from an independent party (a bank)

* The guarantee is triggered (and thereby the payment obligation) based on an “objective” check – based on international standardized rules.

* The fact that nominated banks (parties) can act under the LC – thereby obligating themselves and/or the issuing bank makes it flexible and very useful.

 

… just to mention some.

 

But then what IS the problem with the LC instrument?

 

My answer would be the following: The main problem with the LC instrument is the way it is being handled by the various parties – primarily the banks!

 

There is a paragraph in draft 5 of the coming version of the ISBP that reads as follows:

 

Many of the problems that arise at the document examination stage could be avoided or resolved by the respective parties by careful attention to detail in the credit application and issuance or amendment of the credit. The applicant and beneficiary should carefully consider the documents required for presentation, by whom they are to be issued, their data content and the time frame in which they are to be presented.

 

When discussing this paragraph in ICC Denmark a colleague of mine commented that this sounds a bit “schoolmaster-like” – and questioned if it was really necessary to write this. The answer is that in the perfect world – where all LCs are issue in a clear an unambiguous way – there is not need for this paragraph. There may not even be a need for the ISBP – and surely there would be zero queries to the ICC banking commission about the UCP 600.

 

So the problem with the LC instrument is not the LC instrument – it is how LCs are handled on a daily basis. For example:

 

* There are so many poorly drafted LCs – where the parties end up discussing (often guessing) the intention of a certain requirement.

(For example take a look at this blog post: ICC Opinions – means to an end? (http://www.lcviews.com/index.php?blog_id36)

 

* There are so may spurious discrepancies quoted by banks; refusing high value documents because on details.

 

* Although most LCs are issued via SWIFT using standard messages (like the MT700) there are NO standards when it comes to the wording of the specific LC.

 

* There are so many – so very abstract (reaching nerd level) discussions – that are simply lost to the LC applicants and the beneficiaries …. I need only say “negotiation” …

 

In essence: the LC is the best – most unique – most flexible payment/guarantee instrument in the world, but is being mishandled on a daily basis.

 

Please stop this and take care of each other – and the LC!

 

Kim

 



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LCViews - TFPD_05: The LC is an old fashioned instrument that must be replaced by more up to date instruments