TFPD_06: Here we use guarantees. Here we use standby LCs


Trade Finance Paradigm #6: Here we use guarantees. Here we use standby LCs

 

The next of the eight Trade Finance Paradigms is: Here we use guarantees. Here we use standby LCs

 

Earlier this month I visited a customer, and they told me that “here we use guarantees. Not standbys. And our guarantees are issued in all kinds and forms; direct, indirect and for all kind of purposes.” I am sure that if I visited a similar company in the US – the answer would have been the opposite: They use standbys – not guarantees.

 

The approach that a company has to standbys and guarantees differ around the world. People perceive things in different ways, and practice evolves in different ways. Sometimes the practice becomes a paradigm. It seems to me that the practice regarding the use of standbys and guarantees is a paradigm: We do this or we do that – and we do it in so and so a way …. Full stop! The practice has become a paradigm – and the paradigm blocks the way you think … and that is when you must change your paradigm!

 

The fact is that although standbys and guarantees are similar instruments – they work in different ways:

 

The traditional guarantee begins in the situation where a guarantor issues an undertaking vis-à-vis a beneficiary. If the beneficiary would like to obtain an undertaking from its own bank (a “local” guarantee), this is solved by using a counter-guarantee. This means that the beneficiary of the guarantee receives a guarantee issued by a bank (guarantor), even though it is originally issued by the applicant’s bank (counter-guarantor). The counter- guarantee indemnifies the guarantor in the event a complying demand is made (by the beneficiary) under the guarantee. The counter-guarantee and the guarantee are two separate guarantees, independent of one another. (I am sure that for the untrained ear this sounds like nonsense :-)

 

In similar circumstances using a standby, the standby is confirmed by a confirming party. I.e. the standby is issued by the issuer – and advised to the beneficiary by a confirmer. The ISP 98 rules state that the “issuer” includes a “confirmer” as if the confirmer was a separate issuer and its confirmation was a separate standby issued for the account of the issuer (ISP 98, Rule 1.11(c)). There is only one instrument, but two parties (issuer and confirmer) obligated under it.

 

In other words: two similar instruments – but two different structures to solve the same issue.

 

So which is best? I am sure that this question can be debated for ages – and for sure you can argue both ways. The point I am trying to make however is that since the two instruments do not have the same structure, they will fit into the transaction that they are to support in different ways. Sometimes better. Sometimes worse. It all depends on the structure of the transaction. For that reason it makes no sense being “locked” to one of the instruments. A company with an open and holistic view as to choice of instrument surely can choose the instrument that best suits the specific transaction.

 

So my advice would surely be for banks and corporate customers to forget about how they use to do things; including which instrument they suggest/use – and start suggesting /using the more appropriate instrument for the specific transaction.

 

More information in my article "Guarantees versus standby letters of credit.” DCinsight Volume 18 No 1 – January-March 2012.

 

Take care of each other – and the LC – and the guarantee – and the Standby!

 

Kim

 



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