Letters of Credit: A Question of Sanctions

Q.  As beneficiaries of a Letter of Credit, we have recently had a set of documents returned by the advising bank in the UK stating that they are not willing to handle them as there appears to be a problem within the documents which breaches sanctions regulations. How can this have happened? What can we do?  

A.  Banks are very strict these days in ensuring that they do not breach any regulations relating to countries where sanctions are in place . It is, without doubt, one of the areas in international trade finance which is now much more carefully controlled than it used to be in previous years. However, even with these strict controls in place a number of major UK banks have been found guilty of breaches of sanctions regulations, and the fines which have been imposed have been very significant, not to mention the damage that this causes to the bank's reputation. The consequences can be very severe not only for the bank but also for the bank employee who has been implicated in the sanctions breach.            

Many banks use sophisticated software in a regimented screening procedure for any documentary presentation whether it is an Export Letter of Credit, Import Letter of Credit, Export Collection or an Import Collection . Careful screening is carried out in order to check that there is no connection within the documents and particular emphasis is given to;

Any Organisations/Entities

Countries

Individuals

Specified goods

Banks – including reimbursement banks – any bank mentioned. 

Documents – all the below mentioned documents and schedules are scrutinised and the above highlighted elements are extracted and screened by the software. This extraction is, in the main, a manual process, and requires a bank employee to key in the required information into the screening software application relating to:

Invoices

Bills of Exchange

Certificate of Origin

Transport Documents

Insurance Documents

Bank schedules

Customer schedules

If there is a “hit” or as it is also called an "alert" this will obviously need to be investigated,

and in many cases these instances can be resolved quite easily. It may be that the alert relates to the name of an organisation, but on closer scrutiny it is clearly a different entity in a different country. In these, and many other cases the alert can be eliminated. However, in some circumstances the alert is upheld having referred the case to their senior compliance officials for a ruling. In these cases the bank may make the decision to return the documents to the client.  

     

One of the more common “hits” is a vessel named on a transport document which is owned by a sanctioned entity on the sanctions list. In an attempt to get around this, vessel owners rename their ships, but the bank software that screens the documents is updated on a regular basis. 

If a bank considers that there is a issue with the documents regarding a breach of sanction regulations it will return the documents to the customer who presented them and a fairly standard response will be along the lines of ;

"The bank follows the legal requirements of the UN, EU, UK, USA and all other jurisdictions that it operates in (this will obviously vary from bank to bank). Consequently we screen transactions against various lists, especially those related to the UN Security Council Sanctions, and the FATF guidance related to Non-Proliferation of Weapons of Mass Destruction (NPWMD). The transaction in question, when screened against the UN and other NPWMD lists that the bank employs, includes one or more parties names on those lists. The bank's policy is to observe these "positive result" findings and to not complete a transaction should a positive result be found when applying the above criteria. We trust that this explains the reason that we have declined this transaction. All the information that we use is publicly available through, either UN or government web sites, or from specialist companies providing aggregations of these web sites databases".

Some banks have added a specific clause which refers to sanctions, and this clause is included in their terms and conditions stated on the initial advice of the Letter of Credit to the beneficiary. There has been some suggestion that the insertion of a "sanctions clause" in a Letter of Credit advice, may cast doubt on the confirming/nominated bank's (acting upon their nomination) obligations to honour a compliant documentary presentation. It is therefore recommended that beneficiaries of Letters of Credit, who have concerns about these issues should seek legal guidance. It is likely that most major UK banks would refer any "hits" to their internal legal units, but it is also likely that the bank's adherence to their policy on sanctions would override UCP 600.   

           

In answer to the question, it would be a prudent step for exporters to seek any available assistance from their freight forwarders regarding the vessel and ownership of the vessel and also their preferred legal advisor. Should the worst happen and documents be returned, there is little chance that an alternative bank will be found to process/handle the transaction as they will all use similar software to screen the documents /transactions.  

It is very clear that the whole issue of sanctions and their effect on the screening procedure carried out by banks is still emerging and will continue to change. It is without doubt one of the most important areas concerning the presentation of documents under Letters of Credit. 

Letter of Credit Training: The Top 5 Reasons

During the past 2 - 3 years we have seen a huge increase in demand for training in all areas of export, particularly on 'hot topics' such as basic procedures, customs compliance and Incoterms.

From my perspective, I have never been busier as large corporate organisations around the UK and Europe seek specialist training in understanding the financial risks and costs of trading internationally.

But what are the main reasons for this sudden increase in demand for training?

1. In order to spread risk, diversify and increase margins, many companies are developing business in a range of new, challenging and emerging markets where there will be a heightened awareness of payment risk, whether related to the buyer or the political / economic environment. Letters of Credit have a major role to play in mitigating these risks, so staff at all levels, from sales to finance and shipping need to be aware of how Letters of Credit work, how to minimise costs and administration and most importantly, how to present complying documents to the bank.

2. I am seeing a trend for companies who have previously outsourced the document preparation to an external supplier such as a freight forwarder or consultant, to try to reduce costs by bringing this function 'in-house'. Staff preparing Letter of Credit documents thus require intensive and professional training in order to equip them with the requisite skills to do so efficiently and confidently.

3. As I continually state throughout my blog articles, 70 - 80% of documents presented to the bank contain discrepancies, resulting in significant costs and delays in payment. Whereas previously, many companies accepted this as a 'fact of life' and trusted buyers to take up discrepant documents, in the current financial climate there is an increased awareness of potential buyer default. Finance teams in particular are anxious to generate cash as quickly as possible and it is therefore essential that every step is taken to ensure that documents comply with Letter of Credit terms.

4. The 'Doris' or 'Albert' effect, as stated in an earlier article means that companies may be heavily reliant on one or two key individuals with the experience and expertise to consistently prepare 'clean' sets of documents against Letters of Credit. There is a definite move towards upskilling a broader range of people within a business in order to mitigate the huge operational risk associated with such experience leaving, falling ill, taking a holiday or retiring.

5. Whereas I have generally trained staff involved with the administering of Letters of Credit and associated documents, there has been a significant increase in the number of sales managers attending courses. These guys are at the 'sharp end' of negotiating export deals and it is vitally important that they understand the implications to the business of requesting Letters of Credit which may contain onerous or impossible terms and conditions.

Book a Letter of Credit Training Course

Letter of Credit Charges - a worked example

How much is your company paying for export Letters of Credit ?

A large UK based manufacturer exporting globally receives approximately 20 Letters of Credit p.a., each of which is confirmed by a major bank and payable at sight.

The Letter of Credit values average GBP 250,000.00 with a validity of 4 months and cover just one shipment per L/C.

Bank charges* for each L/C amount to approximately GBP 2,562.50

This includes:

1 x advising commission: GBP 75.00
2 x amendments: GBP 100.00
1 x shipment drawing (based on 0.125% of documents value): GBP 312.50
1 x presentation of discrepant documents: GBP 100.00

Confirmation fee (charged per quarter or part thereof @ 1.5% p.a) : GBP 1,875.00

Other charges (reimbursing bank charges, courier fees etc): GBP 100.00

Total annual cost (bank charges) GBP 2,562.50 x 20 L/Cs = GBP 51,250.00

*The above charges are based on the tariffs of several UK banks and are for illustrative purposes only. Confirmation fees will vary according to confirming bank's perception of issuing bank / country risk.

In addition to the above, the company will be paying costs of certain documents, such as certified / legalised Certificates of Origin.

There are also the 'intangible' costs including the time and administration associated with Letters of Credit when compared to more straightforward shipments / payment terms.

Are you accurately factoring the cost of Letters of Credit into your export sales price?

By training your key personnel, including export sales, finance and shipping administrators, the above costs can be identified and managed. Unnecessary amendment and discrepancy fees can be significantly reduced by understanding how to manage the whole Letter of Credit process from start to finish.

See what our clients say about Letter of Credit training 

When is a Letter of Credit not a Letter of Credit?

Let's paint a brief picture....

An engineering company has received a letter of credit in their favour for a high value piece of machinery.

The credit  has been issued by a little-known bank in an emerging market, but has been confirmed by a first class European bank.

A delay in receipt of a vital component of the finished goods means that shipment will be effected 5 days after the Latest Shipment Date specified in the credit.

The applicant is desperate to receive the goods and undertakes to the beneficiary by email to accept the discrepancy of 'late shipment' when documents are presented to the bank.

Sound familiar? What would you do.......?

Having come across this scenario several times recently, it is worrying that exporting companies suddenly become complacent just because they have obtained a 'confirmed' letter of credit and will suddenly lose track of rational thought when something goes wrong.

It is absolutely vital to understand that you MUST comply with ALL terms and conditions of the credit in order for the bank to honour its obligation as issuing or confirming bank.

Once a bank identifies discrepancies in documents, it is no longer obligated to honour or negotiate.

The mere 'promise' of the applicant to honour discrepancies in the case as described, should not be taken lightly as the exporter would effectively be instructing the bank to handle documents on a 'collection' basis only.

What if the applicant changes his mind?

Remember why you requested a letter of credit in the first place!

If in any doubt, insist on an amendment to the credit before shipping the goods.

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Free Letter of Credit Review

Are you or your clients.....

....regularly receiving Letters of Credit?
....constantly requesting amendments?

....struggling with adminstration of the paperwork?
....paying unacceptably high bank charges?

....finding the banks unhelpful?

For a limited period (and subject to availability) , MJ Hayward Associates Ltd is pleased to offer UK based exporting companies a free consultation to help you identify key problem areas and make suggestions to save time and costs, ie: make the job easier and more profitable for you and your colleagues!

If your company or any of your clients regularly receive Letters of Credit and would like to benefit from this independent review, please contact Mark Hayward on 0800 043 4052 or email us for further information: info@mjhayward.co.uk

Import Letter of Credit - is your bank giving you a fair deal?

Richard Casburn, Training Partner of MJ Hayward Associates, answers a recent question raised by a bank client seeking a facility to issue Letters of Credit to overseas suppliers:

Q. 

"We are an established company and we import a variety of finished goods from suppliers in China, India and Vietnam. In most instances our suppliers require settlement by Letters of Credit payable at Sight. We have an Import Letter of Credit facility with our bank which works reasonably well. However, on speaking to a competitor at a recent networking event, I was advised that his bank are prepared to "risk weight" his Letter of Credit facility. He explained that this meant that his bank are prepared to actually take into account the value and nature of the goods when deciding on the level of security they  need to support the facility. Our bank requires us to cover 100% of the value of the facility with tangible security.

Is this usual and could I negotiate a better deal in terms of securing my facility with my bank?" 

A. 

An Import Letter of Credit constitutes a definite obligation for the issuing bank to pay against presentation of compliant documents regardless of whether it is able to reimburse itself from the applicant. So the majority of Banks will see this as a commitment which represents a 100% risk, and they will therefore require security/collateral which will equate to that value.

In the scenario in the question, it would be reasonable to ask the customer's bank to consider risk weighting the facility. In simple terms this means that the bank would give consideration to the nature of the goods, and most importantly that the bank will have control of the goods during the course of the Import Letter of Credit transaction.         

A bank will always look "worst case", and this would involve taking delivery of the goods and appointing a third party to realise some value in a forced sale situation. Therefore there are many considerations for the importer's bank to evaluate including;     

• Obsolescence - What is the likelihood of the goods becoming obsolete and therefore very difficult to sell, unless they are imported and sold quickly?

• Perishability - Does the product set have a shelf life? Food or fresh flowers for example would not be attractive goods for a bank to consider risk weighting in a Letter of Credit facility.

• Packing - Is special packing required?, e.g. refrigerated container

• Marketability - Is there a strong demand for the products. The bank is thinking that in a worst case scenario how easy would it be to sell these items?  

• Does the Letter of Credit call for a full set of Bills of Lading, and if so, can they be consigned to the issuing bank which will provide extra control over the transaction. If goods are shipped by air, the airway bill will almost certainly be required to be consigned to the issuing bank.

• What is the margin of profit on the goods and are the goods presold against confirmed orders?

• What are the Incoterms - are goods adequately insured? In some instances a bank may insist on holding the original insurance policy as a security item.

• Speculation/overtrading - Does the Letter of Credit facility requested reflect the customer's normal trading patterns? The bank may be concerned that a customer is attempting to stockpile goods to take advantage of price fluctuations which could potentially have serious implications for the business if the market for the products crashed. 

• Storage - is there appropriate and sufficient storage for the goods when they arrive in the UK? Who owns the warehouse? Is insurance adequate? In some instances a representative of the bank may actually inspect the warehouse to ensure that it meets with the bank's expectation in terms of security etc.

• Import License - Certain goods may require the issue of an import license and the bank may required confirmation of this prior to the approval of a Letter of Credit facility.

• Fluctuating price - a long delivery cycle increases the risk that a sudden fall in price may render the goods undesirable or worst case loss making.

If all these considerations and risks can be considered and mitigated then a number of UK banks will be prepared to offer an Import Letter of Credit facility which is "risk weighted" and does take into account the above mentioned factors. The weighting will reflect the potential loss the bank would suffer upon default after recovering funds from selling the goods. Therefore a 20% risk weighting, which is in most instances the very best that any UK bank would consider, implies that the bank would recover £0.80 for each £1 of value of goods. In reality this is very rarely the case in a forced sale situation. It is more likely that a 50% - 75% weighting may be applied, but clearly this would be assessed on a case by case basis, as the factors are varied and open to interpretation by the bank's Trade Finance representative. The bank may require the customer to sign what is called a General Pledge. This is an undertaking whereby the customer acknowledges that the goods and or documents of title to the goods will be in pledge to the bank.

In summary it is well worth asking your bank whether they would be willing to consider this, as most will allocate a 100% risk weighting, which is in effect an easy option for the bank, and does not accurately reflect the actual risk.     

Import Letter of Credit Training 

   

Financing the Trade Cycle

As an international trader (importing, exporting or both), is your bank offering you finance which matches your trade cycle?

Over the past few years regulations have dictated that banks have to lodge more funds centrally if they provide their customers with facilities, notably overdrafts. Unsurprisingly, banks are therefore seeking to provide alternative financing structures which attract less centrally held funds.

This can work well for a bank's customers too, and Trade Loans can be structured to match with funding gaps for importers and exporters. This type of facility can be used in conjunction with traditional trade solutions such as Letters of Credit or Documents and Bills for Collection, or (given the right circumstances) in support of open account transactions.

Best advice is to ensure that your bank's international trade manager fully understands your trade cycle/s and recommends a loan facility to match with that funding gap. You should seek an improved lending margin other than that traditionally charged for an overdraft, as the bank is benefiting as mentioned previously. 

Most banks will require you to establish these loans with their Trade Services Centres, so again, you should be compensated (by a better borrowing rate) for this extra administration. The overall benefit for a bank's customers being funded in this way is a reduced cost to borrow, with facilities that accurately match their funding needs. The banks benefit as they will understand exactly what their lending is funding (i.e. the goods) and they will need to deposit less funds centrally.