Negotiating Documents under Unconfirmed Letters of Credit

Q.  Over the years it seems that Banks in the UK have to some extent lost their appetite to act on their nomination and truly "negotiate" documents presented under unconfirmed Letters of Credit. It used to be quite commonplace for a beneficiary of such an L/C to ask their bank to negotiate , and this request was regularly acceded to, albeit on a "with recourse" basis. This practice seems to be much less common now.

Is this perception true?

A.  In order to provide a balanced answer to this question it is important that Article 12 of UCP 600 regarding "Nomination" is examined. 

It is stated in a). "Unless a nominated bank is the confirming bank, an authorization to honour or negotiate does not impose any obligation on that nominated bank to honour or negotiate, except when expressly agreed to by that nominated bank and so communicated to the beneficiary".

Therefore a nominated bank is under no obligation to negotiate, i.e. to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.  It is, and always has been, the nominated bank's decision as to whether to negotiate or not. However, it is also probably the case that many major UK banks are less inclined to agree to offer to negotiate unconfirmed Letters of Credit these days, and generally they will not proactively offer this when the Letter of Credit is initially advised through to the beneficiary. In most cases the advice to the beneficiary will state that the Letter of Credit is advised "without liability or engagement" (of the advising bank). 

  

The actual risks for the nominated bank to negotiate should be considered, and these are in line with the risks which would evaluated, had the Issuing Bank requested confirmation to be added. The main considerations would include;

• The financial standing of the Issuing Bank.
• The Political/Economic/Sovereign risks associated with the country of the Issuing Bank.
• That there are no other reasons which would preclude a limit being marked on the Issuing Bank such as sanctions against the country etc.
•  If drafts are called for, who are the drafts drawn on?
• How is the negotiating bank able to claim reimbursement under the terms of the L/C? 

 In previous years, if a nominated bank was willing to consider negotiating the documents, and having satisfied themselves regarding the financial standing of the Issuing Bank and associated Country Risks, they would seek to levy a commitment fee from the beneficiary. This fee was generally broadly in line with the confirmation charge, had the Issuing Bank requested confirmation to have been added. On payment of the fee, the nominated bank would then examine the documents, and if they considered them to be compliant, would pay the beneficiary "with recourse". 

"With recourse" means that the beneficiary of the Letter of Credit is legally responsible for the repayment of the funds, and the payment will be shown as a liability on the beneficiary's balance sheet. 

      

However, in most cases, the beneficiary used not to request negotiation until they had presented documents. This left them exposed, from the period that the original Letter of Credit was received, to the point that the nominated bank agreed (or declined) to negotiate.

Clearly this practice is still available and many banks will give due consideration under a "Commitment to Negotiate" or "CTN" as it is commonly known. 

A CTN is a more formalised offering of the above mentioned practice of taking of a commitment fee, but Banks still do not proactively offer or publicise this service. It is only considered, usually for the bank's own customers, on a case by case basis. The principal risk to the negotiating bank in a CTN is Documentary Risk, as the CTN is only truly valid when the negotiating bank determines that the documentary presentation is compliant, although clearly the afore-mentioned Country & Issuing Bank risks are also key once the presentation is made. 

The bank's obligation under the CTN exists from the time of receipt of a compliant presentation until the due date for payment at which time the bank must pay without recourse - so in this respect a CTN is actually better for the beneficiary of the L/C than the former practice of paying a commitment fee, but getting paid the proceeds "with recourse".

In some circumstances, the Issuing Bank may be unwilling to ask for their Letter of Credit to be confirmed, perhaps because they consider this to be questioning their integrity, with a suggestion that they will not honour their own paper. So beneficiaries frequently require some added security to an unconfirmed Letter of Credit, with the added benefit of an acceleration of payment.

In summary, the broad perception relating to the original question is probably true, but times change and banks generally have become more risk averse in recent years, especially since the 2008 global financial crisis. Beneficiaries of Letters of Credits should approach their banks, and investigate their appetite to truly "act upon their nomination".  

Letter of Credit Training

 

  

      

Confirmed Letters of Credit - Why does it take so long?

Some important changes appear to be taking place regarding banks in the UK adding their confirmation to Letters of Credit issued by overseas correspondent banks. 

Traditionally, the decision on whether a UK bank would add confirmation to an incoming Letter of Credit has been based on a number of factors including requisite SWIFT key arrangements between the banks involved, assessment of political/economic/sovereign risks in the country pertaining to the Issuing Bank , sanctions considerations, reimbursement arrangements  and clearly the actual creditworthiness and financial standing of the Issuing bank.

This process / decision seems to be increasingly heavily regulated in the UK with an escalation of KYC (Know Your Customer) procedures which are required to be carried out by the bank in the UK which is considering adding the confirmation. This typically involves that bank carrying out a series of increasingly exhaustive due diligence measures / actions including checks that the beneficiary of the Letter of Credit is a valid trading entity and that they are known to the bank. There may be additional checks on the applicant (KYCC – Know Your Customer’s Customer) as well as any other parties named within the L/C. 

Clearly this process involves considerably more work than previous controls and checks carried out by prospective confirming banks in the UK, and in turn, may translate into delays in beneficiaries receiving their Letters of Credit.

We would be interested in receiving your feedback, comments or concerns.

Learn more about Letters of Credit Procedures

Are Your Transport Documents Late Again?

The failure rate of first presentations of documents by exporters under Letters of Credits continues to be high, with banks quoting these rates at between 60% and 80%.

The reasons for these high levels are varied but will include the failure of the beneficiary to initially check the terms of the Letter of Credit to ensure workability and that the terms mirror those in the commercial contract/agreement. A general lack of adequate Letter of Credit training and understanding will also contribute to exporters struggling to present a compliant set of documents under a Letter of Credit.

So it is a challenge, especially for the more inexperienced exporters to make sense of, and then collate and present a clean set of documents, and to further exacerbate this issue, there have been a number of instances where the late delivery the original transport document/s, to exporters, has resulted in their inability to meet the time constraints as laid down in the Letter of Credit.

Recent examples have involved exporters who have used “FCA seller’s premises”, Incoterms® 2010, where quite appropriately the seller has loaded their goods on a means of conveyance provided by the buyer. Once legal delivery has occurred, it is of course, the buyer's responsibility to have arranged for the main contract of carriage, which in the cases seen, has involved transport by vessel, and the procurement of a full set of Bills of Lading. Unfortunately, this is where the delays appear to have occurred, where the buyer's agent has been in slow in obtaining the Bills of Lading, and failing to make these available to the exporter for presentation under the Letter of Credit in a timely fashion.

Possible solutions/actions;

• The exporter could consider one of the Incoterm rules which affords them the responsibility (and control of) of arranging the main contract of carriage to an agreed place of destination in the buyer's country. So CPT....an agreed place of destination, may be an option. However this would involve a fundamental change to the existing delivery terms with the buyers, but having arranged the main transport of the goods, the seller should be able to obtain the requisite Bills of Lading in a more timely manner and therefore be able to accelerate the presentation procedure. 

• Change the requirement in the Letter of Credit from a full set of Bills of Lading to a receipt of goods issued by the buyer's agent on taking delivery of the goods at the seller's premises. This is a possible solution, but in increasing instances, the Issuing bank of the Letter of Credit will want to call for a full set of Bills of Lading, with that bank named in the consignee box on the Bills. This is often the case with Indian Letters of Credit, as this will provide the Issuing bank with the security that if the buyer (in a worst case scenario) is unable to pay when a compliant set of documents is received, then the bank will arrange to take delivery of the goods and potentially sell these to realise some value to help meet the bank's obligations under the Letter of Credit. 

• The exporter could, initially ask for additional presentation days when they are negotiating with the buyer prior to the issuance of the Letter of Credit. Article 14 of UCP 600 indicates that the required transport document must be made by the beneficiary of the Letter of Credit not later than 21 calendar days after the date of shipment, but in any event not later than the expiry date of the credit. It is quite unusual to see more than 21 days permitted under the terms, but a longer period could be agreed upon, if this did not cause issues regarding the goods arriving at the port of destination before the original documents, resulting in demurrage costs etc.

It is a fact that timing issues are a major factor in the presentation of discrepant documents and it is unfortunate to hear of these particular examples where the tardiness of an overseas buyers agent has resulted in problems for the UK exporter. Some of the potential solutions as stated would help to resolve this problem, and enable the exporter to present a compliant set of documents and get paid in a timely manner.

What is a Letter of Credit? A Short Video

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