By John Baranello, Head of Trade & Risk Services-Americas Solutions Office, Global Transaction Banking-Trade Finance, Deutsche Bank
Open-account trading has become increasingly popular, now capturing about 80 percent of trading activities. More exotic supply-chain finance structures have generated more buzz. However, letters of credit (L/Cs) still form the foundation for risk mitigation in trade financing globally. When the ability to receive payment is a concern, L/Cs are still a highly viable means to ensure payment (see related story).
Starting July 1, the UCP 600 (which replaces the current UCP 500), will clarify the rules governing L/C transactions. Implicit in this revision is also the expectation that by making the rules clearer, and expediting letter of credit processing, the UCP 600 will also make L/Cs more attractive as a trade risk-mitigation tool.
Generally speaking, the new rules are leaner, cleaner and more applicable to today’s global trade transactions. They address language, documentary and marketplace evolution in the banking, insurance and transportation industries. However, to take advantage of the benefits of the UCP 600, L/C users and their banks must revise all documentation, applications and policies to comply with the new changes.
KEY CHANGES
The first thing that issuers of L/Cs must note is that every article of the prior UCP has been changed (and the total number reduced to 39 from 49). As a result, documentation referencing prior articles must be updated to not only reference UCP 600 as the applicable standard, but specific article references must also be updated to reflect this new revision.
One of the most straightforward and beneficial changes involves the time given for certain banks to examine beneficiaries’ documents and determine compliance. Under the UCP 500, banks were given a reasonable time (not to exceed seven days). This less-than-clear timeline left some beneficiaries with the perception that confirming and issuing banks were arbitrarily withholding payment for their clients’ benefit. The new rules specify a maximum of five banking days, which should bring greater certainty to the timing of payment.
The “rules” provide further certainty by recognizing that the UCP 600 dictates that a credit is irrevocableand that it is the banks’ mandate—not all parties that deal with goods, services or performance to which the documents may relate—that should bring greater exactitude to the rules.
The introduction of articles 2 and 3 on Definitions and Interpretations, respectively, which contain the concept of honor, along with the inclusion of certain International Standard Banking Practice paragraphs into the UCP, should bring about far greater clarity and precision (see sidebar below). The definitive description of negotiation as purchase of drafts and/or documents by a nominated bank should help lay to rest the
controversies surrounding the term “negotiation.”
|
A GUIDE FOR L/C EDUCATION AND COMPLIANCE One of the key tenets of letters of credit that continues in the UCP 600 is that documents must be presented in accordance with the terms and conditions of the L/C, in order for payment to be effected. One of the best tools to assist in the creation of complying documents is the ISBP, or the International Standard Banking Practice for the Examination of Documents under Documentary Credits. These ISBP guidelines were created by the International Chamber of Commerce (ICC) in 2002, as a supplement to its UCP rules. An updated version is being released in conjunction with the new UCP 600. MORE THAN A CHECKLIST The ISBP complements the UCP in two important ways: 1) It provides a checklist of items that document examiners need to review when they go through L/Cs. 2) It details the specifics of documentary credit operations, e.g., how to sign bills of lading, the key features of insurance documents and how to handle misspellings or typing errors. In the ICC’s own words: “The ISBP filled a gap between the general rules of the UCP and the daily job of the letter of credit practitioner.” Exporters as much as banks should use the ISBP to educate L/C practitioners and ensure compliance of their L/C practice with the UCP. In the current environment, this also means that key ISBP items belong in relevant internal audit and control frameworks. |
Another clarification that should end arbitrary findings of discrepancies is a provision that the addresses of the applicant and beneficiary appearing in any stipulated document need not be the same as the credit terms as long as they are within the same country.
KNOW THE RULES OF THE GAME
Ultimately, the effective use of L/Cs under UCP 600, as under the prior UCP, requires a thorough understanding of the rules as well as each participant’s role and responsibilities. Thus, it is not good enough for treasury to simply have a high level understanding of L/Cs.
Instead, treasury needs to ensure that all L/C-related documentation and templates are revised and that all operational functions involved (internal and external, such as freight forwarders) conform to the UCP; more than 80 percent of the beneficiaries’ documents that are presented are rejected due to misinterpretation and misapplication of the UCP.
Banks active in trade finance have long been caught in the middle between
1) Beneficiaries who see the UCP rules as helping to ensure that L/Cs mean “U= you, C=can, P = pay” on behalf of the buyer; and
2) Buyers that use UCP to mean “U = you, C= can, P = prolong” payment.
To avoid this, treasurers are asked to join the effort of trade banks, who are investing a lot in educating all parties on the proper application of the UCP 600 in order to improve L/C usage.
Readers are invited to send any UCP-related questions to [email protected]