A Reference Guide to Trade Finance TechniquesCase study
Making efficiencies by centralising trade management
The treasurer in a rapidly growing company wanted to centralise management
of its trade financing across all its operations. Growth has been achieved mainly
through worldwide acquisitions, so understanding the group’s positions was
a fundamental driver for this project. A centralisation project also offered the
treasurer the opportunity to negotiate better end-pricing and to make internal
savings by adopting single operational processes for managing letters of credit,
documentary credits and bank guarantees.
to release the documents to the buyer. In this
case, the buyer’s bank will ask the seller’s
bank for further instructions. Even if the
situation is resolved between the buyer and
the seller, the seller will face a delay in the
receipt of payment and additional storage
costs. If the buyer refuses to pay, the seller
will face further costs, either in the form of
transportation to a new buyer or the cost of
disposal of the goods if a new buyer cannot
be found. This also applies if the buyer
refuses initially to accept a bill of exchange.
If the documents are released on the
buyer’s acceptance of a bill, but the buyer
refuses to pay on maturity, the seller is in a
weaker position. The buyer’s bank will still
seek further instructions from the seller’s
bank. In this case, the buyer’s bank may
pursue payment of the bill of exchange
through the legal system. (However, this
position is preferable to an unpaid open
account transaction, as the seller has
evidence of the debt which any court would
assess prior to making a judgment.)International standards
Most internationally applied letters of credit
conform to the Uniform Rules for Collections
(URC) standardised by the International
Chamber of Commerce. The current version
of the standards is known as the URC522,
which came into force on 1 January 1996.
To avoid confusion, the version of URC
standards that is used should be stated on
the collection documents.Documentary credit
A documentary credit, or letter of credit (L/C),
shifts the balance of risk even further from
the seller towards the buyer, compared with
both open account terms and a documentary
collection. As with a documentary collection,
the importer takes control of the goods on
presentation of an appropriate document of title
(typically, the same documents which would
be presented under open account terms).
However, the documentary credit is also a
bank guarantee that the buyer will pay the
seller, as long as the documents presented by
the seller meet the terms of the letter of credit.
As with a documentary collection, a
documentary credit is administered by banks,
which have the responsibility of ensuring
that the documents presented match the
documents required under the terms of the
contract. As the importer’s bank (the issuing
bank) will have effectively guaranteed
payment under the terms of the letter of
credit, as long as the exporter presents
documents which match the requirements
of the L/C, payment will be made by the
importer’s bank to the exporter. This is the
case even if the goods do not meet the
importer’s expectations (whether through
damage in transit or poor original quality).
On the other hand, if the exporter does not
provide the documents as set out in the
L/C, there is no obligation on behalf of the
importer’s bank to pay, even though the bank-
issued L/C is a guarantee of payment.