The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

Case study

UK SME supplying valves in the construction of the water and

sewage system in Abu Dhabi

The company needed GBP 500,000 to fulfil a GBP 2 million order. Because

the company was providing products as part of a much larger capital contract,

there was a long lead time in which to source and manufacture the valves. The

company received a confirmed letter of credit in its favour.

Although the confirmed letter of credit
offered the company a guarantee of
payment, this was conditional on the
terms of the letter of credit being met.
However, in order to be able to meet the
terms of the L/C, the company needed to
finance the sourcing and manufacturing
of the valves. The company approached
its bank to ask it to finance production of
the valves.

Before offering the necessary finance, the
bank needed to be sure the company had
the ability to fulfil the contract. Critically,
the bank needed to ensure that not only

was the company able to manage a

contract of this size and manufacture the

valves, but it would also be able to present

the necessary documents under the terms

of the L/C. Once satisfied on both counts,

the bank provided a facility using the

confirmed L/C (which was a commitment

from the buyer’s bank) as security. A

funding structure was provided which

enabled the company to fund payments to

key component suppliers.

As a result of the success of this structure,

the UK company was able to tender for a

contract worth GBP 15 million.

Other types of letters of credit

ƒ Transferable.
This is used where a supplier sells the
product to the buyer through a third party.
This allows the third party to provide
payment under the letter of credit issued
by the buyer’s bank and also, if necessary,
to keep the identities of the supplier
and the ultimate buyer confidential from
each other. This works when there is
no difference between the terms and
conditions used when the goods are first
sold by the supplier to the third party
and then subsequently sold by the third
party to the ultimate buyer. There are two
major exceptions: the price of the goods
will be lower for the transaction between
the supplier and the third party (and the
value of the L/C will usually reduce when
transferred to the supplier), to account

for the profit made by the third party, and

the dates will differ, to take into account

the different shipment periods and time

frames for the presentation of documents.

A transferable letter of credit must be

explicitly stated as such (using the word

‘transferable’) at the time of issue.

ƒ Back-to-back.

A back-to-back L/C is sometimes

used when there are three parties to a

transaction, but a transferable letter of

credit is not suitable. It is in effect two

separate L/Cs. The first is issued by the

ultimate buyer’s bank to the seller. The

second is then issued by the seller’s

bank to its supplier. The arrangement

is considered a ‘back-to-back’ L/C if

the first L/C is used as security by the

seller’s bank for the second L/C. In

contrast to the transferable L/C, the