Red Clause Letters of Credit and Green Clause Letters of Credit – What are they?
When Letters of Credit were first developed, there were a number of specific Letters of Credit that developed. The two main ones were Red Letters of Credit and Green Letters of Credit:
Red Clause Letters of Credit (Red Clause LCs)
A Red Clause Letter of Credit incorporates a special clause that allows the beneficiary (the person who will derive benefit from the Letter of Credit being issued) to draw a pre-shipment advance against a simple receipt and a draft.
The Red Clause Letter of Credit can provide the beneficiary with credit that may not otherwise be available locally or with cheaper financing, by having the funds advanced by the issuing bank.
What was the background of the Red Clause Letter of Credit?
It is reputed that the Red Clause Letter of Credit was started on the back of the Australian Wool Trade. Exporters in Australia were able to draw money in order to purchase wool and the clause that stated this was red. The clause was written in a red colouring so as to draw attention to the nominated bank. However, in todays market the advantages that were associated with Red Clause Letters of Credit are usually cancelled out by the request of an Advance Payment Guarantee.
As stated above, the reason for the red clause was to assist the exporter as a pre-export finance product. It was mainly used in the farming, agriculture and in general the commodity markets as it provided finance for the buyer to source commodity from the grower. It is not obsolete as cotton and wool buyers still use it to finance their pre-shipment costs.
How does a Red Clause LC work in practice?
There will be an instruction from the importer to the advising bank, which will be for a percentage of credit available to be advanced prior to shipment. This will usually be around 20-25% of the amount of the Letter of Credit value. It will also usually be for the amount to provided in the local currency and will be against security from the exporter. The funds will be repaid when the documents are presented and goods are shipped. In terms of costs, the amount of the advance plus interest and fees are deducted from the available credit.
Green Clause Letters of Credit (Green Clause LCs)
Green Clause Letters of Credit are usually used in the commodity sector and were originally written in green ink. There would be a specific instruction from the applicant to the issuing bank which will enable the exporter to purchase commodity from the grower. Similar to a Red Letter of Credit, it finances pre-shipment costs.
There are differences from Green Letters of Credit to Red Letters of Credit. The differences to Red Letters of Credit are that advances of cash are made against the actual documents of title and not simply just an undertaking to produce them. Therefore it is a secured lending product and not unsecured. It is secured against commodities that will be registered in the banks name and usually up to 75-80% of the face value of credit can be advanced. Therefore, security is provided to the buyer and the buyer can be confident that there are goods which are at the bed of any advance.
Have you seen our Letter of Credit Guide?