As trade finance participants may have noticed, there is no specific provision in the Uniform Customs & Practice for Documentary Credits (UCP) 600 for partial confirmation of letters of credit (LCs).
Likewise, no such provision is offered by the International Standard Banking Practice (ISBP) 745 either.
But despite this, partial confirmation of LCs is possible under UCP 600:
- The rules of UCP 600 define “confirmation” as a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation. (The confirming bank is the bank that adds its confirmation to an LC upon the issuing bank’s authorisation or request.)
- Although the confirmation relates to the LC, it is a separate undertaking of the confirming bank to the beneficiary, and it is independent of the undertaking of the issuing bank to the beneficiary.
- Provided that the confirming bank does not alter what would constitute a complying presentation under the LC, the undertaking of the confirming bank need not be identical to that of the issuing bank. The confirmation can therefore be made for an amount different from that of the LC.
Defining best practice for partial confirmations
What is, or ought to be, the international standard banking practice for partial confirmations?
It is worthwhile to begin our discussion by noting a ‘natural’ example of a partial confirmation.
A partial confirmation occurs when a bank that has confirmed an LC does not confirm an amendment for an increase of the LC amount.
Say, for instance, if an LC was originally issued for an amount of $500,000 and confirmed, and an amendment was then issued to increase the LC amount to $700,000.
The confirming bank advised the amendment without adding its confirmation, so the beneficiary now has an LC for an amount of $700,000, and a confirmation for an amount of only $500,000.
[As per UCP 600 sub-article 10(b), the confirming bank may choose to advise an amendment without extending its confirmation.
If the confirming bank chooses not to add its confirmation to the amendment, it must inform the issuing bank without delay and inform the beneficiary that it has not added confirmation to the amendment in its advice.]
Consider a different example of partial confirmation: An LC is issued for an amount of $4 million, with a request to the advising bank to confirm.
The advising bank has an available risk limit of $2 million for the issuing bank, and hence wishes to add confirmation of only $2 million to this LC.
It obtains the agreement of the beneficiary on this lower amount to confirm.
The confirming bank should pay attention to how it structures a partial confirmation. It should take into account certain specifics of the LC, for example:
- Are partial shipments prohibited?
- Are instalment drawings or shipments provided for?
Such terms in the LC have implications on the amount that the confirming bank should honour or negotiate without recourse in a drawing.
This is because, in cases where the LC prohibits partial shipments and does not provide for instalment drawings, only a single presentation shall be made – the confirming bank’s undertaking is to honour or negotiate without recourse on this single presentation up to its confirmation amount.
If, however, the LC does not prohibit partial shipments or provides for instalment drawings, it will be important to be clear how the confirmation amount will be applied to different drawings under the LC.
Taking the example of a bank confirming $2 million of a $4 million LC in this situation, does the confirming bank honour or negotiate without recourse an amount up to $2 million based on first drawing(s), or up to $2 million by applying a percentage (50%) to the amount in each drawing?
Suppose the first drawing was for $2.5 million for a partial shipment: does the confirming bank honour or negotiate without recourse the full $2 million (its confirmation limit) in this first drawing, or does it limit it to 50% of the drawn amount, i.e. $1.25 million of the amount drawn (and 50% of each subsequent drawing until the $2 million is reached)?
If the confirmation merely states that it is for $2 million, it will reasonably mean that the confirming bank should honour or negotiate without recourse the amount of $2 million of the first drawing(s).
If, however, the confirmation states that it is for 50% of each drawing for a total amount not exceeding $2 million, the amount that the confirming bank honours or negotiates without recourse shall be in the stated proportion (50%) to each drawing, for a cumulative total of $2 million.
Little to no risk for confirming bank
The author is of the opinion that there is little or no increased risk to the confirming bank to honour or negotiate without recourse the amounts up to its confirmation limit based on first drawing(s).
The risk to the confirming bank is not reduced by the proportionate approach, but could actually be slightly increased as the timeframe for reimbursement by the issuing bank is stretched out over multiple drawings.
Here we shall consider some practice questions pertaining to partial confirmations:
- If an advising bank wishes to partially confirm an LC, must the bank inform the issuing bank?
In the author’s view, the advising bank ought to, based on the principle outlined in UCP 600 sub-article 8(d):
“If a bank is authorised or requested by the issuing bank to confirm a credit but is not prepared to do so, it must inform the issuing bank without delay and may advise the credit without confirmation.”
Partial confirmation may be construed to mean that the advising bank is not prepared to confirm the LC up to the amount authorised or requested, and hence the bank should inform the issuing bank that it is adding confirmation for a lower amount.
- Does partial confirmation require the consent of the issuing bank?
Notifying the issuing bank of the confirmation amount is sufficient, and requesting the issuing bank’s consent is unnecessary.
This is because, as per sub-article 8(d), an advising bank that chooses not to add its confirmation (at all) may inform the issuing bank and advise the LC without confirmation to the beneficiary – without requiring the issuing bank’s consent to advise the LC without confirmation.
By the same logic, the advising bank may inform the issuing bank that it has added confirmation for a lower amount and advise the LC accordingly to the beneficiary, without requiring the issuing bank’s consent to do so.
As confirmation is for the benefit of the beneficiary, the agreement of the beneficiary to the partial confirmation is the only agreement that the confirming bank needs.
- Are there risks to the confirming bank if it does not obtain the issuing bank’s consent for a partial confirmation?
A confirming bank’s rights to reimbursement from the issuing bank is tied to its honouring or negotiating a complying presentation, as outlined in UCP 600 sub-article 7(c):
“An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank.”
A confirming bank does not enjoy separate protection in UCP 600 – its protection is the same as that of any nominated bank, i.e. the confirming bank, as a nominated bank, is entitled to reimbursement from the issuing bank if it has honoured or negotiated a complying presentation, and forwarded the documents to the issuing bank (and is further protected by article 35 covering loss of documents in transit from the confirming bank or nominated bank to the issuing bank).
As long as the confirming bank or another nominated bank has acted on its nomination pursuant to the LC and forwarded the documents to the issuing bank as instructed in the LC, the issuing bank must reimburse that bank at maturity.
(This is also the case in a commitment to honour or negotiate (also known as ‘silent confirmation’ at some banks) where a nominated bank undertakes to honour or negotiate a complying presentation for LCs for which confirmation was not authorised or requested by the LC.)
- Does the method of LC availability restrict partial confirmations?
There are four methods of availability provided by UCP 600 – for a discussion of these, please refer to my article from August 2020 published by TFG.
Honouring and negotiating – the banks’ responsibilities
When adding partial confirmation, a bank should give thought to how it shall honour or negotiate without recourse up to the amount of its confirmation, taking into account the method of LC availability.
If a draft is to be drawn on the confirming bank, the confirming bank should provide instructions in its confirmation on the amount of the draft(s) that it shall accept.
If the LC is available by deferred payment, the deferred payment undertaking of the confirming bank needs to be carefully worded to reflect the partial confirmation.
There are alternatives to partial confirmations for a bank that wishes to add its confirmation but has insufficient limits for the full amount.
These alternatives include:
- Risk participation – The confirming bank may find another bank to participate in a portion of the confirmation amount. The confirming bank substitutes the risk of the issuing bank with that of the participating bank(s) for the amount(s) of risk the bank(s) participate in.
- Guarantee from a multilateral development bank (MDB) – MDBs like the ADB, EBRD, and IFC provide full or partial guarantees for LC confirmations. This requires the issuing bank and the confirming bank to both be participating banks in the MDB’s trade finance/facilitation programmes. The confirming bank substitutes the risk of the issuing bank with that of the MDB for the amount of the guarantee.
- Irrevocable reimbursement undertaking (IRU) from another bank – The confirming bank may request the issuing bank to arrange for an IRU and subject its LC to URR 725 as a prerequisite to adding confirmation. The confirming bank substitutes the risk of the issuing bank with that of the reimbursing bank for the amount of the IRU.
- Credit insurance – The confirming bank may purchase a policy from a credit insurer to cover part of the confirmation amount. The confirming bank may treat the credit insurance as a form of collateral, noting that payment from credit insurance is usually subject to a waiting period.
The alternatives to partial confirmation may provide opportunity for the risk transaction to be more remunerative to the confirming bank, as the confirming bank would likely be able to retain a margin or have a skim over the costs of these risk mitigation techniques.
That being said, providing partial confirmations is straightforward and efficient, and requires a lot less effort on the part of the confirming bank.
However, partial confirmation requires the beneficiary to be agreeable to it, whereas the other techniques typically do not.