10 Trade Finance Questions and our Answers
Given that the TFG trade finance team speaks funders, banks, people looking to trade and open Letters of Credit, we’ve put together a list of 10 questions that are commonly asked or raised during the process of trading goods and/ or services overseas.
1. How long can a usance Letter of Credit be opened for?
There are no explicit or implicit mentions in the UCP 600 or ISBP regarding the maximum time period in which a usance Letter of Credit can be issued. So the time period is often defined by the local laws of the issuing bank’s country which control LC terms.
Find out more about the different types of Letter of Credit and terms here.
2. Can a Bank Guarantee be issued for services and goods such as commodities?
The instrument itself, be that a Bank Guarantee or a Standby Letter of Credit, is not as important as the contractual wording of the financial instrument, and the applicable UCP Rules governing the instrument.
Generally Standby Letters of Credit, or commercial SBLCs are the cheaper and more normal payment guarantee over Bank Guarantees. Furthermore, looking at the processes of obtaining BGs versus SBLCs (issuance protocols and document examination- fees, time and expertise spent) and risk covered, LCs are the more popular means of payment in trade finance.
BG and SBLCs are triggered out of default (a breach of any kind under any type of contract- financial, payment, tender/bid, insurance, and many other forms of contract). LCs, we all know, cover performance.
Read our post on the difference between Bank Guarantees and Letters of Credit here.
3. What’s deferred payment and how does it differ from a usance Letter of Credit?
A usance Letter of Credit can be issued meaning that the payment is delayed until a period for time has passed or the buyer has had an opportunity to inspect or sell the related goods.
There is not a huge difference between usance and deferred payment LCs, although the latter are rarely issued.
The essential difference is the absence of the draft. The draft serves no significantly useful purpose in an LC anyway, so LCs calling for usance drafts would be just as effective if they did not call for the draft and were merely issued as a deferred payment LC.
4. What documents are required for a Letter of Credit?
When financiers put together a Letter of Credit, generally, the following documents are required for preparation:
Bill of Lading, B/L
Generalized System of Preferences (GSP)
Beneficiary certificate, fax, email etc.
Phytosanitary & fumigation certificate
Shipping company certificate
All above documents are in practice but some buyers require short documents rather than “Container of Documents”.
5. How many times can a Letter of Credit (LC) can be amended?
None of the existing applicable ICC published rules (UCP600, URDG758, ISP98) limit the number of amendments to which an LC can be amended. That said, it is often difficult to examine documents against LCs with multiple amendments, and especially when beneficiaries do not communicate which amendments are accepted.
6. How relevant is a Letter of Credit in a world where most trade is done under ‘Open Account’ terms?
The vast majority of trade is intra-national (in-country), which is clearly less risky. Yet in the global international trade space, where there is risk of no payment and no insurance available, LC’s suddenly become a must have item.
We do however note that the hot topic right now is the blockchain, and how it can disrupt trade finance. However, when we look closely, the same approach taken for Letters of Credit in giving both parties the proof that the transaction is fair. As market complexity increases, and speed of transaction and efficiency is important, we think that there will be a new set of opportunities in the future.
7. What is Avalization?
In simple terms Avalization is another word for endorsing a Bill of Exchange. This is where a person or a corporate effectively acts as a guarantor for the obligations of the Bill. In most cases this would be a Bank. An endorser of good credit will increase the value of the Bill should drawer of the Bill wish to discount it with a financial institution.
In other words, it is a guarantee on a negotiable instrument which states that the party providing it’s AVAL will pay the instrument upon its maturity if the drawee or obligor fails to fulfill their obligation. When overseas companies are the obligors on negotiable instruments, the provision of an AVAL by a bank is often necessary to make the instrument acceptable for discounting.
8. What is reverse factoring? How is this different from factoring?
Reverse factoring (also a form of Supply Chain Finance) is when a finance company, such as a bank, places itself between a company and its suppliers, and commits to pay the company’s invoices to the suppliers at an accelerated rate.
Reverse factoring allows suppliers to receive discounted payments of invoices which are due to be paid by a buyer (i.e. an account payable (AP)). Once the buyer has approved the invoice for payment, the finance is raised separately against the AP by the supplier from a finance provider (usually a bank or factoring company), who relies on the creditworthiness of the buyer. The buyer will pay the finance provider at the agreed invoice due date, and the supplier receives a much prompter discounted payment from the Factor.
9. Is the issuing bank allowed to make payment in a currency other than the currency agreed in the Letter of Credit?
Generally speaking, the currency specified in the Letter of Credit should be what is paid by the Issuing Bank to the beneficiary. However, whilst the bank is obliged to pay in the currency of the LC, there is nothing to stop the bank agreeing to the beneficiary’s request to settle the equivalent amount in a different currency.
Does the marine insurance cover the risk of damage to goods at a warehouse at port of discharge or just during voyage?
It is standard practice for perishable goods to be shipped under temperature-controlled conditions, regardless of whether carried in containers or otherwise.
The exporter should have included such a condition in his instructions to the carrier and if the contract of carriage included storage at a warehouse in the port of destination, the temperature-controlled condition should have applied there also. These conditions should also have been reflected in the contract of insurance, but you have not given us this information for either of these two contracts. If delivery is at the port, standard insurance terminates there.