Practical Insights Series

Five Trends. Five Tools. Five Tips.

DOCUMENTARY
LETTERS OF CREDIT

Understanding Realities, Protecting Your Interests

Alexander R. Malaket, CITP

 Documentary Letters of Credit
Contents 2
Trends, Tools & Tips 3
Basics 4
Discrepancies 6
Risk & L/C Confirmations 7
Bank Relationships & Fees 8
A Banker’s View 9
A Corporate’s View 10
SWIFT 11
Selected Quotes 12
Selected Resources 13

Contents

© Copyright OPUS Advisory International Inc. All Rights Reserved.

2
Documentary Letters of Credit
Five Trends
1. While new solutions in trade finance and transaction banking have been under development,
recent events have highlighted the effectiveness, importance and continued relevance of
traditional solutions such as Documentary Letters of Credit.
2. There is a global consolidation in the financial sector, which is also leading to a consolidation
of trade finance providers. Several of the top names in trade finance were significantly impacted
by the global crisis. The full implications remain unclear.
3. There is a “flight to quality” in banking, including trade finance. Banks have been selective in their
focus and maintenance of customer relationships. Commercial clients have been reviewing
their banking relationships, in light of the crisis in the global financial sector.
4. Financing costs related to international trade had increased by a factor of 300-400% over the
course of the crisis. Rates are trending down, but have not yet normalized to pre-crisis levels.
5. Some non-bank providers of trade finance had partly retreated from the market, but are
cautiously re-entering some markets. Non-bank sources are worth investigating.

Five Tools
1. Download (or obtain) detailed guides to trade finance—including Documentary Letters of
Credit—from a major international bank.
2. Obtain a copy of the official publication which governs the use and interpretation of Letters
of Credit—the Uniform Customs & Practice, UCP 600, from a trade finance bank, or from
the International Chamber of Commerce in Paris: www.iccwbo.org
3. Seminars and courses on trade finance are available from various sources. An introductory
course is available through FITT in Canada, and can be taken online. www.fitt.ca
4. Freight forwarders and other service providers can be very helpful and effective in the
preparation of documents to be presented under Letters of Credit.
5. Visit the website of the International Trade Centre in Geneva for various guides related to
trade and trade finance: www.intracen.org

Five Tips
1. Discrepancies under Documentary Credits represent a potentially serious risk to exporters.
The terms and conditions of the L/C should be carefully reviewed to ensure they can be fully
met, or, an amendment to the L/C should be requested.
2. Assess and approach risk in terms of optimization, not elimination.
3. Review a proposed L/C transaction end-to-end; assess all fees, commissions and interest that
may arise. If financing is required, ensure that L/C-based financing is cost-effective.
4. L/C Confirmations can be invaluable to exporters in higher-risk transactions and markets.
Exporters can look beyond their primary bankers for Confirmation options and pricing.
5. In international trade, it is important to understand the role and value proposition of export
credit and export insurance agencies, as well as import promotion organizations

3
 Basics
A Documentary Letter of Credit can be one of the most secure
methods of payment and financing in international trade, and while the
instrument is proven and effective in many circumstances, it is, in practice,
“A Letter of Credit is prone to error and potentially risky if poorly structured.
just like cash in
hand…” A Documentary Credit (also a Letter of Credit, or simply an L/C) should be
carefully issued, to ensure it protects both importer and exporter as it was
intended to do.

No! L/C’s have been used to facilitate international trade for hundreds of years.
They are well and consistently understood across the world, with over 160
countries agreeing to be guided in their interpretation and enforcement of L/C
obligations, by the Uniform Customs and Practice for Documentary Credits
(UCP), published and updated by the international Chamber of Commerce in Paris.

Documentary Credits are financial instruments typically issued by a bank (the Issuing Bank) at the request of the
importer (buyer/Applicant), in favour of the exporter (seller/Beneficiary). An L/C is an independent and binding prom-
ise to pay, by the Issuing Bank to the Beneficiary (exporter), provided the terms and conditions specified in the L/C are
fully complied with by the exporter.

Documentary Credits are typically sent to the exporter’s bank, which receives, reviews and authenticates the L/C, then
Advises the Credit to the Beneficiary (exporter), commonly sending a copy of the L/C to the exporter.

Sales L/C Exporter Presents Documents

Purchase
Issued & Prepares For Verified &
Contract Order Advised Documents Payment Paid

L/C’s may be straightforward instruments with only basic terms and conditions, or they can be detailed, highly
complex and rich in options, generally depending upon the monetary value and the complexity of a shipment or
transaction. L/C’s can be used to cover a low-value shipment meant to test a new trading relationship, or they can
cover shipments valued in the tens of millions, involving complex procedures and examination of dozens of
documents prior to payment.

Documentary Credits can serve multiple purposes in an import/export transaction: facilitation of efficient and secure
cross-border payment; risk mitigation for both trading parties; financing for either or both trading parties, and the
facilitation of timely information flow about the transaction.

A Documentary Credit protects importers by ensuring that payment is effected only once the banks verify that all terms
and conditions have been fully complied with by the exporter.

Exporters are protected because an L/C represents a payment promise “L/C’s will soon be a
from the Issuing Bank. Once the exporter meets all terms and conditions thing of the past. They
specified, the L/C ensures that payment will be approved and processed.
have no purpose in
In Theory. Read on, for Practical Insights about L/C’s... 21st Century trade…”

No!

4
 Documentary Credits
Payment Financing Risk Mitigation Information
Secure Available to importer Risk Transfer Financial flows
Timely & Prompt or exporter Country, Bank and Shipment Status
Global Several stages in the Commercial Risk Quality of Shipment
Low-cost transaction Transport Insurance L/C systems include
All leading currencies No impact in Operating Export Credit Insurance
web & desktop
Line for exporters
solutions

The global financial and economic crisis of 2008-09 brought sharply into focus, the continuing value of traditional trade
financing instruments such as the Documentary Letter of Credit. Emerging solutions proved lacking in the risk mitigation
aspect of trade finance. L/C’s remain viable and important in the conduct of international trade, especially in conditions,
markets or with trading partners where an element of risk exists.

Sales Contract and

Simple L/C Flow
Delivery of Goods

Importer applies for L/C,

Importer specifies Terms & Conditions
(Buyer/Applicant) Issuing Bank structures &
Exporter
(Seller/Beneficiary) transmits to Advising Bank
Advising Bank reviews L/C
Importer
Payment, Exporter
for consistency & workability,
Exchange for Documents, transmits to exporter
Documents Exchange for
Payment Exporter reviews L/C &
prepares documents/shipment
Presents documents for
settlement as per L/C terms
Documents are verified
against L/C terms, if fully
Verification & Transmission of
compliant, settlement is effected
Issuing Bank Documents, Remittance of Funds or authorized
Advising Bank Documents sent to importer to
(Confirming Bank)
clear shipment through Customs

L/C transactions can involve multiple parties including several banks acting in various capacities. Payments can be “At Sight” -
literally meaning that payment is due immediately after documents have been verified against the L/C and deemed compli-
ant, or they can be “Term” - at an agreed future date, such as 30 days after Sight, or 90 days after shipment date. Both the
Advising Bank (commonly the exporter’s bank) and the Issuing Bank (the importer’s bank) must examine the documents
presented by the exporter.

An exporter may be concerned that the payment promise represented by the L/C is at risk, either due to the dubious
standing of the Issuing Bank, or as a result of risks related to the importer’s country (civil unrest, economic or financial
instability, shortages in foreign currency…). In such cases, the exporter may require that the L/C be issued so as to allow
Confirmation: the addition of a separate and independent payment promise by a trusted financial institution, usually selected
by the exporter and usually located in the exporter’s home country. Confirmations of L/C’s can be costly, but are an
excellent risk mitigation option for exporters.

The exporter presents documents to the Confirming Bank, and is assured of payment against compliant documents,
regardless of what happens thereafter. Risk is transferred from Issuing to Confirming Bank.

5
Discrepancies
L/C’s cannot protect against fraud, as the obligation of banks to verify the
“A Letter of Credit can transaction stops at verification of documents. If a document presented
in support of a request for payment looks authentic, banks will accept this
even protect against to be the case.
fraud…” Even Inspection documents, thought to mitigate the risk of fraud, can be
counterfeited. Goodwill and a desire to see the transaction completed as well

No! as trust between buyer and seller remain key to the conduct of international
trade .

Discrepancies: Non-Compliance
Non-compliant documents are documents presented by the exporter in support of a request for payment under
an L/C, that are deemed to have failed to meet the terms and conditions set out in the Letter of Credit. Certain
discrepancies are considered significant, others trivial in nature. Late Shipment is significant; a minor typographical error in
certain documents is likely to be considered trivial, but even minor discrepancies can delay or prevent payment.

Discrepancies can, in worse-case scenarios, have the effect of completely eliminating the protection provided
to the exporter under an L/C, since the banks can either refuse payment on the basis of the discrepancies,
or the importer, given an opportunity to waive the discrepancies, may refuse to do so. Given that the goods are likely at
destination by the time the document verification process is complete, the exporter may be forced to provide a significant
discount, or secure another buyer for the goods—likely at a loss, and having incurred unanticipated expense to store the
goods at the port of destination while identifying an alternate buyer.

Banks are meant to make determinations about documents on an independent basis, but many will consult
with their respective clients—exporters offered the opportunity to “correct” discrepancies where feasible, and importers
in some cases asked by the Issuing Bank to verify the documents before the bank provides a response to the Advising Bank.
There have been cases where importers have instructed their bankers to “find a discrepancy” as a means of refusing
shipment (as when the price of the items purchased has dropped significantly and can be secured elsewhere, at lower
cost).

It can be important to understand the approach of banks relative to document verification and the handling of
discrepancies: certain banks take a “black letter approach” and will point out every discrepancy identified, no matter how
trivial, while others take a more commercially-oriented view, and acknowledge only material discrepancies.

the L/C and, for example, the Commercial Invoice, is a critical

discrepancy”

Yes!

Excessive detail in a Documentary Letter or Credit can often prove counterproductive, particularly in the context of transactions
that are beneficial to and desired by both trading partners. Excess detail can result in otherwise avoidable discrepancies, may
delay the verification of documents, and may cause errors in the shipment, the shipping documentation, or the
document-checking process at the banks.

An L/C should be structured and issued in a manner which maximizes the likelihood of a secure and timely conclusion of the
transaction, and ideally, supports the development of trust in the trading relationship between buyer and seller, importer and
exporter.

6
Risk & L/C Confirmations
Eliminating risk is, in most cases, impractical, and even if it were
feasible, would involve prohibitively high cost. “The best way to
Risk and reward (profitability) are directly related, and the presence of
(perceived or actual) risk can serve as an effective barrier, discouraging
handle risk in
No!
international business,
potential competitors. Risk is to be assessed in terms of related return as well is to eliminate it.”
as risk appetite, then optimized: applying appropriate and cost effective risk
mitigation techniques and strategies. No!
Effective risk management and mitigation starts with due diligence—knowing trading partners and markets, and ensuring that
appropriate measures are taken, to protect commercial interests. While risk tolerances clearly vary between individuals and
organizations, prudent management of risk in international business is a matter of sound business practice. Applying
excessive/unnecessary mitigation can be costly

Commercial Risk Risk

Commercial Risk: The risk
of default of either the
Political/Country importer or the exporter,
Risk leading to non-performance
Importer Exporter by the exporter or
(Buyer/Applicant) (Seller/Beneficiary) non-payment by the importer
Bank Risk: For some, a form of
commercial risk, but one that
involves the risk of default or
non-payment by one or more
banks in the transaction
Country or Sovereign Risk:
Advising Bank Political risk, including risk of
Issuing Bank (Confirming Bank) civil unrest or war, risk of
expropriation, economic crisis,
Bank Risk insufficient currency

Risk mitigation is a critical element of trade finance, and a core value proposition of the Documentary Letter of Credit. When
an exporter requests that an L/C be Confirmed by a trusted financial institution (generally located in the exporter’s country),
this is a very effective form of risk mitigation in that it addresses commercial, bank and country risk altogether, assuming of
course that the exporter’s country of residence, and the Confirming Bank, are both secure.

L/C Confirmations represent a significant risk for the Confirming Bank. Often, the Confirming Bank will obtain export credit or
private sector insurance to mitigate its own exposure, and the exporter will incur additional costs as a result. Confirmation
Commissions charged by banks can be significant, especially in high-risk or developing markets, and the margin on the trade
transaction—or the perceived/expected potential of the trading relationship—must justify the added cost.

Banks will differ on the Confirmations they are prepared to provide (and at what cost), both by country, and based on their
assessment of the Issuing Bank. Approval timeframes related to Confirmations may also vary depending on the extent to
which the transaction falls within existing country and bank lines and within established risk parameters.

7
 Bank Relationships & Fees
The global crisis motivated a “flight to quality” both among banks
“Relationship Banking seeking to preserve top-tier commercial and corporate client relation-
is no longer available: ships, and more uniquely, among corporates concerned for the first time
everything is transaction-based in many decades, about the long-term viability of their financial institutions
now” in many parts of the world.

No! Enduring, secure and sustainable relationships are highly prized, and a
relationship approach is likely to be well received.

Although an increasing number of exporters are now also importers (sourcing inputs to their products in foreign markets),
it is useful to note an important difference in the link between banks and their importer versus exporter clients.
An import Letter of Credit is issued by a bank for an importer, on the basis of an existing relationship and some type of
facility—usually a line of credit which the bank will debit in settlement of the importer’s payments under the L/C. It would
be difficult, in most situations, to walk into a bank branch and request issuance of an L/C without an existing relationship,or
without going through an account setup and due diligence process. Importers are tied to the banks where they have, or
can obtain, facilities and lines of credit.

An exporter, however, may have more flexibility in choosing a financial institution to help with a transaction under an export
L/C. This is the case, because any risk or financial liability undertaken on the export side is typically a matter of bank risk
and/or country risk—not commercial risk associated with the exporter. Fees will vary in relation to the risk associated with
the risk of the Issuing Bank. Confirmation of an L/C involves risk related to the Issuing Bank and the country in which the Issuing
Bank is based. Similarly, financing extended on the basis of an export L/C will ultimately be repaid by the Issuing Bank—not
the exporter. The implication is that an exporter can, where appropriate or necessary, seek assistance from a financial
institution other than the company’s primary bankers.

Acceptance Sample
Commission L/C Charges
Financing &
Risk Mitigation Confirmation
Discount
Interest Commission
L/C Issuance

Importer Exporter
(Buyer/Applicant) (Seller/Beneficiary)

Amendment
Transaction
Processing Discrepancy Advising
Fee
Discrepancy
Amendment Fee

L/C fees, commissions and financing costs can be significant,

particularly in high-risk markets. Where Term L/C’s are used,
banks will charge Acceptance Commission to guarantee the ““L/C’s can be expensive: it is
payment obligation until maturity. Financing based on bank risk worth looking carefully at the
may be less expensive than financing based on commercial expected fees, commissions
(importer or exporter) risk. and interest…”

Review the proposed structure and features of an L/C, and the likely
related costs. Where financing is required, assess the most effective
Yes!
financing option available: in some cases, financing through an operating
line may prove to be cost-effective.

8
 A Banker’s View

“Why is it that my bankers for being risk-averse, or for providing little or no

bankers are never markets.

active in the most
promising/interesting Even when they are active, clients often complain that trade bankers

markets?”

obligation to provide returns to shareholders.

the resources of the bank, based upon the strategic priority of the business, and the historical/expected return that

allocate lines of credit at the country level. They also allocate lines to banks within each country, with which they

straightforward and quick, if the deal is acceptable to the bank. In the event that lines are not available, or the

transaction to a central credit group for review and approval. Regulatory and compliance issues are increasingly
fundamental to the approval process as well.

The bank may simply decide that a transaction is not in line with credit and risk guidelines; in other cases, trade

nature of the global relationship with a client can be a factor. Commercial clients can help their trade bankers by
providing as much detail about the trading partner and the transaction as possible.

consider their commercial customers’ requirements in L/C

transactions. They must also consider the nature of the “Why does my bank decide
Documentary Credit and its use and function in internationalto make payment for a
trade. shipment under MY import
L/C, without my prior
An L/C is a payment undertaking—a promise which is legally approval?”
binding– by the Issuing Bank, to pay the exporter in cases where the
terms and conditions of the L/C are fully met. A bank which fails to

institutions, and/or by exporters in international markets. Banks may thus make payment under an L/C even if a client
disagrees.

practices, and countries or banks which have been found to engage in such activities have faced commercial
consequences as a result.

International trade transactions work best when they are conducted and concluded in good faith and with a
long-term, relationship view. As an importer, the standing of an Issuing Bank is very important to the successful and

increase costs, and discredit the system to the detriment of all.

9
A Corporate’s View

operations background, often express the view that the greatest

customers are interested concern of trade clients, is the accurate and timely processing of
transactions.
processing”
Leading providers will document and be guided by Service Level
Agreements (SLA’s) in which they commit to timeframes and turnaround,
related to transaction processing.
Trade banks can organize their transaction processing business in several ways. Options include:

Settlement)
By customer, including potentially by industry sector

While the operational model of the bank should be immaterial from a client point of view, there is some advantage to
having at least an assigned contact to assist with communication, resolution of issues, and generally to ensure timely
and correct processing of transactions.

specialists, as well as senior experts whose focus is on structuring more complex deals involving export credit
insurance and other related mechanisms.

the business, while providing operations specialists the opportunity to participate in business development planning
and client calls.

holistic, solution-oriented approach to meeting the needs of clients “We are lenders and
engaged in international business. processors of transactions
—not
consultants or advisors”
support, top trade banks understand the value of their expertise, and are
both able to and interested in providing advisory support.
Transaction
Processing
The need for advisory support in international trade can arise even in the most experienced organization, based on

A partnership approach to managing trade banking relationships can prove valuable in many respects. As with
traditional banking, the more a trade specialist understands about the business of a commercial client, the more

to conduct necessary due diligence, and to prepare adequately to meet any internal requirements (such as

and holistic approach—by bank and client—is best.

10
SWIFT
SWIFT is the Brussels-based Society for World Inter-bank Financial Telecommunications—a membership based
organization, which through its network, facilitates trade finance-related transactions and payments across the globe.
SWIFT allows financial institutions to send secure and authenticated messages and/or financial transactions such as
transfers of funds and payments between banks.

SWIFT has also devised a series of formatted message types, the structure, purpose and usage of which are well
understood across the world, and which enable fast, secure and consistent communication across borders.

700-Series SWIFT messages relate to Documentary Letters of Credit. The example below is from SWIFT.

A sample MT-700 SWIFT is

shown here (MT is “Message
Type”); the fields in the
message are intended to
contain very specific data, as
illustrated.

The MT-700 is the message

format used to transmit a
Documentary Letter of Credit.

In the graphic, the left column

is an explanation of the
information typically contained
in a given field.

The right column shows the

“Field Tag - the field number—
in the formatted MT 700
message, followed by a
sample of the type of
information that might be
included in an actual L/C.

The first entry, for example,

shows Field Tag 20, with the
data being the L/C number
assigned by the Issuing Bank,
No. 12345.

Each financial institution, and in many cases, subsidiaries and individual branches, are assigned a SWIFT Code—a
unique code which identifies that individual entity within the SWIFT system. Field 41A shows SWIFT Code
AMRONL2A, identifying the bank with which the L/C is available, and field 57A shows MEESNL2A as the bank
through which the L/C is to be Advised.

SWIFT is a critical contributor to and enabler of international payments and trade. The organization offers
numerous solutions in support of trade and trade finance, and is currently in the process of providing corporate
clients (non-bank) with access to the SWIFT network.

11
Selected Quotes...

Technology is increasingly central to the efficient

conduct and flow of trade, including trade
finance.

Documentary Credits are used in about 5-7% of

global trade transactions. Pre-crisis, there was a
global shift away from L/C’s in favour of
Open Account.

Non-bank providers of trade finance have been

and will continue to be active in this sector.

The ability to offer financing at competitive rates is

often a determinant in the selection of a vendor or
service provider.

Trade finance is an important but poorly

understood subject. Obtain expert advice to
extract maximum value and to effectively
Transaction mitigate risk.
Processing

The profile of trade finance at all levels has

been unprecedented since the global crisis.
Programs have been launched globally, in
support of trade finance.

Industry estimates suggest that 50-70% of

documents presented for payment under
Documentary Credits are non-compliant.

12
FITT—The Professional Path to Global Markets
www.fitt.ca

International Trade Centre

www.intracen.org

IFC Global Trade Finance Program

http://www.ifc.org/ifcext/gfm.nsf/Content/
TradeFinance

International Chamber of Commerce

www.iccwbo.org

OECD Trade Section

http://www.oecd.org/