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A Documentary Letter of Credit (LC) is a written undertaking given by the issuing bank at the request of the buyer (applicant) to hon- our a presentation of compliant documents, i.e. to pay the beneficiary at sight, to incur a deferred payment undertaking or accept a bill of exchange and pay the beneficiary at maturity. Such letters of credit come in many forms of which irrevocable, confirmed or unconfirmed are the most common. LCs may involve receipt of cash on shipment once the presentation of documents occurs or may include a variety of financial options including discounting of accepted bills or pre-shipment finance. The most appropriate reference to a comprehensive guide to documentary finance is the ‘Uniform Customs and Practice for Doc- umentary Credits’ revision 600 (UCP 600), a set of rules on the issuance and use of letters of credit utilised by bankers and commercial parties in more than 175 countries involved in trade finance.

1.

Forms of bank-intermediated trade finance

The importer and exporter must always re- member that unlike transactions in a domes- tic market, the complete and timely collection of outstanding international transactions may be affected by issues related to country risk, notwithstanding the standing of the foreign trading party. Both credit and country risk are relevant in the assessment process.

The provision of bank-intermediated Doc- umentary Letter of Credit (LC) requires the bank to undertake an assessment of the creditworthiness and performance capability of the party on whose behalf an LC is issued or confirmed – the buyer or importer, as well as understanding the credit and performance characteristics of the beneficiary or exporter, as well as meticulously executing the transac- tion as a process. Accordingly, these forms of finance are relatively expensive.

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markets where factors such as exchange control rules, business habits, country risk and the credit standing of buyers and local banks motivate the use of confirmed LCs.

Standby and Performance LCs

are simpler in form but present a more com- plex series of risks than Documentary LCs. As a conditional payment instrument, they may be issued in advance of shipment or contract fulfilment by a supplier to secure a tender or contractual performance. A simple demand or a pre-agreed statement evidenc- ing non-performance is usually the basis of triggering payment. For the issuing bank the open nature of the commitment requires careful assessment. In some cases these instruments are used outside the trade re- lated area to effectively provide a guarantee for the granting of credit by another financial institution. It is important to distinguish the trade related type of standby/performance LC from the use they are put to for the credit enhancement of financial transactions. The exporter that decides to request the

use of an LC must always be aware of the costs and operational requirements of such a transaction. It should be borne in mind that a large number of LC transactions involve dis- crepancies and thus the payment obligation depends ultimately on the other commercial party to accept and pay for the goods, albeit there is a structured payment process in- volved. The exporter must also be aware that the counterparty risk shifts from the buyer to a bank, and therefore it is important to assess the standing of the banks concerned and determine the need for appropriate confirma- tions.

Although 80 to 85 percent of trade transac- tions are estimated to be settled on an open account basis , the LC remains an important transactional instrument. A solid foundation of documentary credit-based trade will remain, especially between companies that have just started a trading partnership. They are still in the process of getting to know one another better and the level of reciprocal trust is not yet at the point where open account transac- tions can take the place of more risk-averse documentary credit exchanges. The passage to open account will eventually happen once the level of confidence has reached the level for which a purchase order is sufficient to ensure the fulfilment of the order and the subsequent execution of the payment against an issued invoice.

LCs are likely to retain their popularity in con- nection with well­defined trade flows: for ex- ample in Asian trade where the instrument is commonly used to raise pre­shipment finance as well as assurance of payment. Another example is its use by exporters into emerging

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Credit transfer

(also known as a funds or bank transfer) is the most commonly used form of payment in both domestic and international B2B transac- tions. The credit transfer is a transfer of funds from the account of the ordering customer into the account of the beneficiary, usually by electronic means. With regard to choosing the credit transfer as a form of payment, it is a simple payment instrument that should be used in the case of high trust and confidence between trade partners. The bank normally advises its clients that the use of this form of payment must be tightly linked to the timing of acceptance of goods. The commercial con- tract should specify the date of execution of the payment transfer, or establish a starting point after a fixed number of days from the date of invoice. Trading parties also often ar- range for Cash (Payment) on delivery (COD) or even Cash (Payment) in advance.

The majority of credit transfer payments are usually domestic in nature and that is where the larger volumes lie. For cross-border payments the SWIFT based credit transfer payment is most common, although there are a variety of other remittance services. In Europe, the payments market is integrating based on the Single Euro Payments Area (SEPA) and further underpinned by the Pay- ment Services Directive (PSD).

In international trade there are various means of payment not guaranteed by the bank that provide value and provide some degree of protection and security for the trading parties. The choice of the degree of protection de- pends on the perceived credit risk as seen by the exporter and the respective negotiating powers of the trading parties.

Documentary collections

are a means of payment where the bank acts as an intermediary between the exporter and importer based on the collection of a bill of exchange and related shipping documents. It is an intermediate instrument between a transaction secured by a letter of credit and an open account transaction which is settled with a simple bank credit transfer. The costs of this service are generally lower than for a letter of credit and higher than for a credit transfer. In a documentary collection the exporter’s bank, once it has received a mandate from its customer, transmits to the importer’s bank the commercial documents that prove the dispatch of the goods or the provisioning of a service. The receiving bank delivers these documents to the importer only on payment of the amount due. The responsibility of the banks is therefore limited to forwarding and delivery of the documents against payment or acceptance of a draft without any responsibility and commitment to pay. The banks have no responsibility for the validity and effectiveness of the documents submitted, and no responsibility for delays, losses, or translation mistakes. A bank may consider the discount of such collections, and if undertaken without recourse can be consid- ered as close to a forfaiting transaction. 2.

Forms of traditional support for trade without bank intermediated finance or risk assumption

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Direct debits

are collections arranged by the creditor that require prior authorisation by the debtor. They are usually adopted for recurring payment transactions. In the presence of numerous, ongoing payments, the Supplier or Exporter may open an account at a bank in the country of the Buyer/Debtor. The direct debit may have some useful features for the exporter under such an arrangement as proceeds of sales can be received with certainty. Direct debit is more common in domestic markets for recurring consumer bills, although it also has benefits for B2B transactions, including international business flows. Specific B2B direct debit services are becoming more common, e.g. in the SEPA DD B2B scheme.

Cheques and Lock Box services

for the handling of traditional paper-based payment instruments are still convenient in certain circumstances although considered increasingly slow and expensive. Trading parties may also consider the use of Bank Drafts, which are checks that are guaranteed by a bank.

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Annex 5 / ICC Global SCF Forum Terms of Reference

are sold by different institutions, thereby con- fusing the importers, exporters, regulators, experienced and new practitioners as well as investor communities. Given the rapid growth of SCF there is a need for common under- standing and operationalised terminology to be used in SCF transactions.

The objectives are five-fold: 1.

Collect all existing SCF nomenclatures developed by various trade associations in an effort to do a precise mapping of existing efforts undertaken in this field and define the precise typology of SCF products and servic- es to fall under these ToRs

2.

Harmonise SCF existing market terminology to make it operational and usable in daily practice by banks and non-banks when pro- cessing, financing and risk mitigating trade transactions. In doing so, it will be important to remove any ambiguity in the existing terminology and standardise language at a global level. We are not expected to introduce new nomenclatures as we believe that exist- ing market nomenclatures are sufficient to meet the industry needs nor do we intend to go beyond the financial industry/create new products and services

A / Purpose and objectives

The purpose of this project is to address the growing need of the trade finance industry to standardise and harmonise the market terminology for products and services in the global supply chain finance space and offered by financial institutions such as banks as well as factoring and forfaiting companies. It comprises both traditional and other products and services such as Open Account tech- niques generally designated as Supply Chain Finance (SCF). SCF products and services cover all risk mitigating and liquidity products a corporate client requires to optimise work- ing capital along the entire value chain. Especially the so-called SCF is a growing market with many opportunities identified for the near future. With the increase in collaboration from a wide range of bank and non-bank participants in facilitating domestic and cross border trade and advent of internet and new communication technologies, the industry is now developing a rich array of processing, financing and risk management techniques to support an increasingly glo- balised supply chain.

However, the industry has not reached an agreement to have a globally consistent nomenclature to describe the various SCF solutions. Institutions use different nomen- clature to describe similar SCF solutions that

Annex 5 –

ICC Global SCF Forum