ucp-600

Letter Of Credit

U C P 600

By:Kamal Hassan

Vikas AroraSusovan MaityMayank Kapoor

Int’l Trade Procedures & Documentation - UCP 600 & LC Mechanism

Exporter Importer

1. Sale Contract sent

4.Submits Documents for Collection

Exporter’s Bank

5. Documents forwarded

Importer’s Bank

6.Documents Presented

International Trade Operational Cycle

3. Ships the Goods

2. Contract accepted

Goods Delivered against Documents

7.Payment/Acceptance

8. Payment Forwarded

Payment credited


Risks associated with trade

SellerBuyer

Payment made without Receipt of Desired quality/quantity of

Goods

Possession of Goods given up without

Receipt of Payment

Parties are located in different countries

Different legal systems Different Regulations and

Restrictions Different Currencies Exchange rate Fluctuations Political Instability Unpredictable Natural Disasters Unpredictable FinancialMarket

Disasters


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An arrangement by means of which a Bank (Issuing Bank)

Acting at the request of a Customer (Applicant)

Undertakes to pay / Accept & Pay (Honour)

To the Beneficiary of LC

A predetermined amount ( LC amount)

Before a given date (LC Expiry date)

According to stipulations (Terms) against presentation of stipulated documents

All parties to a credit deal with documents and not with goods / services / performances

Definition of Letter of Credit


Exporter / Beneficiary

Importer / Applicant

Issuing Bank

Applies for LC

Advising Bank

Advises LC

Issues LC through

Ship the goods

Negotiating / Confirming Bank

Presents documents

Negotiates & Pay

Pay / Accept & Pay

Present documents

Present docs and debit

Take delivery of goods

Sales contract entered

LC Operation Cycle


Types of Documents

Commercial

DocumentsPrincipal

Bill of ExchangeCommercial InvoicePacking listBill of lendingInsurance PolicyCertificate of InspectionCertificate of OriginShipment Advice

Auxiliary

Shipping instructions Insurance declarationIntimation for inspectionShipping orderMate's receipt etc

Regulatory Documents

Exchange Control DocumentsFreight Payment CertificateGate PassShipping Bill AREVehicle Pass etc


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Applicant

Beneficiary

Issuing Bank

Advising Bank

Confirming Bank

Nominated Bank

Reimbursing Bank

Negotiating Bank

LC

Various parties to LC


Advantages to LC

1. The beneficiary is assured of payment as long as it complies with the terms and conditions of the letter of credit The credit risk is transferred from the applicant to the issuing bank.

2. The beneficiary can enjoy the advantage of mitigating the issuing bank’s country risk by requiring that a bank in its own country confirm the letter of credit. That bank then takes on the country and commercial risk of the issuing bank and protects the beneficiary.3. The beneficiary minimizes collection time as the letter of credit accelerates payment of the receivables.4. The beneficiary’s foreign exchange risk is eliminated with a letter of credit issued in the currency of the beneficiary’s country


Disvantage to LC

1.Since all the parties involved in Letter of Credit deal with the documents and not with the goods, the risk of Beneficiary not shipping goods as mentioned in the LC is still persists.

2. The Letter of Credit as a payment method is costlier than other methods of payment such as Open Account or Collection

3. The Beneficiary’s documents must comply with the terms and conditions of the Letter of Credit for Issuing Bank to make the payment.

4. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the Issuing Bank’s country and Foreign Exchange Risk in case of Usance Letter of Credits


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Issuing Bank (Opening Bank) Issues (Opens) the LC based on the LC

Application of applicant Once the documents under LC are received

from Negotiating / Confirming Bank honour its commitments.

Or in case if discrepancies are found in documents communicate the same to negotiating bank within 5 banking days

While communicating the discrepancies the same has to be done in one lot and not in installments and should state that it is holding documents at the disposal of Negotiating/Confirming Bank awaiting further instructions

See Article 16 of UCP for waiver of discrepancies

Obligations of various parties to LC


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Negotiating Bank

Receive the documents submitted by beneficiary

Examine the documents in terms of LC If they appear on their face to be in

accordance with LC negotiate the same under LC (pay or agree to pay or accept)

Negotiation includes pre-purchase of draft, if the bills of exchange are drawn on another Bank

Forward the documents to Issuing Bank Claim reimbursement from the issuing

bank or reimbursing bank (as per LC) on the due date



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Confirming Bank If requested by Issuing Bank, add its

confirmation to LC Step into the shoes of the Issuing Bank Advise the confirmation (providing additional

undertaking) to Beneficiary of LC Once the documents under LC are received

from Beneficiary honor the LC commitments.

In case if discrepancies are found in documents

Communicate the same within 5 Banking days in one lot stating that it is holding documents at the disposal of Beneficiary awaiting further instructions.



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Nominated Bank

If a Bank is nominated by Issuing Bank for negotiation such Bank is called Nominated Bank and negotiations / payments are restricted to such nominated Bank.

Such Bank will become the Negotiating Bank

If no Bank is nominated, any Bank can be a Nominated Bank.



Reimbursing Bank:

If a credit states that reimbursement is to be obtained by a nominated bank claiming on another party, such other Bank is referred as “Reimbursing Bank”

The credit must state that the reimbursement is subject to the ICC rules for bank-to-bank reimbursements in effect on the date of issuance of the credit.



Advising Bank

By advising an L/C, the advising bank signifies:

An advising bank that is not a confirming bank advises the credit and any amendment without any undertaking to honour or negotiate.

By advising the credit or amendment, the advising bank signifies that it has satisfied itself as to the apparent authenticity of the credit or amendment.

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16

Beneficiary to LC (Seller / Exporter)

Ship the goods within the dates stipulated in the LC

Submit the documents as per LC terms to the Nominated Bank within the dates stipulated in the LC for presentation



17

Applicant to LC (Buyer / Importer)

Importer is responsible to make payment to Issuing Bank in terms of LC application, if all the documents and terms of LC are in compliance.



Types of Letters of Credit


Revolving Credit Transferable Credit Installment Credit Deferred Credit (with undrawn balance) Red clause Credit Green clause Credit Revocable Letter of Credit Irrevocable Letter of Credit Back-to-back Credit Sight Credit and Usance Credit Standby Credit (ISBC of ICC)

Various types of Letters of credit


Single L/C that covers multiple-shipments over a long period.

Instead of arranging a new L/C for each separate shipment, the buyer establishes a L/C that revolves either• in value (a fixed amount is available which

is replenished when exhausted) or • in time (an amount is available in

fixedinstallments over a period such as week, month, or year).

L/Cs revolving in time are of two types: in the cumulative type, the sum unutilized in a period is carried over to be utilized in the next period; whereas in the non-cumulative type, it is not carried over.

Revolving Credit


A transferable letter of credit allows the beneficiary to act as a middleman and transfer his rights under a letter of credit to another party or parties who may be suppliers of the goods.

Depending on whether the letter of credit permits partial shipments, fractional amounts may be transferred to more than one beneficiary.

The letter of credit however, can be transferred only once: the secondary beneficiaries cannot transfer their rights to a third

party. Transfer of a letter of credit can be made on

specific application by the original beneficiary to the authorized transferring bank

Transferable Letter of Credit


A red clause letter of credit incorporates a clause, traditionally written in red, which authorizes the bank acting as the negotiating or paying bank to pay the beneficiary in advance of

shipment. This enables the purchase and accumulation

of goods from a number of different suppliers, and the arrangement of shipment in accordance with the letter of credit terms.

Such advances will be deducted from the amount due to be paid when the documents called for are presented under the letter of credit.

Red Clause Letter of Credit


This type of letter of credit envisages grant of storage facilities at port over and above the pre-shipment payment to the exporter.

In India opening of Green Clause LC covering import of goods in our country requires prior permission.

Green Clause Letter of Credit


A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification.

It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank.

There is no provision for confirming revocable credits as per terms of UCPDC, Hence they cannot be confirmed.

It should be indicated in LC that the credit is revocable.

If there is no such indication the credit will be deemed as irrevocable.

Revocable Letter of Credit


In this case it is not possible to revoke or amend a credit without the agreement of:

Issuing bank Confirming bank, and Beneficiary

Form an exporters point of view it is believed to be more beneficial.

An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made.

Irrevocable Letter of Credit


Confirmed Letter of Credit is a special type of L/C in which another bank apart from the issuing bank has added its UNDERTAKING.

Although, the cost of confirming by two banks makes it costlier, this type of L/C is more beneficial for the beneficiary as it doubles the assurance of payment, especially from a local bank which is better known to beneficiary.

Confirmed Letter of Credit


Sight credit states that the payments would be made by the issuing bank at sight, on demand or on presentation.

In case of usance credit, draft are drawn on the issuing bank or the correspondent bank for specified usance period.

The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank.

Sight Credit and Usance Credit


Although not recorded on a letter of credit, “back-to-back” is a term used in transactions involving two irrevocable letters of credit.

Such transactions originate when a seller receives a letter of credit covering goods which must be obtained from a third party who in turn requires a letter of credit.

The “second” issuing bank looks to the first issuing bank for reimbursement after paying under the second letter of credit.

The difference between back-to-back letters of credit and transferable letters of credit, is such that in a transferable letter of credit, the rights under the existing letter of credit are transferred.

In a back-to-back transaction, different letters of credit are actually issued.

Although not recorded on a letter of credit, “back-to-back” is a term used in transactions involving two irrevocable letters of credit.

Such transactions originate when a seller receives a letter of credit covering goods which must be obtained from a third party who in turn requires a letter of credit.

The “second” issuing bank looks to the first issuing bank for reimbursement after paying under the second letter of credit.

The difference between back-to-back letters of credit and transferable letters of credit, is such that in a transferable letter of credit, the rights under the existing letter of credit are transferred.

In a back-to-back transaction, different letters of credit are actually issued.

Back to Back Letter of Credit


Standby letters of credit may apply in general to transactions which are based on the concept of default by the applicant in performance of a contract or obligation.

In the event of default, the beneficiary is permitted to draw under the letter of credit.

Standby letters of credit may be used as a substitute for performance guarantees, or issued to guarantee loans granted by one firm to another, thereby securing payment to the creditor in the event the other party fails to repay its obligation on the due date.

Even if the applicant claims to have performed, the bank issuing the letter of credit is obliged to make payment provided the beneficiary produces complying documents, usually a sight draft, and a written demand for payment.

Standby Letters of Credit

ucp-600

Documents

advising bank

lc mechanism

red clause

lc mechanism

lc application

issuing bank

nominated

dates stipulated