Company Name:
Lishui Huanqiu Bearing Trading Co., Ltd.
Company Address:
No.11 Shiting Road, Shuige Industrial Zone,Lishui, Zhejiang,China
Contact Person: William
Email: admin@tradebearings.com
Homepage: www.asiabearings.com
Bearing B2B: www.tradebearings.com
Incoterms 2000 are a set of 13 delivery terms universally used in international trade transactions published by the International Chamber of Commerce (ICC). Despite the fact that the current set of terms are nearly 10 years old, they are not as well understood as might be wished. That may be a problem since the selection of a specific Incoterm may affect the documentary requirements of Letter of Credit (L/C) transactions.
Part 1 of this article reviewed the buyer’s and seller’s responsibilities under the 13 different Incoterms 2000. This article discusses the documentary requirements of an L/C transaction under the various terms.
Letter of Credit Transactions and Documentary Compliance
Letters of Credit are an instrument of trade finance that operate under a special set of rules, the current revision of which is commonly referred to as the UCP 600. These rules have been devised by the ICC and are adhered to by banks worldwide. L/C transactions are quite complex and the issue of an L/C gives rise to a number of contracts among the various parties involved in the sales contract and this method of payment, as shown in Figure 1.
Figure 1: Typical contracts arising from a Letter of Credit transaction
<img src=http://www.bearing.com.cn/direc/myimg/201202099.bmp>
Contract 1 is the sales contract, and this specifies that payment will be through an L/C. Contract 2 is the application for the L/C, and this is done by the buyer.
Contract 3 shows that the L/C substitutes the buyer’s credit risk with that of their bank, making this a more attractive proposition for the exporter in the context of credit risk. It is the issuing bank that, in an L/C transaction, provides a conditional guarantee of payment in favour of the named beneficiary (the seller/exporter). The condition that triggers payment is documentary compliance against the L/C requirements. This means the exporter has to achieve 100% correctness of data on specified documents. Banks do not deal with the goods but rather with documents that represent the goods. Documentary compliance continues to remain a problematic issue, as the ICC estimates that there is up to a 70% error rate on documentation lodged to banks under L/C transactions.
Contract 4 is between the issuing bank and their correspondent (advising bank) in the exporting country. The advising bank plays at least an anti-fraud role as it checks the genuineness of the L/C and subsequently advises this to the exporter. In case of doubt on the genuineness of an L/C, the exporter would be advised of a potential problem.
Contract 5 is between the advising bank and the exporter (beneficiary). In most circumstances the documents are presented to the bank advising the L/C, although this need not be necessarily so.
Given that documentary compliance is the trigger for payment, what should the exporter be considering when dealing with L/C transactions?
A risk minimization strategy must be pursued to ensure documentary compliance. This strategy can be assisted by the decisions made as to the choice of Incoterms 2000 in the contract of sale. However, this may be easier said than done. EXW creates the least amount of responsibility for the seller and certainly does not require the provision of a transport document, but realistically, how many importers buy on this term? Although the exact figure is not known, the usage of this term appears to be low.
As stated earlier, the main terms used are between FOB and CIP. These will require the provision of a transport document and additionally, for CIF and CIP, the provision of evidence of cargo insurance.
The more documents required to be presented under the L/C, the higher the likelihood of errors being created. This is simply a function of quantity. If one data field is filled there is a chance of one error, if two data fields are completed, then there is a chance for two errors and so on.
For the exporter the problem is exacerbated when the documents are issued externally, such as in the case of transport documents that are issued by third parties: the carriers. Instructions have to be issued by the exporter to the carrier. Those instructions are an interpretation of the L/C requirements by the exporter. These are subsequently interpreted by the carrier, who issues a transport document. Under these circumstances, we can observe two interpretations on one requirement, and as we all know that humans are not perfect, there is a potential for errors to be introduced into the documentary issue process.
Given that it is unlikely that transport documents can be eliminated, other processes may assist such as electronic transmission of forwarding instructions to avoid transposition errors and reducing the amount of human manipulation of data. Another strategy may be to make sure that the draft of the L/C is provided to the exporter beforehand, so this may be checked and required changes negotiated before the L/C is actually issued. This strategy will reduce the requirement for subsequent amendments and avoid bank fees.
Certificates of insurance are presumed to present less of a problem since these are issued in-house by the exporter without third party involvement. The presumption is that the regular exporter will be skilled enough to meet the data requirements of the L/C when issuing in-house documents, therefore these comments also apply to other documents such as invoices and packing slips/lists.
An area of separate concern is the use of delivered terms in L/C transactions. On the one hand, the type of documents required may seem to be no more onerous than the other Incoterms. Yet on the other hand, there are the demands of the L/C that may produce surprising situations for exporters. As Contract 3 in Figure 1 shows, the buyer’s credit standing is replaced with that of their bank. Indeed, under an L/C, the payment originates from the issuing bank and not from the buyer.
What happens then if the delivery document called for under an L/C requires the buyer’s intervention? An example of this may be in a DDP where the document required may be a proof of delivery rather than a conventional transport document. If this were to be the case, then the exporter is at the buyer’s mercy in terms of getting that document signed and subsequently getting paid. This may not be the type of arrangement that the exporter might have predicted.
In conclusion, the exporter needs to follow processes that maximize the chances of getting paid under an L/C transaction. In a typical organization, contract negotiations and the provision of L/C documentation are done by different departments. It is common practice for the sales and marketing team to “clinch a great deal,” but perhaps this may not be such a good deal for the operations people who must to try to meet what at times are difficult documentary requirements, often against tight deadlines, especially if production is running behind schedule.
In an ideal organization, all concerned would consult with one another to make sure that the L/C transaction is successful for the company as a whole. The “silo” mentality is no longer prudent in modern business practices and runs contrary to the principles of Enterprise Risk Management (ERM). ERM advocates processes that are inclusive of all internal stakeholders involved in a transaction as a way to minimise risk for the enterprise.
Unfortunately, documentary discrepancies continue to be reality in L/C transactions. However, there are opportunities to minimize risks, and one solution may well be the application of a more strategic approach to the actual choice of Incoterms 2000 with the full knowledge of their consequences for L/C transactions.
( linda )09 Feb,2012
