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Features and benefits

A Documentary Credit (DC), also known as a Letter of Credit (LC), is a written undertaking by a Bank, issued on the instructions of the buyer of goods (the applicant), in favour of the seller of goods (beneficiary), to effect payment under stated conditions.

Stated conditions include but are not limited to:

• Against stipulated documentsA cheque book
• Within a stated time frame
• Up to a stated sum of money

Benefits:

Risk mitigation: Payments are only made upon receipt of documents in strict compliance with the terms and conditions of the DC. Buyer's rights and payment obligations are therefore protected by the terms of the DC

Convenience: Sometimes goods arrive before the documents. In such cases 'shipping guarantees' can be used. A shipping guarantee is an application from the bank to authorise the release of goods by a shipping company against our undertaking to deliver the original bill of lading in future. Usually applicable under import DC transactions, this allows prompt clearance of goods ahead of documents arrival. However by taking the goods, protection against discrepant documents will be lost

DC's may be revocable or irrevocable

Revocable credits can be amended or cancelled by the buyer without prior warning or notification to the seller. This feature gives very little protection for the seller and thus revocable DCs are rarely used. FIM specifies that Group offices must only issue revocable DCs for customers of particular sound standing, and that their trade terms require such DCs.

Irrevocable credits can be amended only with the agreement of all parties, and is the most commonly used form.

There are four main methods for authorising payment under a DC. DCs are thus described as being available by:

Payment (Sight): The issuing or nominated bank will effect payment immediately after receiving documents in compliance with the terms stipulated in the DC

Deferred Payment: Payment is effected on a fixed or determinable future date

Acceptance: A nominated bank accepts documents/drafts drawn on them and effects payment on a usance date stipulated in the DC

Negotiation: A nominated bank can discount the documents/drafts presented under a DC with recourse to the drawer. In the case of freely negotiable DCs, any bank can be the nominated bank.

A DC can also be confirmed. Confirmation of a DC constitutes a definite undertaking by the advising/negotiating bank to assume the obligations and liabilities of the issuing bank under the credit. By requesting a local HSBC office to confirm a DC, country and issuing bank risks for the beneficiary (exporter) are eliminated.

Special DC's to suit Importers

Back-to-back DC – A back-to-back DC can be issued at the request of a customer who is the beneficiary of an export/master DC. Taking the original master DC as a form of security, a facility is set up prior to issuance of the back-to-back/baby DC. It can be used to assist trading companies (middlemen), who may have limited financial resources to purchase goods from a supplier on DC terms

Transferable DC – A transferable DC can be transferred by the original beneficiary (the transferor), to a second beneficiary (the transferee). There can be a number of second beneficiaries/transferees if the DC allows for partial shipment, but a DC cannot be further transferred by a second beneficiary. Transferable DCs are very restrictive in terms of the types of documents that are allowed to be replaced/substituted by the transferor (ie. invoice and draft only). As payment is only released to the transferee after receipt from the issuing bank, a transferor does not require a facility in order to effect a transfer

Standby DC – It is a DC issued to cover the 'non-performance' of one party to the contract. The terms are simple and usually stipulate that a sum will be paid to the beneficiary upon demand in the event that the beneficiary submits a signed statement stating default or non-performance by the applicant

Revolving DC – In a revolving DC the terms and conditions state that the DC amount is renewed or automatically reinstated without specific amendments being required. This can be used for a continuous cycle of trading, which calls for regular shipments of the same goods for a similar amount over a long period of time (e.g. a year). There are two types of revolving DCs:

1. Revolve around time: must state a maximum amount to be drawn within each time period
2. Revolve around value: automatically reinstated upon utilization within a given overall period of validity

Finance

Loan against import (LAl): A working capital facility can be made available to pay for the goods imported under the DC. The finance is usually required in order to turn the goods into manufactured (saleable) items. By setting up a LAI as payment for the DC, goods are released under trust receipts (TR) to the customer for the manufacturing period

LAI periods are usually below 120 days

Clean Import Loans (CIL): A variant of LAI, advance is made on sight of original invoices and shipping documents only.

Target customers

• All importers/buyers, distributors, or traders who do not solely conduct trade on open account terms
• Cross-sell opportunities/tips
• Foreign exchange services
• Deposits services: Time deposits
• Trade finance products (e.g. LAI, factoring)
• PCM services eg. Autopay