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LC / SBLC Process & Procedures SBLC Trade Finance

STANDBY LETTER OF CREDIT ISSUANCE PROCESS

How Standby Letters of Credit Work

The numbering is commensurate with that shown in the extract below.

1. As with any other trade transaction, an underlying sale contract is agreed between the exporter (seller) and importer (buyer). For the purpose of our example, the contract provides for settlement to be made in an agreed manner and for the issuance of standby to act as security for the exporter in the event of non-payment by the importer, despite the exporter complying with the conditions of the contract.

2. The importer applies to its bank for the issuance of standby in favour of the exporter.

3. Assuming the bank is willing to proceed, e.g., a credit facility exists for such issuance, the standby is issued and advised through a bank in the country of the exporter. At this point, the exporter is referred to as the beneficiary of the standby, and the importer is referred to as the applicant.

4. The standby is advised to the beneficiary. If confirmation has been requested, and added, this will form part of the advice that is sent to the beneficiary.

At this point, the beneficiary should ensure that the conditions of the standby reflect suitable security for it to proceed to perform under the contract. The standby is held by them as security, in the event it becomes necessary to make a claim thereunder.

For example, the standby should (a) be for the amount that may become due under the sale contract; (b) have an expiry date that extends beyond the completion of the contractual terms, including any period in which the applicant would be required to pay by the agreed means; and (c) clearly indicate the document(s) that is/are to be presented in order to demand payment thereunder.

Different Types of Standby

We can assist you with a wide variety of types of Standby Letter of Credit. This are more commonly seen in trade finance transactions. Common Ones are listed below. Most of these will be familiar to those acquainted with demand guarantees.

Performance – agreeing to undertake, deliver and/or complete contractual obligations. 

Advance Payment – undertakes repayment of all or part of a percentage of the value of a contract that has been paid by the beneficiary to the applicant as a down payment, advance payment, or deposit, upon the signing of the contract. 

Bid or tender bond – ensures a bidder (applicant) cannot alter its tender proposal, or withdraw from the tender process before the tender is awarded.

Counter – a standby issued by one bank, in favour of another bank, to support the issuance of a standby, guarantee, documentary credit or other forms of the undertaking, by that other bank.

Financial – supports a financial obligation to pay or repay.

Insurance – reinforces applicant obligations with respect to insurance or reinsurance activity.

Direct-pay – not necessarily related to default and is likely to be the primary means of payment rather than secondary which is normally the case. 

Commercial – acts as a security for payment of goods or services not settled by a buyer under other arrangements i.e., via open account trading or documentary collection.

Benefits and attributes of a Standby

  • A standby is often used to cover, and to mitigate, the many risks that can occur in finalising a contract between a buyer and seller. The benefits and attributes of a standby include: 
  • Independence from any underlying contract.
  • Provision of security.
  • Protection against non-performance of obligations, as opposed to a performance which results in non-payment (as is covered by instruments such as documentary credits i.e., with the shipment of goods and presentation of complying documents).
  • Can cover financial or non-financial obligations.
  • Can be used for cross-border or domestic transactions.
  • Contains many of the characteristics of a documentary credit e.g., independent from the underlying contract, payment made only if certain conditions are fulfilled, issued by banks, subject to a set of international rules.
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LC / SBLC Process & Procedures SBLC Trade Finance

Incoterm categories

There are 11 Incoterms, which are for use in domestic and international transactions.

Each one sets out the obligations of the seller and buyer under the sales contract and indicates the point at which responsibility is transferred from seller to buyer. The seller’s obligations escalate from EXW (‘ex-works’ – the minimum) to DDP (‘delivered duty paid’ – the maximum).

Any obligation that does not appear in a particular Incoterm is the responsibility of the buyer unless the sales contract states otherwise.

The 11 Incoterms are divided into two groups: seven that are suitable for any mode or modes of transport; the remaining four applying to sea or inland waterway transport only.

When incorporating an Incoterm into a sales contract, the seller and buyer should take care to ensure that the term selected is appropriate to the agreed point of delivery and the mode of transportation to be used.

SBLC Trade

The 11 Incoterms are grouped as follows:

◆◆ Group 1: Rules for any mode or modes of transport

–– EXW (‘ex-works’)

–– FCA (‘free carrier’)

–– CPT (‘carriage paid to’)

–– CIP (‘carriage and insurance paid to’)

–– DAT (‘delivered at terminal’)

–– DAP (‘delivered at place’)

–– DDP (‘delivered duty paid’)

◆◆ Group 2: Rules for sea or inland waterway transport only

–– FAS (‘free alongside ship’)

–– FOB (‘free on board’)

–– CFR (‘cost and freight’)

–– CIF (‘cost, insurance and freight’)

Applying the appropriate Incoterm, and the applicable transport and insurance document requirements. The Incoterms are set out in a logical order under each grouping, starting with the term that imposes the least obligation on a seller and ending with that which imposes the most.

Sellers and buyers are advised to review the full content of ICC Publication No. 715 once an Incoterm has been identified so that they understand its full implication and the obligations that it imposes. Irrespective of the chosen Incoterm, the buyer pays for the goods according to the terms of settlement agreed in the sales contract, proforma invoice or purchase order.

Courtesy – ifs University College 2015

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SBLC Trade Finance

STANDBY LETTER OF CREDIT

What is a Standby Letter of Credit (SBLC / SLOC)?

A Standby Letter of Credit (SBLC / SLOC) is a guarantee that is made by a bank on behalf of a client, which ensures payment will be made even if their client cannot fulfil the payment. It is a payment of last resort from the bank, and ideally, is never meant to be used.

How can a contractual SBLC be used?

An SBLC is frequently used as a safety mechanism for the beneficiary, in an attempt to hedge out risks associated with the trade. Simplistically, it is a guarantee of payment which will be issued by a bank on the behalf of a client. It is also perceived as a “payment of last resort” due to the circumstances under which it is called upon. The SBLC prevents contracts from going unfulfilled if a business declares bankruptcy or cannot otherwise meet financial obligations.

Furthermore, the presence of an SBLC is usually seen as a sign of good faith as it provides proof of the buyer’s credit quality and the ability to make payment. In order to set this up, a short underwriting duty is performed to ensure the credit quality of the party that is looking for a letter of credit. Once this has been performed, a notification is then sent to the bank of the party who requested the Letter of Credit  (typically the seller).

In the case of a default, the counter-party may have part of the finance paid back by the issuing bank under an SBLC. Standby Letter of Credit’s are used to promote confidence in companies because of this.

SBLC Trade

How can you apply for a Standby Letter of Credit?

There are many aspects that a bank will take into consideration when applying for a Standby Letter of Credit, however, the main part will be whether the amount that is being guaranteed can be repaid. Essentially, it is an insurance mechanism to the company that is being contracted with.

As it is insurance, there may be collateral that is needed in order to protect the bank in a default scenario – this may be with cash or assets such as property. The level of collateral required by the bank and by the size of the SBLC will largely depend on the risk involved, and the strength of the business.

Other Application steps

There are other standard due diligence questions asked, as well as information requests regarding assets of the business and even possibly the owners. Upon receipt and review of the documentation, the bank will typically provide a letter to the business owner. Once the letter has been provided, a fee is then payable by the business owner for each yeah that the Standby Letter of Credit remains outstanding.

What are the fees for Standby Letters of Credit?

It is standard for a fee to be between 1-10% of the SBLC value. In the event that the business meets the contractual obligations prior to the due date, it is possible for an SBLC to be ended with no further charges.

What is the difference between SBLCs and LCs?

A Standby Letter of Credit is different from a Letter of Credit. An SBLC is paid when called on after conditions have not been fulfilled. However, a Letter of Credit is the guarantee of payment when certain specifications are met and documents received from the selling party.

Letters of credit promote trust in a transaction, due to the nature of international dealings, distance, knowledge of another party and legal differences.

How do SBLCs work in Cross-Border trade?

Where goods are sold to a counter-party in another country, they may have used an SBLC to ensure their seller will be paid. In the event that there is non-payment, the seller will present the SBLC to the buyer’s bank so that payment is received.

A performance SBLC makes sure that the criteria surrounding the trade such as suitability and quality of goods are met.

We sometimes see SBLCs in construction contracts as the build must fulfill many quality and time specifications. In the event that the contractor does not fulfill these specifications then there is no need to prove loss or have long protracted negotiations; the SBLC is provided to the bank and payment is then received.