Documentary Credit PDF

Topic 6 Pre-issuance considerations and requirements Learning objectives By the end of this topic, you should be able to: describe the benefits and risks when a documentary credit is the method of settlement; understand the basic components of a credit facility when a documentary...

Topic 6 Pre-issuance considerations and requirements Learning objectives By the end of this topic, you should be able to: describe the benefits and risks when a documentary credit is the method of settlement; understand the basic components of a credit facility when a documentary credit is issued; explain the know your customer and customer due diligence policies and procedures; identify the key fields of a documentary credit application form; and recognise the different delivery modes of a documentary credit application form to an issuing bank. Introduction This topic provides details of the benefits and risks that are faced by an applicant and beneficiary when deciding upon a documentary credit as the means of settlement, the need for a credit facility to be in place with the bank that is to issue the documentary credit, and the completion and delivery to that bank of a documentary credit application form. Think… Before you start work on this topic, consider what you already know about the issuance of a documentary credit, and the risks and benefits to an applicant and a beneficiary. There are no rules or guidelines detailing what is required to occur, or be in place, prior to the issuance of a documentary credit. This is left to each bank to manage. Are you aware of the policies and procedures that are to be followed un your bank or company? Does your documentary credit application form allow the customer, as applicant, to indicate the type, issuer and data content for each required document? Do you know the criteria that an applicant and beneficiary should consider agreeing in a sale contract, so that the completed documentary credit application form will truly reflect the agreement that exists between the two parties? © The London Institute of Banking & Finance 2021 1 6.1 A documentary credit as the method of settlement As you learned in Topic 5, one of the key decisions to be made when a seller and buyer negotiate a sale contract is the selection of the terms of payment. When a documentary credit is chosen, both the buyer (who will be known as the ‘applicant’) and seller (who will be known as the ‘beneficiary’) receive an independent undertaking in the exchange of goods, services or performance for settlement. The comfort provided to both an applicant and a beneficiary by the independent undertaking of a bank is one of the main reasons why a documentary credit is often the preferred method of settlement in international trade. 6.1.1 Benefits Applicants As the applicant of a documentary credit, the buyer receives an undertaking from an issuing bank that no settlement will be made unless the beneficiary has: presented the documents as stipulated in the documentary credit; and complied with all of its terms and conditions. An applicant’s mandate to the issuing bank is on this basis. The mandate should incorporate an authorisation to debit the applicant’s account or contain an undertaking from the applicant that it will remit the value of any presentation to the issuing bank concerning any settlement made by the issuing bank. Beneficiaries As the beneficiary of a documentary credit, the seller receives an irrevocable undertaking from the issuing bank of that documentary credit (and the separate undertaking from a confirming bank, in the case of a confirmed documentary credit – see Topic 10) that it will receive settlement provided that the: documents are presented as stipulated in the documentary credit; and all of the terms and conditions of the documentary credit are complied with. An undertaking of an issuing bank, or confirming bank, is addressed directly to the beneficiary and is legally binding. When an issuing bank or confirming bank effects settlement to a beneficiary, it does so on a ‘without recourse’ basis, which means that settlement is final and there can be no claim upon the beneficiary for any refund or repayment. 6.1.2 The autonomy of the documentary credit Documentary credits are used in international trade because settlement is made on the basis of the presentation of complying documents. An issuing bank, confirming bank, if any, or nominated bank acting on its nomination is required to effect settlement only if all of the terms and conditions of the documentary credit are met. There is no responsibility to assess whether or not the terms of the sale contract have been met. This is what we mean by the ‘autonomy’ of the documentary credit. This autonomy has been upheld in the courts of many countries. Any party seeking to obtain an injunction preventing a bank from honouring its obligations under a documentary credit will usually find it very difficult to do so. This can even be true when there has been fraud and the granting of an injunction is appropriate. Issues relating to fraud and injunctions are covered in Topic 25. The autonomy of a documentary credit is evidenced in the following articles and sub-articles: © The London Institute of Banking & Finance 2021 2  article 2 by the definition of credit, refers to an irrevocable and definite undertaking of the issuing bank to honour a complying presentation; sub-article 4 (a) by emphasising that a documentary credit is separate from any sale or other contract on which that documentary credit may be based, even if there is reference to that sale or other contract in the documentary credit; article 5 by clearly stating that banks deal with documents and not with goods, services or performance to which any documents may relate. sub-article 7 (a) , by reference to the undertaking that is applicable to every issuing bank of a documentary credit; and sub-article 8 (a), by reference to the undertaking that is applicable to a confirming bank, where the documentary credit authorised or requested that confirmation be added and such confirmation was added. It is the responsibility of the applicant and the beneficiary to reflect the applicable terms and conditions of the sale contract that are to be complied with and/or evidenced within one or more stipulated documents by their incorporation into the completed documentary credit application form, or to ensure that they are added to the terms and conditions of an issued documentary credit by a subsequent amendment. We will cover amendments in Topic 8 and Topic 11. Check your understanding An applicant’s ________ to an _______ bank should incorporate an ____________ to ________ the applicant’s account. 6.1.3 The roles, responsibilities and risks involved in using documentary credits It is important to recognise that although a documentary credit can provide comfort to both an applicant and beneficiary, the respective interests and risks they face in both the documentary credit and the underlying transaction remain different. Their interests differ in two key ways: Cash flow – a beneficiary usually wants to receive payment as soon as possible, while an applicant will normally want to delay payment until the latest possible time. Documents – an applicant will want to ensure that the documents received are as stipulated in the documentary credit. This is certainly the case if the applicant has sold the imported goods and settlement to them depends on correct documentation. A beneficiary will want to make sure that the stipulated documents can be presented as soon as possible after the shipment of the goods or completion of any services or performance to which the documentary credit relates. A beneficiary should be concerned about the possibility of settlement being delayed because of potential discrepancies in these documents. These different interests are reflected in the different risks to which the two parties are exposed. © The London Institute of Banking & Finance 2021 3  Check your understanding A buyer (applicant) of a documentary credit receives an undertaking from an issuing bank that no settlement will be made unless the beneficiary has done what? Select the correct answer. a. Presented the documents as stipulated in the documentary credit and complied with all of its terms and conditions. b. Instructed a nominated bank to effect settlement. c. Assessed whether or not the terms of the sale contract have been met. d. Arranged an examination of the documentary credit. 6.1.4 The risks faced by an applicant An applicant faces the following risks. Non-delivery of goods as described in the presented documents – goods may not be delivered because of fraud by the beneficiary. In such circumstances, the applicant may still remain liable to reimburse the issuing bank when a complying presentation is made. Short-shipment, or shipment of inferior goods – goods may be short-shipped (that is, a lesser quantity shipped than ordered or a lesser quantity as evidenced in the presented documents) or the goods may be of inferior quality, despite the presentation of documents that comply with the terms and conditions of the documentary credit. In this event, an applicant may suffer a loss on the eventual sale of the goods. The same risk also applies if the goods are received late and an applicant is unable to sell at the price originally anticipated. To minimise losses being sustained for these reasons, it is important that an applicant makes every attempt to establish the integrity and trading record of the proposed beneficiary before entering into a documentary credit transaction. In this respect, some comfort may be gained by obtaining a bank or credit agency status report on the beneficiary. It may also be appropriate to require an independent pre-shipment inspection of the goods, with the outcome evidenced on one of the documents to be called for in the documentary credit. Goods received by the applicant prior to documents being received by the issuing bank – if an applicant is required to take delivery of the goods by the use of a shipping guarantee, rather than by using the usual transport document, this will normally require it to authorise settlement under the documentary credit notwithstanding any discrepancy in the documents when they are received. We will discuss shipping guarantees in Topic 20. Loss or damage to goods in transit – if goods are lost or damaged in transit, the owner of the goods at the time of such occurrence will look to its insurers for financial compensation. Both parties should ensure that they fully understand which party is responsible for arranging insurance when agreeing the terms of the sale contract, for example via the use of an Incoterm, which should be reflected in the type and content of the documents called for under the documentary credit. The applicant should be satisfied that the level of cover to be arranged provides an appropriate level of protection. Foreign exchange risk – if the currency of the documentary credit is not the applicant’s operating currency, there may be a difference in exchange rates between the time when the documentary credit is issued (or the time of the underlying agreement) and the time at which settlement is made. If the movement is unfavourable to the applicant, it may have to pay more than the anticipated price, reducing its profit margin or incurring a loss. An applicant can protect against this © The London Institute of Banking & Finance 2021 4  risk by entering into a forward foreign exchange contract (‘forward’) or by buying an option. A forward has the effect of fixing the future exchange rate (which could be at a higher rate than the market rate at the time of settlement). Failure of the issuing bank – in the event of a failure of the issuing bank, an applicant may be required to settle with the beneficiary directly. This may result in the applicant effectively paying twice – that is, if it had already deposited funds with the issuing bank to meet its liability under the documentary credit, as part of the conditions of the credit facility. Fraud in the presented documents – an applicant also faces the risk that settlement will be obtained for non-existent or worthless merchandise against the presentation of one or more documents that are subsequently found to be fraudulently issued or signed. Check your understanding 1.What is meant by the autonomy of a documentary credit? Select the correct answer. a. Only the applicant can make an amendment to the terms and conditions of an issued documentary credit. b. A court injunction can prevent a bank from honouring its obligations under a documentary credit. c. There is no responsibility to assess whether or not the terms of the sale contract have been met. d. Banks deal with the goods, services or performance to which the documents relate. 2. A documentary credit provides reassurance to both the applicant and the beneficiary. The respective risks and interests to both parties are the same. True or false? 6.1.5 The risks faced by a beneficiary A beneficiary faces the following risks. Failure to comply with the terms and conditions of the documentary credit – a documentary credit is a substantial safeguard of settlement for a beneficiary. The main risk for a beneficiary is that the nominated bank or issuing bank will refuse settlement because the documents do not comply with the terms and conditions of the documentary credit. A beneficiary can minimise this risk by reading the documentary credit carefully as soon as it is received. The beneficiary should then immediately request an amendment if any of the terms and conditions appear to vary from those of the sale contract, or if the beneficiary would find it difficult to satisfy any of those terms and conditions. Failure of, or delays in settlement from, the issuing bank – in the case of an irrevocable, but unconfirmed, documentary credit, a beneficiary bears the risk of failure of the issuing bank, together with the country risk relating to the country in which that bank is located. This can pose a potential problem when the country concerned lacks adequate foreign exchange reserves. If an issuing bank becomes insolvent, its undertaking is placed in jeopardy and the beneficiary may need to rely on settlement for the goods being received directly from the applicant. In the case of country risk, settlement may be prevented or delayed by incidents © The London Institute of Banking & Finance 2021 5  such as balance of payments difficulties affecting the country of the issuing bank or by government restrictions on the transfer of funds outside the country. A beneficiary can mitigate these risks by obtaining a confirmation of the documentary credit from a bank located in its own country. Confirmation of a documentary credit is covered in Topic 10. Documentary credit issued by an entity other than a bank – all of these risks to a beneficiary, as outlined above, may increase if the issuer of the documentary credit is not a bank. If a beneficiary has any doubts as to the status of the issuer of a documentary credit, or if it is clearly issued by a non-banking institution, the beneficiary should exercise caution before shipping the goods and placing reliance on the documentary credit as its guarantee of payment. The ICC Banking Commission issued Opinion R505 –When a non-bank issues a letter of credit – on this subject on 30 October 2002. Fraud – there is the risk that the documentary credit itself may be fraudulently issued. This might induce a beneficiary to ship goods or perform a service against an apparent bank undertaking to pay that does not in fact exist. In this event, the beneficiary will have no enforceable claim against the named bank because either that bank did not issue the documentary credit or the bank does not exist. Foreign exchange risk – if the currency of the documentary credit is not the beneficiary’s operating currency, there may be a difference in exchange rates between the time when the documentary credit is issued (or the time of the underlying agreement) and the time at which settlement is made. If the movement is unfavourable to the beneficiary, it may receive less than the anticipated price, reducing its profit margin or incurring a loss. A beneficiary can protect against this risk by entering into a forward foreign exchange contract or by buying an option. A forward has the effect of fixing the future exchange rate (which could be at a lower rate than the market rate at the time of settlement). 6.1.6 General risks There are also some general risks that affect all parties to a documentary credit. The simple solution for an applicant to avoid becoming involved in a fraudulent transaction or falling foul of legislative and regulatory requirements is simply to ‘know your customer’ – that is, the seller (beneficiary). The old maxim ‘If goods are being offered for sale at a price that sounds too good to be true, then it probably is too good to be true’ is a good yardstick that, if followed, may save a good deal of embarrassment and financial loss that could prove disastrous to a company. Wide-ranging legislation is aimed at the prevention of money laundering, transferring the proceeds of drug trafficking and the funding of terrorist activity. Legislation varies in content and application from country to country, but as the global community seeks to control and eradicate such activities there is an increasing responsibility on banks to understand better who their customers are and the true nature of their customers’ businesses. Banks that fail to undertake the required levels of due diligence run the risk of incurring severe penalties imposed by their local regulatory or legislative bodies (see section 6.2.3 and, for more detail, Topic 25). Other general risks include the following. Sovereign and regulatory risks – these are the risks that performance of the documentary credit may be prevented by government action outside the control of the parties. This may occur, for instance, if a government imposes foreign payment restrictions or import / export prohibitions after a documentary credit has been issued, but before it has been fully performed. This risk may also be referred to as ‘country risk’. Legal risks – while sovereign and regulatory risks may disrupt the documentary credit by © The London Institute of Banking & Finance 2021 6  means of events outside the framework of the documentary credit operation itself, legal risks concern the possibility that performance of a documentary credit may be disturbed by legal action relating directly to the parties and to their rights and obligations under the documentary credit. Check your understanding Name three possible risks that the beneficiary could face. Try to think about the potential scenarios from your studies before checking the answers. 6.2 The prerequisites for the issuance of a documentary credit When a documentary credit has been chosen as the means of settlement, establishing a documentary credit is not a straightforward task whereby the buyer (applicant) can simply go to its bank and request its issuance. As we have seen, a documentary credit constitutes a definite and independent undertaking of an issuing bank to honour a complying presentation made by, or on behalf of, the beneficiary (seller). If an issuing bank is to be expected to make settlement to a beneficiary, on a ‘without recourse’ basis, it needs to be certain that the applicant will reimburse it. 6.2.1 The need for a credit facility A credit facility agreement or documentation serves to establish the terms and conditions under which the bank will agree to issue one or more undertakings on behalf of the applicant. For example, if the bank is willing to treat the purchased goods as adequate security for issuing a documentary credit, it will seek to control access to those goods by having the transport document indicate that the goods are consigned to, or to order of, the bank. However, it may require the applicant to deposit with it a certain percentage of the value of each documentary credit issued, or even a deposit for the full amount, as a form of security. It may also seek other forms of security that have a monetary value and can be used in the event of default by the applicant. The terms and conditions will be agreed between the bank and the applicant, and such terms and conditions will vary between different bank clients. In simple terms, a credit facility can be described as an arrangement with a bank that enables a person or company to be given credit or to borrow money when it is needed, for example for the establishment of documentary credits, bank guarantees or other products that require an undertaking to be given by a bank, to a seller or supplier, in respect of the purchase of goods, or the provision of services or performance. Most credit facilities covering trade finance products will refer to the rules under which a bank is willing to issue a bank undertaking. For documentary credits, this will be UCP 600, a set of internationally accepted rules that were discussed in Topic 2 and which will be referred to throughout the learning materials. For a standby letter of credit, either UCP 600 or ISP98 will be the chosen rules. A bank may either leave the choice to the applicant or identify a preference within the facility documentation. We discuss standby letters of credit in Topic 21. Sub-article 4 (a), makes it clear that the beneficiary cannot avail itself of the relationship that exists between an applicant and the issuing bank, or between all the banks involved in the documentary credit. © The London Institute of Banking & Finance 2021 7 One effect of this sub-article is that a beneficiary cannot argue that it has knowledge of an existing credit facility that has been granted by the issuing bank to the applicant, and as a consequence the bank is bound to issue a documentary credit in its favour that would fall within the parameters of that facility. An issuing bank is at liberty to accept or reject any instructions from its customer, even if a credit facility is in place and there is sufficient availability for a new transaction. A similar rule can be seen in ISP98 rule 1.07 Independence of the Issuer-Beneficiary Relationship for standby letters of credit. 6.2.2 The main components of a credit facility agreement or document As mentioned in section 6.2.1, a credit facility serves to inform a bank’s client of the terms and conditions under which it will be willing to issue one or more bank undertakings – this will include the maximum amount that may be outstanding at any one time, the maximum period for which an undertaking may be issued (in terms of expiry date and/or usance period for any settlement to be made) and the expectations of the bank as to how it will be reimbursed by the applicant for any settlement that is made under any undertaking it issues. Other components or sections of a credit facility agreement or document include: representations and warranties – that is, requirements that the client should inform the bank of any change in status of the company or matters that could impact the fulfilment of its obligations under the facility document; the responsibilities of the bank – that is, to act with reasonable care according to instructions that it will receive, except to the extent that the bank may advise that it is unable or unwilling to issue a transaction in the manner requested; limitations on liability – such as that the bank will issue a transaction only subject to rules such as UCP for documentary credits or standby letters of credit, or ISP for standby letters of credit, and that it will also abide by any laws, customs or regulations to which it is subject; reference to the basis under which the credit facility is being granted – that is, with the goods as partial or full security, or partial or full collateral being deposited with the bank; general indemnification and disclaimer clauses that will protect not only the issuing bank, but also any bank that the issuing bank chooses to act as an advising bank and/or confirming bank; a discrepancy waiver – that is, a clause to the effect that the bank is under no obligation to accept any waiver of discrepancies, in the presented documents, that may be offered by the applicant either in response to a request of the bank or as a result of information provided by the beneficiary directly to the applicant; the period of validity – that is, the time for which the credit facility will operate prior to renewal being required; fees and expenses – that is, the charges that will be levied by the bank and an agreement that the customer will pay them, which will include not only the usual transaction fees, but also legal fees and local regulatory fees that may be incurred; and the applicable law to which the credit facility will be subject. The general indemnification and disclaimer clauses will usually follow the format of UCP 600 articles and sub-articles, and be suitably adapted where a standby letter of credit is a form of undertaking that is to be requested. The relevant articles and sub-articles are: Sub-article 4(a) that it is the responsibility of the applicant to ensure that its documentary credit application form reflects the terms and conditions of the sale or other contract, as agreed with the beneficiary, and that it will not be able to rely on any conditions in that sale or other contract that are not reflected in the documentary credit that will be issued – also, that any honour effected under the documentary credit will be the decision of the issuing bank and © The London Institute of Banking & Finance 2021 8  without any claims or defences put forward by the applicant; article 5 a recognition that “banks deal with documents and not the goods, services or performance to which the presented documents may relate”; article 34 as a consequence of article 5, that banks are required to examine a presentation on the basis of the documents alone, to determine whether or not the documents appear, on their face, to constitute a complying presentation (as referred to in sub-article 14(a)), that banks have no liability or responsibility for matters such as the form, sufficiency, accuracy and genuineness of any presented document; article 35 that banks have “no responsibility for any delays or loss [of documents] in transit or the mutilation or errors in the transmission of […] messages”, where they are sent according to the requirements of the documentary credit; article 36 the impact on a documentary credit if an event of force majeure is declared by a court or tribunal with jurisdiction, a government or a regulatory authority; article 37 general indemnification for the choice of another bank, failure of instructions to be carried out by that bank, collection of unpaid fees and charges, and obligations and responsibilities imposed by foreign laws and usages. Check your understanding Fill in the blanks in the following sentence. ------ that fail to undertake the required levels of ---- ----- risk incurring severe ------- imposed by their local regulatory or legislative bodies. 6.2.3 Completion of know your customer (KYC) and customer due diligence (CDD) formalities Today, the principles of know your customer (KYC) and customer due diligence (CDD) are firmly established in the day-to-day activities of banks when opening new accounts and / or credit facilities (KYC) and engaging in the ongoing monitoring of a customer’s business profile (CDD). A bank’s KYC procedures should include a process whereby it is able to obtain sufficient evidence of a prospective client’s identity. This is achieved by means of identification – that is, obtaining information from the client as to the ownership and corporate structure, up to the ultimate beneficial owner – and verification – that is, the checking of this data against an independent source or by other means. In addition, banks will seek information such as the background and geography of the company, the range of its business activities, the source of the goods, the frequency of its transactions, the product and service needs – that is, whether documentary credits are to be issued or received – and the source and nature of funds that the company will receive and / or the wealth of the owners. A bank’s CDD measures require the ongoing review of a client’s business profile. Completion of the KYC process is not a single one-time event. Each bank should have processes in place that will identify any change in the business activities of a company, for example a company originally imported household electrical equipment and has now started importing pipe and engineering materials. Any changes in a company profile should be reported to the relationship manager for the client so that follow-up action may be taken as necessary. For example, this could mean a new review of the client’s business activities so that the bank is satisfied as to the purpose for which the new line of goods will be used. © The London Institute of Banking & Finance 2021 9 The required due diligence should, as a minimum, be undertaken in relation to the customer who is the instructing party for a transaction. Any further, or enhanced, due diligence will be subject to the internal policy of each bank. For the issuance of a documentary credit, the instructing party will be the applicant, and for the advising or confirmation of a documentary credit, it will be the issuing bank. In addition to KYC and CDD formalities, a bank should also assess transactions from a potential money laundering, terrorist financing and sanctions perspective. We will consider these issues in Topic 25. Check your understanding Complete the following sentence. A ------ agreement or ------- serves to establish the ------ and ------ under which the bank will agree to issue one or more undertakings on behalf of the ------. 6.3 Applying for the issuance of a documentary credit It is a buyer’s responsibility to request the issuance of a documentary credit. The time when it should be opened should be detailed in the sale contract. If no date is indicated, a documentary credit should be issued so as to be in the hands of the beneficiary prior to the earliest date of any specified shipment date. Beneficiaries often use documentary credits opened in their favour as the basis for obtaining bank finance. This finance may be necessary to enable them to procure raw materials or to ship the goods. As a result, a beneficiary is under no obligation to do anything until the documentary credit is issued. You should not be concerned with the legal remedies that an applicant and beneficiary may have against each other, but simply with the fact that an applicant has a responsibility to arrange for the documentary credit to be issued in good time to enable shipment to be made. The type, nature, terms and conditions of a documentary credit An applicant and beneficiary should jointly agree the type, nature, and terms and conditions of a documentary credit. Most problems with the execution of documentary credits occur because the parties have not completely agreed these points. In many cases, it may have been assumed that they have reached agreement, but it will subsequently be found that their interpretations of that agreement are different. This is recognised in Preliminary Considerations, paragraphs iii and iv. 6.3.1 General conditions when completing a documentary credit application form Having agreed the establishment of a credit facility with a bank or that there is sufficient availability within a previously agreed credit facility, the main responsibility of an applicant is to complete the bank’s documentary credit application form. © The London Institute of Banking & Finance 2021 10 The main purpose of a documentary credit is to pay for an applicant’s purchase, not to police or administer the underlying sale contract or proforma invoice. Therefore, when completing the application form, an applicant should: provide its bank with clear and precise instructions, avoiding any form of ambiguity in describing the terms and conditions that are to be complied with by the beneficiary; maintain an awareness of the documents that are necessary for the import of the concerned goods, or those that are to evidence delivery of the services or performance that is to be provided by the beneficiary; provide details of the type, issuer (if applicable) and data content of the documents that are to be presented, which should include within one or more of those documents any reference to specifications or quality requirements that are to be met and evidenced; (where there is a requirement that the goods are to be subject to a form of inspection) clearly indicate the type of document and, where appropriate, the name or type of company that should issue it (for example the presentation of an inspection certificate issued by an inspection or quality assurance company, with or without stating the name of that company), along with the standard or quality that is to apply to the goods; and ensure that all terms and conditions, and the documents called for, are in accordance with the sale contract or proforma invoice agreed with the beneficiary. It is often the case that, apart from describing the goods and indicating the value of those goods, the only other information provided in a sale contract or proforma invoice will be the desire of the beneficiary to receive a documentary credit that is payable on a sight basis or at a future date. This leaves the buyer to complete the application form in a manner that it will deem appropriate and it often leads to subsequent amendments being required as a result of the inability of the beneficiary to comply with one or more conditions. As part of the sale contract negotiation, an applicant and beneficiary should agree, at least, upon the answers to the following questions relating to the issuance of a documentary credit. Is settlement due on a sight or usance basis? Is it to be available by sight payment, deferred payment, acceptance or negotiation? What is the currency and amount? Is there any tolerance that is to be applied? What is the validity (or expiry) date? What is the last date for shipment, and what is to be the period for presentation of documents? What is the routing of the goods to be? Are partial shipments or drawings to be allowed or prohibited, and is transshipment to be allowed or prohibited? How are the goods, services or performance to be described? If there is a quantity of goods, is it subject to a tolerance? Is there a unit price or prices that are applicable? What is the appropriate transport document (for goods) and which Incoterm is applicable? What are the other required documents? Are there any special terms and conditions? If so, what are the documents to be presented to evidence compliance with such terms and conditions? Who will pay the respective bank charges under the credit? Is it to be confirmed or not? Each bank will maintain its own style of application form, whether in paper form or available online, but the individual fields will usually follow the structure of a SWIFT MT700 message to make the review and issuance process easier to manage. © The London Institute of Banking & Finance 2021 11 The standard terms and conditions applied by a bank in its application form or format, including indemnification clauses, usually seek to evidence the applicant’s acknowledgement at least that: the documentary credit will be issued subject to UCP 600; any necessary insurance will be arranged by the buyer, depending on the Incoterm (for example FOB); any necessary government regulations have been/will be complied with; the applicant will reimburse the issuing bank for any payments made under the credit; the applicant recognises that the bank has no liability or responsibility for the form, sufficiency, accuracy, genuineness, or falsification of documents, as detailed in article 34; and the applicant agrees to pay all charges and costs designated for its account and those not paid by the beneficiary. Check your understanding A beneficiary has to arrange for a documentary credit to be issued in good time to enable shipment. True or false? 6.3.2 Delivery of the completed documentary credit application form to the issuing bank The application form, when completed and either approved online or signed by the applicant, acts as a request to its bank (which will become known as the ‘issuing bank’) to issue an irrevocable documentary credit in favour of the named beneficiary. The application will be submitted to the bank in either electronic or hard copy. The application form itself and/or other documents signed by the applicant, as part of the credit facility documentation, will provide not only details of the documentary credit that is being requested to be issued, but also an agreement for the bank to debit the applicant’s account for any payment made (or an undertaking that the applicant will remit funds as requested by the bank). The general indemnification clauses will also mirror some of the clauses that appear in the credit facility agreement. At this point, it should be remembered that an applicant is not a party to the documentary credit. Once the documentary credit has been issued, any attempt to change its terms and conditions will be subject to at least the agreement of the issuing bank and the beneficiary. It is therefore imperative that an applicant ensures that the terms and conditions of the documentary credit that is to be issued are complete and precise, and accurately reflect its understanding of the sale contract agreed with the proposed beneficiary. © The London Institute of Banking & Finance 2021 12 Conclusion A documentary credit cannot be issued without a completed documentary credit application form; the importance of which cannot be understated. It is therefore incumbent on each bank that offers a documentary credit issuance service that its application form allows its customer (the applicant) to provide complete details for the required documents, and applicable associated terms and conditions. Banks will often maintain their own standard terms and conditions that are either embedded into the application form or added when the documentary credit is issued. These terms and conditions will be part of the bank’s policies and procedures and will include requirements like the presentation of a draft (bill of exchange), that documents must be issued in a certain language, a sanctions clause (see Topic 25), and clauses relating to fees such as discrepancy fees. Think again… Now that you have completed this topic, how has your knowledge and understanding improved. For instance, can you: outline the risks for an applicant and a beneficiary? describe the criteria that forms the basis of a credit facility that is granted to a bank customer? explain the roles of the applicant and the beneficiary when completing a documentary credit application form? © The London Institute of Banking & Finance 2021 13