Letter of Credit is a financing tool used to facilitate international trade by big banks. As a bank’s product, the beneficiary to the letter of credit can be transferred to another party. Provided that the instructions to transfer the letter of credit is given before the facility is arranged. This is called a transferable letter of credit, one of the many conveniences that come at a cost to the importer.
In international trade, sometimes the distinction between who is the buyer and who is the seller is not always obvious. Modern business complexities have birthed countless forms of intermediary businesses that complicated a simple transaction of buying and selling.
As trading transactions became global, the means of exchanging goods for money is constantly evolving to improve a transaction’s security, accuracy, and timeliness.
Our blog article has always been focused on the exchange of goods, but equally important is the exchange of money.
A letter of credit is such a financing facility, where it adds a layer of security by bringing in the big banks to underwrite the risk of buyer’s default.
The fundamental concept of a letter of credit is simple, where the buyer engages an international bank to issue a letter of credit as a form of actionable “IOU”.
Once the buyer verifies with the bank (with shipping documents) that the seller has exported the goods, the seller will receive money from the bank.
So, can the seller transfer the letter of credit’s money directly to another beneficiary? Yes. It is called a transferable letter of credit.
But before a seller can transfer a letter of credit to another beneficiary, a few things have to be in place. In this article, we will rely heavily on the UCP 600 guidelines and understand how a transferable letter of credit is processed.
How Transferable Letter of Credit is Works?
To understand how transferable letter of credit works, we need to understand the parties involved and how it interacts with each other
Issuer – the Bank that issues the Letter of Credit, very often the issuer is the buyer’s representative bank.
Buyer Applicant – The buyer applicant is the importer that seeks an international credit facility with the issuing bank.
Seller Beneficiary – The exporter that is actually trading with the issuer/buyer.
Transferee Beneficiary – The final recipient of the payment dues by the bank.
Nominated Bank – The bank that is “partnered” with the issuing bank “Issuer” to transmit payment to the seller.
Normally, the instructions to submit a payment is performed with a SWIFT message, SWIFT is a messaging network used by banks to transmit information, in this case, the SWIFT message is for an instruction to transfer money.
If there is a need for a Transferable Letter of Credit, usually there are two business contracts at play. The UCP 600 guidelines refer them as
- Supply Contract
- International Sales Contract
For the purpose of this article, we will note the following definition: –
Supply Contract – a contract between the seller and its intermediary vendors, suppliers, or service provider that is performed to execute the seller’s international sales obligation.
International Sales Contract – a contract between the seller and the final buyer located in another country.
To elaborate with an example, a seller may be in the business of exporting a completely built-up car to another country.
But the seller outsources almost 90% of its manufacturing procedures to another manufacturer. The seller may only be responsible for assembling parts of the car for export.
To establish a level of trust between the seller and its vendors, the seller leverages on the most trustworthy monetary source – the bank.
The seller places an order for car parts to assemble and establishes a credit facility with the vendor by transferring its letter of credit to the vendor once the finished goods are exported.
Procedures to facilitate a Transferable Letter of Credit
Firstly, the letter of credit has to be issued as a transferable letter of credit. This means that the seller has to give explicit instruction to the buyer to issue a transferable letter of credit.
Secondly, once the issuing bank “issuer” issues a transferable letter of credit, the seller can instruct the beneficiary bank to transfer partial payments to another beneficiary.
One added benefit to the seller is that the seller can not only improve cash flow by transferring the buyer’s payment to the seller’s vendor, and at the same time, the seller can hide its vendor’s identity. Because the seller’s instruction to transfer partial payments to its vendor is between the beneficiary bank and the seller only, the buyer/applicant is not involved in the transfer.
Thirdly, a buyer/applicant’s bank relies strictly on shipping documents to validate that the business transaction has been made. Hence, the buyer has to follow the buyer/applicant’s bank’s strict document requirements.
The buyer/applicant’s bank will inescapably request for an Original Bill of Lading, with the consignee section of the Bill of Lading consigned strictly to the name of the buyer/applicant’s bank name.
You would often see the term “To the order of xxx Bank” highlighted on the consignee section of the Bill of Lading.
The buyer/applicant’s bank will also request other transaction documents such as an Invoice, Packing List, and any other supporting import permit and accreditations.
Lastly, once the buyer/applicant’s bank verifies that the documents are all in order, it places a SWIFT code to instruct the seller/beneficiary’s bank to reimburse the seller. The seller/beneficiary’s bank will disburse the money according to the seller/exporter’s standing instruction.
In a letter of credit transactions generally, only the beneficiary named in the credit may draw. A transferable letter of credit differs from a conventional letter of credit, the transferee beneficiary would have to present relevant documents to withdraw payments due from the letter of credit.
If this fails, the beneficiary bank will proceed to transfer all payments to the seller.
Other Aspects of Transferable Letter of Credit
Who pays for the extra cost of transfer?
The seller/beneficiary is responsible for the extra fee imposed for arranging transferable credits. According to UCP 600, the transfer fee is paid in advance.
Can there be multiple transferee beneficiary?
Yes, the seller/beneficiary can arrange for multiple transferee beneficiaries. The more transferee is arranged, the more expensive the cost. The bank has to approve the transaction first.
Can the transferee beneficiary transfer to another entity?
The bank normally does not accept secondary beneficiaries.
Can the transferee beneficiary details be amended?
Yes. It can be amended at a cost.