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Q&A with Dr. Roberto Bergami discussing letters of credit

Recently we had a great oportunity to ask a few questions to Dr. Roberto Bergami, International Trade Senior Lecturer at Victoria University in Melbourne Australia. He has specialized in methods of payment and delivery from a risk management perspective and was gracious enough to offer his expertise on these issues. He has also provided a few good questions a buyer should be asking when trying to combat payment and delivery issues.

1. Tell us about why you picked this topic for research and why it is relevant to buyers of products made overseas?

Payment is a crucial aspect of any international business transaction and it gets very complicated trying to work out strategies to avoid non-payment or even payment delays. L/C represent a significant proportion of trade transactions and are suitable in particular in high value and high risk transactions. And this is all based on pedantic requirements for certain data contents on documents to match the L/C requirements – this is what makes it ‘peculiar’ and also (for me) a bit of fun because I was an international trader for about 20 years.

2. I realize your research is on ASEAN, but do a similar situation exist re: L/C when placed with China?

Yes similarities exist, but there are also variations caused by a number of ‘environmental’ factors. In a L/C the buyer’s credit risk is substituted with that of their bank. The bank is providing a promise to pay (A conditional undertaking to pay). The degree of security that a bank may require from the buyer in order to have the L/C established will influence that bank’s behaviour when there are discrepancies, or when the buyer has little funds available at settlement time.

In theory the bank is meant to pay no matter what – that’s what the rules say, but practice and theory commonly differ. Imagine this situation (very common in a market like China). The bank asks for 10% security of the par value of the L/C. It has, therefore, a 90% exposure on the deal – the bank promises the seller to pay the full par value by establishing the L/C. If discrepancies exist, the rules will be pretty much followed usually. This is where the buyer’s bank seeks a waiver from the buyer to accept documents with data elements that do not match the L/C. Usually some ‘horse trading’ goes on and if the seller –buyer relationship is good they kiss and make up and the payment is forthcoming, without too much problem, but if not there could be delays while the buyer usually seeks a discount or some other advantage – he is in the box seat – the goods have either arrived already or are certainly on their way and the seller knows that it costs money to park goods at wharves etc.

Where the documentation complies with the L/C the bank has to pay, but what if the buyer has no money at maturity. It means the bank has to hand over 90% of its own money to settle the debt and then hassle the buyer to get it back – remember the bank only took 10% security. The bank will not be keen to do this, so what they will do instead is ‘manufacture discrepancies’. This is where fatuous mistakes are cited that in fact do not exist. The intention is not to cause a bad debt necessarily, rather it is to cause a payment delay in the hope that the buyer will get some money soon, so that payment can progress. This does go on. Of course there is a hidden cost to the seller who, having exported the goods sees its cash flow projections go out of the window because of the payment delay. I could go on, but hopefully you get the drift.

By the way China appears to have some legislation surrounding L/C trade, whereas the majority of the world does not – certainly this is the case for virtually all anglo-saxon law countries.

3. What do new buyers need to know about using an L/C

They need to understand that the L/C does not replace trust in a relationship and that to be successful they need to be in it for the long haul and build the seller –buyer relationship. No point in trying to have clauses the seller cannot comply with, because payment may not be forthcoming. They also need to know very clearly what the Incoterms are and what the seller/buyer responsibilities are under each of the 11 delivery terms (contracts of carriage and insurance as well as documentation, customs clearance etc. are all caught up in this and this is reflected in the L/C conditions.) Talk to a bank first so you understand the process by which L/C operate. You cannot manage what you do not know and you cannot manage what you do not understand.

4. What are some of the aspects of using L/C that even experienced buyers don’t always understand?

Some of the documentary requirements of the L/C are at times not well understood and buyers are also subject to bankers that know little about trade and so ask for documents that are not necessary and should not even be asked for at times based on the Incoterms 2010 seller-buyer responsibilities.

5. Any surprises come out of your research that you didn’t expect?

Yes, Australian exporters, particularly the smaller ones appear do to better at managing their risks with L/C trade than the rest of the world. The approach is simple, but works well. They have sat down with their bankers and drafted an L/C template that states the acceptable (to the seller) terms and conditions as well as the documentary requirements of the L/C. They are familiar with these, so it reduces error and bank rejection rates. This does not mean that some did not get caught anyway – and they were candid enough to report that in their survey responses.

Questions buyer should be asking: There may be many, but these are common and they should be asked before the contract is signed, not after – stable doors and horses…..

1. Who is the seller – reliability, quality, etc – have we done due diligence on them? After all we do need to trust them regardless

2. Which Incoterms will be used? – this impacts the type and number of documents in the L/C

3. How long is the credit limit? – will the seller provide credit terms or not – impacts on the L/C maturity, but also impacts on the net price paid (cannot finance your business for nothing – time is money)

4. When will supply be made and how? – mode of transport (sea/air etc) and also whether transshipment and partshipment are allowed – these may increase the transport and transit risks

5. Is L/C confirmation required (by another bank – typically the seller’s bank)? Whilst this may indicate a degree of ‘mistrust’, confirmation has been on the increase as a result of the global financial crisis – no surprise really humans looks for safe havens in times of uncertainty. If confirmation is required, who pays for it? Hopefully the seller.

Mike Bellamy is an Advisory Board Member & Featured Blogger at the not-for- profit China Sourcing Information Center. He is also the author of "The Essential Reference Guide to China Sourcing" and founder of PassageMaker Sourcing Solutions.

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