A new set of rules for documentary credits is expected to restore the reputation of this much-maligned method of trade finance. But will bankers be able to meet the July deadline? Michael Imeson writes.

What is it?

It is a revised version of the Uniform Customs and Practice for Documentary Credits, the internationally recognised rules governing documentary credits (DCs), also known as letters of credit. UCP 600 will replace the existing rules, UCP 500, on July 1. A DC is a widely used payment instrument in international trade. It is a letter from the importer’s bank to the exporter’s bank, guaranteeing that the importer will pay the exporter once the goods or services have been received. If the importer does not pay, the importer’s bank will honour its guarantee and pay the exporter.

Who dreamed it up?

The Banking Commission of the International Chamber of Commerce. By a unanimous vote, the Banking Commission approved UCP 600 last October and published it in January. The rules were introduced in 1933 to overcome conflicting laws on DCs in different countries and today are the essential ground rules for billions of dollars of trade transactions every year.

The rules had to be simplified and clarified to move with the times. As trading on open account has increased dramatically around the world, the use of DCs has fallen into relative and, in many cases, absolute decline. Many exporters see the procedure as too complicated, prone to errors and fraught with risks – ironic since it is meant to guarantee payment.

Some 70% of documents in the DC process are rejected by banks on first presentation by exporters, an indication of how difficult DCs are to use, despite their obvious benefits.

What are the rule’s main provisions?

  • The number of articles has been reduced from 49 to 39.
  • New ‘definitions’ and ‘interpretations’ have been added to clarify the meaning of ambiguous terms.
  • The phrase “reasonable time” for acceptance or refusal of documents by a bank has been replaced by a definite period of five banking days.
  • There has been a change in the procedure used by banks to refuse documents.
  • The problem of inconsistent data in documents has been resolved by stating that data need not be identical to, but must not conflict with, other data in the documents.

 

What’s in the small print?

DCs will still contain numerous disclaimers – good for banks, bad for traders.

What does the industry say?

“The UCP 600 rules are an improvement on UCP 500,” says Diane Galloway, partner at law firm Reed Smith Richards Butler. “But banks only have a limited time to prepare. They need to revise their terms and conditions, re-write their DC opening forms, and retrain their document checkers.

“It’s entirely possible there will be confusion in the early days. Sales contracts are being made now using UCP 500, yet delivery will be when UCP 600 is in force, so there will be a period when both UCPs will be in operation.”

Pradeep Taneja, head of global trade services at BankMuscat International, Bahrain, and a member of the ICC’s UCP 600 Consulting Group, says the rules had to be tightened to cut the number of document rejections by banks. “Little did the drafters of the first UCP in 1933 realise that they were leaving a legacy that would, one day, convert the DC from a payment vehicle into a means to avoid payment,” he says.

How much will it cost?

It won’t be cheap to reprint all the documents and retrain document checkers.

What do the rule-makers say?

Gary Collyer, head of the ICC group that drafted the rules, says the new UCP has obvious advantages, including an easier-to-read text and a simplified structure.

Could we live without it?

Yes, but not for long. Without UCP 600, the use of DCs would continue to decline, and banks would lose significant trade finance revenue.

Rating: 4

Rating scale:

5 = Essential;4 = Useful; 3 = Neutral; 2 = Unnecessary1 = Waste of time

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