The Methods of Payment in International Trade Transactions - Essay Example

The methods of payment in international trade transactions will need to evolve to reflect the changing nature of these transactions. It is arguable that some of the existing instruments do not meet users needs Introduction The value of letter of credit transactions internationally are reported to be US $ 1 trillion per annum 1 and the letter of credit is described as “the life blood of international commerce”2 The International trade transactions are reported to be in the region of $ US 7 trillion per year and the cost of documentation for the transaction which is put at 6% works out to a staggering figure of the US$ 420 million per year3 A bulk of this amount represents cost of using the documentary letter of credit. About 30 % of the import trade of the U.S. is paid through this letter of credit mode.4 The percentage of six as the transaction cost is not a small amount. Major portion of this cost is attributed to the return or refusal of the bankers involved at various stages of the routing of the documents from the importing end to the exporting end for reasons of accompanying documents not complying with the descriptions stipulated in the governing letters of credit. Although the ICC 5 sponsored UCP 5006 of 1993 governing the handling of the letter of credit during the course of transactions between the importers and exporters has recently been simplified by the UCP 600 7 in 2007 for hassle free transactions, it is still inadequate to keep pace with the fast paced transactions in the wake of electronic commerce that has emerged during the last few decades. This paper seeks to highlight the various legal barriers that parties involved have to face in the documentation of the international trade, different modes of payments in practice including the documentary letter of credit and justify the need for a more favourable climate for documentation which can be more aptly called as negotiation of documents for collection of payments for goods and services supplied in the course of international trade. Documentary Letter of Credit This is the predominant type of mode of payment for international transactions for goods and services which the UCP 600 (formerly UCP 500) is entirely devoted to. The payment is collected through the party usually a bank or two corresponding banks trusted by the buyer and seller. The buyer’s bank is the issuing bank and the seller’s bank is the confirming bank. Since the buyer and seller come from different legal jurisdictions banks are invariably different enjoying the confidence of the respective sides i.e the buyer and the seller. While the buyer does not like to part with his money without a proof of shipment, the seller is not willing to despatch the goods without a proof of payment. This is where the respective banks step in as third party to assure the buyer and seller their respective expectations subject to their honouring their respective commitments. Thus the issuing bank issues a letter of credit on behalf of the buyer , usually irrevocable, promising to pay the confirming bank on account of the seller subject to his providing the shipping documents such as bill of lading and other relative documents such as packing slip etc either immediately on production of documents or after certain period of say 90 days of providing the said documents provided further the documents submitted are in order as per the stipulations the letter of credit issued. This is the area where the UCP 600 comes into play in regard to scrutiny of the documents and their acceptance or otherwise. And this area potential for unimaginable disputes as to conformity with the stipulation of the documents. History has it that much time and money are lost in the scrutiny and acceptance or otherwise of the documents. Acceptance means honouring of the commitment by the issuing bank and rejection means not honouring the commitment made to the seller because of the discrepant documents.8 It has been observed that letters of credit are invariably rejected on the first presentation of documents which are bound to be imperfect in one way or other. It is said that the US banks find themselves rejecting at least 50 to 60 % of the letters of credit presented to them with discrepant documents.9 In the U.K. the scenario is that Lloyds bank alone has rejected 34 % of the letters of credit in1997 though it was an improvement from 55% rejection rate they had two years earlier10. The rejection results in delay in transmission of documents at every stage and delay in ultimate payment to the beneficiary/exporter. The importer/applicant also incurs heavy loss as he has to pay interest for the delay and demurrage and wharfage at the port for the delayed clearance of the cargo. Now that high value and low volume goods are invariably airfreighted, the importer incurs even heavier loss as demurrage charges are apparently higher than charges for sea transport. One report says that there will be a minimum of two weeks delay in case of discrepant documents.11 Besides letter of credit, other modes of payment in use are cash transfer, credit card and other consumer payment systems unsuitable for high-value transactions as they have threshold limits. Cash transactions are permitted only up to a certain value Credit transfer and open account are better suited for large value transactions.12 Direct Credit Transfer A system called SWIFT enables Telegraphic Transfer (TT), Electronic Funds Transfer (EFT) and Financial EDI (F-EDI) known as Giro payment methods. These methods are used for direct transfer of funds from buyer to seller depending on the high trust and confidence enjoyed by the buyer with the seller in case of credit supplies and similarly seller with the buyer in case of advance payments. The risk in either case is obvious if the buyer does not make payment or the seller does not make shipment.13 Open account This is similar to domestic trading where the outstanding balance in account at periodic intervals is paid by the buyer to seller by credit transfers without the backing of letter of credit or bank guarantee.14 The above are traditional manual payment systems slowly being replaced by electronic methods. But the models remain the same with only mode being replaced by electronic means. In this connection, the letter of credit payment system needs to be addressed for all the delay and shortcomings it entails when issued manually. However, the electronic system for establishment of letter of credit has not completely replaced the manual process involved in the conduct of transactions at various stages. Banks have only enabled application for letter of credit electronically which thereafter gets printed out and processed by the bankers manually. So, it cannot be strictly an electronic method which should be ideally automatic process till the end. Since matching of letters of credit to bill of lading and other documents is a strict compliance, delays due to errors in the documents presented are unavoidable.15 As the letters of credit and bills of lading are manually processed even after thirty years of computerisation of banking transactions, the following doubts arise. 1) Whether efficiency is possible through electronic circulation of documentation. 2)Whether automatic matching of trade documents with payment documents at the banks can be achieved.3) Whether universally acceptable electronic system can be developed as an alternative to the manual processing, having the same desirable characteristics of an international payment system.16 In this connection there have been proposals to develop payment systems conducive to the electronic processing. Trade card Trade Card System has been announced by General Electronic Information Systems (GEIS), Word Trade Canters Association (WTCA), Warberg Pincus (an investment bank) and Marsh (a large insurer). The trade card system enables parties to negotiate payment terms on-line from various locations. The buyer sends his purchase order with a seller through the TradeCard Network and receipt and finalise the terms and conditions whereupon a TradeCard contract format is fed into a compliance engine for parsing and storing of the contract. The system transmits export financing and credit guarantee proposal to finance intermediaries for approval. The seller and buyer are duly notified of the approval for the seller to proceed with shipment within the time allowed. On shipment, the related parties already nominated such as consolidators, freight forwarders, inspection agents etc submit pre-determined data by electronic means to TradeCard compliance engine to conclude the transaction. As soon as the compliance is met after review of disparities if any and correction, the system of TradeCard sends payment instructions to the finance institutions already named by the parties and the institutions initiate money transfer process. Immediately thereafter, financial intermediaries are sent with details of payment which the buyer and seller receive as arranged.17 TradeDoc This internet based service introduced by Chase Manhattan Bank in January 1999 accelerates the letter of credit process through electronic generation of the connected documents thus replacing the paper documents and enabling the exporters to outsource the process to Chase through internet.18 Bolero The Bolero system has been introduced by the Society for World-wide Interbank Finacial Communication (SWIFT) and the Through Transport Club (TTClub).Bolero initiated in 1997, started operation in 1999.This system mainly focuses on generation of Bill of lading and its secure transfer of title. The standard trade documents provided by Bolero available in a secure network across al the trading countries are meant to reduce delays in transfers between banks and the business parties. Once Bolero is popular and covers all the trade documents apart from the Bill of Lading, electronic version of commerce will increase exponentially. The Bolero system uses SWIFT network, internet and other value added networks to carry the documents electronically by using secure technologies. The XML-based client interface and Application Programming Interface (API) offered by Bolero make the direct client input viable. The banking systems can access Bolero through API on the Platforms of Mainframe, Midrange, PC, MVS, Unix and Windows.19 Although the potential efficiency of electronic matching of documents is apparent, bankers are reluctant to adopt it as they maintain that volume of transactions at individual level does not warrant such a system.20 This is in contrast to the staggering figure of international volumes. It appears that the volume is fragmented all over the world which probably makes the cost of electronic matching unviable compared to the existing manual process. Therefore the trade should decide which is the better alternative, whether speedy transmission and error free or the existing errors-galore manual process. Conclusion In spite of error-laden letter of credit system of trade financing, it is still preferred for the banks’ role played between the applicant and the beneficiary. This is more of personalised nature at the respective party’s level which is a confidence building measure. The international trade litigation is abounding with cases of documents not in conformity with the stipulations in the letter of credit established between parties. The seemingly trivial nature of discrepancies such as invoices or packing slips not being original and even though they are in fact original not having been stamped as such are not taken lightly by the collecting banks. They promptly return the documents and refuse to honour the commitment in the letter of credit since the buyer can always litigate on such matters and hold the bankers liable. It is understandable if the Bill of lading is not in original form since original alone is considered a negotiable instrument. If the original with blank endorsement goes to wrong hands, it can always be used to clear the shipment from the harbour before the importer comes to know of it. So also, insurance policy which should be in original since insurer will entertain a claim without production of the original. But any one else making a fraudulent claim is a remote possibility unless the insured sleeps over any loss incurred by him. Even though original versions of invoices and packing materials are not going to present immediate problems in accessing the goods, difficulties will arise in inland transit if cleared goods are not accompanied by the original and at the time of tax assessment when the tax authorities would disallow deductions without the original invoices in the records of the importer. The tax assessment will be held some time later when it may not be possible for the importer to claim it from the exporter. He may have as well lost it and obviously cannot create another original. He can only give a certified true copy of the original and not the original itself. Hence it is quite understandable to insist on the documents to be strictly as stipulated by the letter of credit to avoid future complications. Hence, focus should be as to how to improve the existing system of letter of credit transactions. The ideal characteristics of a letter of credit are reliability, trust, lasting, negotiable, collateral, international, distance, third-party, irrevocable, transferable, conditional, flexible, legal and structural. With these characteristics the letter of credit seems to be irreplaceable from the international trade practices.21 A new system of payment that govern the contractual relationship from the importer to exporter encompassing all the intermediaries, can therefore arise only from the concept of letter of credit for which ICC has brought out guidelines in the form of UCP serving as almost as a secondary legislation for the parties involved. It is no exaggeration to say that UCP is almost a Bible for the bankers. The UCP 500 has been already updated taking into consideration of the practical difficulties and new version UCP 600 has been brought out in 2007 to be enforced from 2007 and it is too premature to comment upon its functioning. Bergami22 says that letter of credit continues to remain an acceptable instrument of finance although in the U.K. ₤ 113 million per annum are incurred to rectify discrepant documents.23. The UCP 500 had 49 articles whereas UCP 600 has only 39 articles which is a pointer to the simplification of the guidelines. Article 13 of UCP 500 had required bankers to verify the documents presented by the exporter as per the International standard banking practice. Actually there was no such standard until ICC itself (the author of UCP) brought out International Standard Banking Practice (ISBP) in 2003 and it was not made mandatory but voluntary. The article 13 of UCP 500 has been replaced by article 14 of UCP 600 in which the “doctrine of strict compliance” is still in place. As such even a spelling error between two documents not relevant to the fields of the letter of credit is not tolerated. Rather a regime of ‘inventing discrepancies’ has been established over the years as a result of the doctrine. Article 16 of UCP 600 (ex article 14) stipulates action to be taken on the discrepant documents. While under UCP 500, the issuing bank can approach the importer for waiver and even in the case of waiver, the issuing bank is under no obligation accept it in view of the other contractual considerations in the letter of credit mechanism, the UCP 600 provides that the export can consult with the bank prior to its request for the waiver. Article 14 of the UCP 600 (ex article 37) dilutes strict compliance in respect of product description on the invoice.24 The new versions of international payment instruments integrating the electronic process should focus on overcoming the following impediments. They are complexity, Dos-intermediation, acceptability and adoption. Complexity refers to the risk associated with large volume of transactions through electronic means causing disruptions in payment process which might prompt the users to avoid the system. The Dis-intermediation is the changes in the roles of the intermediaries. The TradeCard above does away with the need for a bank at the buyer’s end. The Bolero acts as a party to the transaction. Hence, such structural changes would result in risks of different nature and additional costs to the parties involved in the transaction. Acceptability: The new method must be accepted across multiple jurisdictions. And adoption refers to the time needed to prove robustness of the new system for being accepted as a new concept for which a critical mass of users will be necessary.25 It is therefore right to say that ‘‘The methods of payment in international trade transactions will need to evolve to reflect the changing nature of these transactions. It is arguable that some of the existing instruments do not meet users needs References Baker W, 1999, ‘Export L/Cs; Did you want your money now or later’, Business Credit, 101(6) p 33 Bergami Roberto, 2007 ‘Will the UCP 600 Provide Solutions to Letter of Credit Transactions?’ International Review of Business Research Papers, .3 (2) June, Pp. 41 –53 Bolero, 1999, The Bolero Service: Business Requirements Specification, version 2.0, The Bolero Project, 9 Jan. Chase.com, available at accessed 27 December 2009 Clarke, D. 1999, ‘Wire News: Unclogging International Trade’, Wired, July, 8. D’Arcy, Murray and Cleave, 2000, DArcy, L, Murray, C & Cleave, B 2000, Schmitthoffs Export Trade: The law and practice of international trade, Sweet and Maxwell, London, U.K. Dixon Mark and Glasson Bernard, Electronic Payment Systems for International Trade, Klein, CH 2006, Letter of Credit Law Developments, Jenner & Block LLP, Chicago, Il, USA. Geva, B. 1995, International Funds Transfers: Mechanisms and Laws, Chapter 1, in Norton, Reed and Walden Mauleella B.M, 1999, Payment Pitfalls for the Unwary, World Trade, 12(4) p 76-79 International Trade Fiance, 1998 Tam, A. 1999, Interview with Arthur Tam, Head of International Trade, BankWest, August. Tradecard.com, available at accessed 27 December 2009 SITPRO Ltd. 2003, Report on the use of export letters of credit 2001/2002, SITPRO Ltd., London. U.S.Bureau of the Census, 1999, Read More