Types of letters of credit: What should an exporter compare?

There is more than one classification

A credit can be both confirmed and payable at a future date. Start by separating three questions: whose undertaking supports payment, when is payment due, and does an intermediary need to make the credit available to a supplier? Pre-shipment funding is another issue. Treating all these labels as competing products can obscure the actual decision.

Confirmation is different from advice

A bank that advises a credit does not thereby add its own payment undertaking. Confirmation adds the confirming bank’s undertaking for a complying presentation. It matters when assessing issuing-bank and country exposure, but it does not cure defective documents.

Payment timing changes the economics

Payment at sight does not mean that documents bypass examination. With a deferred payment, identify the event from which the period runs. Sixty days after shipment and sixty days after the invoice date may produce different cash-flow dates.

A quotation comparison should therefore include the expected receipt date, financing costs and banking fees alongside the price. An apparently attractive margin can be offset by the cost of carrying the order.

Transferable and back-to-back credits

A transferable credit must be expressly designated as transferable under UCP 600; the bank’s agreement to carry out a transfer also matters. A back-to-back arrangement involves a separate credit issued against the first. The intermediary should compare the two sets of dates and documentary requirements, rather than assume that the second undertaking simply copies the first.

Standby support and advance funding

A standby credit commonly supports performance or payment if the expected obligation is not met. Its applicable rules and demand documents need attention. A red clause credit instead addresses pre-shipment funding through an advance mechanism.

The instruction “use a letter of credit” is therefore incomplete. Finance should map payment dates, operations should confirm that the required documents can be obtained, and legal review should examine the undertakings and claim conditions against the same draft.

Sources and further reading

• International Trade Administration — Trade Finance Guide
• ICC — UCP 600
• ICC Academy — Standby letters of credit

The examples are hypothetical. The governing law, banking documents and contract terms need to be assessed for the particular transaction.

Related reading: Red clause letters of credit