The Advantages of Negotiation in Documentary Credit Transactions
Many trade finance bankers ¡ª particularly from Europe ¡ª are of the opinion that there is no need for the retention of negotiation as an option for documentary credits in the next revision of the UCP (Uniform Customs and Practice for Documentary Credits). They argue that the whole concept of negotiation in the UCP is very vague and widely misunderstood in practice. Many of them also say that there is virtually no need for negotiation and no real advantages to keeping it in the next revision of the UCP. I partially agree with the first argument but I do not think that the whole concept of negotiation is completely redundant and without value.
In this article I am trying to discuss the value of negotiation within the UCP 600 context. I feel that the most suitable way to tackle the issue might be to compare credits available by negotiation to credits available by payment,deferred payment and by acceptance. The aim is to discuss the advantages and disadvantages of negotiation (that is documentary credit available by negotiation),provided that the credit is available with the nominated bank (which can also be the confirming bank) and complying documents are presented.
UCP 600 and Negotiation
In article 2 of the UCP 600 negotiation is defined as follows:
"Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation,by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank."
Consequently,it is obvious that:
- negotiation can be,in the context of UCP 600,made only by a nominated bank,not by the issuing bank;
- not only drafts,but also documents alone can be negotiated under a credit available by negotiation;
- UCP 600 envisages only negotiation in case of complying presentation;
- negotiation is a "purchase" which constitutes providing payment of funds in advance or agreement to advance funds in favor of the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.
It is,therefore,wrong to issue credits to be available by negotiation with an issuing bank or any other bank than the nominated bank or banks.
Negotiation vs. Sight Payment
The Beneficiary's Perspective
In case of credit available by negotiation (sight negotiation credit),the beneficiary obtains payment from the nominated bank but pays interest until the negotiating bank receives the proceeds (or reimbursement) from the issuing bank. If the negotiation is effected by the nominated non-confirming bank,the negotiation is usually provided with recourse. However,in practice the recourse is not often exercised as documents are taken up in the majority of cases even if discrepant. The price for negotiation is based on the credit risk of the issuing/confirming bank and the respective domicile country. In a majority of cases,the price is quite favorable,and as a result banks might be inclined to negotiate.
In a freely negotiable credit the beneficiary can shop around among banks to find the best price for the negotiation. If the beneficiary has difficulty finding a bank willing to negotiate,the nominated confirming bank would have to negotiate a complying presentation without recourse.
If the credit is available by sight payment,the beneficiary gets payment free of any interest. The nominated (confirming) bank usually reimburses itself immediately. Even if the payment is done by the nominated (non-confirming) bank,it is final,that is without recourse ¡ª unless done under reserve or similarly when the documents were discrepant.
The fact is that the nominated (non-confirming) bank often does not pay immediately but rather sends the documents to the issuing (confirming) bank for payment and pays the beneficiary only after it receives the proceeds even if the documents are found by that bank to be compliant.
The Applicant's Perspective
By providing credit through negotiation,the applicant gives the beneficiary (the applicant¡®s contracting party) favorable payment terms. The negotiation credit puts the beneficiary in funds promptly.
When the credit is available by payment with the nominated bank and the documents are taken up by that bank as compliant,some issuing banks reimburse the nominated bank at its request from their own funds. After the issuing banks receive the documents and determine they are in order ¡ª or after any possible discrepancies are waived by the applicant ¡ª they debit the applicant for the document's value. The issuing banks charge the applicant interest for the period for which they are out of funds. There is no similar charge in case of negotiation credit for the account of the applicant. Therefore it seems that in this case the negotiation credit is more convenient to applicants than the use of sight payment (with the nominated bank). However,this practice is not upheld universally. The practice of many other issuing banks is to debit the applicant's account immediately when reimbursing the nominated or confirming bank,which is arguably even less favourable to him than to pay the respective interest alone.
Whatever the practice of the issuing bank regarding debiting the applicant regarding the reimbursement of the nominated bank,it is clear that the negotiation credit is more favourable to the applicant than the sight payment credit. In the case of payment credit,the applicant either gets debited before the documents arrive at the counters of his or her own bank or pays the interest.
This is not the case when the negotiation credit is applied. In that case the nominated bank advances funds to the beneficiary from its own pocket. The issuing bank reimburses the nominated negotiating bank only when it receives the documents and finds them in order or accepts them despite discrepancies.
The Bank's Perspective
It appears that the negotiation credit is suitable for a nominated bank as the bank could make extra money without unreasonable risk. On the other hand,it pays the value from its own resources,it takes the risk that it does not get reimbursed and also it would not be able to obtain the money back from the beneficiary if the negotiation is made with recourse (by a non-confirming bank).
What about the perspective of the issuing bank? It seems clear to me that the issuing bank finds the option of reimbursing the nominated bank only after it receives and examines the documents (such as in case of negotiation credit) more appealing than reimbursing the nominated bank beforehand.
From an operational point of view,the issuing bank runs the risk that the nominated bank pays the beneficiary despite discrepancies,either in the unlikely case of a deliberate action or the more likely instance of failing to detect discrepancies. The issuing bank may then face difficulties in obtaining a refund from the nominated bank in case the documents are not taken up by the issuing bank.
Credit by Negotiation vs. Deferred Payment
The Beneficiary's Perspective
In the case of a credit available by negotiation,the beneficiary gets payment but would pay interest for the period from the payment until the negotiating bank receives the proceeds from the issuing (confirming) bank. If the negotiation is effected by the nominated non-confirming bank,the negotiation is,moreover,normally provided with recourse.
If the credit is available by deferred payment,the beneficiary receives the payment at maturity. The nominated bank pays the beneficiary on the maturity date and reimburses itself on that date. If the beneficiary wants the money earlier,after the documents are taken up and the respective bank or banks incur the deferred payment undertaking in his or her favour,a bank can be asked to provide the beneficiary with financing.
In which form can such financing be provided? Let's first assume that the nominated bank does not act according to its nomination,and does not incur its own deferred payment undertaking. The issuing bank takes up the documents and incurs its deferred payment undertaking (to pay on the maturity date),which the nominated bank (which does not act on its nomination) can possibly discount.
In other words,the nominated bank would discount the deferred payment obligation of the issuing bank (or confirming bank,if any) incurred in favour of the beneficiary. The beneficiary can,in line with applicable law,sell such a receivable to anybody else,such as to the nominated bank or any other bank which may not have been involved in the credit transaction at all. Such a sale of the receivable would be made by means of the assignment of proceeds,for value,as discounted proceeds.
Discounting of deferred payment obligations under documentary credits is normally done as a forfait,or without recourse. However,in the case of fraud in the credit transaction,the position of the discounting bank ¡ª the assignee ¡ª is apparently less secure than that of a bank that negotiates under a negotiation credit. Consequently,the position of the nominated bank which negotiates in good faith is better than the position of the nominated or any other bank which discounts in go