Guide to Letters of Credit

Let’s start from a UK export point of view. As an example we’ll take a UK manufacturer selling a high value piece of equipment to a buyer somewhere outside of the EU. (It could also be within the EU). The export order is relatively large for the UK company and the finance director is anxious not to incur a significant financial risk, and may also need to raise some pre-shipment finance to source components to build the finished product. In addition to the risk of default by the buyer there may be other risks associated with an export to a particular country without having been paid first, for instance arbitrary imposition of new customs regulations or even a change of regime upsetting that country’s economic stability.

For his part, the overseas buyer is not prepared to pay for the goods in advance of shipment as he has no guarantee that the UK company will perform satisfactorily.

The solution is a letter of credit opened by the buyer’s bank providing a conditional guarantee to the seller.

  • The letter of credit contains a list of documents that must be presented by the seller to a UK bank acting as correspondent of the buyer’s bank.
  • Payment will be guaranteed by the buyer’s bank without further reference to the buyer provided the letter of credit term are met.
  • The bank will determine whether or not the conditions of the letter of credit have been met by the seller at the time that the bank receives the shipping documents.
  • The documents required will include at the very least an invoice, and a movement document e.g. a full set of bills of lading or an air waybill signed by an agent of the carrier, evidencing that the correct goods have been irrevocably despatched to the port or airport of destination within the agreed time period. Other documents the buyer might require are a certificate of origin issued by a chamber of commerce, a packing list, various certificates issued by the seller and perhaps also a pre-shipment inspection certificate issued by an independent third party inspection agency.

Shortly after the sale is agreed, the UK exporter receives a letter of credit from an overseas bank, passed on by a UK bank, which, if the terms and conditions are correct, allows the exporter to proceed with production and/or procurement with confidence and security. The overseas buyer is irrevocably committed to the purchase – but only if the seller conforms in every minute way to the terms and conditions stipulated in the letter of credit. Some important information is given below after a description of the process.

​Here's how the process works step by step:

Step 1

The UK seller (Beneficiary) and overseas buyer (Applicant) agree the terms of the contract. The price of the goods might include freight or insurance to the port of destination.

Step 2

The applicant instructs his bank to issue a letter of credit. The buyer is the Applicant of the letter of credit and the seller is the Beneficiary.

Step 3

The overseas Bank (the Issuing Bank) sends their letter of credit to their UK correspondent (the Advising Bank).

Step 4

The UK Advising Bank delivers the letter of credit to the Beneficiary (seller).

Step 5

The Beneficiary (seller) checks through the letter of credit terms and if happy, prepares the goods for shipment.

Step 6

The goods are shipped and the documents evidencing shipment such as a bill of lading or air waybill are issued by the shipping company.

Step 7

The beneficiary prepares the other documents specified within the Letter of Credit (i.e. Invoice, Packing List Certificate of Origin) and present to the advising UK bank.

Step 8

Depending on the Letter of Credit conditions, either the advising or issuing bank effects payment to the beneficiary and releases the shipping documents to the applicant.

The bank will scrupulously check through all the documents, looking for discrepancies between the documents, for example any slight difference between weights or descriptions of the goods between the documents, or any terms and conditions of the letter of credit that have been missed or not complied with in any way. Remember that the UK bank, even if it is your own bank (but it could be any other UK bank), is acting as agent for the buyer’s bank to protect the buyer from having his letter of credit drawn down without all of the terms and conditions having been met. They take this very seriously especially if they have confirmed the letter of credit (see below).

If Synergy have prepared the documents, the bank will find the documents to be completely compliant – we have never presented a set of documents that have failed these criteria in many years and many thousands of documentary presentations. However, around 60-70% of presentations to banks ARE rejected due to discrepancies. This figure is not verifiable but many of us in Synergy have worked within the letter of credit departments of UK banks, and we know from personal experience that this is very likely to be correct.

Important Additional Information

For a fee, the UK Advising Bank can enter into the commitment given by their overseas correspondent bank – the Issuing Bank – and can undertake to pay you against presentation of the required documents without referring to the Issuing Bank.  This is called “confirmation” and is highly recommended under most circumstances but can be a waste of money if the terms and conditions of the letter of credit don’t exactly suit your needs.  Working with Synergy you can be sure that this is the case and we can make recommendations about how the letter of credit is set up and which UK bank is most suited to be the “Confirming Bank”.  We know all of the UK Advising Banks, how efficient they are, their appetite for overseas bank risk and the fees they charge.

Come to us as early in the process as possible, before the letter of credit is set up, so that we can make sure that you are secure in the transaction and get paid on first demand.

Some letters of credit include a credit period, meaning that if the documents you present are all in order the bank will commit to pay you at a future date. This is usually in the range of 30 to 180 days. It is worth considering this if it is attractive to the buyer because the Confirming Bank should be happy to discount this period at a fine rate so that you do not wait for payment until the due date. We will check with the prospective Confirming Bank before the letter of credit is issued to make sure this option is available