Documentary Risk in Commodity Trade Part 1
Introduction
to Documentary Credits
The documentary credit system has been used for over a hundred and fifty years, and still plays a major role in international trade. Letters of credit have been estimated to represent more than US$100 billion in banking obligations annually. At least 60 per cent of commodity trading is conducted through letters of credit.
Documentary credit is an essential part of the export process. It is a trade finance mechanism that was developed to add a measure of security to trade transactions, particularly between buyers and sellers from different countries, and to assert sufficient pressure in case of any violation or non-performance to the trade contract. The letter of credit calls for the participation of a third party, which is the bank.
The bank provides additional security for both parties; it plays the role of an intermediary, by assuring the seller that he will be paid if he provides the bank with the required documents, and by assuring the buyer that his money will not be paid unless the shipping documents evidencing proper shipment of his goods are presented.
Documentary credit or letter of credit is an undertaking issued by a bank (Issuing bank) for the account of the buyer (the Applicant) or for its own account, to pay the Beneficiary the value of the Draft and/or documents, provided that the terms and conditions of the Documentary Credit are complied with.
There are initially three parties involved in documentary credit, the issuer (issuing bank), the account party (buyer/applicant), and the beneficiary (seller). Three agreements represent the relationship between the parties, a trade contract between buyer and seller, the documentary credit between the issuing bank and the seller, and a reimbursement agreement between the issuing bank and the buyer. Although the three agreements are related to the same transaction, each of them is independent, and the breach of one agreement may not constitute breach of another agreement.
There are strict requirements that govern the formulation of documentary credit. The International Chamber of Commerce (ICC) is the organization which has developed the most extensive and most commonly applied rules, models, and materials related to documentary credit.
The documentary credit system has been used for over a hundred and fifty years, and still plays a major role in international trade. Letters of credit have been estimated to represent more than US$100 billion in banking obligations annually. At least 60 per cent of commodity trading is conducted through letters of credit.
Documentary credit is an essential part of the export process. It is a trade finance mechanism that was developed to add a measure of security to trade transactions, particularly between buyers and sellers from different countries, and to assert sufficient pressure in case of any violation or non-performance to the trade contract. The letter of credit calls for the participation of a third party, which is the bank.
The bank provides additional security for both parties; it plays the role of an intermediary, by assuring the seller that he will be paid if he provides the bank with the required documents, and by assuring the buyer that his money will not be paid unless the shipping documents evidencing proper shipment of his goods are presented.
Documentary credit or letter of credit is an undertaking issued by a bank (Issuing bank) for the account of the buyer (the Applicant) or for its own account, to pay the Beneficiary the value of the Draft and/or documents, provided that the terms and conditions of the Documentary Credit are complied with.
There are initially three parties involved in documentary credit, the issuer (issuing bank), the account party (buyer/applicant), and the beneficiary (seller). Three agreements represent the relationship between the parties, a trade contract between buyer and seller, the documentary credit between the issuing bank and the seller, and a reimbursement agreement between the issuing bank and the buyer. Although the three agreements are related to the same transaction, each of them is independent, and the breach of one agreement may not constitute breach of another agreement.
There are strict requirements that govern the formulation of documentary credit. The International Chamber of Commerce (ICC) is the organization which has developed the most extensive and most commonly applied rules, models, and materials related to documentary credit.
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