Article

by Mark Ford

Letters of credit (L/Cs) may be one of the world's oldest trading instruments, but they can also be powerful instruments for policymakers wanting to restrict or promote international trade, raise taxes or simply to make a geopolitical point.

The humble L/C may even have helped engineer Arizona Senator John McCain's dramatic emergence from the political ashes on Super Tuesday in the US to become the Republican choice to face the Democratic candidate in the race for the White House.

Iran and Cuba

Insistence on the use of L/Cs for all sales to Iraq in the United Nations' oil-for-food programme between 1993 and 2003 was possibly the most sustained use of the documentary credit as a tool for implementing policy. Now the focus has shifted. The main target is Iran, with which L/C business is becoming increasingly difficult to write, largely due to a US presidential decree issued in the wake of the 9/11 attacks on the US.

When US President George Bush signed Executive Order 13224 on 23 September 2001, he bestowed massive powers on US Secretaries of State and Treasury who, in consultation with each other and the Attorney General, have the authority to disrupt the financial support network for terrorists and terrorist organizations.

Without having to go to court or consult the international community, the order allows Washington "to designate and block the assets of foreign individuals and entities that commit, or pose a significant risk of committing, acts of terrorism". Effectively, US firms and financial institutions can be barred from dealing with blacklisted entities.

In January 2007, the US blacklisted Bank Sepah, Iran's fifth largest bank, accusing it of ''direct and extensive financial services to Iranian entities responsible for developing missiles capable of carrying weapons of mass destruction''. In October 2007, Treasury officials imposed sanctions on three more Iranian banks - Bank Mellat, Bank Saderat and Bank Melli. Washington said Bank Melli was blacklisted because it had ''provided a range of financial services on behalf of Iran's nuclear and missile industries, including opening letters of credit and maintaining accounts''.

Despite denials from Iranian officials, it seems the sanctions have had a severe impact on Iranian L/C business and affected pricing in other locations. What has been particularly damaging in terms of Iranian L/C business is Washington's apparent success, over and above banning US firms and financial institutions from dealing with the blacklisted banks, in encouraging major European banks to cut business links with the Islamic republic.

Global banking giants such as HSBC, UBS and Credit Suisse took the lead, followed by Deutsche Bank, Commerzbank and BNP Paribas, all of which refused to accept L/Cs issued by their Iranian counterparts. Non-US financial institutions voluntarily curb ties with institutions blacklisted by Washington, figuring through their own risk assessments that Washington could blacklist them too if they deal with a proscribed institution.

Banks in Japan and India have quietly followed suit, according to US Treasury officials, but the extent to which they have or not is not so clear-cut. In December, the State Bank of India (SBI) denied that it has been pressured by the US to stop honouring L/Cs issued by Iranian banks.

Some countries are under political pressure to show that they are not simply going to go along with Washington. Even countries heavily dependent on the US - including Afghanistan and Iraq - have so far resisted pressure to take action against Bank Melli.

Iran is still writing L/C business with some major customers. Japan's Nippon Oil, however, has started opening L/Cs to pay for Iranian oil in yen rather than in US dollars, a move that is justified by Iranian officials who argue the currency shift is due mainly to the weakening US dollar.

Cuba is also in Washington's sights, and again the US is using L/Cs, in this instance to restrict trade. In 2000, the US said agricultural products, medicines and medical supplies may be exported to Cuba, as long as they are paid for through a L/C from a third country financial institution that may be confirmed or advised by a US financial institution or by payment of cash in advance. Except as authorized, no bank in the US or overseas branch or subsidiary of a US bank may advise an L/C involving Cuba.

Controversial L/C policies

Governments across the world contemplate L/Cs in the course of framing domestic policies, and several countries routinely change taxes and duty on certain L/Cs to control aspects of the economy. In June 2007, Pakistan's government imposed a five per cent federal excise duty on L/C issuance, along with 11 other types of non-fund banking services in a bid to generate nearly USD 100 million in additional revenues in fiscal year 2007-08.

Using L/Cs in political contexts can be controversial. Bangladesh imposed a 100 per cent L/C margin on 56 imported items in 2001 in order to boost shrunken foreign exchange reserves. The government was subsequently persuaded to scrap the margins by the International Monetary Fund (IMF) after it said some of its loan disbursements were conditional on doing so. The margins were not popular with traders while the IMF's call to lift them upset former finance minister Saifur Rahman.

In Lebanon, the use of L/Cs by the government to support state power producer Electricité du Liban (EDL) has also proved to be controversial. Last November, critics of the government from within EDL's management said that widespread power blackouts were imminent because of delays in issuing L/Cs needed for tankers to unload the fuel required by the power producer. The criticism forced finance minister Jihad Azour to reassure the public that the government would issue all the L/Cs required. He reckoned officials at the state-run utility were raising the issue of L/C delays because they disapproved of government plans for the much- needed reform of EDL. "Every two months or so the same problem emerges. They want to divert attention from the real problem and turn it into an issue of delays in issuing L/Cs and the threat of blackouts, knowing that the government will bail them out every time," he said.

A force for good

Legislators can also harness L/Cs for positive purposes. In 2006, Vietnam introduced new legislation to provide guarantees for importers and exporters in a bid to encourage cross-border trading. Guarantees of up to 85 per cent of the value of some deals are now available. China and Russia late last year formally launched a trade platform that will allow L/C transactions and futures trading in cement, construction materials and other goods between the two countries. Up until this move, L/Cs had not been accepted in recent years for Sino- Russian trades of this type.

The Chinese government, meanwhile, was pressed hard last year by a "pro-L/C" group of investors in China's manufacturing companies who wanted the authorities to accept L/Cs in lieu of cash deposits under new trading laws meant to make the manufacture of cheap goods in China more difficult. The Chinese government had planned to rid the country of its reputation for cheap manufactured goods by making it more difficult to operate in this sector by requiring manufacturers to pay cash deposits for importing 1,853 types of raw materials. The pro- L/C investors - many of them based in Hong Kong - forced Beijing to delay its decision on cash deposits.

L/Cs for votes

A potentially dramatic use of an L/C in a political context emerged in a report from the state of Iowa suggesting that US Senator John McCain used an L/C to financially engineer his spectacular political turnaround that saw him emerge on Super Tuesday as the unexpected frontrunner in the race to be nominated the Republicans' 2008 candidate for the White House.

When the results were announced, McCain was more than halfway towards the number of delegates needed to clinch the nomination. In contrast, in mid-2007, his campaign was off the tracks and he was nearly broke, leading pundits to declare the senator's trail to Washington was at a dead end.

Deserted by donors, McCain decided to rescue his campaign by turning to Fidelity Bank & Trust, with which he arranged a USD 4 million loan, according to a Federal Election Commission report released on 30 January 2008. According to commission documents obtained by DCInsight, McCain's campaign tapped into the loan during November and December 2007, drawing down a total of USD 297,1697.20 in ten tranches of between USD 70,000 and USD 788,125. McCain's campaign had finished 2007 with just USD 2.9 million available and debt of USD 4.5 million according to the report.

According to a report in the Des Moines Register, McCain used an L/C to pay for "substantial television advertising time" in New Hampshire and South Carolina, two of the early nominating states. McCain's campaign office declined to provide specific details about how L/Cs were deployed by the campaign. A journalist who has extensively covered the US primaries, and who has spoken directly with McCain and discussed L/C usage in the campaign with the senator's staff, however, confirmed to DCInsight that the senator and his officers "never disputed the use of the term letter of credit".

Mark Ford's e-mail is markford@gotadsl.co.uk