Article

by T.O. Lee

The commodities trade has many special features: to name a few, very large transaction amounts, market prices based on the industry index, highly volatile price fluctuations and delivery by maritime charter. There is also a special jargon of the trade. Because the transaction amounts are so large, letters of credit are often used to offer protection to the seller, particularly in highly volatile market situations. However, payment disputes often arise for the following reasons:

1. In most banks, there is no specially organized commodity desk to handle the commodities trade. Document checkers are called upon at random to handle the document checking, and they are often not familiar with the trade jargon and consider the use of it to be a valid discrepancy. One banker friend told me frankly that he takes the easy way out: "If I do not understand the term, I treat it as a discrepancy. I have no obligation to find out its meaning or implication. This is not required under the UCP or ISBP."

2. Most document checkers on the commodity desk, even if they have passed the CDCS examination and are experienced in credit operations, are not sufficiently trained by experts in commodities on subjects such as charter party bills of lading, Incoterms 2000, trade practices and jargon, etc., particularly with regard to steel products and hydrocarbons that comprise the majority of the disputes concerning discrepancies.

3. Some well-established banking practices in document checking may well have to be modified in order to harmonize them with the transactions in commodities.

DOCDEX example

An example of these problems can be found in DOCDEX Decision No. 262. The credit in this case had the following provisions under description of goods in SWIFT field 45A after amendments: "CFR basis one safe berth/port Dongguan, China. Price shall be in USD per barrel based on the average of mean of PLATT'S (MOPS) quotations for Singapore physical 95 UNL cargoes as published in PLATT'S Asia Pacific/Arab Gulf Marketscan for 5 issues, namely 2 issues immediately preceding, 2 issues immediately following, and the issue on B/L date with a premium of USD5.20 (five point twenty) per barrel plus USD36.50 per MT." Price formula: "(MOPS for 95 UNL + USD5.20) per BBL (barrel) + USD36.50 per metric ton" where "USD5.20 per barrel" was the agreed price premium for the seller and "USD36.50 per metric ton" was the agreed sea freight.

Price formula

Should the issuing bank check the price formula stated in the credit? The price of the commodity (hydrocarbons) in this case was based on an authoritative industry index, the Platts daily quotations for hydrocarbons. To be fair to both the seller and the buyer in a volatile market, the final price used for invoicing is the mean value of the Platts quotations for five consecutive working days, so that wide price fluctuations during these five days, if any, can be ironed out more evenly.

Based on the averaged Platts quotation, a mutually agreed premium (USD 5.20 per barrel) for the seller was added to create the FOB price. To calculate the CFR price, the mutually agreed sea freight (USD 36.50 per MT) was used, multiplied by the final quantity shipped on board. All of these separate calculations were added up to comprise the price formula. This cannot be checked by the naked eye; use of a calculator is a must to check the correctness of the invoiced amount.

However, ISBP 681 paragraph 24 states: "Detailed mathematical calculations in documents will not be checked by banks. Banks are only obliged to check total values against the credit and other required documents." Unfortunately, the supply of commodities, such as agricultural produce, depends on weather conditions, and hence a variance of up to 10 per cent is customarily allowed. Loading also depends on weather conditions. Rice brans, for example, being combustible, cannot be loaded at 40 degrees Celsius, according to the Lloyd's survey handbook. Hydrocarbons cannot be loaded on dry days measured by a "flash point" that may trigger combustion or, even worse, an explosion, according to a provision in the popular ASBATANKVOY tanker voyage charter party.

These and other cases mean that the credit quantity may not be shipped in full. As a result, the invoice amount may differ from the credit amount. Under these circumstances, the issuing bank may be compelled to check the price formula to ascertain the correctness of the price shown in the invoice. But according to ISBP 681 paragraph 28, banks need not check complicated calculations. This is clearly a problem.

The Platts index

The Platts daily quotations for hydrocarbons are published by McGraw Hill and are available exclusively to members who pay an expensive membership fee. Banks that do not deal with hydrocarbons on a regular basis find the fee prohibitive. But the credit in this DOCDEX case did not require presentation of Platts' quotations print-outs. Without these print-outs in hand and being unable to enter the Platts website, the issuing bank cannot ascertain whether the invoiced amount, in units of millions of USD, is correct or not.

Furthermore, if during the period specified in the price formula, Platts quotations are not available due to holidays, the quotations for the following working days have to be used. For the reasons stated above, the issuing bank has no way to verify this fact and must trust the statements made by the beneficiary. In practice, to increase their profits some unscrupulous sellers may mislead the bank concerning holidays of commodity index publishers and use a more favourable quotation from another working day. Once the credit is fully paid, it is difficult and costly to claim back the overcharged amount from the beneficiary. Solely from a risk management point of view, the issuing bank should approach the applicant for this trade information, even though this is not required in the UCP or the ISBP.

Trade jargon

Should quoting a popular trade jargon in the calculation of price formula be deemed to be a valid discrepancy, even though the invoice and other documents have "copied and pasted" the description of goods stated in the credit? The credit in the DOCDEX case asked for "mixed aromatics" based on the "PLATTS MOPS physical 95 UNL" index. The number "95" refers to the octane rating; the higher this number, the more power is produced by the gasoline. "UNL" is an abbreviation for "unleaded". This description of the goods in the credit was duly mentioned in the commercial invoice and other documents. Only in the price calculation part of the commercial invoice was the term "Mogas 95 UNL" used. Because there is no quotation for "physical 95 UNL" in the Platts index report, the nearest index, "Mogas 95 UNL", was used to calculate the price, and by applying an adjustment factor (being the premium of USD 5.20 per barrel), "MOPS physical 95 UNL" was converted to "Platt Singapore Mogas 95 UNL". This fact is clearly understood in the price formula in SWIFT field 45A, and the document checker should have been aware of this. The conclusion: the alleged discrepancy in the DOCDEX case: "L/C stipulates price based on MOPS quotations while invoice shows 'MOGAS 95 UNL' quotation" should have been judged invalid.

Conclusion

In view of the special nature of the commodities trade, it would be useful for the ICC Banking Commission to provide a position paper or statement concerning ground rules for checking documents in this area. I believe this trade merits this special treatment because the transaction amounts are very large, often involving complicated price formulas and popular trade jargon, not to mention that letters of indemnity are often used in lieu of charter party bills of lading in some contingency situations.

T.O. Lee FAE MCIArb MITD was a member of the UCP 600 Consulting Group, and is a Fellow of the Academy of Experts, London. His website is www.tolee.com