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Copyright © International Chamber of Commerce (ICC). All rights reserved.
( Source of the document: ICC Digital Library )
by Kim Christensen
by Kim Christensen
In my article on sanctions in the last issue of DCInsight, I discussed the troublesome issue of sanctions clauses that are appearing more and more in letters of credit and noted that sanctions can be directed against countries, but are normally directed against persons, entities or specified goods and/or commodities (such as petroleum, drugs and weapons) imported from or exported to certain countries. I also observed that the main concern is clauses that go beyond informing the parties that the (issuing/confirming) bank is subject to sanctions. Some clauses may also include the bank's special provisions, which ask for more than what the sanctions imposed require.
In the second part of this article, I will look at the problems that arise concerning sanctions clauses in different trade finance instruments - documentary credits, guarantees and collections.
Sanction texts and customers
Although sanctions and compliance are governmental requirements that banks can do nothing about, there are questions that arise vis-à-vis banks and their customers - the buyers and sellers.
Most customers, when they think about sanctions at all, perceive them to be an evil created by banks in order to include some kind of "reserve" in their undertaking - e.g., "a confirmation with an escape clause". The result is that banks have a big task explaining why compliance checks have to be carried out. But since not all banks include a sanctions text in their documentary credits, confirmations and guarantees, this has become, in some ways, a competitive issue; i.e., "If your bank insists on this clause I will go to Bank X that does not have such a clause."
This attitude may not be reasonable, because the same compliance requirements would apply without the sanctions text, just as the same (most likely1) would apply to other banks in the same country. There are, however, some specific issues for companies doing international trade using trade finance instruments.
At the outset it is the customers who are the key here. They are the ones who determine with whom they do business, what goods they ship and to which destinations, with whom they ship, etc. It is ultimately their risk if there is a sanctions breach. There is also a global challenge in that customers may not be subject to the same legislation as issuing or confirming banks. For example, consider an EU-based company exporting goods to Myanmar. It is not prohibited for EU companies to do business with that country; however, some banks in Myanmar are on the US OFAC SDN list of sanctioned companies, which means that banks applying the list must not handle such transactions. This can be difficult to monitor, even for the most proactive banks and enterprises.
In any case, banks should be discouraged from using sanctions to gain a competitive advantage. The issues are too important for that.
Different trade finance products raise different challenges. Consider first documentary credits.
In the trade finance community, it is likely that the sanctions texts in documentary credits that have been the most discussed. It is here that the majority of "hits" are to be found, because the involved banks have access to the full documentation of the transaction. As mentioned in my previous article, sanctions texts in documentary credits can be troublesome if they interfere with the irrevocable nature of the instrument. But if a text merely states what governmental sanctions apply to the issuing/confirming bank, it is hard to argue against it.
Unfortunately, however, there are situations where the documentary credit text goes far beyond this. One I mentioned in my last article: ("Bank X has adopted policies which in some cases go beyond the requirements of applicable laws and regulations"). Another one, equally troublesome, was the following:
"Under UCP 600 concerned banks (i.e. nominated bank, presenting bank, confirming and issuing bank) shall examine the presentation taking into consideration the sanctions and regulations enforced by the US, EU and United nations against certain national shipping lines and/or vessels and/ or ports, therefore, we (as issuing bank) shall consider any presentation that shows a breach of such sanctions and regulations, as discrepant and reserve our right to stop payment/reimbursement or claim refund or any already paid payment/ reimbursement. The bank assumes no liability for rejecting any presentation of documents that may violate the aforesaid condition and any loss, damages or delay arising directly or indirectly in connection with the aforesaid matters" [Emphasis added]
What makes this clause problematic is the fact that it links the UCP to the sanctions and regulations. When dealing with sanctions and documentary credits, it is vital to separate the two, so that there is no doubt about the bank's obligation under the documentary credit.
There may well be situations in which the bank is obligated under a documentary credit because a complying presentation has been made, but where the bank is not allowed to handle the transaction because of the sanctions in effect. In such a case, the sanctions must be applied. But if for some reason the sanctions are lifted, the obligation still stands, and the bank must honour or negotiate. If the "breach of a sanction" is considered to be a discrepancy according to UCP 600, the document can be duly refused, and the bank is not obligated to honour or negotiate.
One could argue that guarantees are less risky than L/Cs in terms of sanctions, because normally the trade documentation is not routed via the guarantee, meaning that banks may not have access to the names of all of the involved parties nor to the name of the vessel if there is one. Nonetheless, sanctions apply to guarantees just as they do to documentary credits. Therefore, banks may also elect to include a sanctions text in guarantees.
This can cause problems, in part because it is not standard practice to include text in addition to the agreed guarantee text, but also because of the structure of many guarantees. For example, in the case of a counter-guarantee, the question is whether a sanctions text should be part of the guarantee text to be quoted to the beneficiary, or in the text to the guarantor or both.
In many cases, guarantee texts are carefully structured by lawyers before being passed on to the guarantor, and in such instances the commercial parties may object if the guarantor includes additional text.
Ironically, there is also an issue regarding guarantees issued in favour of governmental entities. These are often standardized texts, and changes to them may not be acceptable because the entity could have to go back to its legal department to determine if a change makes a difference in terms of the coverage of the guarantee and the obligation of the guarantor.
Collections can be a special case when it comes to compliance checks. URC 522 article 4 includes the following two statements:
- Sub-article 4 (a) (3): "Banks will not examine documents in order to obtain instructions."
- Sub-article 4 (3) (b) (6): "A collection instrument should contain as appropriate ... List of documents enclosed and the numerical count of each document."
In collections, banks will count the documents but will not examine them. A compliance check requires that documents be examined, and this means extra work, which of course is an additional burden for a product that is relatively cheap.
Direct collections are even more problematic, since the documents are sent directly from the principal to the collecting bank on behalf of the remitting bank. The remitting bank has no real opportunity to do a compliance check, unless of course it obtains access to the documents. But if it does, the idea behind direct collections is weakened, as well as the economic incentive of using them.
The bottom line is that compliance checks must be carried out. This can be done in a number of ways. Most of the sanctions lists are available on the Internet. Moreover, there are companies that have developed software allowing banks to do automated compliance checks.
When it comes to the messages sent via SWIFT this works quite well, but one challenge is the quantity of documents flowing in and out of trade finance departments relating to documentary credit and collection deals. Doing automated screening of documents requires that they be scanned, and anyone who has seen documents presented under a documentary credit or for collection will realize the practical difficulties of doing this. There may be hundreds of pages in one set of documents, often fastened with staples and coming in different sizes and shapes.
Nevertheless, many banks do screen documents on a daily basis, while most other banks still do not have any kind of compliance check in place.
In addition, the compliance software is a challenge in itself, and considerable work must be done by the bank in order to only obtain real and reliable "hits".
It is difficult to find perfect solutions to these challenges, but some general observations can be made.
1. Much is said about sanctions but one thing is sure: they will not go away. Therefore, banks have to accept them and develop constructive solutions that take into account the special nature of trade finance transactions; e.g., the large number of physical documents.
2. Nominated and confirming banks to a documentary credit have special roles that require protection.
3. Compliance checks may be structured in a number of ways. What is important is that they be well thought through, well documented, communicated and logged.
This field is not yet mature, and what banks are experiencing today is only the beginning. Sanctions issues haven't taken up much space in trade finance publications, which is unfortunate, since discussions of them will make the trade finance community more aware. At the end of the day, more information will help us all move to broader solutions - better suited to trade finance products.
Kim Christensen is Vice President and Head of Trade Products and Business Relations in Nordea in Denmark. His e-mail address is email@example.com
1Of course there may be differences - for example US banks operating outside the US must still apply US law - which means they must check the transactions they handle against the OFAC List.