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Copyright © International Chamber of Commerce (ICC). All rights reserved.
( Source of the document: ICC Digital Library )
by Roberto Bergami
As DCInsight readers know, the Irrevocable Documentary Letter of Credit (IDLC) is regarded by sellers and buyers involved in international trade transactions as a "safe" form of payment. The attractiveness of the IDLC is evidenced through the impact of the global financial crisis (GFC) that caused resurgence in IDLC business, because in times of uncertainty people look to safe havens. Indeed, recent estimates point to IDLC business increasing from an approximate 30% (pre-GFC) to the current 42%.
The IDLC is attractive to sellers because the buyer's credit risk is replaced by that of the issuing bank (IB). The IB gives a payment undertaking to the seller (beneficiary) based on documentary compliance because, in an IDLC, banks deal with documents only, in accordance with article 5 of UCP 600. Data content on documents, therefore, are crucial in the determination of whether the beneficiary has complied with the IDLC requirements in order to trigger the payment mechanism. Where discrepancies occur, a non-compliant presentation will result, with the beneficiary running the risk of payment delays and, in more severe circumstances, bad debts.
As reflected in past articles in ITALICS DCInsight, the issue of documentary discrepancies continues to be a concern. For a considerable period of time, the trading world was informed that, according to ICC estimates, worldwide documentary discrepancy rates on first presentation were an alarming 70%. In 2010, however, ICC admitted that "Industry is well aware that a lack of a comprehensive set of statistics on trade finance limits efforts to confirm the trends revealed by market intelligence surveys." (Rethinking Trade Finance: Global Survey 2010). Some believe that discrepancy rates are at much lower levels than earlier estimates, at perhaps half - around 30 to 35%.
This article focuses on discrepancies based on an Australian study of manufacturing exporters to ASEAN. The study was based on more than 150 responses and in-depth face-to-face interviews with exporters, service providers and banks across the country. The discrepancy rates are identified and discussed form a risk management perspective, and comments were provided about the production of documentary data highlighting possible underlying causes for documentary errors.
The Australian study
The rates of IDLC discrepancies in the Australian study based on the number of transactions are summarized in Table 1 below. The data show that in nearly three-quarters of transactions discrepancies happen at a rate of 25% or less. For a small proportion of respondents (4.3%), discrepancies almost always happen. As one interviewed exporter stated: "We have experienced discrepancies. Not frequently and usually typographical. They are actually unavoidable ... you inevitably get typographical errors. We just fix them. Easily done. It's been that way in this job." This highlights the reality of the exporter's problem in matching the data content requirements of the IDLC.
In order to explore the issue of documentary discrepancies, data were gathered on the specific types of errors that may occur in the execution of an IDLC transaction, both from a documentary perspective and from an operational perspective, that is, contributing discrepancy factors (events). These are summarized in Table 2.
Table 2: Discrepancies
The data show that documentary errors (items a to h) are evenly spread. The lowest level of discrepancies is evident with inspection certificates and government certification. The slightly lower rates may be explained by the generally lower usage of these documents in transactions. It would be unusual for an inspection certification to be demanded for every consignment, whereas a commercial invoice would be an inescapable requirement of any transaction. Likewise, government certification, such as quarantine certificates, would only feature against product-specific transactions, and therefore not be routine.
What is significant are the discrepancy rates for documents where beneficiaries are completely responsible for their production (items a to c) - the bill of exchange, the commercial invoice and the packing list - these documents alone accounted for 27.7% of discrepancies.
Arguably, the beneficiary is also responsible for errors in insurance certificates, as typically exporters use open marine policies that allow them to produce these certificates. The same considerations also apply to certificates of origin that are typically completed by the exporter, with the issuing chamber only adding a certificate number and signature as appropriate.
The transport document is another type of document where the exporter may share responsibility for documentary errors, as this document is produced by the carrier or its agent based on data from forwarding instructions supplied by the exporter. It would appear that the beneficiary may be responsible for about half of the documentary discrepancies reported.
With regard to discrepancy factors (items i to n), it appears that the beneficiary may be responsible for all of these, and it would be difficult to imagine how third parties may be a contributing factor. Late presentation, presentation after IDLC expiry and missing documents account for nearly 20% of discrepancies; and late shipment, missed scheduled consignments and incorrect shipments represent 15.7%.
Causes and suggested solutions
Although the data do not specifically give the underlying cause for these discrepancies, there are a number of contributory elements that can be offered to explain why they occur.
Documentation errors in documents produced in-house by the beneficiary, such as in the commercial invoice, packing list and bill of exchange, are most likely the cause of human error, a significant source of risk in any business. This suggests some dysfunction in the workplace - either through poor internal processes, such as lack of policies and procedures, or poor understanding of IDLC processes and the UCP 600 - or a combination of both. One possible solution to address these problems is for organizations to ensure they have sound policies that are followed by staff and that staff have the technical skills required to produce compliant documents. In this respect, the beneficiary's banker may be a good educational resource; however, staff may need to pursue more formal education options.
Another possible solution is to have automated documentation production through software solutions. Automating results in higher productivity and likely reduces human error caused by incorrect input of the same repetitious data that appear across various documents. However, software solutions can be an expensive answer to the documentary discrepancy problem, and it may be difficult for non-regular exporting microenterprises to justify this on a cost basis. In fact, the Australian study found that the majority of small- to medium-sized enterprises produce their internal documents manually, and therefore carry the highest documentary discrepancy risk.
Documentation produced by third parties, but with input from the beneficiary, such as on transport documents, is another area subject to human error by third parties, such as carrier and freight forwarders often acting as a carrier's agents. Wherever possible, data transfer should be automated, for example by using electronic forwarding instructions, thereby diminishing the opportunity for human error. The beneficiary should ask for a draft copy of the transport document to check data contents before it is issued
The majority of exporters in Australia appear to use freight forwarders on a regular basis, often relying on these service providers to provide local cartage services between the exporter's premises and the exporting carrier and to obtain export customs clearance. Whilst the freight forwarder commonly issues transport documents acting as the carrier's agent (as is commonly the case for air freight consignments), few forwarders provide full export documentation services.
Insofar as the discrepancy factors identified in Table 2 are concerned, there is little excuse for presenting documents late (item k) or presenting these after the IDLC expiry (item l), unless these are a result of late shipment. Where late shipment is concerned, the beneficiary should be aware of a looming problem ahead of time and should take the necessary steps to have the IDLC amended, even if it means the beneficiary paying for such amendments.
The data from the Australian study confirm that documentary discrepancies continue to be a cause of concern, but there are a number of remedies that may be pursued to ameliorate this situation, including:
- automation of data production by the beneficiary;
- automation of data transfer to thirdparties, such as carriers; and
- specific staff training to reduce human error in IDLC transactions.
Bankers also have a role to play in the reduction of discrepancy rates. IDLC business represents an important part of the banker's overall portfolio. Consequently, the banker should take a proactive role in assisting beneficiaries to understand documentary requirements through tailored programs, such as in-house seminars and workshops.
Roberto Bergami is Senior Lecturer, School of International Business, Victoria University in Melbourne, Australia. His e-mail is Roberto.Bergami@vu.edu.au