Article

by Roberto Bergami

ICC has played a crucial role in international trade facilitation over the past century. Some of the most important initiatives in this area include the Uniform Customs and Practice for Documentary Credits (UCP) and the Incoterms® rules. The codification of these processes has continued in a regime of regular updates, to foster a consistent trading environment with predictable outcomes in specific business processes, no matter where they happen on planet Earth. This can be observed through the universal adoption of the current UCP 600, the release and uptake of the Incoterms® 2010 and the current revision of the ISBP that is occurring at the time of writing this article.

It must be remembered that ICC, despite the important and crucial a role it plays in international trade, is neither a government organization nor an international lawmaking body. This means that any rules ICC promulgates are subject to the provisions of the laws of individual nations. This also means that UCP 600 and Incoterms® 2010 rules, the focus of this article, must be voluntarily incorporated in relevant contracts, or else they will not apply.

In fact, the UCP have enjoyed little incorporation into national legal systems, with the majority of countries leaving it up to banks and traders to strike commercial arrangements (contracts) for letter of credit transactions and the incorporation of Incoterms® 2010 into contracts. Not unexpectedly, the codification of any process is subject to different interpretation by individuals, and this is where the problems arise, as discussed below. It should be noted that this article is limited to international trade transactions and, therefore, does not deal with domestic transactions.

Incoterms®: the importance

It is commonly accepted that bankers are a vital link in trade finance, and a number of solutions have evolved over the centuries to keep the international wheels of business turning. The L/C remains probably the most important international method of payment, especially in the context of high-risk/ high-value transactions, and exporters, generally speaking, perceive the L/C to be safest form of payment.

Problems arise in the context of L/C transactions when Incoterms® are used, as it appears there is misalignment between what bankers demand and what good Incoterms® practices suggest. Incoterms® are extremely important from a number of perspectives, including:

• costing of goods for export and import;

• a means of delineating the responsibilities of traders, on a mutually exclusive basis, on matters related to delivery of goods, such as customs clearance, freight and insurance; and

• a risk management tool, particularly as this relates to goods in transit.

Improper use

However, when Incoterms® are improperly used, many of their benefits are lost, especially through the incorrect application of these rules to the different modes of transport, an important consideration in the new Incoterms® 2010 rules, effective from 1 January 2011.

In order to explore the extent of these tensions a random survey of L/C application forms available on the Internet was conducted in the first quarter of 2012. The enquiry concentrated on the Incoterms® 2010 options that each bank offered on its L/C application.

A summary of the findings are shown in Table 1. For the purposes of anonymity, banks are not named in this article, but the countries from which they operate are identified. The total number of online application forms found in the survey was 23, but four of these were excluded from Table 1. Three forms (2 x Australia and 1 x Malaysia) correctly showed all eleven Incoterms® 2010 options available to applicants to choose from. The fourth form (Finland) was excluded as it showed no Incoterms® 2010 at all on the application form. It was interesting to note that in the accompanying completion instructions, these referred to Incoterms® 2000, not Incoterms® 2010.

It is commonly accepted that maritime transport is by far most commonly used in international commercial transactions, and of this the majority is carried in containers. The inappropriate use of traditional maritime terms such as FOB, CFR and CIF has been highlighted for about three decades now, but it seems old habits die hard. It is known that traders inappropriately use these, but bankers are seemingly no better at correctly applying Incoterms® to the relevant mode of transport. This assertion is based on the fact that, as can be observed from Table 1, all L/C applications, except one in Germany, feature these three Incoterms®. In percentage choice, these three Incoterms® account for 55% of options, and consequently it is not difficult to see the misalignment between banking practices and the correct application of Incoterms® 2010 to modes of transport.

The precise reasons why bankers continue to use old and incorrect Incoterms® are not known. The explanations could be many, and no doubt a degree of "defensive" reasons could be cited by the banking industry, but these cannot be allowed to excuse or condone the current status.

Paradox

It seems that a paradox in practices exists in L/C banking practices. On the one hand, banks claim they vigorously comply with the ICC-issued UCP 600 and follow it to the letter, relying on the assistance of the ISBP for clarification on the interpretation of these rules. On the other, the Incoterms®, also issued by ICC, appear to be ignored, perhaps not understood at all or deemed to be not of concern to the banker. However, it should be of concern to all parties dealing in L/C transactions, as the choice of Incoterms® influences the type of document required to be presented.

The problem can best be illustrated with an example using the data from Table 1. The German bank only has FOB and CIF as the Incoterms® option. What transport document would they demand if the consignment was transported by air? An air waybill hardly fits with either of these terms, yet this is what is routinely issued by carriers.

Consequences of misuse

One of the problems with the misuse of Incoterms® is that bankers, by playing a central role in international trade finance facilitation, open L/Cs with incorrect terms, and they may unwittingly also influence traders to cave in to banks' pressure and structure their contracts accordingly, just to keep the banker happy and get the L/C issued so business can take place. The bank has little interest in the transit risks that traders are exposed to and, in one sense, the UCP 600 support this through article 34 of UCP 600 that states inter alia that the banker has no responsibility for the existence of the goods because, pursuant to article 5, banks only deal with documents and, in any case, the wellestablished autonomy (or independence) principle separates the L/C from the contract. I would argue that for traders the L/C is only one part of the overall business dealing - an important part, I'd be the first to admit, but only one part nevertheless.

What would happen if cargo was damaged and the incorrect Incoterms® chosen? It would just make the issue of working out who carried the risk in transit more difficult, especially when containers are involved, as container movements are invariably part of multimodal carriage. From a risk management perspective, it is more preferable to have certainty in transactions, and this can be easily achieved by the correct usage of Incoterms® 2010.

I hope this article will be interpreted by the banking industry as constructive criticism, and that it can help result in a review of L/C application forms to reflect the current Incoterms® 2010 and to show all of them on their forms.

This reminds me of a situation when, just prior to the introduction of Incoterms® 2010, I was asked to address a meeting of senior managers of a bank about supply chain finance. Unbeknownst to me, this was a national teleconference. During the discussion, I made a reference to the new terms (Incoterms® 2010) soon to become reality and made a passionate plea for their adoption. A banker, whom I had known for over thirty years, claimed it would be difficult to change because "the rest of the world is not doing it." My response to that was that "a revolution starts with the first sword."

Some banks have taken up their swords and made changes to their L/C applications. I trust that others will follow, as ultimately convergence on the correct application and usage of Incoterms® 2010 will benefit traders and bankers alike.

Perhaps it may be timely for the ICC to take note of these misalignments and issue a position statement to encourage the correct usage of Incoterms® 2010 by banks. They should as, after all, both UCP 600 and Incoterms® 2010 are ICCsponsored rules. l

Dr Roberto Bergami is Senior Lecturer, Practice of International Trade, School of International Business, Victoria University, Melbourne, Australia and Visiting Professor, Department of Tourism and Trade, Faculty of Economics, University of South Bohemia, Ceske Budejovice, Czech Republic. His e-mail is Roberto. Bergami@vu.edu.au