Stern warnings on issuing standby letters of credit (L/Cs) and even sterner warnings on the usage of non-documentary standby L/Cs are included in a summary of recommended best practices for commodity trade finance (CTF) published in response to the slew of huge trade finance scandals in 2020.

Ten banks active involved in CTF in Switzerland produced the summary recently published by the Swiss Trading & Shipping Association (STSA).

L/C warnings

Banks should abstain from issuing standby letters of credit (L/Cs) in favour of unknown suppliers according to the summary. They should also insist on a reference to underlying contracts in standby L/Cs and request copies of shipping documents for payments in cancelled standby L/Cs.

Additionally, banks should limit usage of non-documentary standby L/Cs to established suppliers. They should also obtain a waiver from applicant or bank to send to the applicant a disclaimer, essentially an indemnity to pay a seemingly on demand valid claim without further objection.

The recommendations in the summary are not obligatory and banks remain free to tailor the degree of adoption to the circumstances of its individual client relationships.

Bank exposure

Wholesale trade finance fraud was laid bare in the energy and commodities sector in 2020 when the coronavirus pandemic precipitated a slump in oil prices and banks experienced substantial losses. This led the ten banks to conclude that there is a need to strengthen and standardise market practice in the field of commodity finance.

Multiple banks are exposed to L/C losses associated with traders, notably in Dubai and Singapore. ABN Amro Bank lodged a claim against collapsed Hin Leong Trading that includes applications for charges related to irrevocable L/Cs tied to the Singaporean oil trading giant's assets (DC World News, 21 April 2020).

Banks including ABN Amro and the Swiss operations of BNP Paribas have exited trade and commodity financing, others have cut back the scale of their operations while traders and banks are embroiled in many lawsuits.

Other recommendations

Amongst other recommendations in the STSA summary, banks are advised to refrain from circular financing where transactions are staged so that a cargo is bought and then immediately sold back to the initial seller as a way to generate working capital.

Banks are also advised to carry out checks that goods actually exist by adopting procedures to approve warehouses and establish with them the right to carry out third-party checks. They should also undertake due diligence on warehouses and terminals.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.