- Hello Customer - Log in or Register!
by Roberto Bergami
One of the prime considerations for exporters (sellers) and importers (buyers) is the question of payment security. The letter of credit (L/C), an instrument of trade finance, is commonly accepted to be the safest form of payment, while the open account is typically considered the least safe payment option from the seller's view point.
The L/C is particularly suited to high-value and high-risk transactions. It is typically used where there is insufficient trust in the buyer, perhaps due to the high value of the transaction, or where sometimes a country, such as Algeria, requires it for all import transactions. In trade with Asia, the L/C is quite common and has an average value of just over USD 516,000. Letters of credit are issued through the banking system, where a fee is typically charged proportional to the par value of the L/C. Additionally, banks require security to issue a L/C to protect their financial exposure. The percentage of security varies between countries, with often less than 10% requirement in China and 100% in Australia.
An L/C replaces the buyer's credit risk with that of their bank, which provides a conditional guarantee of payment based on data requirements on specified documents. Failure to meet the banker's requirements weakens the guarantee and exporters run the risk of payment delays and, in more drastic cases, non-payment altogether. Documentary non-compliance is estimated to occur in about 30% of transactions. This is costly in terms of time spent to rectify errors and also in financial and cash-flow implications resulting from inevitable payment delays, to which must be added the risk of non-payment, although estimates suggest this occurs in less than one percent of cases.
The open account is suited to inter-company trading, such as between subsidiaries or affiliates of multinational companies that inherently carries a very low credit risk, or where there is a mature trading history and the seller trusts the buyer implicitly to honour the agreed payment terms and conditions.
To reduce the costs of doing business for buyers and enhance payment security for sellers, a new method of payment—the Bank Payment Obligation (BPO)—is being introduced. In risk terms the BPO fits somewhere between the L/C and open account.
The BPO was devised by the Trade Service Utility (TSU) of SWIFT, the financial industry's own communications network. The BPO works by electronic matching of data through the TSU between a purchase order (these data are called the baseline) and shipping documents, such as invoices, and transport and insurance documents. If the data supplied electronically by the seller matches that required in the BPO baseline, automatic payment is triggered.
The payment obligation in a BPO comes from the Obligor Bank, the bank that establishes the BPO, and is transmitted to the Receiving Bank. The BPO, therefore, is an inter-bank payment arrangement, but it must work through the TSU. This means that the arrangements to set up and advise the BPO are outside its scope. These arrangements need to be independently and individually negotiated between the buyer and the Obligor Bank, and the Receiving Bank and the seller—a situation that is essentially the same as L/C transactions. There is, therefore, an issue of trust that arises between the traders and their respective banks, as well as between the seller and the Obligor Bank as the Receiving Bank is under no obligation to underwrite the Obligor Bank's pledge to pay. Nevertheless, it is not difficult to see that the BPO does provide a better payment security alternative than the open account as, after all, the BPO offers bank underwriting while open account does not.
There are advantages and disadvantages in the operations of a BPO. One advantage is electronic matching of data so as to remove as much human intervention as possible and thereby reduce documentary risk through different interpretations of what are compliant documents. This is one of the problems with L/C trade. Another advantage is that the BPO should be much cheaper to use than comparable L/C transactions as its functions are automated.
However, the BPO also presents challenges. All electronic transmissions need to be done through the TSU and, for traders, this means having systems that are capable of communicating with specific message types, mainly ISO20022 compliant messages. This may mean expensive IT solutions, although as the data will be submitted through the banks, hopefully they will offer suitable IT solutions to traders. These are likely to be proprietary rather than generic solutions, so as to lock in the client's (trader) business. Traders may well find themselves pursuing different IT solutions if they deal with more than one bank.
The BPO does have disadvantages. The data requirements for L/C transactions are governed by an established set of rules (UCP 600) and are further supplemented by a set of guidelines (ISBP)—both issued by the International Chamber of Commerce (ICC)—to assist in the documentary data checking process. However, to date, there appears to be no such codification of BPO transactions. Rather, data mismatches are resolved between the banks and traders. This may be a risky situation depending on the market circumstances at the time.
To try and foster greater confidence in the BPO, SWIFT and ICC have formed a working party and announced a formal relationship. The aim is to produce a set of BPO rules with the backing of the ICC leveraging on the well-known and respected UCP 600. It is likely that a large degree of success will depend on how easily banks will issue BPO and what level of security they will demand.
There is only some information about the BPO at present as it is being progressively released. In the meantime those interested should consider joining the LinkedIn Group, Supply Chain on SWIFT, and also attend their webinars. I have attended a few of them, and they are quite good. The bonus is that after each webinar the TSU tem will send you a link to the event and also the Q&A from others. It's very worthwhile.
| Product Model | Inside Diameter | Outside Diameter | Thickness |
| 6910NR NACHI | 50 | 72 | 12 |
| 6810NR NACHI | 50 | 65 | 7 |