What type of Letter of Credit is most suitable for re-export trade?
Resolved
My company recently plans to engage in re-export trade and is not very familiar with Letters of Credit. I would like to ask what type of Letter of Credit is generally better to use in re-export trade. I hope for a detailed introduction to the characteristics and applicable scenarios of different types of Letters of Credit in re-export trade, to help me make a better choice to mitigate risks and ensure smooth transactions.
Trade Expert Insights Answers
In re-export trade, back-to-back Letters of Credit and transferable Letters of Credit are relatively common.
A back-to-back Letter of Credit refers to a situation where, after a middleman receives a Letter of Credit from an importer, they request the original advising bank or another bank to use the original L/C as a basis to open a new, similar L/C to another beneficiary. Its characteristic is that the two Letters of Credit are independent of each other; the issuing bank of the original L/C and the importer are not related to the beneficiary of the new L/C. This can better protect the middleman's commercial secrets and is suitable for situations where the middleman does not wish to disclose information about the actual supplier and the buyer.
A transferable Letter of Credit refers to a Letter of Credit where the beneficiary (first beneficiary) can request a bank authorized to pay, incur a deferred payment undertaking, accept, or negotiate (collectively referred to as the "transferring bank"), or, when the L/C is freely negotiable, can request the specially authorized transferring bank named in the L/C to transfer the L/C in whole or in part to one or more beneficiaries (second beneficiaries). It is relatively simple to operate and is suitable for situations where the middleman merely earns a margin and is willing to let the actual supplier know the importer's information.
A Red Clause Letter of Credit can also be used in re-export trade, allowing the exporter to draw part or all of the payment before shipment and presentation of documents. This is an option for re-export traders who need capital turnover, as it can alleviate financial pressure. However, the importer's risk is relatively higher, requiring a good foundation of trust between both parties.
A Revolving Letter of Credit also has applications in re-export trade. When re-export trade involves continuous and regular goods transactions, using a revolving L/C can save on issuance procedures and fees. As long as it is within the stipulated amount, the L/C can be used multiple times in a revolving manner, making it suitable for re-export trade scenarios with long-term stable cooperation.
A Sight Letter of Credit is also relatively common in re-export trade. After the exporter submits documents that comply with the L/C requirements, the issuing bank or paying bank makes immediate payment. Funds are recovered quickly, and the risk is relatively low, ensuring that re-export traders quickly receive payment for goods and facilitating capital turnover.
In re-export trade, with a Usance Letter of Credit, the exporter ships goods first, and the importer pays at a predetermined future date. This provides the importer with some time for capital turnover, but the exporter's collection time is extended, entailing a certain collection risk. It is suitable for situations where the importer has financial pressure but both parties have a good cooperative relationship.
A Confirmed Letter of Credit provides good protection for re-export traders. In addition to the issuing bank, another bank adds its confirmation to the L/C. When the issuing bank fails to fulfill its payment obligations, the confirming bank assumes the payment obligation, reducing the risk of the exporter not receiving payment.
The advantage of a back-to-back Letter of Credit in re-export trade lies in the ability to flexibly adjust terms. The middleman can adjust terms such as goods description, price, and delivery period according to actual circumstances, to better meet the needs of different trading parties.
When using a transferable Letter of Credit in re-export trade, it should be noted that the documents submitted by the second beneficiary may be substituted by the first beneficiary to protect the middleman's interests. However, this may introduce some operational complexities.
For trading parties whose creditworthiness is difficult to assess, it is more appropriate for re-export trade to choose an Irrevocable Letter of Credit. Once issued, the issuing bank cannot unilaterally amend or revoke it without the consent of the beneficiary and relevant parties, which ensures the stability of the Letter of Credit.
If re-export trade involves multi-country transactions and document processing is complex, choosing a Documentary Letter of Credit is more appropriate. It uses documents as the basis for payment; as long as the documents comply with the requirements, the issuing bank will make payment, reducing trade disputes.