Trends in Syndicated Trade Facilities
A syndicated trade facility is required to enable trading companies to issue a sufficient amount of letters of credit in order to guarantee a sustainable flow of raw materials. These raw materials, which will be used in production and then sold, are needed to consolidate and increase a company’s annual turnover. This facility, with at least two wholesale banks, is a prerequisite for the issuance of commercial letters of credit, financial letters of credit and bank guarantees.
A company would use a syndicated trade facility for two main reasons:
The aim of a letter of credit is to obtain a durable and predictable flow of raw materials that are necessary for production. Sufficient trade lines are also needed in order to anticipate future needs and demands of the company’s global logistics and operations. The challenge for banks is the ability to issue the required transactions at any time on any day. On a daily basis, business and deals have to be executed without any delay. Flexibility and creativity on the Agent’s side, including the other fronting banks, is obviously one of the main conditions.
Letters of credit and bank guarantees also provide the exporter with proof of creditworthiness and facilitate sellers as well as buyers in starting and building a sustainable relationship.
In addition, we must distinguish between commercial and financial letters of credit (documentary credits and stand-by letters of credit).
A commercial letter of credit is a payment instrument required for the purchase of goods (or services). A letter of credit covers the risk of non-payment (insolvency of the buyers) and is required when the contract shows letter of credit as the payment condition.
A commercial letter of credit is governed by the Uniform Customs and Practice for Documentary Credits (UCP 500). The UCP 500 is issued by the International Chamber of Commerce and, according to the UCP 500, a letter of credit should be issued by a bank. From 1 July 2007, the new UCP 600 will come into force and the issuance of letters of credit will no longer be restricted to banks.
The issuing bank is committed to paying the beneficiary, provided that the beneficiary has presented (shipping) documents that comply with all terms and conditions as stipulated in the letter of credit. The advantage for buyers is that they determine all terms and conditions of the documentary credit. The buyer is then able to ensure that the seller acts in accordance with the terms and conditions of the document or contract.
Conditions in a letter of credit should be related to the contract terms. When the contract terms are amended, the terms and/or conditions of the letter of credit have to be amended accordingly. Problems arise when new conditions in the letter of credit create a disadvantage for the beneficiary because the transaction may be hindered or delayed due to the fact that the beneficiary’s consent is always required. The advantage of using a letter of credit for the seller is that the risk of non-payment is covered. An export letter of credit is a highly recommended instrument to mitigate commercial and, if applicable, political risk. As a result, a letter of credit is an important credit management instrument.
One disadvantage for the exporter is that document handling is labour-intensive. In practice, it is difficult to present documents that strictly comply with all letter of credit terms and conditions.
A financial letter of credit (stand-by letter of credit) can be considered as a bank guarantee. In contrast to the commercial letter of credit, a financial letter of credit or bank guarantee is not a payment instrument but forms an unconditional commitment to pay in case the beneficiary makes a claim. A bank guarantee is therefore an instrument that enforces all terms and conditions of a contract.
Stand-by letters of credit are either governed by the ICC 500 or by the International Standby Practices (ISP 98). For bank guarantees different regulations are applicable, for example, the Uniform Rules for contract guarantees and demand guarantees. Local law can also be applicable. In general, stand-by letters of credit or bank guarantees are unconditional and can be claimed on first demand. Usually a claim addressed to the issuing bank will be honoured immediately upon presentation of statements, certificates or other documents.
Bank guarantees, such as bid bonds or performance bonds, may also be used to extend production capacity (purchase of production units). These instruments have to be issued within a limited period of time as stipulated in the tender. To obtain such a tender, interaction and understanding between the company and the bank is vital.
Cash-related short-term facilities can be extended with more specific trade facilities. The required tenure for these trade facility agreements is usually three to seven years.
One or more fronting banks facilitate an external credit facility and its main purpose, between the lender and borrower, is to satisfy the flexible demand of working capital. A working capital facility may be used for day-to-day business. Utilisation is related to market conditions, and the goals and sales performance of the company.
Working capital requirements have to be flexible and sustainable for a long period of time. In accordance with customers’ requirements, Rabobank, for example, offers a revolving facility, a single or multi-currency facility, and a specific purpose facility for letters of credit and/or bank guarantees.
In large syndicated credit facilities, credit risk is usually backed by more participating banks through a risk-sharing agreement. Other banks will be invited (by the fronting banks) to cover part of this credit risk. The participating banks will receive a commission for this participation.
The working capital facility has mainly developed for large trading and production companies. The minimum amount within this kind of facility is more than US$100m (or its equivalent amount in other currencies).
The banks involved in syndicated trade facilities must have a committed trade finance sales team supported by credit and trade specialists. A dedicated specialist from the operational department should participate in the ‘deal team’ immediately after first contact with the companies involved.
The dedicated trade specialist has to implement all a client’s special requirements in order to enable the operational department to anticipate the workflow (e.g. stand-by letters of credit, commercial letters of credit and bank guarantees).
After finalising implementation, and all requirements have been included in the administration of the bank system, business can start. The daily communication between the Agent and the trade services department has to be a reliable and predictable process, which is why dedicated staff in the trade services department is indispensable.
Multinational companies are establishing shared service centres in order to centralise their regional or global logistics (payments, treasury and trade activities). A shared service centre requires its own global working capital facility to address all operational needs. To accomplish this objective, a limited number of (fronting) banks are invited to arrange a trade facility.
At the same time, a large number of banks are required to cover part of the risk. Business areas, such as trade finance, treasury and cash management, are generally granted to the fronting banks. Only the Agent will manage all of the financial logistic requirements, therefore awareness of the requirements necessary in specific industries is, without doubt, the key to a successful and sustainable relationship.