Post-UCP 600, whither the online LC?

UCP 600 has closed more loopholes that result in maddening discrepancies for its users. For similar changes to come to online LCs, though, corporates will have to look outside the banking system for relief.

With much fanfare – or at least as much fanfare as the global banking industry is capable of – UCP 600 (Uniform Customs Practice for Documentary Credits) is now duly updated and officially part of the banking environment. Certainly, it is good news for users of these ancient trade finance instruments, the first of which were reportedly deployed to finance a sale of marble from Italy to England during the Middle Ages.

Beyond straight-through processing

What about, though, their electronic cousins – the online letter of credit (LC)? Yes, there were some administrative changes in UCP 600 that affect banks’ back-end systems, making the process more fluid and less prone to error.

However, the main regulatory changes necessary to make online LCs easier to use have already been made – through SWIFT last year and through the development of the eUCP. This is the acronym for the supplement to the Uniform Customs and Practice for Documentary Credits for Electronic Presentation, which was implemented in 2002 to meet the needs of electronic trade.

But the fundamental changes necessary to make the online LC a truly consumer-friendly instrument now is outside the reach of the global banking system’s regulatory and legal apparatus – and is not likely to be lobbied for by the banking industry.

“Everything that UCP could do for an online LC has been done,” says Vincent Maulella, a former banker with a global trade finance bank and now a banking consultant and contractor in the greater New York City area.

“Now, most banks have online systems on which customers can send an application; those have been around since the early 1980s.” Also, he says, more banks are now able to transmit documentation electronically to a beneficiary bank or at least post it to that bank’s website for review.

In short, the issuance and amendment functions are sufficiently automated – although, of course, with every enterprise application there is always room for even slight improvement.

The real challenge, however – and one banks are not willing to take on because of costs – is the current inability of the customer to create an initial electronic record, Maulella says. That is because the information necessary to create such a record – bills of lading, insurance information and so on – is likely to be in different mediums, such as paper or electronic PDF files. Also, banks would have to have a legal and IT system in place to govern the necessary agreements with the correspondent banks and with applicants.

There is nothing in UCP 600 specifically designed to propel banks towards accommodating electronic presentation, Maulella concludes. “There is no mandate. There are no incentives and there are unlikely to be any in the future.”

Change, if any, will have to come from outside the banking community. “To develop a system that can accommodate mixed presentation would cost too much for banks to be willing to consider,” he says. A solution will either have be pushed strenuously by global corporates, or outright developed by them, he says.

Current developments

It may happen, of course. Fifteen years ago the cutting edge in online LC product development was to reduce the manual inputting of information and, thus, future discrepancies. At the time, with discrepancy rates topping 70%, this was huge for both bankers and corporates.

To their credit, banks continue to work to eliminate such errors – even when those errors are potentially beneficial to them in terms of fees and delays in releasing funds.

For instance, last November SWIFT tweaked some of its conventions that govern the electronic transmission of LCs, says Robert Foutts, vice president, JPMorgan Chase global trade services in New York. Many of these were seemingly minor, but still important enough to cut down on the error rates, he says. “It used to be that if you issued a 700 series message it was automatically subject to UCP 600. Now, you have to reference specifically what rules apply,” Foutts says. “If the credit is silent then it is not subject to anything.”

Other bankers along with Foutts point to UCP 600’s discrepancy notification waiver as a positive change as well for the online LC, despite the necessary customisation to the messaging template it required.

Under UCP 500, there were only two options to indicate why a bank was refusing payment, or refusing to accept the documents and what would be its intended course of action as a result. These options were either, simply, that the bank was holding the documents or returning the documents to the presenter.

UCP 600 expands the responses available to banks to four. One option is that the bank is holding documents pending further instruction from the presenter. The second is that the bank is holding the documents until it receives a waiver and agrees to accept it. The third is that the bank is returning the documents. Fourth is that the bank is acting in accordance of the instructions previously received.

Up until now, banks have not had much of a chance during the official process to explain what it plans to do – ie, hold documents until it hears from the recipient.

The promise

UCP 600 could have a tremendous effect on the use of LCs in general if banks embrace its spirit and enthusiastically apply it, says Jon Dunlap, founder of InterNetLC.com, a California-based company that provides pre-shipment financing for exporters through an electronic format.

“The question about online LCs is entirely separate,” says Dunlap. Echoing other online LC advocates, he says there are a number of current barriers that hinder online LCs’ full potential.

“First, banks don’t have much case law for handling electronic documents. Also, there are no procedures in place for the handling of digital signatures or electronic signatures. And finally, there are no financial incentives for banks to address these as it means they will lose fees.”

There are no financial incentives, he reiterates, on the part of the banks as they would have to change their online LC business model – but there is definitely motivation for an exporter-led movement to establish a parallel system that could supplement, or even supplant, the online LC process.

Similar initiatives have been done before by other parties, he says, pointing to TradeCard and Bolero as examples.

One initiative designed specifically to replace the online LC, he envisions, would be an internet bank addressing these issues that is located in a financial-services-friendly location such as the British Virgin Islands. It would be backed by a trade finance fund and would support transactions in trade loans. Investors would get a higher rate of return than they would in traditional asset-backed trade finance loans. Meanwhile the volume generated by the flexible system would also provide a revenue source. Dunlap is able to describe his fantasy business so well because he is working to turn it into a reality. Currently he is raising funds for the necessary start-up capital.

“The changes we saw in UCP 600 would be miniscule compared to the impact such a bank could have on the LC community,” he says.

To be sure, few global banks are likely to be worrying over their potential lost fee income at this moment; start-up electronic endeavours, after all, have been notoriously short-lived in the trade finance arena. Even the surviving ones have not made the splash originally envisaged by their proponents.

However, Dunlap and others say, something will have to give with the current online LC process and, ironically, the tipping point may be the changes UCP 600 brings to LCs overall. “UCP definitely makes it easier to issue and use an LC,” Maulella says. “Companies are going to start wondering why online LCs can’t catch up.”