Home Uncategorized CAN THE ISSUING BANK DISCOUNT ITS OWN ACCEPTED DRAFT OR DEFERRED PAYMENT UNDERTAKING?

CAN THE ISSUING BANK DISCOUNT ITS OWN ACCEPTED DRAFT OR DEFERRED PAYMENT UNDERTAKING?

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QUERY FROM Ghubshawi
Can the issuing bank negotiate?

Dear All,

According to article 7.a.i & b of UCP600 the responsibility of the issuing bank is limited to honour and not to negotiate.

Assume that a deffered L/C is available by negotiation with a nominated bank and that bank doesn't negotiate, could the issuing bank, in light of article 7.v., negotiate in this exceptional case?

If yes, can the negotiation be with recourse or with out recourse?

If no, please offer other solutions.

Best
Ghubshawi

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COMMENTS

FR MR. OLD MAN

Negotiate or Discount

Before giving my answer to Ghubshawi’s question, I think some points of his question need to be clarified:

1/ What does he mean by deferred LC ?
I guess he means usance LC that may include (i) an acceptance LC and/or (ii) a deferred payment LC.

2/ Discount or Negotiate ?
In accordance with the above reasoning, the term “discount” instead of “negotiate” should be used to indicate the action of purchasing at a discount of an accepted time draft or of a deferred payment undertaking (though in reality the term. “negotiate” is sometimes used by some banks).

3/ Can the issuing bank discount a bill of exchange or a deferred payment undertaking accepted or incurred by itself ? My answer is yes. However, the issuing bank is not obligated to discount unless it is willing to do so as its obligation under an acceptance LC or under a deferred payment LC is to honour a bill of exchange or a deferred payment undertaking accepted or incurred by itself. Except for sight payment LC, the term “honour” is understood as its action of (i) accepting a bill of exchange (draft) drawn by the beneficiary and pay at maturity or (ii) incurring a deferred payment undertaking and pay at maturity .

4/ Discounting with recourse or without recourse ? And risk of loss ?
Discounting if any should be on a without recourse basis. The issuing bank has no risks when discounting its own accepted bill of exchange or its own deferred payment undertaking as it is the issuing bank that shall reimburse itself when due.

The issuing bank may suffer risk of loss in case the applicant fails to fulfil its obligation under its contract with the issuing bank for opening usance LC. That the issuing bank refuses to discount but pay at maturity does not help it avoid the same risk if any.
However, to avoid risks regarding possible disputes between the applicant and the beneficiary in connection with the cargoes shipped under the LC, a cautious bank should choose the right time to discount, i.e. discount after the applicant has been in full receipt of the cargoes and satisfied with the quality (though I know banks deal with documents not with goods).

5/ What benefit does the issuing bank earn from discounting a bill of exchange or a deferred payment undertaking accepted or incurred by itself ?

By discounting, the issuing bank may get the benefit both from the beneficiary (due to paying at a discount) and from applicant (due to aval commission).

I think in reality that the beneficiary requests the issuing bank to discount its own accepted bill of exchange or its own deferred payment undertaking rarely happens. However, if someday my bank receives such request from the beneficiary of the acceptance or deferred payment LC issued by my bank, I will not hesitate to advise my staff to take it into consideration.

Frammi and Shahriar, I will appreciate your comments on my point of view.

Best regards,
Nguyen Huu Duc

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FROM Shahriar
well pointed out

Dear duc,

Very well pointed out. ofcourse issuing bank can discount its accepted bill. in fact sometimes we do so. but there is a little confusion in me. Is this discounting a part of LC? To me its a different arrangement between the exporter and the issuing bank. So far I understand, as soon as the acceptance / refusal advice is given, the lc is over. as per lc paymnt wil b made at maturity. any early discount is against the acceptance nt draft. in negitiation there is no such acceptance, rather draft and complying presentation. whats ur opinion?

Anyway let me share what we do in real life. such discounting is nt very common as central bank strongly discourage it as there are higher chances for accomodation bills / similar irregularity especially when the importer and exporter are sister concerns; common in BTB LCs!! second when discounting such a bill, its done by two different department as if they are two different banks!!! thus more people get involved and banks' risk minimized. :))

Shahriar

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FROM MR. OLD MAN

Hi Shahriar

I highly appreciate your comments. I wish to exchange with you the following:

Draft when accepted shall become a negotiable financial instrument that is independent of the LC and can be forfaited or sold on the market. Therefore, any banks including the issuing bank can discount (purchase at a discount) such a draft if they wish to do so.

I am afraid that a deferred payment undertaking is not largely accepted as a financial instrument that can be forfaited or sold on the market like an accepted draft. Therefore, the bank that discounts such a deferred payment undertaking may not be protected by UCP. Yet, one thing I wish to draw your attention to is that UCP 600 Art. 12 (b) has given the green light to the nominated bank to prepay or purchase its own deferred payment undertaking (or its own accepted draft). It was the famous court case “Banco Santander” that brought about this change in UCP.

UCP has a definition for the term “negotiation” which you can refer to in Art. 2 but no definition for the term “discounting”. In practice when referring to an action of purchase at a discount of a time draft, the term “discounting” is used. However, in the marketplace the two terms are sometimes used interchangeably without causing any misunderstanding.

Thanks for your experience sharing.

Best regards,
Nguyen Huu Duc
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15 Comments

  1. anonymous

    February 17, 2012 at 3:02 am

    writes:How do you reflect the accounting entries in your books?? How is it reflected in your balance sheet? Let's say the bill is for USD 100 million with a tenor of 150 days. You are the LC issuing bank and directly dealing with the beneficiary.First step – You accept the bill – In your books it will show as outstanding acceptance i.e. off-balance sheet item. Under Basel- II CCF requirement is 100%. In your customers book it will show as trade payable – not loan Second step – beneficiary (drawer) request for discount. You agree and make a discounted payment to drawer (beneficiary). In you books it will show as on balance sheet item. In your customers books it still shows as trade payables and not loan.Now the item is appearing an off balance sheet item and also an on balance sheet item. The question is would you liquidate the outstanding acceptance part. On whom will you show, in your books, the liability of direct funded item (the discount). May anyone of you show the details accounting entries that you will be passing??

    Reply

  2. slax43

    October 5, 2012 at 6:10 am

    Can you help me discount a time draft ?Thanks Steven Lax

    Reply

  3. anonymous

    January 4, 2013 at 9:01 pm

    Anonymous writes:Hi Mr Old Man, I am so confused by how 'honour' and. ' negotiation' works. And the fact how draft being drawn under deferred undertaking, acceptance and Negotiation, and drawn on whom. Even though it's well explained on above on discount, prepay or puchase – still how each connect to the 4 types of credits. Appreciate your explanation. Especially how UCP view those mentioned above rather than in practise. ThAnk You.

    Reply

  4. mroldmanvcb

    January 4, 2013 at 10:01 pm

    Originally posted by anonymous:

    Anonymous writes: Hi Mr Old Man, I am so confused by how 'honour' and. ' negotiation' works. And the fact how draft being drawn under deferred undertaking, acceptance and Negotiation, and drawn on whom. Even though it's well explained on above on discount, prepay or puchase – still how each connect to the 4 types of credits. Appreciate your explanation. Especially how UCP view those mentioned above rather than in practise. ThAnk You.

    Hi,The terms “honour” and “negotiation” are defined in Article 2 UCP 600 as follows:Honour means: a. to pay at sight if the credit is available by sight payment. b. to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment. c. to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance. Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. Negotiation L/C (or L/C available by negotiation) requires presentation of sight draft(s); Acceptance L/C (or L/C available by acceptance) requires presentation of time draft(s).Sight payment/deferred payment L/C (or L/C available by payment/deferred payment) does not require presentation of draft(s).Draft(s) presented under L/C must be drawn on the issuing bank or on a nominated bank; An L/C must not be issued available by a draft drawn on the applicant.According to Article 12(b), . by nominating a bank to accept a draft or incur a deferred payment undertaking, an issuing bank authorizes that nominated bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank. Regarding 4 types of L/C, please refer to my following answer to Neville Dcosta:QUOTETue, 09/11/2007 – 02:12 — nhduc.dng LC AvailabilityDear Neville Dcosta, As you may know, an LC may be stipulated available by payment, available by negotiation, available by acceptance or available by deferred payment. LC available by (sight) payment does not require sight drafts to be presented and normally the payment is to be effected at the counter of the issuing bank or at its nominated bank upon receipt of the complied documents. The beneficiary under LC available by payment normally may not obtain the payment in advance by negotiating (selling at a discount) the documents at his bank. Different from LC available by payment, LC available by negotiation allows the beneficiary to receive the payment by negotiating the sight drafts and documents at a nominated negotiating bank which is normally located in his country. The negotiation may be effected on a with or without recourse basis. However, under a confirmed LC, the confirming bank must negotiate the documents on without recourse basis. Acceptance LCs and deferred payment LCs are usance LCs. The difference is that the acceptance LC requires a time draft, whereas the deferred payemt LC does not. Under acceptance LC, the beneficiary may receive the payment before the draft is due by discounting the accepted draft at its bank or discounting it on forfaiting markets (as the accepted draft is a financial instrument which can be transferable). Under deferred payment LC, after his presentation of complied documents, the beneficiary receives a deferred payment undertaking incurred by the issuing bank or its nominated bank. Deferred payment undertaking is not largely accepted as a financial instrument, therefore, normally the beneficiary may not discount the deferred payment undertaking. However, in some cases, the beneficiary can use the deferred payment undertaking incurred by the issuing bank or nominated bank as a security for the advance given by his banks. UCP 500 was silent on negotiating/discounting deferred payment undertakings. The dispute between Banco Santander and Banque Paribas in connection with the discounting of a deferred payment undertaking led to the change in UCP. Under UCP 600 Art. 12 (b), the nominated bank is allowed to purchase (buying at a discount) its own deferred payment undertaking. Hoping the matter has been clear. Best regards,Nguyen Huu DucUNQUOTEBest regards,Mr. Old Man

    Reply

  5. anonymous

    January 5, 2013 at 12:01 am

    Anonymous writes:Pls explain yr quote: ''Negotiation L/C (or L/C available by negotiation) requires presentation of sight draft(s)''. In my view, L/C available by negotiation with time draft(s)/ usance draft(s) drawn on drawee as Issuing bank,for example, Usance L/C with draft at 60 days from BL date, F41D: available with any bank by negotation, drawee: Isssuing bank. In this case,if nominated bank (is any bank) prepay or purchase a draft accepted by Issuing bank, not a draft accepted by that nominated bank i.e issuing bank did not authorize that nominated bank to prepay or purchase a draft accepted by that nominated bank. Therefore, it is not applicable Aricle 12b. As per this L/C, issuing bank authorized nominated bank to negotiate. In this case, negotiation was happen because arcorrding to Article 2, Nominated bank purchased a draft(drawn on a bank other than the nominated bank) and/or documents under a complying presentation, and advanced funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. Consequently, it seems inconsistent with yr quote: L/C available by negotiation requires presentation of sight draft(s). I think L/C available by negotiation could still require presentation of time/usance draft(s).

    Reply

  6. anonymous

    January 5, 2013 at 9:01 am

    Anonymous writes:Thank you for the explanation. It's very helpful. Refer to "Negotiation LC (LC available by negotiation) requires presentation of draft.". I thought under this type of LC, draft may or may not be required?

    Reply

  7. anonymous

    January 5, 2013 at 9:01 am

    Anonymous writes:Thank you for the explanation. It's very helpful. Refer to "Negotiation LC (LC available by negotiation) requires presentation of draft.". I thought under this type of LC, draft may or may not be required?

    Reply

  8. mroldmanvcb

    January 5, 2013 at 9:01 am

    Hi,It is agreed that article 12 (b) deals with the case where L/C is available with a nominated bank by deferred payment or by acceptance; the nominated bank that has acted its nomination, i.e., incurred its deferred payment undertaking or accepted usuance draft is authorized by the issuing bank to purchase or prepay the deferred payment undertaking or accepted usuance draft.L/C available by negotiation of usance draft is not recognized as one of the four common types of L/C in UCP 600. It is just like a varied type of L/C that you may see in practice. I see that where L/C is available with any bank by negotiation of usance drafts drawn on the issuing bank, negotiation prior to the issuing bank’s acceptance of the drafts (if any) would be done on a with recourse basis. In fact, it looks like post-export finance with recourse. Banks may accept to discount the drafts that have been accepted by the issuing bank as drafts once accepted would become negotiable financial instruments.Best regards,Mr. Old Man

    Reply

  9. mroldmanvcb

    January 5, 2013 at 10:01 am

    Originally posted by anonymous:

    Anonymous writes:Thank you for the explanation. It's very helpful. Refer to "Negotiation LC (LC available by negotiation) requires presentation of draft.". I thought under this type of LC, draft may or may not be required?

    Hi,

    I would like to draw your attention again to the definition of negotiation in Article 2, which says “ Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank”.

    As seen from the definition, negotiation means the purchase by the nominated bank of drafts, hence, negotiation L/C must include drafts.

    Best regards,
    Mr. Old Man

    Reply

  10. anonymous

    January 5, 2013 at 3:01 pm

    Anonymous writes:Refer to Art 2, Art 12b and your above comments, if a L/C appeas F41D: available with any bank by deferred payment,(of course, almost banks would not agree to act on its nomination except confirming bank), and the Ben would like to achieve funds prior to the nominated bank is reimbursed by the issuing bank, what the following opinion is correct:1. As per Art 12b, the nominated bank that has acted on its nomination, i.e., incurred its deferred payment undertaking. The issuing bank authorized it to purchase or prepay the deferred payment undertaking. Therefore, acting as purchase or prepay means that without recourse.2. As per Art 2, the nominated bank would not act on its nomination, it would negotiate becase ''Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation''. In this definition of negotiation, UCP used pharase ''and/or''. It means that, there are three options: the nominated bank could only purchase drafts (drawn on a bank other than the nominated bank) or only purchase complying docs or purchase both drafts (drawn on a bank other than the nominated bank)and complying docs. Therefore, in this case, the nominated bank could choose option: purchase complying docs (deferred payment L/C not required drafts). Then , it could negotiate on basis with recourse because it does not a confirming bank and not act on its nomination. It seems that it is convenience and the best choice.Which do you choose 1 or 2 because all options are both protect by UCP. Pls give your valued opinion about this issue. If you choose the fist opinion, pls interpret why the second opinion is incorrect ?

    Reply

  11. mroldmanvcb

    January 5, 2013 at 10:01 pm

    Hi,Option 1 is correct. Nominated bank means the bank with which the L/C is available or ANY BANK in the case of the L/C available with ANY BANK . If the nominated bank has acted its nomination, i.e., incurred its deferred payment undertaking and then prepaid it is protected by sub-article 12 (b). The issuing bank must reimburse the nominated bank that has acted its nomination. Sub-article 12(b) allows the nominated bank to prepay the term draft accepted or a deferred payment undertaking incurred by itself, whereas the term “negotiation” as defined in Article 2 is used where the L/C is available by negotiation of drafts at sight notwithstanding the fact that some banks would issue L/Cs available by negotiation of usance drafts which is not one of the four common types covered in UCP.Your questions are very academic. It seems that you can answer them by yourself.Best regards,Mr. Old Man

    Reply

  12. anonymous

    January 5, 2013 at 11:01 pm

    Anonymous writes:Hi,I agree with you that option 1 is correct. However, if some banks issue a deferred payment L/C available with any bank by negotiation which is not one of the four common types. For example: F42P( Deferred payment details): 60 days from B/L date, F41D: any bank by negotiation, it does not require draft. Then, nominated bank (is any bank) would like to negotiate, whether it is protected by Art 2 or not because I would like to emphasize phrase ''and/or '' which used in Art 2. It means that, there are three options: the nominated bank could only purchase drafts (drawn on a bank other than the nominated bank) or only purchase complying docs or purchase both drafts (drawn on a bank other than the nominated bank)and complying docs. Therefore, in this case, the nominated bank could choose option: purchase complying docs (deferred payment L/C not required drafts). It could negotiate on basis with recourse because it does not a confirming bank. In case deferred payment L/C available with any bank by negotiation, whether it is protected by Art 2 or not?

    Reply

  13. anonymous

    January 6, 2013 at 12:01 am

    Anonymous writes:According to Sub Art 6: ''A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation'' i.e, there are four types of L/C covered in UCP . Therefore, all banks issued a varied type of L/C is not recognized as one of the four types of L/C covered in UCP 600 that we may see in practice, is these banks not protected by UCP, is it? Why do you think that term “negotiation” as defined in Article 2 is used where the L/C is available by negotiation of drafts at sight. It is obvious that, the definition of negotiation in Art 2 does not exactly reflect that negotiation is used where the L/C is available by negotiation of drafts at sight or time/usance draft or other circumstances. From term “negotiation” as defined in Article 2, we could only recognize as the nominated bank could only purchase drafts (drawn on a bank other than the nominated bank) or only purchase complying docs or purchase both drafts (drawn on a bank other than the nominated bank)and complying docs. I would like to emphasize phrase ''and/or '' which used in Art 2

    Reply

  14. mroldmanvcb

    January 6, 2013 at 12:01 pm

    Hi,Article 2 refers to the situation where the nominated bank purchases draft(s) DRAWN ON A BANK OTHER THAN THE NOMINATED BANK, whereas sub-article 12(b) refers to the situation where the nominated bank prepays/purchases term draft(s) DRAWN ON THE NOMINATED BANK AND ACCEPTED BY THE NOMINATED BANK or where the nominated bank prepays/purchases ITS OWN DEFERRED PAYMENT UNDERTAKING.In addition to the four common types of L/C covered in the UCP, it is also recognized that there are other types of L/C existing in practice, for instance, UPAS L/C, L/C available by negotiation of usance drafts, L/C available by negotiation of documents without drafts…In my opinion, notwithstanding the fact that the L/C issued is not one of the four common types covered in the UCP, the nominated bank that has acted its nomination complying with the L/C terms and conditions is still protected by Article 7 (c) UCP 600.I must admit that your interpretation of the definition of the term “negotiation” in article 2 is correct, but what I’m trying to tell you reflects a common and standard practice. As above said, in addition to sight drafts, the nominated bank can NEGOTIATE the documents presented under L/C available by negotiation (without draft), documents presented under L/C available by deferred payment with any bank or the usance drafts and/or document presented under L/C available by negotiation of drafts drawn on the issuing bank… The nominated bank that has negotiated in accordance with the issuing bank’s instruction is entitled to the issuing bank’s reimbursement if the documents are complying.Abeit admitting the existence of varied types of L/C in practice, I always ask my staff to issue L/C in accordance with one of the four standard types. This does not mean that we always refuse to negotiate such varied L/Cs.Nice to discuss with you.Sunday is not my holiday today!Best regards,Mr. Old ManP/s: Sorry if my English is not clear.

    Reply

  15. anonymous

    January 6, 2013 at 1:01 pm

    Anonymous writes:Thank you so much for your great enthusiasm. Sorry for any inconvenience caused.Best wishes to youBest regards,^^

    Reply

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