A Documentary Letter of Credit (DLC) is an essential financial instrument in international trade that provides a guarantee of payment between buyers and sellers. This article will explore the intricacies of a DLC, its various uses and benefits, and the process involved in obtaining one.
Introduction to Documentary Letters of Credit
A Documentary Letter of Credit, also known as a Letter of Credit at Sight, is a financial instrument issued by banks or commercial financial institutions through a SWIFT MT700 message. It ensures that sellers receive payment from buyers once the terms specified in the DLC are met. Importers and exporters often require an intermediary, such as a bank or financial institution, to guarantee payment and delivery of goods in international business transactions.
The Purpose of a DLC
The primary purpose of a DLC is to provide financial security to both parties involved in a transaction, particularly when they have not yet established a close business relationship or are located in different countries. By utilizing a DLC, sellers can mitigate risks associated with international legal systems and lack of trust with buyers.
The parties involved in issuing a Documentary Letter of Credit are:
- Seller/Exporter (Beneficiary)
- Issuing Bank or Financial Institution
- Buyer/Importer (Applicant), who is also a customer of the bank or financial institution
- Advising Bank, of which the seller/exporter (beneficiary) is a client
Key Features of a DLC
A Documentary Letter of Credit requires the seller/exporter (beneficiary) to present specific documents before the expiration of the letter of credit. These documents are directly related to the contract between the seller/exporter and the buyer/importer, as they demonstrate to the issuer that the seller/exporter has fully fulfilled their part of the deal.
Conforming Presentation and Payment
Once the seller/exporter makes a conforming presentation, the issuing bank or financial institution will make a payment to the seller/exporter, even if the buyer/importer does not want to pay.
The Documentary Letter of Credit is governed by a set of guidelines known as the Uniform Customs and Practice (UCP 600), created by the International Chamber of Commerce (ICC) in the 1930s.
Process of Obtaining a DLC
Step 1: Application
To obtain a DLC, the applicant must complete a DLC application and submit it alongside their proposal documents, such as a proforma invoice, Sales and Purchase Agreement (SPA), or contract.
Step 2: Draft
A bank or financial institution then prepares a free draft SWIFT MT700 documentary credit for the applicant and their seller/exporter to review and confirm.
Step 3: Draft Review and Opening Payment
After reviewing and making any necessary changes to the draft, the applicant and seller/exporter must remit the opening fee to the bank or financial institution as per the proforma invoice. Once the remittance is received, the completed Documentary Letter of Credit will be sent to the issuing bank or financial institution for the issuance of the SWIFT MT700.
Step 4: Issuance
In most cases, the bank will issue the DLC within 48 hours of approval. The bank will then email a copy of the letter of credit sent to the beneficiary via MT700 SWIFT, including the reference number of the letter of credit. The supplier/exporter can confirm receipt of the DLC shortly thereafter.
Step 5: Submission of Documents
After preparing and loading all goods for shipment, the seller/exporter must send the required documents for the particular shipment to their advising bank. The advising bank then forwards these documents to the issuing bank, who will email copies of the submission and all submitted documents to the buyer/importer for review and approval.
Step 6: Payment for Goods
Before the issuing bank can release the original documents, they must receive payment for the submission. Upon receiving payment, the bank will sign the documents and deliver them to the buyer/importer’s carrier or consignee of choice the following day, completing the transaction.
Advantages of Using a DLC
A DLC enhances trust between buyers and sellers in international trade, as it provides a guarantee of payment and delivery of goods.
By utilizing a DLC, sellers can reduce risks associated with international legal systems and lack of trust with buyers.
DLCs facilitate international trade by providing a secure and efficient method of payment between parties from different countries.
Disadvantages of Using a DLC
DLCs can be costly, as banks and financial institutions charge fees for their services in issuing and processing the instrument.
The process of obtaining and using a DLC can be complex, particularly for businesses unfamiliar with international trade regulations and practices.
A Documentary Letter of Credit is a vital financial instrument in international business transactions, providing a guarantee of payment and delivery of goods between buyers and sellers. By understanding the intricacies of a DLC and following the proper procedures, businesses can effectively mitigate risks and enhance trust in their international trade endeavors.