Standby Letter of Credit (SBLC)/ Bank Guarantee (BG)
Standby Letter of Credit (SBLC)/ Bank Guarantee (BG) is a guarantee of payment issued by a bank on behalf of a client that is used as “payment of last resort” should the client fail to fulfill a contractual commitment with a third party. Standby letters of credit are created as a sign of good faith in business transactions and are proof of a buyer’s credit quality and repayment abilities. The bank issuing the SBLC performs brief underwriting duties to ensure the credit quality of the party seeking the letter of credit, then sends notification to the bank of the party requesting the letter of credit (typically a seller or creditor).
A standby letter of credit shows a company’s credit quality and ability to repay loans. Although SBLC/BG is not intended for use as a replacement for immediate cash payment obligation, it helps fulfill business obligations in case the business stops operations, cannot pay its vendors or becomes insolvent.
Small businesses often face difficulty when securing financing. For this reason, Standby Letters of Credit may be especially beneficial for encouraging investors to lend money to such a company. In case of default, investors are assured they will be paid the principal and interest from the bank through which the SBLC/BG is secured.
Standby Letters of Credit are issued for use in a wide variety of commercial and financial operations. Standby Letters of Credit are very much alike Documentary Letters of Credit (DLC). The main difference between a Documentary Letter of Credit and a Standby Letter Of Credit being that unlike DLCs, SBLCs only become operative in case the applicant defaults. In case of default, the beneficiary in whose favor the SBLC was issued, can draw on the SBLC and demand payment.
Historically, Standby Letters of Credit were developed because the US regulator legally limited US bank’s authority to issue Bank Guarantees.
SBLCs are also very similar to Bank Guarantees (BG), which too require that the presentation of stipulated documents be compliant with the terms and conditions of the Bank Guarantee. SBLC’s and Bank Guarantees are different in terms of protection, they both serve the primary purpose of making sure that sellers get paid, but while a Standby Letter of Credit protects the seller, a Bank Guarantee (BG) protects both sides, since it also protects the buyer in case the supplier never ships the goods or ships them in a damaged condition.
When requesting a SBLC, a business owner proves to the bank he is capable of repaying the loan. Collateral may be required to protect the bank in case of default. The bank typically provides a letter to the business owner within one week of receiving documentation. The business owner must pay a SBLC fee for each year that the letter is valid. The fee is typically 1-10% of the SBLC value. If the business owner meets the criteria outlined in the contract before the due date, the business owner can cancel the SBLC without further charges.
Standby Letters of Credit (SBLC) are a very flexible tool, making them a suitable product for securing a wide range of payment scenarios. A financial SBLC, the most common type, is typically used in international trade or other high-value purchase contracts where litigation or other non-payment actions may not be feasible. A financial SBLC guarantees payment to the beneficiary if criteria outlined in the contract are left unfulfilled. For example, an exporter sells goods to an overseas buyer who guarantees payment in 30 days. When the payment does not appear by the deadline, the exporter presents the SBLC to the importer’s bank and receives the payment.
A performance SBLC ensures the time, cost, amount, quality of work and other criteria are fulfilled in a manner acceptable to the client. The bank pays the beneficiary if any of the written obligations are unmet. For example, a contractor guarantees a construction project will be finished in 90 days. If work remains incomplete after the 90-day period, the client can present the SBLC to the contractor’s bank and receive the payment due.
The SBLC should not be confused with the documentary credit which is instead a means of payment since the buyer goes to his bank and asks him to pay the seller at a given moment, i.e. on a date or to the fulfillment of a condition (delivery for example).
The following are very important facts;
All SBLC/BG are Asset/Cash backed. A newly created SBLC/BG is called “Fresh Cut” whereas an already existing SBLC/BG is called “Seasoned”
Whether purchased of leased, SBLC / BG is issued for a “term” having validity normally for 1 year and 1 day which may extend up to multiple years depending on the Provider’s own discretion and Provider’s level of comfort with the Beneficiary.
Most banks will issue an SBLC/BG to any of its customers if they have sufficient (100% of Face Value of the Instrument) liquidity (cash) in their bank account or available balance in their credit line (if they are already availing a credit line from the bank). It’s a complete myth that “Banks Do Not Issue SBLC/BG). This direct transaction between a client and his bank is the “Primary Market” transaction.
Providers of SBLC/BG generally are a part of the “Secondary Market” transactions. SBLC/BG Providers are high net worth corporations or individuals who hold bank accounts at the issuing bank that contain significant cash sums (assets). SBLC/BG Provider would often be a collateral management firm, a hedge fund, or private equity company. SBLC/BG Provider instructs its issuing bank to secure and encumber cash in his own account and authorizes the bank to “cut” (an industry terms meaning to create a financial instrument such as SBLC/BG ). Effectively, the SBLC/BG is “leased” or “sold” to the Beneficiary as a form of investment since the Provider receives a return on his commitment.
SBLC/BG is issued under ICC/URDG 758 (UPC 600) protocol and is readily accepted by almost all International as well as Private Banks.
SBLC/BG is issued by the Issuing Bank of the Provider to the Beneficiary’s bank account at the Receiving Bank and is transmitted inter-bank via the appropriate SWIFT platform alone (MT-760).
The Provider and the Beneficiary agree to enter into a Collateral Transfer Agreement (CTA) which governs the issuance of the SBLC/BG. The SBLC/BG is specifically issued to the Beneficiary for a defined purpose and each contract is bespoke. It is effectively a form of “Securities Lending” and often a derivative of “re-hypothecation”. The fact that there is an underlying agreement (the CTA) has no bearing on the wording or construction of the Guarantee (SBLC/BG). This allows the Beneficiary to use the SBLC/BG to raise credit, to guarantee credit lines and loans or to enter trade positions or buy/sell contracts.
SBLC/BG is valuable in the secondary and tertiary markets, and this also creates an environment for Intermediaries to profit on the leasing and selling of SBLC/BG. Unfortunately, this also creates misunderstandings and opportunities for fraud. Scammers keep trying, by imposing their “procedures” which in general, involve rushed deals with no hard copies to follow, advanced payments, and so on.
By its own nature and definition, only banks can legally issue SBLC (Stand-By Letters of Credit) or BG (Bank Guarantee). This is not only common sense, but actually regulated by banking laws in most countries since these are debt obligations issued by banks.
SBLC/BG must be UCP-600 compliant and hence it must be issued by a licensed bank alone. Otherwise, it will not be UCP-600 compliant, regardless of the wording of the document. If it is not UCP-600 compliant, no bank will ever accept it as collateral or even as a documentary credit. While it is true that URDG-758 changed this from banks to “a bank, other institution or person” may act as a guarantor, the fact is that URDG-758 rules implied that financial stability of the guarantor is obligatory, and that the issuance of said documents shall be governed by the internal legislation of each country. Regardless, most banks will only accept documentary credit from other banks, due to their financial stability and their full compliance with local laws.
Banks, in general, will monetize only an “owned/purchased” SBLC/BG. They will not monetize a “leased” SBLC/BG. In contrast to a purchased or owned SBLC where the buyer becomes the official owner of the instrument and in turn would be able to lease the SBLC out to a Third Party, a “leased SBLC” cannot be “leased out” any further.
There are private Monetizers who would monetize a “leased” SBLC/BG. Some Monetizers will, however, only accept SBLC/BG with CUSIP or ISIN Numbers. This means they will NOT accept a fresh cut bank guarantee, ONLY seasoned instruments. Seasoned BG’s cost more and generally are only available to be purchased from secondary owners not banks.
Although a leased SBLC/BG is not considered an “asset” (a leased SBLC/BG is not trading securities, trading debt instruments, or trading investment funds. There is no public market for the trading of SBLC/BG. All SBLC/BG transactions are private transactions), it can still be monetized, discounted or funded (whereby the SBLC/BG is turned into usable cash) by a resourceful Monetizer. Remember, SBLC/BG is after all a written obligation of the issuing bank to pay a sum on to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary. The Instrument/ Security remains valid during the term before the Expiry Date. Such resourceful Monetizers possess the capacity to a draw a line of credit against “leased” SBLC/BG and use part of the cash to pay the client his “Non Recourse Monetization Payment” (often 40% to 65% of the value of the Leased Bank Instrument known as “Loan To Value” (LTV). The Monetizer then takes the balance of the money from the Line of Credit and places these funds into Trade / PPP using a proprietary trading platform. This platform is often a group of experienced bank traders who use the Monetizers cash and trade it generating significant profit returns on a weekly or monthly basis. Often the Platform uses normal trading risk protection strategies to ensure the Monetizers funds receive significant protection from all trading downside risk.
Most people often confuse the term NOT RATED with the fact that some SBLC/BG issuing entities are not real banks, but private companies offering consulting services, and sometimes, issuing documents that are beyond their legal and financial capacity, hiding themselves behind the excuse that because they are an “offshore bank” or a foreign corporation or because they only deal with foreigners, they do not need to hold a banking license or comply with reserve deposits with the Central Banks of the jurisdictions from where they operate. The reality is, a rating is just an opinion given by one person or company, about the credibility of the bank or institution what the rating is about; but this has almost nothing to do with the truth, that the documents in question are worthless not because of the credit rating of the issuer, but because the issuer is not a bank.
For political reasons, most Eurozone regulated banks avoid, as much as they can, to work with banks of certain countries. Trying to monetize an instrument issued by a Latin American country, or even China is almost impossible!! Even Europe is not free of that problem; for example, while the list of embargo banks from Russia and Ukraine is very small, most Eurozone regulated banks prefer to not accept as collateral instruments issued by any Russian or Ukraine based banks, they say it is to reduce their risks as much as possible, and to avoid working with banks that while not currently on the embargo list, can be included in said list at any time. Some other countries have strong, reliable and highly praised banks with excellent credit ratings, like Azerbaijan, yet almost no Eurozone regulated bank wants to work with instruments issued by them; this limits the ability of most monetizers to work with instruments from banks of these countries regardless of the credit rating of the bank.
To determine if a borrower is worthy of an SBLC/BG, many banks will undertake a credit analysis. Credit analyses focus on the ability of the organization to meet its debt obligations, focusing on default risk. Lenders will generally work through the five C’s to determine credit risk: the applicant’s credit history, capacity to repay, its’ capital, the loan’s conditions, and associated collateral. This form of due diligence can revolve around liquidity and solvency ratios. Liquidity measures the ease with which an individual or company can meet its financial obligations with the current assets available to them, while solvency measures its ability to repay long-term debts. Specific liquidity ratios a credit analyst may use to determine short-term vitality are current ratio, quick ratio or acid test, and cash ratio. Solvency ratios might entail the interest coverage ratio.
SBLC/BG denotes an irrevocable obligations assumed by banks. The principle that if a compliant demand is made under a standby letter of credit, an issuing bank must pay, subject to only very limited exceptions.
A key purpose of the widespread use of standby letters of credit to finance commodity transactions is the comfort it gives to the seller that it will receive payment.
The drafting of the SBLC/BG should provide that the presentation of a demand would be conclusive evidence that the amount claimed was “due and owing” to the Beneficiary of the SBLC/BG. The beneficiary’s belief that payment was “due and owing” should activate payment.
The meaning of the words “obligated to pay” has to be considered in the context of the certificate to be tendered under the SBLC/BG.
Exceptions to the rule that an issuing bank must pay under an SBLC/BG are limited and difficult to prove. If you have concerns about the reliability of your counterparty, requiring them to provide an SBLC from a reliable bank and governed particularly by English law remains a good way of securing payment.
If you are the beneficiary of an SBLC/BG, you should insist that it contains clear wording to the effect that presentation of a demand by you will be conclusive evidence that the amount claimed will be “due and owing”. In order to rely on the strength of these decisions, you should also ensure that English law governs the SBLC/BG, even if it does not govern the underlying contract.
The great utility of the standby letter of credit is reflected in the fact that it can be used in practically any situation in which one party to a contract is concerned with the other party’s ability to perform. Some of the many ways in which a standby letter of credit can be used are: to ensure payment or performance in construction financing, corporate consolidations, real estate transactions, management contracts, leases on real and personal property, stock transfers and purchases, and bid and performance bonds; to ensure payment of salaries to highly paid individuals such as professional athletes and entertainers; and to ensure payment of professional services such as attorney’s fees.
The standby letter of credit is neither a contract nor a negotiable instrument and if it is not properly drafted, it will not be considered a guarantee at all. The standby letter of credit or SBLC/BG is a distinct legal instrument, unlike any other. The obligation of the issuer of the SBLC/BG is independent of the underlying contract between the issuer’s customer and the beneficiary of the SBLC. The standby letter of credit enables a businessman to enter into business ventures with minimal fear of loss. By substituting the credit of a third party, usually a bank, for that of the debtor, the businessman can help to protect his investment. Finally, the standby letter of credit is particularly well suited for preventing loss or delay of payment caused by the debtor’s bankruptcy. Because the standby letter of credit and its proceeds are not part of the bankruptcy estate, the beneficiary of a standby letter of credit should receive payment from the bank without delay. The low cost and adaptability to a wide range of business transactions make the standby letter of credit very attractive to the business community and to business lawyers.
Standby letters of credit frequently involve negotiated, complex agreements and larger dollar amounts where lawyers tend to be more involved. Examples include standbys supporting or securing municipal bond issues, construction contracts, subdivision and municipal improvements, commercial real estate leases, equipment leases, cable installations, reinsurance requirements of nonadmitted reinsurers, power purchase contracts, SWAP agreements, securitizations, self-insured retention amounts in insurance fronting arrangements, indemnification obligations for surety bonds, supersedeas bonds to stay execution of a judgment pending an appeal, prejudgment attachments bonds, government contracts or privileges, clearing obligations of brokers and dealers, advance payment guarantees, and open account sales.
Commercial letter of credit customs and practice carry over and are applied to standby letters of credit because standby letters of credit evolved from and have many characteristics in common with commercial letters of credit. Commercial letter of credit customs and practice were established well before standby letters of credit gained usage and popularity. Until 1998, when the International Standby Practices or “ISP”5 was promulgated, almost all letters of credit were issued subject to the Uniform Customs and Practice for Documentary Credits (the UCP).The UCP is specifically geared to examining documents presented in international trade such as drafts, bills of lading, other types of shipping documents, insurance certificates, inspection certificates, commercial invoices, and packing lists. The UCP also provides for the “negotiation” of drafts and documents presented to banks other than issuers that are “nominated” in letters of credit to purchase and present the drafts and documents. Both of these situations—live commercial documents and negotiation of drafts and documents—are seldom relevant to or found in standby letter of credit practice.
The UCP governs standby letters of credit to the extent that its articles are applicable.The UCP does not explain when and how its articles should be applied to standby letters of credit.Even preparing a draft to be presented under a standby letter of credit can present challenges for those who do not have a working knowledge of how banks expect drafts to be worded and presented. Yet every regime that governs letters of credit provides that standard banking practices or international standard banking practices are to be used to determine whether documentary presentations and other aspects of letter of credit transactions are proper and compliant.
Much of the lack of familiarity with or transparency of standby letter of credit practices has been overcome by the International Standby Practices, or ISP. The ISP’s rules specifically address standby letter of credit practice separate and apart from commercial letter of credit practice. The ISP’s rules are well written and for the most part are clear, even-handed, and straightforward. They avoid significant pitfalls of using the UCP in standby letters of credit, such as presentation of stale documents, installment drawings, force majeure, and the requirement that documents and data in documents be consistent. Unfortunately, the UCP is still used in almost half of the standby letters of credit issued in this country and probably in more than half issued by foreign banks in other countries. Additionally, even the ISP’s rules are not all-encompassing. Resort to standard banking practices outside the ISP, caselaw, and the UCC is necessary to fill in the gaps. Finally, there are several rules or provisions of the ISP, the UCP or the UCC that govern standby letters of credit that lawyers and their letter of credit applicant or beneficiary clients may not be familiar with, overlook, or miscomprehend their import. Many letter of credit customs, practices and rules are counter-intuitive and cannot be predicted by resort to simple contract law principles or even other articles of the UCC.1
Private Placement Programs
This is often referred to as PPP or PPIP. The main aim of every PPP is to create wealth and the first thing every client needs to understand is that in this new age, Private placement programs are transactions of privilege and before you are invited into such programs, you must have gone through rigorous due diligence by any trader who puts you in such program.
PPP creates wealth through anticipated profit.
For Example, A person (individual, company, or organization) is in need of $100. He generates a debt note for $120 that matures after 1 year, and sells this debt for $100. This process is known as “discounting”. Theoretically, the issuer is able to issue as many such debt notes at whatever face value he desires – as long as borrowers believe that he’s financially strong enough to honor them upon maturity.
Why does a trader need your Bank Guarantee, Standby Letter of Credit, or Medium-Term Notes:
No private placement program can start unless there is a sufficient quantity of money backing each transaction. It is at this point the clients are needed, because the involved banks and commitment holders are not allowed to trade with their own money unless they have reserved enough funds on the market, comprising unused money that belongs to clients, never at risk.
For Example, The trading banks can loan money to the traders. Typically, this money is loaned at a ratio of 1:10, but during certain conditions, this ratio can be as high as 20:1. In other words, if the trader can “reserve” $100M, then the bank can loan $1B. In all actuality, the bank is giving the trader a line of credit based on how much money the trader/commitment holder has since the banks won’t loan that much money without collateral, no matter how much money the clients have. Because bankers and financial experts are well aware of the open market, and equally aware of the so-called “MTN-programs”, but are closed out of the private market, they find it hard to believe that the private market exists.
HOW SAFE IS PPP:
Such programs never fail because they don’t begin before all actors have been contracted, and each actor knows exactly what role to play and how they will profit from the transactions. A trader who is able to secure this leverage is able to control a line of credit typically 10 to 20 times that of the principal. Even though the trader is in control of that money, the money still cannot be spent. The trader need only show that the money is under his control, and is not being used elsewhere at the time of the transaction.
For Example: Assume you are offered the chance to buy a car for $30,000 and that you also find another buyer that is willing to buy it from you for $35,000. If the transactions are completed at the same time, then you will not be required to “spend” the $30,000 and then wait to receive the $35,000. Performing the transactions at the same time nets you an immediate profit of $5,000. However, you must still have that $30,000 and prove it is under your control.
Confusion is common because most seem to believe that the money must be spent in order to complete the transaction. Even though this is the traditional way of trading – buy low and sell high – and also the common way to trade on the open market for securities and bank instruments.
This is why clients’ funds in Private Placement Programs are always safe without any trading risk.
Compared to the yield from traditional investments, these programs usually get a very high yield. A yield of 50%-100% per week is possible.
For example: Assume a leverage effect of 10:1, meaning the trader is able to back each buy-sell transaction with ten times the amount of money that the client has in his bank account. In other words, the client has $10M, and the trader is able to work with $100M.
Assume also the trader is able to complete three buy-sell transactions per week for 40 banking weeks (one year), with a 5% profit from each buy-sell transaction:
(5% profit/transaction) (3 transactions/week) = 15% profit/week
Assume 10x leverage effect = 150% profit…PER WEEK!
Even with a split of profit between the client and trading group, this still results in a double-digit weekly yield. This example can still be seen as conservative since first-tier trading groups can achieve a much higher single spread for each transaction, as well as a markedly higher number of weekly trades.
Your Position In The Value Chain
The involved clients (program clients) are not the end-buyers in the chain. The actual real end-buyers are financially strong companies who are looking for long-term, safe investments, like pension funds, trusts, and insurance companies. Because they are needed as end-buyers, they are not permitted to participate “in-between” as clients. The client who participates in a PPP is just an actor in the picture along with many other actors (issuing banks, exit-buyers, brokers, etc.) who benefit from this trading. Usually, the client does not interact with others involved in the process.