Issuance Process Step by Step

The issuance of a standby letter of credit follows a clear sequence, and an SME should be able to walk through it step by step. Step 1, the applicant and the beneficiary agree the underlying contract, and agree that a standby will be given as security. The contract states the amount, the expiry date, the drawing conditions, and the governing rules, UCP 600 or ISP98. Step 2, the applicant applies to its bank, the issuing bank, for the standby. The application states the beneficiary, the amount, the expiry, the drawing conditions, and the collateral the applicant offers. The bank assesses the applicant creditworthiness, and decides whether to issue the standby, and on what terms. Step 3, the bank approves the application, and agrees the collateral and the fee. The collateral may be a cash deposit, a lien on the applicant assets, or a guarantee from the applicant parent company. The fee is normally a percentage per annum on the standby amount, for example 1 percent per annum on USD 1,000,000, which is USD 10,000 per year. The bank may also charge an issuance fee and an amendment fee. The applicant signs the application and the indemnity, promising to reimburse the bank if the bank pays the beneficiary. The bank records the standby as a contingent liability, and it reduces the applicant available credit limit by the standby amount. Step 4, the issuing bank issues the standby. It sends the standby to the advising bank by SWIFT, normally as an MT700 message, the issue of a documentary credit. The MT700 carries the fields that define the standby. Field 40A states the form, STANDBY. Field 20 states the documentary credit number, the bank reference. Field 31C states the date of issue. Field 31D states the date and place of expiry. Field 50 states the applicant. Field 59 states the beneficiary. Field 32B states the currency and amount. Field 41a states the available with and by, normally the issuing bank, by payment. Field 46A states the documents required, normally a written demand. Field 47A states the additional conditions, which may include the evergreen clause or the reduction clause. Step 5, the advising bank receives the MT700, authenticates it, and advises the standby to the beneficiary. The advising bank checks that the MT700 is genuine, that it comes from the issuing bank, and that the terms match the agreement. It then delivers the standby to the beneficiary, either as a paper advice or as an electronic message. The beneficiary examines the standby, checks that the amount, the expiry, the drawing conditions, and the governing rules match the contract, and confirms acceptance. If the terms are wrong, the beneficiary asks the applicant to arrange an amendment, which is sent as an MT707 message. Step 6, the standby is outstanding. The applicant performs its obligation, and the beneficiary holds the standby as security. The bank monitors the expiry date, and it will notify the applicant before the expiry if the standby has an evergreen clause, which automatically extends the expiry unless the bank gives notice of non-extension. The bank charges the fee periodically, normally quarterly, and it reports the outstanding standby in its statements to the applicant. The standby remains outstanding until it expires, until it is cancelled by the beneficiary, or until it is drawn. Step 7, if the applicant defaults, the beneficiary draws the standby. It presents a written demand to the issuing bank, or to the confirming bank, stating that the applicant has defaulted, and presents any documents the standby requires. The bank examines the demand, and if it complies, it pays the beneficiary. The bank then debits the applicant account or calls on the collateral. If the applicant performs, the standby expires on its expiry date, and the bank releases the collateral and restores the applicant credit limit. The standby is closed. The evergreen clause deserves attention, because it is common in standby letters of credit and it is a source of error. An evergreen clause states that the standby will automatically extend for a further period, for example one year, unless the issuing bank gives notice of non-extension before a stated date, for example 30 days before the expiry. The bank must diary the notice date, and must decide whether to extend or not, based on the applicant credit position. If the bank forgets to give notice, the standby extends automatically, and the bank remains liable for another year. If the bank gives notice, the beneficiary is warned that the standby will expire, and it may draw the standby before expiry, or it may ask for a replacement. An SME who reviews a standby should always check for an evergreen clause, and should check that the bank has diaried the notice date. For a business analyst, the issuance requirement must cover the application, the approval, the collateral, the MT700, the advising, and the monitoring. The requirement should state that the system records the applicant, the beneficiary, the amount, the expiry, the drawing conditions, and the governing rules, that it generates the MT700, that it diaries the expiry and the evergreen notice date, that it charges the fee periodically, and that it releases the collateral on expiry or cancellation. A system that cannot diary an evergreen notice date will extend a standby by mistake, and the bank will remain liable when it intended to exit.