Key points

ER? ––The BPO, although it has similarities to a letter of , is in many ways a V Feature different instrument. R E ––Under a BPO, the seller in the underlying transaction has no direct claim against the obligor if the recipient bank fails to perform. W, O W, ––The automation of the data set comparison process in the mechanics of the Uniform Rules for BPOs removes the element of subjectivity. – NO– T Authors GeoffreyL. Wynne and Hannah Fearn F CREDI The bank obligation: will it ER O ER TT replace the traditional letter of credit – AL LE ON I T now, or ever? RADI The International Chamber of Commerce (ICC) suggests that a bank payment comparison of the data set against the

HE T obligation (BPO) can be viewed as an electronic letter of credit. This article requirements of the established baseline. analyses the BPO and explores the differences between a BPO and a letter of If there is a match, the TMA sends an credit, compares the transferability of BPOs and letters of credit in supply chain automatic notification to the parties and the financing and considers the benefits and risks of automation for . It obligor bank is bound to pay the recipient suggests how banks might use BPOs to offer financing to traders and considers bank in accordance with the payment terms T REPLACE T whether BPOs will replace letters of credit as a method of payment settlement of the BPO. in transactions. It is possible for a single established baseline to include more than one BPO. : WILL: I This allows a buyer to ask several banks to

ON What is a BPO?

I A spotlight has been placed on the a single transaction. Under URBPO, T nBPO following the ICC’s launch The underlying nature of a BPO is the same each such obligor bank gives an independent of the Uniform Rules for Bank Payment as for a letter of credit: it is an irrevocable BPO, and no joint and several obligations

BLIGA Obligations (URBPO) in June 2013. The undertaking given by one party to another are created between those banks. purpose of URBPO is to establish the to pay on satisfaction of certain specified

NT O means of using BPOs in the global banking conditions. It allows buyers and sellers to BPO v letter of credit: the market. However, the success of the BPO mitigate the risks of trading by transferring beneficiary and the rights of ME

Y rests not only on the success of URBPO the payment risk to a bank. the underlying seller in establishing a set of uniform rules, but A BPO is created in relation to an The most important difference between a K PA also in determining whether there is either underlying trade transaction. The banks BPO and a letter of credit is the identity of N the scope or the need for another trade of the seller and buyer, who have agreed to the beneficiary. A BPO exists between two instrument in the market. participate in the BPO, submit data about banks: the obligor bank, who undertakes

HE BA A key driver in developing the BPO the underlying transaction to an electronic to make a payment, and the recipient bank, T was the opportunity for banks to tap into data matching platform (transaction who receives that payment. The seller in the the huge proportion of international trade matching application or TMA). This data underlying transaction has no direct claim transactions currently settled on an open is called a “baseline”. If matching data is against the obligor bank if the recipient bank account basis. It is hoped that trading submitted by the two banks, the TMA sends fails to perform. Further, the relationship counterparties, looking for a way to lower an automatic notification and the baseline between the recipient bank and the seller is the risks of open account trading, but for is “established”. At this point, the buyer’s outside of the scope of URBPO. The terms whom letters of credit are not appropriate bank, known as the obligor bank, becomes on which the proceeds of a BPO are paid to (perhaps due to cost, timing or the level of irrevocably bound by the terms of the BPO. the seller must be agreed separately between sophistication involved in making complying Once the seller has shipped its goods, the the recipient bank and the seller. presentations), will turn to BPOs as a seller’s bank, known as the recipient bank In theory, a seller could mitigate the risk cheaper, perhaps simpler, alternative. (or another bank who has agreed to submit of the recipient bank failing to perform by The ICC suggests that the BPO is an data for the BPO), may upload the relevant requesting an of the proceeds alternative “electronic” letter of credit. data about the shipment to the TMA. This of the BPO in its favour (as permitted The BPO, although it has similarities to a is called a “data set” and might include, under art16 of URBPO). However, the letter of credit, is in many ways a different for example, commercial, transport and obligor bank’s consent is required for any instrument. The question is, does the BPO information about the shipment. assignment, and the role of the recipient have the potential to replace the letter of The recipient bank is not required to submit bank in the BPO cannot be transferred (so credit in international trade transactions? any documents. The TMA performs a only the recipient bank could submit data

102 February 2014 Butterworths Journal of International Banking and T Feature BA HE N K PA Y ME O NT BLIGA to establish the BPO and trigger payment and there are risks for banks of mistakenly would have control over the submission of under it). disclosing the second beneficiary’s data to trigger payment. Contrast this to T

By contrast, a letter of credit is issued to the end-buyer and causing a breach of a back-to-back letter of credit, where the I ON in favour of the seller, meaning that the confidentiality. middleman’s bank needs to take seller (as beneficiary) has a direct claim Another possibility is assigning the over the first letter of credit to protect I : WILL against the issuing bank (the buyer’s bank) proceeds of the letter of credit under art 39 its . for payment. This relationship is within the of UCP 600. This might work where the scope of the Uniform Customs and Practice middleman’s supplier does not want the BPO v letter of credit: the T T REPLACE for Documentary , 2007 Revision, right to perform as beneficiary under the benefits of automation? ICC Publication No. 600 (UCP 600), and letter of credit. BPOs are established and managed using there is no need for a separate contractual Neither of these methods will work TMAs. The entirely electronic nature of relationship between the issuing bank and where the middleman’s end-buyer has BPOs is reflected in URBPO, which defines the seller. agreed to settle payment with a BPO. This is the ISO 20022 trade services management T HE If a letter of credit is issued, and the because the middleman is not party to that messages (TSMT messages) used to RADI beneficiary seller is concerned about the BPO and has no rights to transfer or assign. communicate the existence and terms of issuing bank’s ability to perform, it can A third possibility is the issuing of BPOs between banks. T I obtain further comfort by asking its own back-to-back letters of credit. Here, the The automated nature of the BPO ON bank to confirm the letter of credit. This middleman, on receiving of a letter of is demonstrated when considering how AL LE AL independent undertaking given by the credit for the sale of his goods, uses this as payment is triggered under a BPO, confirming bank to the beneficiary seller is collateral for the issue of a letter of credit when compared to a letter of credit. An also within the scope of UCP 600. in favour of his supplier. The middleman’s issuing bank must honour a letter of TT As a BPO does not give any rights to bank, who issues the second letter of credit, credit on the occurrence of a complying ER O the seller, there is no provision within will invariably act as under the presentation (art 7 of UCP 600). By F CREDI URBPO for the recipient bank to give a first letter of credit, giving it comfort as to contrast, an obligor bank must honour “confirmation”-style undertaking to the the existence of the first letter of credit and a BPO when the TMA performing the seller. This is not to say that the recipient control over presentation of the documents relevant data comparison notifies the bank cannot choose to give the seller an under that letter of credit. parties of a data match. T – NO independent undertaking against receiving

a BPO, but this would fall outside the scope W, O of the BPO. “The automated nature of the BPO is demonstrated

when considering how payment is triggered under a R E BPO v letter of credit: V the middleman – BPO, when compared to a letter of credit” ER? transferability and back-to-back transactions This type of arrangement is not expressly There are two key distinctions here. There are several ways for the middleman in recognised within UCP 600 and this is First, a letter of credit requires presentation a supply chain to use the benefit of a letter of not necessary as both letters of credit can of documents. A BPO requires submission credit issued in his favour (on the application be separately subject to the rules. Using of data only. This requires a change of of his end-buyer) to make payment to his back-to-back letters of credit can offer more practice for those accustomed to dealing supplier. This flexibility comes from the fact flexibility than using transferable letters with physical documentation. that the middleman is the beneficiary of the of credit, as there is more scope to vary the Secondly, and most importantly for letter of credit, and has direct rights that he terms of the two letters of credit. However, these purposes, the bank that receives a can transfer or assign to another party. the bank issuing the second letter of credit presentation under a letter of credit must One possibility is transferring the letter will need to have documentation in place to examine those documents and actively of credit under art 38 of UCP 600. The ensure it can take the proceeds of the first decide whether to accept the presentation as middleman benefits from this arrangement letter of credit. complying or to reject it. UCP 600 contains as he can arrange for payment of his supplier There is no reason why this type of a number of articles on how the bank should without incurring any liability under his arrangement could not be used where the conduct this examination and the conditions credit lines with his bank. However, there end-buyer is settling payment by a BPO. In to which certain documents should conform. are drawbacks to this. For example, there is fact, the middleman’s bank would be in a However, there is an unavoidable element limited scope for amending the conditions better position as the direct beneficiary of of subjectivity. This is made evident by of the letter of credit when transferring it the BPO from the end-buyer’s bank and it the regular publication of ICC Banking

Butterworths Journal of International Banking and Financial Law February 2014 103 Biog box ER?

V Feature Geoffrey L. Wynne is head of Sullivan & Worcester’s trade and commodities finance

R E group, and head of the firm’s London office. Hannah Fearn is an associate in Sullivan & Worcester’s trade & export finance team in London. Email: [email protected];

W, O W, [email protected] – NO– T

Commission opinions, which often concern are similar. For the buyer instructing a high risk area for money laundering and

F CREDI queries relating to discrepant presentations, its bank to issue either a BPO or a corruption and in 2013, the UK’s Financial and by case law generated on this point. letter of credit, there is the possibility of Conduct Authority (FCA) published the

ER O ER The automation of the data set the bank financing the buyer’s findings of its thematic review into financial TT comparison process in the mechanics reimbursement obligation. crime risks in (TR13/3 Banks’ of URBPO removes this element of A seller could ask its bank, as recipient control of financial crime risks in trade

AL LE subjectivity. The seller will provide shipping bank under a BPO, to issue an independent finance). The FCA expects banks to develop

ON and invoice data to the recipient bank, who undertaking to make payment to the seller, policies and controls where necessary to I

T will submit this to the TMA. The TMA regardless of whether the obligor bank pays. implement the FCA’s recommendations of will automatically perform a comparison This is similar to a confirmation under a good and bad practices and this will require

RADI with the BPO’s baseline, and generate a letter of credit, except: more stringent examination of underlying trade transactions.

HE T Letters of credit involve an element of “One thing is clear: it will be very important when human scrutiny. Bank staff at presentation dealing with BPOs, for the underlying parties to ensure counters must examine the documents representing the underlying transaction the data they provide for submission is accurate” before any payment is made. This T REPLACE T opportunity to perform a “sniff test” is message confirming a data match or ––the seller does not obtain any right lost where the human element is removed data mismatch. If there is a data mismatch, of recourse against the obligor bank from the process, as is potentially the : WILL: I the obligor bank has complete discretion who issued the BPO; and case with BPOs. To reap the cost-benefit ON

I as to whether to accept the data and ––the relationship between the of automation, banks may use electronic T make payment. recipient bank and the seller is not platforms that allow their customers However, the automation of the process within the scope of URBPO and so to upload transaction data which is

BLIGA removes the flexibility allowed within the parties would need to document submitted directly to the TMA, without UCP 600. For example, art 14d of UCP this separately. any intervention from the bank’s staff. If

NT O 600 provides that data in documents the FCA requires a level of scrutiny that need not be identical, so as it is A seller may give credit to its buyer by prohibits this automation, the cost of ME

Y non-conflicting, while art 30 provides for permitting it to arrange for a BPO with offering BPOs will increase, the processing tolerances in respect of the words “about” deferred payment terms. The seller could time will lengthen, and some of the K PA and “approximately”. then ask its bank to “discount” that BPO by perceived advantages over letters of credit N While removing the element of giving an independent undertaking to pay will be lost. subjectivity no doubt increases certainty, the seller when the obligor bank’s obligation Both BPOs and letters of credit are

HE BA it will be interesting to see whether to pay becomes unconditional (ie, after a intended to have a degree of independence T the process of automatic comparison is data match), but before payment is due. from the underlying transaction between sufficiently flexible to deal with the realities This is similar to the idea of discounting a the commercial parties. The increased of international trade, for example, by deferred payment letter of credit, with the burden on banks to scrutinise the business allowing for tolerances within quantities same exceptions as above. of their commercial clients might necessitate and prices. One thing is clear: it will be In both cases, by issuing its own changes in the way banks operate all types very important when dealing with BPOs, undertaking to the seller, the recipient bank of independent payment undertakings, for the underlying parties to ensure the takes obligor bank risk. This is conceptually including letters of credit and BPOs. data they provide for submission is accurate. the same as a confirming bank taking For the foreseeable future, it seems that It may mean that BPOs are better used issuing bank risk under a letter of credit. BPOs and letters of credit will sit along where there is no scope for variations in the side each other, and potentially there are data being provided. Wil the BPO replace the letter obstacles for banks to overcome as they start of credit in the future? to use BPOs. Over time, as the industry BPO v letter of credit: The move towards automation in the embraces increased automation and traders financing opportunities financing of international trade is demand faster, cheaper methods of settling for banks happening alongside a worldwide trend of payment, it may be that the electronic Although there are some fundamental regulators demanding that banks increase nature of the BPO means it becomes the differences between BPOs and letters of the scrutiny of trade transactions. Trade preferred method of payment over the credit, the potential financing opportunities finance is often perceived by regulators as traditional letter of credit. n

104 February 2014 Butterworths Journal of International Banking and Financial Law