Kai Fehr, Regional Head of Trade, Asia Pacific, Wells Fargo International Trade Services
Importers and exporters have used letters of credit (L/Cs) for decades, particularly for high-value transactions where the buyer and seller want to ensure a smooth experience on both sides. Approximately 12.5% of all global trade — valued at $2.3 trillion — employs L/Cs.1
L/Cs provide greater certainty to all parties. Buyers may be hesitant about payments or delivery when working with new suppliers, or shipments from emerging economies with less structured financial systems. Suppliers may share similar concerns about timely or complete payment when working with new customers, less common currencies, or subcontractors. L/Cs tap the worldwide banking network to facilitate the transaction and add a layer of protection for both sides.
How a letter of credit works
First, the buyer negotiates finance terms with their bank. The bank next issues the L/C to the supplier and the supplier’s international bank. The seller knows in advance that the buyer’s bank will pay on time and in the correct amount, as long as the buyer’s bank receives documents that conform the L/C requirements regarding terms such as shipping or delivery. Required documents may include packing lists, bills of lading, insurance certificates, invoices, and certificates of origin. The buyer gains reassurance that another qualified party will validate the transaction, as well as working capital benefits.
Letters of credit might also provide an opportunity for buyers to support environmental sustainability by creating enhanced visibility. When the buyer and their bank are ready to receive and pay for goods, banks may have an opportunity to verify immediately that a commodity meets objective standards for sustainability.
The industry is developing an enhanced L/C, called a sustainable shipment letter of credit, which I helped develop during my time as chairman of the Banking Environmental Initiative (BEI) working group that explored how letters of credit can be used to support sustainable supply chains.
Additional visibility into global supply chains would provide buyers and their consumer customers assurance that the goods purchased support positive environmental practices.
Based in Singapore, Kai Fehr is the regional head of trade, Asia Pacific, for Wells Fargo International Trade Services. Kai leads a team of international trade specialists supporting sales, relationships, and partnerships for Wells Fargo’s corporate, commercial, and financial institutions customers.
1. VOX, “Trade finance around the world,” by Friederike Niepmann and Tim Schmidt-Eisenlohr, June 11, 2016