Transparent contracts in cross border transactions

In international trade transactions, the basic activities are export and import executed through four methods. These are: payment in advance, letter of credit (LCs), documentary collection, and open account. All four methods are in operations in Bangladesh. In LC method, both exporters and importers bear risks. In Bangladesh, export by LC method is found to be decreasing, while open account method is increasing.
In LC method, there are different parties such as electronic communication (SWIFT, email, etc) media, international courier, importers, LC issuing banks, LC advising banks, LC transferring banks, LC confirming banks, LC beneficiaries (exporters), transport operators, financiers etc.
LC method is guided by UCP-600 of ICC (International Chamber of Commerce). Article 4(A) of UCP articulates Credits v. Contracts. It states that a credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, negotiate or fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary.
LCs are being transmitted through SWIFT communication system which requires charges based on the message type, data, and volume of messages. Any amendment in the original message is also costly and time-consuming. Interpreting the semantic ambiguities of the legal clauses in LCs necessitates discretionary determination by banks. Study shows that between 60 per cent and 70 per cent of documents presented for LC evaluation are rejected on the first presentation due to such discrepancies. LCs pose material fraud risks to importers. Banks make payments to exporters based on shipping documents and not on the basis of actual quality of goods. LCs cannot solve quality of goods. Despite this, our import trade is dependent on LC method.
Information technology is undergoing fast changes. Recently technology known as 'blockchain' is widely used in international communication. It is also known as 'decentralised ledger'. The system is decentralised but all parties involved for the transactions remain within the block (network). The present banking system uses SWIFT message for transmitting LCs. It is mandatory to use SWIFT for settlement of payment since it works as global payment system aggregator in which nostro accounts of global banks are linked, unless sanctions are imposed. Other than payment settlements, different options can be used for message flows.
It is said that blockchain can bring smart contracts between importers and exporters. LC issued through blockchain technology can easily disseminate information to exporters, importers, issuing banks, advising banks, confirming banks and even transport operators. LC terms and conditions can be drawn by importers and stored immutably on the blockchain network as a draft which is reviewed and agreed upon before presenting to issuing banks.
Blockchain network ensures that there exists only one copy of LC and all parties can work on it depending on their access right. Once reviewed and agreed upon by all parties, issuing banks finalise and issue LCs to exporters. Any changes/amendment can be implemented using multi-signatory mechanism by granting appropriate permissions to participants. Blockchain smart contract contains terms and condition of trade. These are date of delivery, port of delivery, packaging and handling, transport mode, transport document, customs clauses, quality and quantity certificates. Finally, based on documentary evidences submitted by exporters, verification of conditions stated in LCs can be evaluated.
Due to value added services, LC is found transmitting through blockchain technology. In Bangladesh, a blockchain platform known as 'contour 'is reported to transmit LC. Another platform known as 'Green LC' is expected to operate to cater to the needs of local back to back LCs. The technology will ease LC operations bringing all parties in a network. LC is a commitment by banks to make payments to beneficiaries subject to fulfillment of given terms and conditions. But as noted earlier, different parties are integral part of the commitments by banks. As such, banking regulations are not a problem to implement the technology. It is known that before use of SWIFT, telex was in operation. Before telex, mail LC was sent through postal service. Central bank and trade bodies should encourage banks to use blockchain technology for transmission of LCs.
As noted earlier, documentary collection and open account methods are used in export trade. In this case, sales contracts are used. Banks are not a party of the contracts, rather a bilateral issue between exporters and importers. Banks facilitate transactions on receipt of paper documents from exporters but they cannot assess their genuineness.
Export trade of Bangladesh possesses some peculiarities. Once upon a time, exporters exported goods on cash payments for which they procured raw materials on credit. The situation has changed. Now exporters export goods on credit against import of raw materials on cash by way of central bank's refinancing window or buyer's credit. Export is executed under sales contracts but imports of raw materials are executed under LC method. In this system, banks become exposed to default risk. Safeguards to payments defaults may save exporters as well as banks, for which payment guarantees need to be arranged by exporters with the help of banks and foreign importers. Before going for required arrangements, banks need to be ensured of the genuineness of sales contracts.
The prevailing system does not ensure what is needed to banks. The movements of sales contracts need to be disclosed to different parties involved in the transactions, including banks. If it happens, banks can be ensured of the forthcoming transactions. It is only possible provided that dynamic system for movements of sales contracts is used, in which banks will be a party. Decentralised communication networks can be used with involvement of different parties such as exporters, importers, payments guarantors, financiers, nominated suppliers of raw materials, nominated transport operators and others, if any.
This communication networks can also be used for presentation of export documents. Presently export documents can be presented electronically by exporters. But the system is one to one. Banks know about the presentation only when they are informed. As such, all information flows need to be linked with different parties. It is known that exporters use electronic platforms for communication and presentation of documents with importers. It is like a web portal with access by designated parties. This may be a network provided that financial operators like banks can be included.
Inevitably user-friendly technology needs to be used for transmission of LCs with intimation to all related parties. This can definitely reduce operational hassles in executing transactions. In case of transactions without LC method, flows of information and documentation need to be channeled through the same technology, taking all parties onboard. This will surely facilitate protection of non-payments risks associated with the transactions.
No regulatory approval seems to be required for use of the new mode of communication. However, traders need to be aware of the system for which trade bodies should come up with leading role to execute smart transactions.
hossain.shakhawat45@yahoo.com