The Present Context
face="Times New Roman">1.08 In light of the UCP 500’s roaring success in facilitating trade finance, a new revision was always going to prove a long and arduous process given the many disparate interests across the trade, carriage, banking, insurance, and logistics sectors that rely upon the UCP framework.
Indeed, it took over three years for the UCP 600 to reach its final form following the work of the ICC’s UCP Drafting Group, UCP Consulting Group, Commission on Banking Technique and Practice, and 130 National Committees worldwide.[40] The resulting document has a number of notable features. First, after a series of revisions that had increased the overall length and complexity of the UCP, the UCP 600 was notable for its overall reduction in length and the succinctness of its drafting. In part, the reduction in length resulted from a decision to exclude from the UCP’s ambit issues relating to the relationship between the applicant and the issuing bank: given that these parties will almost invariably be located in the same jurisdiction, the form and nature of the applicant’s instructions and the applicant’s obligation to reimburse the issuing bank are properly the concern of the law applicable to the banker-customer relationship between those parties. Accordingly, the UCP 600’s focus is upon the inter-bank relationship, the beneficiary’s obligations with respect to presentation, and the banks’ role in examining the documents. Similarly, the UCP 600 improved the position with respect to some common problems that had arisen under the UCP 500. These included reversing the decision of the English Court of Appeal in Banco Santander SA v Banque Paribas,[41] by deeming that the issuing bank has conferred authority upon a nominated bank to discount its deferred payment undertaking;[42] by allowing a document to be treated as the original if it bears an ‘apparently’ original signature,[43] ‘appears’ to be written under the issuer’s hand,[44] or ‘appears’ to be on the issuer’s original stationery;[45] and by attempting a clearer definition of ‘negotiation’ to mean ‘the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank’.[46]Despite these improvements, the UCP 600 faces the existential threat that, whilst documen- 1.09 tary letters of credit still remain ‘important to about 10% of global merchandise trade’,[47] there is no doubt that the percentage of trade covered by a letter of credit has been dropping for some time and continues to do so.[48] That said, the data are not uniform: there are variations in the letter of credit's continued popularity depending upon the particular trade sector[49] and geographical region, with traditional trade finance mechanisms being far more prevalent in the Asia-Pacific region (in particular China, India, and Korea), much less popular in South America (especially Mexico), and Europe (led by Italy) falling somewhere between the two.[50] As well as economic factors playing their role, the letter of credit’s use may depend upon geographical factors (such as the distance to major commercial centres or trading partners)[51] and upon the presence (or otherwise) of international banks in a particular jurisdiction.[52] Accordingly, there may be isolated instances where the volume of letters of credit continues to hold steady, or even increase, but the overall picture for the UCP 600 is an increasingly bleak one.
A combination of four factors may explain the letter of credit’s dimming star.A. Reliability
The first factor is that letters of credit are becoming increasingly unreliable payment instru- 1.10 ments for sellers and accordingly the UCP regime is considered more and more as something that creates obstacles to payment in international trade, rather than facilitating it. Once a payment instrument loses the trust and confidence of the market that it is designed to serve, it is unsurprising when it goes into terminal decline. The source of the problem lies in the fact that, even at the UCP 600’s advent, there were a high number of discrepancies in presented documents under letters of credit with the result that rejection rates were higher than might otherwise have been desirable from a payment instrument that supposedly guaranteed the seller payment.[53] So severe has the problem become that the presumption of payment under a letter of credit has been replaced with a counter-presumption that no payment will be forthcoming: a joke long doing the rounds is that ‘UCP stands for “You Cannot Pay” ’! Whilst the requirement of strict documentary compliance was originally intended to smooth the passage of the documents by making the banks’ role essentially mechanical, this has increasingly given banks a discretion (often acting upon their customer’s instructions) whether or not to honour the presentation. Indeed, it would be an unusual set of documents that did not contain even the slightest error, no matter how minor.[54]
1.11 The UCP 600 aimed to address this problem, but its provisions dealing with the requirements of documentary presentation and examination were either overly complex (in the case of the carriage documents) or elliptical (in the case of the requirement that documents be examined in the light of ‘international standard banking practice’).
Whilst the ICC certainly sought to address the latter concern by subsequently developing guidance concerning ‘international standard banking practice’, so that document-checkers in different jurisdictions would adopt a consistent approach to the identification of discrepancies, ‘the ICC’s attempt to introduce uniformity as regards details of compliance—made in the International Standard Banking Practice (known as ISBP)—has not achieved its object’.[55] Accordingly, rejection levels have remained stubbornly elevated under the UCP 600 and the letter of credit’s basic machinery appears slowly to be grinding to a halt.B. Competition
1.12 The second factor is that, as a result of the falling levels of trust in the letter of credit and the high bank fees associated with letter of credit operations, legal Darwinism has allowed cheaper, quicker, and better-adapted competitor payment mechanisms to gain market share. The most obvious response was for traders to eschew banks altogether and it is accordingly no surprise that there has been an exponential growth in trading on ‘open account’ terms (when shipment is to occur before payment) or on ‘cash-in-advance’ or ‘prepayment’ terms (for the converse situation).[56] There has also been a renewal of interest in countertrade activities, which are simply not dependent upon banks,[57] and more specialised trade finance mechanisms that banks may not be best placed to deliver.[58] Before the Global Financial Crisis (GFC), there were indications that ‘open account’ trading accounted for up to 60% of global trade payments,[59] although some surveys put the figure even higher at 70%[60] or 80%.[61] While these figures appeared to dip during the GFC, they appear to represent the new normal.[62] Open account financing will be particularly attractive where the trade parties have dealt with each other successfully on previous occasions, already have an established and ongoing legal relationship, and/or for some other reason trust each other (whether as a result of the size or nature of the counterparty’s enterprise or the type of jurisdiction in which it is based).[63] In some instances, commercial standby letters of credit or demand guarantees are used to mitigate the non-payment or non-performance risks under an open-account arrangement.
Open-account or pre-payment trading is not, however, a panacea, as it leaves traders with the cash-flow problem of turning illiquid receivables into liquid funds. As letter of credit fees have dried up, banks have seized the opportunity to continue earning fees through ‘Supply Chain Finance' or ‘SCF', which seeks to provide working capital liquidity to traders by receivables financing, inventory financing, and extensions of credit.[64] Indeed, data suggest that banks view SCF as the area with the greatest potential for future growth, largely at the expense of traditional financing methods.[65] size=1 color=black face="Times New Roman">[66]This trend in ‘do-it-yourself' trade finance may effectively render the UCP regime, and by association the ICC's trade finance role, otiose. Appreciating the risk of being sidelined from trade finance activity, the ICC fought a rearguard action by introducing the eUCP to allow presentation of electronic documents and inventing a complete alternative to letters of credit, namely the ‘bank payment obligation' or ‘BPO', which seeks to replace payment against documents with payment against electronic data. As the BPO has proved too expensive and sophisticated to have much impact, neither initiative has halted the steady march of open-account and SCF at the expense of the letter of credit.
C. Technology
The third factor, linked to the increased competition from challenger payment mechanisms, is that the growth of technology has cast an increasingly strong light upon the fact that presentation of paper documents reduces transaction speed, whilst increasing the costs of compliance. As indicated above, the ICC has made two attempts to capture some of the electronic market. The first attempt was to introduce the eUCP,70 which extended the ambit of the UCP regime to enable beneficiaries to present digitised documents in place of their paper counterparts.
Despite the obvious attraction of this solution, the UCP regime has to date proved largely incapable of accommodating e-commerce within its paper-based philosophy. The principal reason for this failure is that there seems to be little point allowing for electronic presentation of documents until documents are routinely capable of digitisation, which has proved difficult due to fears of increased fraud and the need for bills of exchange and lading to be transferable.[67] Whilst there are increasingly legal[68] and technological frameworks[69] that might allow for the digitisation of bills of exchange,[70] bills of lading, and cargo insurance certificates,[71] these are still at a relatively early stage of their development. Indeed, even if these digital documents perform their intended function at all,[72] there is the risk that the general trend towards open-account, prepayment, and supply chain financing has gone past the point where traders are likely to return to paying the fees associated with letters of credit as a payment mechanism, even in a new digital form.1.15 The second attempt was to introduce an entirely new form of payment mechanism, the BPO,[73] replacing the transfer of documents with the transmission of the data that they contain and replacing document-checking with the verification of the transmitted data against an electronic baseline. The BPO was introduced with much fanfare.[74] Unfortunately, the adoption of the BPO by banks ‘has been lower than expected. .. because it depends on acceptance of the instrument by a “critical mass” of banks',[75] which has not yet to date occurred. Accordingly, the BPO has been compared to being the first owner of a mobile phone; the technology works, but there is nobody to call.[76] The reasons for this slow adoption might be linked to early confusion about the treatment of BPOs for bank capital adequacy purposes and their pricing structure;[77] SWIFT's pricing model ‘making it nigh-on impossible for peripheral banks to join BPO';[78] the high costs on the part of banks and traders in investing in new technology and infrastructure to support a new payment mechanism; and the fact that those banks that initially invested heavily into BPO subsequently abandoned the project when the uptake amongst other banks appeared ‘sluggish’,[79] and there was little chance of a return on investment.
Whilst there has recently been an attempt to reinvigorate the BPO by a consortium of international banks, without broader adoption by banks and a greater realisation on the part of traders as to the potential benefits of the BPO, it is unclear how much more traction it is likely to gain in the future.1.16 Given the simplicity, speed, and cost-effectiveness of open account trading, the fact that banks can now earn their fees through SCF and the availability of distributed ledger technology that does not rely upon a central registry or the ICC to provide the legal or technological framework, the letter of credit's demise is only likely to accelerate.
D. Language, Development, and Regulation
1.17 The final factor is that a number of issues persist with the way in which the UCP 600 operates. First, the language of the UCP 600 remains too technical, with a number of the terms and concepts dating back to the nineteenth century, in particular the continued reference to the use of ‘drafts' and the language of negotiation. Accordingly, in order to understand
the concepts, structure, and operation of the UCP regime, it is often necessary to delve into its history to uncover the issues that the language was seeking to address, rather than being able to deal with the UCP 600 on its own terms. For example, without understanding the law of bills of exchange, it is difficult for banks or traders to operate the acceptance or negotiation mechanisms successfully. Moreover, the UCP 600 often employs legal language to describe issues that are essentially a matter of banking practice, rather than banking law; the language accordingly lacks the precision of an international legal text or domestic legislation, leaving too much scope for reasonable disagreement as to its true meaning.
1.18
Secondly, in such cases of ambiguity in the UCP's text, the UCP regime appears to be interpreted and operated in an unnecessarily pro-bank manner. In Fortis Bank SA/NV v Indian Overseas Bank,[80] Hamblen J stated that the UCP 600 requires a ‘purposive approach to construction' and indicated that this approach should ‘reflect “the best practice and reasonable expectations of market practitioners” Similarly, on appeal in Fortis Bank,[81] Thomas LJ indicated that ‘[c]ourts must therefore interpret [the UCP 600] in accordance with its underlying aims and purposes reflecting international practice and the expectations of international bankers and international traders so that it underpins the operation of letters of credit in international trade'. This view has subsequently been endorsed by the Singapore Court of Appeal.[82] Whilst these statements appear innocuous enough on their face, the suggestion that ambiguities in a document drafted by bankers should be interpreted in their favour does seem odd. Not only is it inconsistent with the basic contra proferentem approach to interpretation adopted in other contexts, but an interpretation of the UCP 600 that prefers banks' interests, rather than prioritising those of beneficiaries, risks undermining the attractiveness of letters of credit to traders generally. Certainly, there should be limits to the extent that banks can rely upon their own practices to cure their own drafting infelicities.[83]
1.19
Thirdly, the mechanisms for amending or supplementing the terms of the UCP 600 are cumbersome. As stated above, a full revision of the UCP regime is a lengthy process requiring ‘not only a minimum 3-year commitment, but also a regular meeting schedule between Working Group participants. An effective Working Group will require 6-8 participants available for frequent meetings, travel, phone conferences and independent work outside the meetings and calls.'[84] Other techniques fare no better. Whilst it is possible for the ICC Banking Commission to issue opinions on controversial matters, there are only two meetings per annum; the drafting of the opinion tends to be dominated by those at the top of its hierarchical structure; no opinion will be issued if there is no consensus as to the appropriate response; and there is a self-denying ordinance when the request for an opinion concerns the terms of a particular letter of credit, rather than the operation of a particular provision of the UCP 600. Even when such opinions are issued, their impact upon national courts is variable, with some opinions being followed wholesale at a domestic level[85] and others being almost totally ignored.[86] Even the ICC's guidance on ‘international standard banking practice' is problematic,title="">[87] as there is no allusion to that guidance's existence in the UCP 600 itself, so that an ingenue may be totally unaware of its existence. Worse still, there are instances when the UCP 600 and the ISBP actually conflict. For example, Article 14(d) of the UCP 600 makes clear that ‘[d]ata in a document... must not conflict with... any other stipulated document or the credit',[88] but the ISBP provides that ‘[w]hen the amount in words and figures are in conflict, the amount in words is to be examined as the amount demanded'.[89] Similarly, Adodo has highlighted another example of such a conflict:[90] the UCP 600 requires that a bill of lading be signed by the carrier or its agent,[91] whilst the previous version of the ISBP indicated that ‘[w]here copies [of a transport document] are presented, they need not evidence signatures, dates, etc'.[92] Nor is it clear that this position has been remedied under the more recent ISBP 745.[93] Accordingly, the manner in which the UCP regime develops is at best not particularly clear, and at worst is a recipe for confusion.
1.20 Fourthly, the regulatory environment in which banks operate nowadays has altered radically, even when compared with the situation that pertained at the UCP 600's introduction. There are three particular sources of regulatory difficulty for banks. The first problem is that there has been some confusion as to how letters of credit should be treated for a bank's capital adequacy purposes: the more costly an instrument in capital terms, the less likely that banks are likely to become involved in that type of transaction.[94] Whilst the Basel Banking Committee has recently indicated that it would adopt from 2018 a more favourable approach to trade-finance instruments for the purposes of regulatory capital,[95] this may have all come a little too late: as a result of the uncertainty, traditional banks have abandoned letters of credit and investment banks, insurance companies, pension funds, export credit agencies, and other shadow banks (which are not directly affected by the capital adequacy, liquidity, and leverage ratios) are filling the void left behind.[96] This is not promising for the UCP regime, which only governs bank-issued letters of credit.[97] The second problem concerns the impact upon the letter of credit of sanctions imposed by the United Nations, the EU Council, or individual countries to achieve political and economic ends.[98] To avoid the criminal penalties resulting from violating such sanctions, banks issuing and confirming letters of credit may no longer just deal with the documents alone (as stated in the UCP 600),[99] ignoring all other matters. Instead, banks must nowadays inform themselves about the details of the underlying sales transactions, including the ultimate destination of the underlying goods or the funds to be disbursed under the credit, in order to decide whether or not a complying presentation should be honoured.[100] Indeed, the ICC has expressed concerns that clauses inserted into a letter of credit to protect banks from the consequences of violating sanctions might undermine the irrevocable nature of the credit, in particular when the clause either purports to confer a discretion upon the issuing or confirming bank as to whether or not to honour its commitment in light of relevant sanctions regimes[101] or allows such banks to decline payment by reference to their ‘internal sanctions-related policy’.[102] The third problem concerns banks' obligations to comply with anti-money laundering and terrorist financing legislation.[103] As well as conducting the usual ‘know your customer’ checks required for all forms of trade finance in relation to an instructing party,[104] the issuing and confirming banks are required to look out for certain ‘red flags’ relating to the underlying transaction that might indicate the existence of trade-based money laundering.[105] Given that banks must nowadays carry out checks into the underlying sale transaction, the letter of credit’s foundational autonomy principle[106] effectively becomes a mirage.
IV.