Useful Tools For Middlemen (2): Transferable Credits

Transferable credits (article 38 (a) and (b) of the UCP 600) are another solution for middlemen, i.e. intermediaries that buy goods from a manufacturer and resell them to a third party, in addition to back-to-back credits.

The advantage of a transferable credit is that the middleman is not required to set up two different credit transactions. In fact, the middleman can use part of the credit that the buyer has opened in his favor as payment for the manufacturer. In effect, the middleman can transfer part of the letter of credit to the manufacturer and make this latter the beneficiary.

Since transferable credits imply that the buyer’s bank must pay a different beneficiary than the one stated in the original contract, parties that want to settle the sale transaction through a transferable credit have to indicate it in the contract and must obtain explicit agreement by the issuing bank.

How Transferable Credits Work

To explain how transferable credits work we bring back the example we made for back-to-back credits. A Singaporean dealer (S) buys wood products from a Malaysian manufacturer (M) and resells them to a UK company (B). Consideration for the goods amounts to GBP 80,000 for the sale transaction between M and S, and to GBP 100,000 for the sale transaction between S and B, with GBP 20,000 being S’s commission.

B will open a transferable letter of credit for GBP 100,000 in favor of S (first beneficiary), with B Bank being the issuing bank. S will receive, attached to the letter of credit, a transfer form; S will write that GBP 80,000 be transferred to M (second beneficiary). M Bank (advising bank) will inform M that S has opened a letter of credit for GBP 80,000 in his favor.

The picture below represents this financial arrangement.

Transferable credits

M will present the documents to S Bank, which in this case is likely to be the transferring bank, i.e. the bank that transfers the credit. S will substitute his invoice to M’s, and will send the whole documents to B. B Bank will pay GBP 20,000 to S and GBP 80,000 to M.

Advantages Of Transferable Credits

From the middleman’s perspective, the advantage of transferable credits is the same as per back-to-back credits: he can carry out the sale transaction with the manufacture and with the buyer without the need to anticipate cash or to raise funds with his bank.

The big beneficiary of a transferable credits versus a back-to-back credit is the middleman’s bank. In fact, in the case of a transferable credit the middleman’s bank does not have to issue a letter of credit to the manufacturer, it just has to transfer the letter of credit that the buyer’s bank has issued to the middleman. Essentially, the middleman’s bank does not risk any of its own funds.

For this reason, transferable credits are more easily issued by banks than back-to-back credits and are therefore a better alternative for middlemen.