Podcast: the application of Letters of Credit in trading with foreign parties

On Tuesday, December 10, Marloes Wittebroek was a guest in ‘De Bedrijfskunde Podcast’ by Frans Augustijn. Listen to the podcast below via YouTube or read the full transcript of this podcast.

Bold text represents Frans Augustijn’s words, with Marloes Wittebroek’s responses below.

Today, in our business administration podcast, we are visiting Marloes Wittebroek. And Marloes, thank you for your hospitality. I’ve already enjoyed two cups of your coffee. Could you please introduce yourself?

First of all, it’s great to have you here. Welcome to Elceco. My name is Marloes Wittebroek. I started Elceco a little over nineteen years ago to handle Letters of Credit.

Okay, and how do we actually know each other?

Yes, that goes back quite a few years, and it’s been wonderful. We were able to work for your wonderful company, handling your letters of credit for your international orders, to China, among others.

Yes, indeed, I remember that. It must have been ten years ago, maybe even longer.

That’s right, at least ten years ago.

You’ve already mentioned that you work for Elceco. Is it your company? And if so, when did you start it? And what was the reason you started this company?

It is my company, that’s correct. And nineteen years ago, I did a management buyout. Sounds almost more exciting than it is. We were part of a company in Rotterdam, and they handled customs activities worldwide.

But in 2005, exports were declining significantly, and they were also involved in secondment. Then they said that we are really going to focus on the core business, and we are going to divest this business of letters of credit. This had just started a year, a year and a half earlier.

Then I actually said, I would like to take it over. And yes, it went that simply, and I have never regretted it to this day.

And where is the company located?

We are in Veghel, between Eindhoven and Den Bosch. Perfect location. Although the location is not so relevant anymore these days, because so much is also digital nowadays.  

And was the company already located in Veghel when you took it over, or did you eventually bring it here?

It was already established in Veghel. The colleagues who worked there were also from the area, so we chose to stay there. We did move to a smaller office to have slightly lower costs, because I was just starting out, of course.

In your introduction, we talked about L/C, but what is an L/C actually?

Yes, an L/C is a letter of credit, also known as documentary credit. And you use it when you do business internationally, especially internationally, to countries in certain regions. Think, for example, of the Middle East, the Far East, parts of Africa.  

And you use the product to ensure the security of your payment. For example, you do business with China or African countries. And by using the banks on both sides, you can control the entire set of documents that you will need to clear the goods later in the country of destination. You maintain control over this by having it go through the banks. Yes, and that adds a great deal of security.

So, with a letter of credit, you actually always need banks on both sides?

That’s right, at least two, and the initiator is always the importer, so your customer in the country of destination. He or she goes to their bank and asks to open an L/C in your favor here in the Netherlands. As the exporter, and then it goes through your own bank or another designated bank here in the Netherlands, which advises you of the L/C.

And you mainly use it to mitigate the country risk and the banking risk abroad. So that you are sure that you will receive the payment. And you gain that certainty because the money, your order amount, is frozen at your customer’s bank. So you know that if you meet the conditions stated in a letter of credit, then you will get your money.

Okay, so if I want security of payment for delivered goods with those kinds of customers in those kinds of countries, then I will actually always have to use a letter of credit, or do I have an alternative form?

You could also have alternative forms. For example, you see cash against documents or when companies use credit insurers. But not all countries can have their risks covered with the credit insurer, for example. Or there are also countries that make it mandatory to use a letter of credit. And if it is mandatory, then you cannot really do otherwise, and then you use the letter of credit.

Are there also countries where you cannot conclude a letter of credit? So, which actually forbid it?

Yes, there certainly are. And these lists can also be requested from the banks. And certain countries in war situations, politically very unstable situations. Those countries are on a sanctions list, and then no trade can be conducted with them.

But that is more of a guideline that comes from the Netherlands or from Europe, I think. Those are more the sanctioned countries. So those are the countries with which you cannot create a letter of credit either.

That’s right, and for us as Elceco. We initially help our clients, for example, to draw up a draft L/C. So a draft letter of credit, so that they can already see the frameworks within which they can move in terms of conditions.

Conditions that are stated in an L/C. These are, for example, your delivery conditions, the incoterm. But also whether you have to deliver everything at once or in partial deliveries, which documents you must add, such as the transport document, a bill of lading or an airway bill for air freight. And depending on that, you put everything together.

Then you just mentioned an incoterm in your answer. What is that?

An incoterm is the delivery condition that you agree upon. So that boils down to when you have an agreement; who arranges the transport and who is responsible for which part of the transport.

Okay, so you can agree with a customer that he or we will arrange the transport ourselves?

That’s right, and with a letter of credit, it is very important to keep as much control over the process as possible yourself. So then I would always say try to use an incoterm where you keep control yourself. So that you arrange the transport yourself and know that you have the bill of lading, because you will then have to submit it to the bank under the letter of credit. That is the principle of the letter of credit. That as an exporter you will soon have to present a set of documents to the bank. And that set of documents must meet the requirements stated in that letter of credit.

So if you book the transport yourself, you can tell the carrier exactly what needs to be stated on that bill of lading or an airway bill. So that you can check it and then forward it to the bank.

That bill of lading, you have mentioned it a number of times now. From whom do I get that bill of lading?

You get it from the carrier where you arrange the transport, and often there is an intermediary that arranges many transports for companies, and they then place it with the shipping companies, such as MAERSK, for example, and they then take care of the bill of lading.

Okay, so MAERSK is a large carrier when it comes to sea freight. That company, the moment it comes on board, that the goods come on board, issues that bill of lading? Is that how I should see it?

Yes, you can agree on a draft with each other in advance, but eventually the goods are actually shipped, and only then can you really get the original documents. And it is a title document. So it is really the bill of lading is an ownership document of the goods.

Title document?

Yes, it is called a title document, a somewhat old-fashioned term, actually. But it is still called a title document, and it actually means exactly as much as ‘ownership document’.

Okay, and if I wanted to create an L/C with you now, or create it with your company, what should I think about? How can I put you to work?

Yes, that’s a good question. We hope that you will call as soon as possible. Actually, the moment you see that I am getting an order, for example to India, Pakistan, Bangladesh, many L/Cs also go there, and you say, well, we are getting the question from the potential customer in the relevant country. Then we say, well, we will look at it with you, because based on your offer, we will already draw up that draft L/C. Then we will, as it were, guide you through that L/C process. So that you know from the beginning what you are putting in there.

But even more importantly, what is the consequence of what is in there. Because there may be things in it that, for example, are not at all feasible to be reflected in documents later. So it is always important to look at that immediately, and we especially like to serve as a source of information.

So do you have a question? Just a quick consultation, call us, email us, because then we will look together at how to make the next step as easy as possible. Yes, and then we actually remain involved in the entire process. See us a bit as a back office for our customers. So we also ensure that all documents and such are properly drawn up. We give the instructions to the carriers. So everything that comes with it, that whole process up to and including the submission of the documents to the bank eventually. And the bank then gives feedback to us. And then we, of course, really want to tell our customers that the documents are in order, sent to the issuing bank, it is called. And that is then the bank of the customer abroad.

And you also talked about things that you actually couldn’t process in the paperwork? Do you have an example of that?

Yes, you see, for example, that on certain documents they want all the information from the manufacturer of the goods. And it is not always wise to put that in there, because you can also be a supplier and that you purchase the products elsewhere.

But I can imagine, commercially speaking, that you don’t want that party to be named in the documents. And yes, we have the experience with it that we sometimes pick it out a bit faster than our customers.

And with a letter of credit, if you don’t meet the conditions one hundred percent, you are not completely sure of the payment either. Well, it usually works out fine in the end, but you still want to prevent it.

I can remember from my own experience, and this is one of the L/Cs that you also handled for us at that time, that we were constantly struggling with that latest date of shipment. That we were actually experiencing delays during the project and then we immediately had a problem with the L/C. Why is that latest date of shipment so important for that L/C?

That’s nice. The latest date of shipment is stated in particular because you have both entered into an agreement with the letter of credit. And it gives you as an exporter a lot of certainty to know that the payment is fixed, the money is fixed in the account. But the importer also deserves certainties, of course. And by mentioning a latest date of shipment, they know when you have to put the goods on the boat at the latest, or on the plane or whatever.

And it is not a problem if you cannot meet the latest date of shipment. But then you have to contact your customer abroad and then they have to request a change to the letter of credit. And that can be an advantage and a disadvantage, because if a project has already been delayed three times, then it is of course not so nice to go back to your customer abroad and say, well, sorry, we are not going to make it, can you adjust it again.

And there are also costs involved with the bank, because for all the changes that you want to make to the L/C, they charge an amendment fee, so a change fee.

Have you ever experienced a customer not accepting that and ultimately the L/C being cancelled and therefore the goods not being sent?

What we see more often is that people both use the L/C and have discussions about it and don’t come to an agreement. Yes, then such an L/C can be cancelled indeed.

Okay, and then does it eventually work out with a new L/C or does it not work out anymore?

Yes, that is a bit different. Egypt is an example of a country where the requirements have changed quite a bit in recent years. Where you as an exporter have an asset procedure, it is called, which is a specific customs procedure that you have to go through. So many extra restrictions, a letter of credit may only be valid for half a year. If you have to make an entire production line in that time and also have to install it, that is often not feasible and then it may be that such an L/C simply does not take place.

Okay, well you have talked about export, especially that is where you use a letter of credit. In that, you do not mention Belgium, for example. So it is unusual if I export to Belgium to then use a letter of credit.

Yes, actually it is. We do see it happen occasionally. Also to England, for example, or Spain, that is really almost countable.

And if I think about who your customers are? These are mainly customers who export goods.

Yes, these are customers who export goods. That can be a sole proprietorship, an SME, but also a multinational. So very diverse actually.

And they export goods, but it can also be that in the sense of a production line, then that entire production line also has to be installed. So that whole part can be covered in an L/C. From, for example, the moment of a down payment up to and including the delivery of the goods, up to building the installation and eventually also a final phase. That the whole installation works well and everything functions properly. And there is then, for example, again a final payment that corresponds to that. Under that same L/C.

Because that was in my time, or in any case, I did not apply that myself at that time. I have actually always insured those goods until the moment of shipment. But the moment we then had to go to that customer to install and then start up such a production line, that often did not fall under an L/C. Was that because I was misinformed and did not know that it was possible? Or was it because it has since changed?

Well, it can also have several reasons, because if you have L/Cs of great value, then it is often also chosen to, for example, keep an advance payment outside the L/C. Because the lead time of the L/C, so those months or perhaps even longer than a year, that period also fixes the money.

So for the importer it is interesting to actually have less and shorter fixed. So then it can also be that a large part goes on L/C and a final payment outside the L/C against a specific document. And it can also be that you have remote control over the machines, for example. That if you know that I can operate the machine from here and I can simply deactivate it abroad, you naturally also have a lot of control. And it also depends a bit on that.

Okay, because how does that work? If I am going to install a machine, then I have delivered the goods and I actually only have to provide services. And one of my questions is actually can I somehow, in addition to delivering goods, also secure the payment of services by means of an L/C?

That is possible. Often it is the combination of, that we then see, both goods and services. And then it is important to properly describe it in the description of the goods, in which you really include that it is not only the goods that you deliver. And often a kind of installation certificate is then requested. And that then also covers the entire installation of the goods.

And you said those customers, those are of course customers who do indeed export. Are those mainly Dutch customers you work with, or do you also work with customers from abroad?

Yes, both. And our largest customers are actually in Belgium.

Okay, and is it then the case that you are also on the other side? So that you also, on behalf of the buying side, for example, make an L/C? So if, for example, a Dutch company wants to buy something from India, do you also help, do you help those kinds of companies with an L/C?

We help them too. What we do see is that this is mainly done by the banks. Because then the entire lines are reversed and then money is frozen from this side at the bank. And then the bank also has a duty of care or the entire know your customer and everything that they go through very thoroughly in all processes. So they already support the companies quite a bit. But we see that we are then also regularly allowed to watch with the companies. Super nice, because that keeps us sharp too.

And for the exporter it is actually also good to have both export and import. Because you understand each other better worldwide anyway. Because then it is also quite understandable that an importer wants to know certain things about quality and such. So also the import side, but that is simply not as laborious.

When we look at insuring that payment, from what amount does drawing up an L/C become profitable? Because there are also costs associated with it. The costs of your company, but also the costs of the banks, as you just said.

That’s right. We often see a minimum amount of around fifteen thousand euros, but occasionally, if you have no other choice with a country than on the basis of an L/C, then companies sometimes say, well, I’ll do the first order for a lower amount against L/C anyway. Even though the margin is probably no longer there. But then it is more of a commercial tool to use it anyway. And using an L/C is indeed costly, but you also buy security. You buy that security through various facets.

You can have a letter of credit, a regular letter of credit. And then the documents go through the entire process, so actually via your own bank to the bank abroad. But that costs quite a bit of time, that whole process. And if you say, well, but I want that country risk and that banking risk, I want to hedge it. Because, well, I can’t or I don’t want to wait that long, or I’m not sure what the situation is in the country of destination, then you can opt for confirmation. And that means that your bank here in the Netherlands takes over the payment obligation from the bank abroad.

And you said that the processes take a long time or are relatively long. How long does it take to draw up an L/C and until it is finally signed by all parties?

Yes, that can take quite a bit of time and that is because you are involved with so many parties in the whole. And what we often see is that everything is neatly organized here from the Netherlands, sent to the company, for example, in India. It takes weeks before they come back, if they come back at all. And then suddenly everything has to be put in order. Also nice and challenging, but then you have to be very careful that you follow the processes well.

Normally the process, once the L/C is there, then you have 21 days from the moment of shipment of the goods, so just days, to present the documents to your bank. But they have 5 working days to check the documents. And then they send them on to the bank abroad and they also have 5 working days to check. So if you agree on a sight payment, you will not be paid directly, but there is quite a period in between. It is very important to keep that in mind, because then it can become a false sense of security. Especially if you, especially if you are a supplier and you also buy all your products and there you have a payment term of thirty days, for example, yes, then you have a gap between them.

Yes, because if I add that up like that, I will already be above thirty days anyway.

Exactly.

Yes, okay. When it comes to drawing up L’Cs, what goes wrong most often? What do you see from your practice that goes wrong the most?

What we see the most is actually what you just indicated, that latest date of shipment. That we see that companies still cannot meet that and have not yet received approval, so to speak, from the end customer. That they say yes, we are still going ahead, we are going to send the goods. Documents that are presented too late to the bank, but also many discrepancies in the documents. And especially that documents are not consistent with each other, so that they do not correspond well with each other, that there are differences between them.

And then does it go wrong at the bank or who notices those differences?

You will receive feedback from your own bank, because that is where you submit the documents, you will then receive feedback that we have found discrepancies, internal discrepancies or external discrepancies. And an internal discrepancy, they do not report that to the bank abroad. But if you have shipped too late, yes, you cannot get around that, so they have to report it.

And then if I look to the future. There is, for example, something like bitcoin and artificial intelligence and blockchain technology, all related to digitization. To what extent does that affect the phenomenon or the instrument of an L/C?

I think that it will eventually have an effect. We now see that it has an effect on the processes and that is a positive effect. Because documents that can already be created digitally, but the stumbling block in it remains for us the bill of lading, because that is really what I just now called a title document, ownership document of the goods.

And that with a letter of credit you are on the international payment instrument and communication medium SWIFT. And earlier all countries in the world, so really in deepest Africa, in the Middle East, wherever, that they are all really connected to SWIFT and that they can all do it digitally. I think we can go ahead for a while in that way. So with the real documents, in many cases also unfortunately, because if you are talking about sustainability and all that kind of stuff, it would be nice if it could all be done that way. But I don’t think it will change in the coming period.

So I don’t have to worry about the future of Elceco then?

I don’t think so, no. We will continue happily with what we do, yes.

Finally, is there a question that I have not asked that you think is interesting for my listeners to know about a letter of credit?

Well, perhaps to give more that a letter of credit is not necessarily a necessary evil. Or that it has to stand in the way of the exporter’s new orders. If you use them well and you can keep it quite simple, then it offers an awful lot of opportunities and therefore also more commercial opportunities for the exporter.

Well, I certainly think that after your explanation, the threshold has been lowered for people to inquire about how that instrument can be used. I think that it is a very important instrument, especially for limiting risk and ensuring money, especially if you really want to enter that export market.

I want to thank you very much for the hospitality, but also for the openness and also for the expertise that you have shown here. And well, perhaps we will speak to each other again, but for today, thank you very much.

You’re very welcome Frans, and we are here with our team of 8 people and are happy to speak to people and help them, because that is ultimately our goal.

Great, thank you.

Good, thank you!