 Trade Ethiopia

 Batch 45
 Assignment 2, LC, CAD and Documentation
 By Tadesse Kebede

 Question # 1
o What are LC and Types of LC?
o What are CAD and Types of CAD?
o CAD Vs. LC
 Question # 2
o What are those Commercial Documentations in International Trade? and Examples
related to Commercial documents in international Trade:
 Financial Documents In International Trade
 Transportation Documents in International Trade
 Commercial Documents in International Trade
 Governmental Documents in International Trade

Answer for Question #1

What Is a Letter of Credit (LC)?

Letters of credit are assurances or guarantees to sellers that they will be paid for a large
transaction. They are particularly common in international or foreign exchanges.

It is a form of payment insurance from a financial institution or another accredited party to

the transaction. The very first letters of credit, common in the 18th century, were known as
travelers' credits.

Because a letter of credit is typically a negotiable instrument, the issuing bank pays the
beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferable,
the beneficiary may assign another entity, such as a corporate parent or a third party, the right
to draw.

How Much a Letter of Credit Costs

Banks will usually charge a fee for a letter of credit, which can be a percentage of the total
credit that they are backing. The cost of a letter of credit will vary by bank and the size of the
letter of credit. For example, the bank may charge 0.75% of the amount that it's guaranteeing.
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Fees can also depend on the type of letter. In an import-export situation, an unconfirmed
letter of credit is less costly. A confirmed letter of credit may have higher fees attached based
on the issuing bank's credit strength.

The most Common types of Letters of Credit (LC) today are?

o Commercial letters of credit,
o Standby letters of credit,
o Revolving letters of credit, and
o Revocable letters of credit,
o Irrevocable Letters of credit,
o Although there are several other types of letters of credit.
1. Commercial Letter of credit

This is a direct payment method in which the issuing bank makes the payments to the
beneficiary. In contrast

2. Standby letter of credit

A standby letter of credit is a secondary payment method in which the bank pays the
beneficiary only when the holder cannot.

A standby letter of credit provides payment if something does not occur which is the opposite
of how other types of letters of credit are structured. So, instead of facilitating a transaction
with funding a standby letter of credit is like an insurance contract in that it protects and
compensates one party (the beneficiary) if the other party named in the agreement fails to
perform the stated duty or meets certain service level agreements outlined in the letter of
credit.

3. Revolving Letter of Credit

This kind of letter allows a customer to make any number of draws within a certain limit
during a specific time period. It can be useful if there are frequent shipments of merchandise,
for example, and you don't want to redraft or edit letters of credit each time.

4. Traveler’s Letter of Credit

For those going abroad, this letter will guarantee that issuing banks will honor drafts made at
certain foreign banks.

5. Confirmed Letter of Credit

A confirmed letter of credit involves a bank other than the issuing bank guaranteeing the
letter of credit. The second bank is the confirming bank, typically the seller’s bank. The
confirming bank ensures payment under the letter of credit if the holder and the issuing
bank default. The issuing bank in international transactions typically requests this
arrangement.

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6. A revocable letter

A revocable letter of credit is uncommon because it can be changed or cancelled by the bank
that issued it at any time and for any reason.

A revocable LC can be modified, amended, or canceled by the issuing bank after its issuance
without taking the persimmon or giving any prior notice to the beneficiary.
- This type of legal arrangement demonstrates a few things that either the issuing bank does
not want to bear the risks of guaranteeing the underlying payment between the buyer and the
seller, or the issuing bank does not have the financial strength to guarantee the payment of the
underlying payment.

- There is one exception regarding the terms of evocating the credit. The issuing bank is
required to reimburse the nominated or confirming bank with which the revocable letter of
credit has been issued only if the fulfillment of the obligations takes place by these banks
under the documentary credit terms & conditions against complying presentation before
receiving the notice of amendment or cancellation from the issuing bank.
- It is a limited security payment method for the beneficiaries as they are subject to amendment
or cancellation without prior consent.

- As a result, these revocable letters of credit are not frequently used in international trade.
- As there is not an absolute undertaking by the issuing bank in the revocable letter of credit,
the exporters are not under that much benefit.

- The bank in the exporter’s country is not aware of any cancellation or amendment, therefore
bears the risks of payment being refused by the issuing bank.

Since revocable LCs are exposed to any type of amendment, modification, or cancellation,
these are less-often used by importers & exporters across the world. Instead of revocable LCs,
global traders should always seek irrevocable LCs.

7. Irrevocable letter

An irrevocable letter of credit cannot be changed or cancelled unless everyone involved

agrees. Irrevocable letters of credit provide more security than revocable ones.

- An irrevocable Letter of credit is a type of letter of credit which does not allow its issuing
bank to modify, amend or cancel without seeking prior consent or giving an acknowledgment
of the same to the beneficiary.

- In simple words, the issuing bank does not have the power to modify the terms & conditions
of the irrevocable LC until it gets authorization from the beneficiary. Any type of amendment
requires the beneficiary's acceptance to be effective.

- An irrevocable letter of credit provides much more security to the beneficiary in comparison
to revocable ones due to the transparency of the modifications.

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- As a result, these letters of credit are widely used by global traders while executing an
international transaction.

- The confirming bank is not compelled to add its confirmation to any type of amendment.
Additionally, the transferable LCs should not be issued as revocable letters of credit.

- The exporter feels more secure with the knowledge that the bills drawn under the credit will
be honored by the issuing bank after the fulfillment of conditions of the LC agreement.

- Any amendment or cancellation of credit will not be effective unless the exporter gives
consent to such amendment or cancellation.

To facilitate a higher degree of security in international transactions, both the importers and
exporters always prefer an irrevocable letter of credit over revocable. This especially occurs
when the relationship between the buyer and the seller or between the bank and the applicant
is relatively new.

These were some of the points of difference between revocable & irrevocable LCs where the
preference of choice depends on ensuring safe & secure international trade transactions.

……………………….…………….//…………………………………….

What Is CAD?

Cash against Documents (CAD) is a kind of transaction used in international trade. It can
also be described as a management and payment tool. With a CAD agreement in place, the
seller will only release the shipping and title documents for the exported goods once payment
has been received from the importer.

These documents often include the bill of lading, invoices and other key ownership
documents.

Once the payment is received by the seller’s bank, the documents are released and the
importer can take possession of the goods and clear customs.

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In simple terms, Cash Against Documents can be thought of as cash on delivery. It’s also
similar to real estate transactions, where funds are held in escrow by a neutral third party
until the transfer of titles is complete.

o What does a Cash Against Document process look like?

1. Once the order is accepted and an agreement made between buyer and seller, the
seller will initiate the Cash Against Documents process.
2. The seller will prepare the required shipping documents required for the country of
origin (where the goods are sent from), and the country of destination (where the
buyer will be receiving the goods).
3. These documents, which typically include a Bill of Exchange, Export Collection form
and other shipping documents, are sent to the seller’s bank.
4. The goods are shipped to the buyer’s country, but can’t be released to the buyer until
the agreed payment is made to the seller’s bank. At this stage, the seller still owns the
shipment.
5. Once payment is made in full, the seller’s bank will release the documents to the
buyer.
6. The buyer can then legally take possession of the shipment at customs.

o What are the pros and cons of using Cash Against Documents?

There are a number of benefits to the Cash Against Documents system for both buyers and
sellers. However, there are downsides too. Let’s run through the pros and cons now:

 Advantages
 It helps to ensure that the seller gets their money on time - providing greater
payment security compared to other methods
 It can give the buyer an opportunity to inspect the goods before transferring funds to
the exporter. This helps to ensure the goods are of the promised quality and that the
shipment is as agreed.
 As a financing/payment method, it’s much easier for both buyer and seller to use
than formal documentary credit processes.
 The cost is relatively low for both parties. In CAD transactions, the bank or
financial institution will usually charge a small fee for its service¹. It’s often the case
that buyer and seller will split the fee, although the sales agreement may stipulate
otherwise.
 Disadvantages
 There’s no guarantee that the importer will pay to complete the transaction - they
may inspect the goods and find a problem, or refuse to transfer payment for another
reason. If this happens, the exporter may be left out of pocket for shipping costs, and
the shipment will be stuck in another country.
 In some cases, poor bank processes could mean that grant documents are
prematurely granted to the importer.

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  No bank guarantee of payment, or insurance relating to the proper management of
the CAD process on the part of the bank.
 Payments through bank can be expensive

……………………….…………….//…………………………………….

Cash Against Documents Vs. Letter of Credit

CAD transactions are most often used for international transactions in which an open trade
account is not possible because the buyer is unfamiliar to the seller or the buyer’s credit
standing may not meet the seller’s criteria.

Both are forms of payment that guarantee payment after the product is delivered.

A letter of credit (LC) is a formal letter from the buyer’s bank to the seller indicating the
bank's financial support of the buyer. The LC authorizes the seller to demand payment from
the bank if the seller fails to pay.

For both buyer and seller, the most convenient arrangement for doing business is through
trade credit. However, trade credit is not possible if the seller believes the buyer is a high-risk
candidate for payment default.

Like cash against documents transactions, an LC is used when the seller is unwilling to offer
open trade credit, often in international transactions. Businesses usually allow customers to
buy using a credit line, called trade credit in business-to-business relationships, whereby the
customer buys the product and pays 10 to 30 days later. Some LCs are used for a single
transaction, while others take the place of trade credit when the buyer plans to make regular
purchases from the seller.

 Advantages and Disadvantages of LC Transactions

The primary advantage of a CAD transaction is for the buyer. A CAD transaction is less
expensive for a buyer than an LC and it does not tie up financing as an LC might. A CAD is
riskier for the seller if the buyer refuses delivery and the seller does not receive payment. At
this point, the buyer must pay to have the product transported back to the origination point.

The primary advantage of an LC transaction is for the seller. Even if the buyer refuses
delivery, the seller can still get payment for transportation and other expenses. An LC ties up
the buyer’s bank line of credit, which could be used to pay other vendors. In some cases, the
bank may require a cash deposit from the buyer to secure the amount of the LC.

Answer for Question #2

Common Import / Export Documents in International Trade

 Financial Documents In International Trade
 Transportation Documents in International Trade
 Commercial Documents in International Trade
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  Governmental Documents in International Trade

There are many documents involved in international trade, such as commercial documents,
financial documents, transport documents, insurance documents and other international trade
related documents. In processing the export consignment, documentation may be executed in
up to four contracts: the export sales contract, the contract of carriage, the contract of finance
and the contract of cargo insurance. It is therefore important to understand the role of each
document and its requirements in international trade.

1. Commercial Documents
 Quotation

An offer to sell goods and should state clearly the price, details of quality, quantity, trade
terms, delivery terms and payment terms. Prepared by: exporter

 Sales Contract

An agreement between the buyer and the seller stipulating every detail of the transaction;
since this is a legally binding document, it is therefore advisable to seek legal advice before
signing the contract. Prepared by: exporter and importer

 Pro Forma Invoice

An invoice provided by a supplier prior to the shipment of merchandise, informing the buyer
of the kinds and quantities of goods to be sent, their value, and importation specifications
(weight, size and similar characteristics). This is not issued for demanding payment but may
be used when applying for an import licenses / permit or arranging foreign currency or other
funding purposes. Prepared by: exporter

 Commercial Invoice

A formal demand note for payment issued by the exporter to the importer for goods sold under
a sales contract. It should give details of the goods sold, payment terms and trade terms. It is
also used for the customs clearance of goods and sometimes for foreign exchange purpose by
the importer. Prepared by: exporter

 Packing List

A list with detailed packing information of the goods shipped. Prepared by: exporter

 Inspection Certificate

A report issued by an independent surveyor (Inspection Company) or the exporter on the

specifications of the shipment, including quality, quantity, and / or price, required by certain
buyers and countries. Prepared by: Inspection Company or exporter

 Insurance Policy

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An insurance document, with full details of the insurance coverage, evidencing insurance has
been taken out on the goods shipped. Prepared by: insurer or insurance agent or insurance
broker

 Insurance Certificate

This certifies that the shipment has been insured under a given open policy and is to cover loss
of or damage to the cargo while in transit. Prepared by: insurer or insurance agent or
insurance broker

 Product Testing Certificate

This certifies the products are conformed to a certain international / national technical
standard, such as product quality, safety and specifications. Prepared by: accredited
laboratories

 Health Certificate

Document issued by the competent country when agricultural or food products are being
exported, to certify that they comply with the relevant legislation in the exporter's country and
were in good condition at time of inspection, prior to shipment and fit for human
consumption. Prepared by: exporter / inspection authority

 Phytosanitary Certificate

Frequently an international requirement that any consignment of plants or planting materials

importing into a country shall be accompanied by a Phytosanitary Certificate issued by the
exporting country stating that the consignment is found substantially free from diseases and
pests and conforms with the current phytosanitary regulations of the importing country.
Application of the certificate in Hong Kong should be made to the Agriculture and Fisheries
Department. Prepared by: exporter

 Fumigation Certificate

A pest control certificate issued to certify that the concerned products have been undergone
the quarantine and pre-shipment fumigation by the approved fumigation service providers. It
is mainly required by the US, Canada, Australia, New Zealand and UK's customs on solid
wood packing material from Hong Kong and the Chinese Mainland. Prepared by: exporter or
inspection company

 ATA Carnet

An international customs document used to obtain a duty-free temporary admission for goods
such as exhibits for international trade fairs, samples and professional equipment, into the
countries that are signatories to the ATA Convention. Prepared by: exporter

 Consular Invoice

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A document required by some foreign countries, showing shipment information such as
consignor, consignee, and value description, etc. Certified by a consular official of the
importing country stationed in the foreign country, it is used by the country's customs officials
to verify the value, quantity and nature of the shipment. Prepared by: exporter

2. Transport Documents
 Shipping Order S/O

A document with details of the cargo and the shipper's requirements, and is the basic
document for preparing other transport documents such as bill of lading, air waybill, etc.
Prepared by: shipper / transport companies

 Dock Receipt D/R or Mate's Receipt

A receipt to confirm the receipt of cargo on quay / warehouse pending shipment; The dock
receipt is used as documentation to prepare a bill of lading. It has no legal role regarding
processing financial settlement. Prepared by: shipping company

 Bill of Lading (B/L)

An evidence of contract between the shipper of the goods and the carrier; The customer
usually needs the original as proof of ownership to take possession of the goods. There are two
types: a STRAIGHT bill of lading is non-negotiable and a negotiable or shipper's ORDER bill
of lading (also a title document) which can be bought, sold or traded while goods are in transit
and is used for many types of financing transactions. Prepared by: shipping company

 House Bill of Lading (Groupage)

A bill of lading issued by a forwarder and, in many cases, not a title document. Shippers
choosing to use a house bill of lading, should clarify with the bank whether it is acceptable for
letter of credit purpose before the credit is opened. Advantages include less packing, lower
insurance premiums, quicker transit, less risk of damage and lower rates than cargo as an
individual parcel / consignment. Prepared by: forwarder

 Sea Waybill

A receipt for cargo which incorporates the contract of carriage between the shipper and the
carrier but is non-negotiable and is therefore not a title document. Prepared by: shipping
company

 Air Waybill (AWB)

A kind of waybill used for the carriage of goods by air. This serves as a receipt of goods for
delivery and states the condition of carriage but is not a title document or transferable /
negotiable instrument. Prepared by: airline

 House Air Waybill (HAWB)

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An air consignment note issued by an air freight agent to provide the cargo description and
records. Again, it is not a title document. Prepared by: forwarding agent

 Shipping Guarantee

Usually a pre-printed form provided by a shipping company or the bank, given by an

importer's bank to the shipping company to replace the original transport document. The
consignee may then in advance take delivery of goods against a shipping guarantee without
producing the original bill of lading. The consignee and the importer bank will be responsible
for any loss or charges occurred to the shipping company if fault is found in the collection. It
is usually used with full margin or trust receipt to protect the bank's control to the goods.
Prepared by: importer's bank / shipping company / consignee

 Packing List (sometimes as packing note)

A list providing information needed for transportation purpose, such as details of invoice,
buyer, consignee, country of origin, vessel / flight date, port / airport of loading, port / airport
of discharge, place of delivery, shipping marks / container number, weight / volume of
merchandise and the fullest details of the goods, including packing information. Prepared by:
shipper

3. Financial Documents
 Documentary Credit D/C

A bank instrument (issuing or opening bank), at the request of the buyer, evidencing the
bank's undertaking to the seller to pay a certain sum of money provided that specific
requirements set out in the D/C are satisfied. Prepared by: the issuing bank upon an
application made by the importer

 Standby Credit

An arrangement between a customer and his bank by which the customer may enjoy the
convenience of cashing cheques, up to a value. Or a credit set up between the exporter and the
importer guaranteeing the exporter will pay the importer a certain amount of money if the
contract is not fulfilled. It is also known as performance bond. This is usually found in large
transactions, such as crude oil, fertilizers, fishmeal, sugar, urea, etc. Prepared by: exporter /
issuing bank

 Collection Instruction

An instruction given by an exporter to its banker, which empowers the bank to collect the
payment subject to the contract terms on behalf of the exporter. Prepared by: exporter

 Bill of Exchange (B/E) or Draft

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An unconditional written order, in which the importer addressed to and required by the
exporter to pay on demand or at a future date a certain amount of money to the order of a
person or bearer. Prepared by: exporter

 Trust Receipt (T/R)

A document to release a merchandise by a bank to a buyer (the bank still retains title to the
merchandise), the buyer, who obtains the goods for processing is obligated to maintain the
goods distinct from the remainder of his / her assets and to hold them ready for repossession
by the bank. Prepared by: importer

 Promissory Note

A financial instrument that is negotiable evidencing the obligations of the foreign buyer to pay
to the bearer. Prepared by: importer

4. Government Documents
 Certificate of Origin (CO)

This certifies the place of manufacture of the exported goods to meet the requirements of the
importing authorities. Prepared by: Trade and Industry Department and five Chambers of
Commerce

 Certificate of Origin Generalized Systems of Preferences (GSP) Form A (or as Form A)

A CO to support the claim for preferential tariff entry (a reduced or zero rate) of the exporting
country's products into the GSP donors under the GSP they operate. In general, a Form A is
issued only when the goods concerned have met both the origin rules of the preference
receiving country as well as the origin criteria of the respective donor country's GSP.
Prepared by: Trade and Industry Department and five Chambers of Commerce

 Import / Export Declaration

A statement made to the Director of Customs at port of entry / exit, declaring full particulars
of the shipment, eg. the nature and the destination / exporting country of the ship's cargo. Its
primary use is for compiling trade statistics. Prepared by: exporter / importer

 Import / Export Licence

A document issued by a relevant government department authorising the imports and exports
of certain controlled goods. Prepared by: Trade and Industry Department, Customs & Excise
Department, etc

 International Import Certificate (IIC)

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A statement issued by the government of country of destination, certifying the imported
strategic goods will be disposed of in the designated country. In Hong Kong, it is issued only to
meet an exporting country's requirement. Prepared by: Trade and Industry Department

 Delivery Verification Certificate (DVC)

A statement issued by the government of country of destination, certifying a specific strategic

commodity has been arrived in the designated country. In Hong Kong, it is issued only to meet
an exporting country's requirement. Prepared by: Trade and Industry Department

 Landing Certificate

A document issued by the government of country of destination, certifying a specific

commodity has been arrived in the designated country. In Hong Kong, it is issued by the
Census and Statistics Department. Application requirements include letter stating the reason
for the application, import declaration & receipt; bill of lading, sea waybill & land manifest;
supplier's invoice; and packing list (if any). Prepared by: Census and Statistics Department

 Customs Invoice

A document specified by the customs authorities of the importing countries stating the selling
price, costs for freight, insurance, packing and payment terms, etc, for the purpose of
determining the customs value. Prepared by: exporter

Five Government approved certification organisations are Hong Kong General Chamber of
Commerce; Indian Chamber of Commerce, Hong Kong; Federation of Hong Kong
Industries; Chinese Manufacturers' Association of Hong Kong; and Chinese General
Chamber of Commerce.

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