How the Letter of Credit consumes your headroom

How the Letter of Credit consumes your headroom

April 2024

About ten years ago, I was a manager of a treasury department of one of the biggest commodity trading companies in the world, headquartered in Rotterdam.

The team consisted of ten colleagues, of which five were busy with cash & FX related treasury work. The other five were dealing exclusively with trade finance. In practice, this meant that they supported the trading department with the settlement of the trades.

The atmosphere was hectic. To give you an idea, ships filled with palm oil, rice, wheat and other types of grains were sailing around the world. Sometimes the ownership of the cargo changed hands during the journey.

It was in that period that I learned how complex the Letter of Credit process really is.

I learned, for instance, that traders sometimes deliberately create a discrepancy in the terms of an LoC in order to give the counterparty more lenient payment terms. Can you believe it? The reason they did this was to boost turnover, as bonus payments were linked to turnover without taking any unfavorable payment-terms into account.

This obviously led to a deterioration of our cash position, as payment terms were being stretched. It had a negative impact on the headroom under our credit facilities, which started to diminish fast. Apart from all this, the many discrepancies increased the workload of my team.

If a trade settlement platform like Mercurion had been available at the time, I certainly would have considered it. Looking at the Frequenly Asked Questions, it seems they have thought about all possible concerns one might have.

The fact that the escrow service is operated by the Baltic Exchange, for instance, gives peace of mind. The exchange has been in the business of secure settlement for some time, is well known in maritime circles and has strong balance sheet.

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