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Back-to-Back Letters of Credit
Global Trade Risk Management Strategies LLC
2
Global Trade Risk Management Strategies LLC
Contract 1End-Buyer Middleman
How Back-to-Back Letters of Credit Work
Back-to-back letters of credit are used by trading companies and other middlemen in trade transactions. The transaction begins with the middleman identifying a buyer of a product that he has also identified a source of. The middleman signs a contract to sell the goods to this buyer.
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer Middleman Supplier
Contract 2
How Back-to-Back Letters of Credit Work
The middleman then turns around and signs a contract with the supplier. Both contracts state that payment will be made by means of a commercial letter of credit and all of the details of what will be shipped, how and when it will be shipped, where it will shipped from and to, applicable IncotermsTM, etc. should match as closely as possible. (The fact that they might not match exactly, however, precludes using a transferable letter of credit.)
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
L/C 1
How Back-to-Back Letters of Credit Work
The end-buyer applies for a commercial letter of credit. His bank reviews the request, the end-buyer’s credit, etc. and, if satisfied, issues the L/C.
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
How Back-to-Back Letters of Credit Work
The middleman requests that his own bank issue a commercial L/C to the supplier. The second L/C should call for all of the same documents as the first L/C but may be for a lesser amount. It is commonplace for the middleman to assign the proceeds of the first L/C to this bank as security.
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
Goods
How Back-to-Back Letters of Credit Work
The supplier produces the goods and ships them to the end-buyer. (The middleman should not be involved in production or shipment—the supplier should be in a position to handle this.)
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
$
Docu-ments
How Back-to-Back Letters of Credit Work
Goods
The supplier collects and presents the documents called for in the second L/C. Recall that these should be the same documents as required by the first L/C, though the invoice may be for less. The middleman’s bank pays the supplier and creates a loan to the middleman.
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Global Trade Risk Management Strategies LLC
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
Docu- ments
$
Docu-ments
How Back-to-Back Letters of Credit Work
Goods
The middleman’s bank works with the middleman to assemble a set of documents that will comply with the first letter of credit. Invoices and other documents may be added to the supplier’s documents or replaced.
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Global Trade Risk Management Strategies LLC
Docu- ments
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
$
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
Docu- ments
$
Docu-ments
$
Goods
How Back-to-Back Letters of Credit Work
The middleman’s bank presents the re-assembled documents to the end-buyer’s bank for examination and payment. The proceeds, when received, are applied to the loan and the remainder is paid to the middleman as his profit.
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Global Trade Risk Management Strategies LLC
Docu- ments
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
$
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
Docu- ments
$
Docu-ments
$
Docu-ments
$
Goods
How Back-to-Back Letters of Credit Work
The end-buyer’s bank charges the end-buyer and delivers the documents to them.
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Global Trade Risk Management Strategies LLC
Docu- ments
Contract 1End-Buyer SupplierMiddleman
Contract 2
L/C Application 1
End-Buyer’s Bank
$
L/C 2L/C 1 L/C Application 2
Middleman’s Bank
Docu- ments
$
Docu-ments
$
Docu-ments
$
Goods
How Back-to-Back Letters of Credit Work
The end-buyer uses the documents to pick up the goods, but is likely never to learn the identity of the actual supplier as the supplier’s name is probably not in the documents that the end-buyer receives.
This set of slides comes from training classes
developed and taught by
Global Trade Risk Management Strategies LLC.
For Information about upcoming seminars
and webinars, visit
http://www.gtrisk.com/Upcoming_Seminars.html.
Global Trade Risk Management Strategies LLC
Credits
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