Transferable Letter of Credit

A transferable letter of credit is a letter of credit that expressly allows the beneficiary named in it (the first beneficiary) to request that the credit be made available, in whole or in part, to one or more other parties (second beneficiaries). It is used mainly by traders and agents who sell goods they buy from someone else, so that the trader can use the end buyer's credit to pay its own supplier without putting up its own bank lines.

Transfer is governed by Article 38 of UCP 600, the International Chamber of Commerce rules for documentary credits. A credit can be transferred only if it is expressly designated "transferable" by the issuing bank, and only through a bank willing to act as transferring bank. Transfer is different from assigning the proceeds of a credit (UCP 600 Article 39), which moves only the right to the money, not the right to present documents and draw.

Picture a ticket reseller who has a buyer's firm promise to pay for concert seats, but does not yet own the seats. The reseller asks the ticket office to pass part of that promise straight to the person who really holds the seats, at a lower price. The seat holder is paid by the office when it delivers; the reseller keeps the difference and never has to put up money of its own.

A transferable credit works the same way for a trading company. The foreign buyer's bank promises to pay the trader. The trader asks a bank to pass that promise, at the supplier's lower price, to the factory that makes the goods. The factory ships, presents its documents and is paid. The trader then swaps in its own invoice at the higher price and collects its margin, often without the buyer and factory ever dealing directly.

A transferred credit must reflect the terms of the original credit, but Article 38 allows the first beneficiary to reduce or shorten certain items so it can make a profit and leave time to substitute documents:

• The amount of the credit and any unit price stated in it can be reduced.
• The expiry date, the period for presentation and the latest shipment date or shipment period can be brought forward.
• The percentage of insurance cover can be increased, so that cover on the lower supplier price still equals what the original credit requires.
• The name of the first beneficiary can replace the name of the applicant, which helps keep the end buyer's identity from the supplier.

The first beneficiary may then substitute its own commercial invoice and draft for those of the second beneficiary. If it fails to do so on first demand, or its invoice creates a discrepancy that the second beneficiary's documents did not have, the transferring bank may pass the second beneficiary's documents directly to the issuing bank, which exposes the trader's margin and supplier.

A credit can be transferred only once: a second beneficiary cannot transfer it on to a third, although transfer back to the first beneficiary is allowed. It may be split among several second beneficiaries if partial shipments or drawings are permitted, which suits a trader sourcing one order from several factories. The transferring bank, often the advising or nominated bank, is under no obligation to transfer except to the extent and in the manner it expressly agrees, and it normally charges a transfer fee, payable by the first beneficiary unless otherwise agreed. Transfers are usually sent to the second beneficiary's bank as a SWIFT MT720 message.

The second beneficiary does not gain a contract with the end buyer. Its security is the issuing bank's undertaking, as transferred; any later amendment to the original credit reaches it only if the first beneficiary has agreed that amendments may be advised to the second beneficiary.

Where the original credit is not transferable, or the trader does not want the supplier to see its terms, the usual alternative is a back-to-back credit: the trader's own bank issues a second, separate credit in favour of the supplier, relying on the incoming credit as support. This needs a credit line for the trader and creates two independent undertakings, so the bank carries the risk that documents valid under one credit fail under the other. A transferable credit avoids that mismatch because there is only one credit. Some traders instead rely on a counter guarantee or pre-shipment finance to fund their supplier.

Transferable credits are common in commodity trading, textiles and electronics, where trading houses sit between manufacturers and importers in international trade. Because the structure can hide the true parties, banks treat it carefully under trade-payment compliance programmes: they screen the first and second beneficiaries, check that the margin between the two invoices is commercially plausible, and look for trade-based money laundering signs such as unexplained price gaps or goods routed through unusual ports. The bill of lading and other trade documents often have to be prepared so that they work under both the transferred and the original credit, which is a frequent source of discrepancies.

• International Chamber of Commerce
• SWIFT