Beneficiaries can fulfill their obligations under a letter of credit by making complying presentations. Once issuing bank receives the complying presentation from the beneficiary it must honor, which means;
to pay at sight if the credit is available by sight payment,
to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment,
to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance.
Figure 1: Letter of credit discounting process
I would like to summarize what I have explained above once again because most of the exporters think that they could discount a letter of credit as soon as they have received it from their banks. This belief is not correct at all. You need to make a complying presentation in order to receive any form of payment under a letter of credit. No complying presentation no payment under letters of credit.
Letter of credit discounting is related to the letters of credit which are available with deferred payment, acceptance or negotiation. At sight letters of credit should not require any discount mechanism as issuing banks or confirming banks must honor at sight credits as soon as they determine that beneficiary’s presentation is complying with the terms and conditions of the L/C.
Some examples of letters of credit which can be subject to discounting:
41D AVAILABLE WITH/BY:
42C DRAFTS AT:
AT 90 DAYS AFTER BILL OF LADING DATE
You need to be careful with one point which is that in trade finance terminology letter of credit discounting and letter of credit negotiation used in the same meaning, but they could have different meanings in regards to banking practice and commercial law.
Negotiation is defined under UCP 600 as follows: Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. This definition also fits for the letter of credit discounting in terms of banking practices in many circumstances.
Special Hints on Letter of Credit Discounting for Exporters:
1. Keep in mind that you cannot get any payment from banks unless you make a complying presentation under a letter of credit.
2. Usually letter of discounting and letter of credit negotiation used in the same meaning in trade finance terminology.
3. Letter of credit discounting is related to the letters of credit which are available with deferred payment, acceptance or negotiation.
4. At sight letters of credit should not require any discount mechanism as issuing banks or confirming banks must honor at sight credits as soon as they determine that beneficiary’s presentation is complying.
What is discounting in a letter of credit transaction?
Letter of credit is not a cheque but rather it is a conditional payment undertaking of the issuing bank. For this reason as a beneficiary first of all you need to fulfill your obligations under a letter of credit before considering yourself to be eligible of the issuing bank’s payment.
5. If you would like to discount a letter of credit you should try to get discount approval from your bank before letter of credit is issued. You can get your banks discount approval and discount conditions by applying them with a draft letter of credit.
6. Confirmed letters of credit can be discounted more easily than unconfirmed letters of credit. For this reason try to have the letter of credit confirmed by your bank to ease up the discounting process.