In international trade finance, payment execution and negotiation play a crucial role in letters of credit. The UCP 600 (Uniform Customs and Practice for Documentary Credits) defines these terms clearly. Let’s break them down in a simplified way.

What Does “Payment Execution” Mean?

Executing a letter of credit means the bank follows through with the payment obligation under the terms of the credit. The way a bank executes payment depends on the type of credit:

• Sight Payment (MT 700, MT 701): If the credit requires payment at sight, the bank settles the payment immediately upon verifying a complying presentation.
• Deferred Payment (MT 710, MT 711): If the credit allows deferred payment, the bank commits to settling it at a later, agreed-upon date.
• Acceptance (MT 720, MT 721): If the credit is available by acceptance, the bank accepts a draft (bill of exchange) from the beneficiary and commits to settling it at maturity.

What Does “Negotiation” Mean?

Negotiation (MT 742, MT 743) refers to when a nominated bank purchases drafts or documents under a complying presentation before reimbursement is due. The bank advances funds to the beneficiary in exchange for the documents. However, negotiation applies only when the draft is drawn on a bank other than the nominated bank.

Types of Payment Execution in Letters of Credit

A letter of credit must specify whether it is payable through sight payment, deferred payment, acceptance, or negotiation. Here’s how each works:

1. Sight Payment (MT 700, MT 701)

When a letter of credit is payable at sight, the nominated bank will settle the payment immediately if the documents comply with the credit terms. The bank then forwards the documents to the issuing or confirming bank for reimbursement.

• If the nominated bank also acts as the confirming bank, it must process the payment at sight (MT 740).
• Otherwise, it may choose to forward the documents and await reimbursement before settling the amount.

2. Deferred Payment (MT 710, MT 711, MT 740)

For deferred payment credits, the nominated bank does not settle the payment immediately. Instead, it issues a deferred payment undertaking, promising to settle the beneficiary’s payment on the maturity date.

Key points about deferred payment:

• The nominated bank must explicitly confirm its payment obligation. (MT 799)
• The beneficiary may request an early settlement (prepayment). (MT 799)
• Settlement is made without recourse, meaning the bank cannot demand repayment from the beneficiary. (MT 799)
• If the nominated bank is also the confirming bank, it must fulfill the payment obligation upon a complying presentation and settle the amount at maturity. (MT 740)

3. Acceptance (MT 720, MT 721, MT 799)

In an acceptance credit, the beneficiary submits a draft (bill of exchange) drawn on the nominated bank. The bank then accepts the draft and commits to settling it at maturity.

Key aspects of acceptance:

• Before accepting the draft, the bank must verify that the documents comply with the credit terms. (MT 799, MT 720)
• Once accepted, the draft becomes an unconditional and irrevocable payment obligation of the bank. (MT 720, MT 721)
• The bank or the drawee may prepay or purchase its own accepted draft upon the beneficiary’s request. (MT 799)
• Settlement is without recourse, as the bank incurs its own independent obligation upon acceptance. (MT 799)
• If the nominated bank is also a confirming bank, a complying presentation made to it obligates the bank to process the payment, and it must settle the amount at maturity. (MT 799)

4. Negotiation (MT 742, MT 743, MT 799)

Negotiation occurs when a nominated bank purchases the beneficiary’s drafts or documents before receiving reimbursement. This allows the beneficiary to receive funds earlier.

Key aspects of negotiation:

• The drafts must be drawn on a bank other than the nominated bank. (MT 742, MT 743)
• This differs from acceptance, where the nominated bank accepts drafts drawn on itself. (MT 721)
• Negotiation provides liquidity to the beneficiary before the final payment date. (MT 799)

Final Thoughts

Understanding how payment execution and negotiation work in a letter of credit is crucial for buyers and sellers in international trade. Whether a credit allows sight payment, deferred payment, acceptance, or negotiation, each method provides a structured and secure way to facilitate global transactions.

This structured approach to finance is similar to how an architect approaches design—ensuring every component aligns with the overall structure, eliminating financial uncertainties much like strong foundations remove structural risks.

References

Export-Import Bank of the United States – https://www.exim.govrovides a structured and secure way to facilitate global transactions.

International Chamber of Commerce (ICC) – https://iccwbo.org

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