What is a Back to Back Letter of Credit?11 April 2023
What is a Back to Back Letter of Credit?
A Back-to-Back Letter of Credit (BBLC) is a financial instrument used in international trade and commerce, particularly when there are multiple parties involved in a transaction. It involves the issuance of two separate and related letters of credit, one of which serves as the primary LC (also known as the master LC), and the other as the secondary LC (also known as the back-to-back LC). This arrangement is often used when an intermediary or middleman is involved in a trade transaction.
Here’s how a Back-to-Back Letter of Credit works:
- Primary Beneficiary (Seller/Exporter): The primary beneficiary, who is typically the middleman or intermediary in the transaction, receives an LC (the primary LC) from their buyer (importer) or the importer’s bank. This primary LC represents the payment they will receive upon fulfilling their obligations under the primary sales contract.
- Secondary Beneficiary (Manufacturer/Supplier): The primary beneficiary, often needing to purchase goods or services from a different supplier or manufacturer, opens a secondary LC (the back-to-back LC) in favour of the secondary beneficiary, who is the supplier or manufacturer. This secondary LC is collateralized by the primary LC, and its terms are based on the terms of the primary LC.
- Intermediary’s Role: The intermediary, who holds the primary LC, uses the back-to-back LC to purchase the necessary goods or services from the secondary beneficiary. The back-to-back LC essentially mirrors the terms of the primary LC but includes adjustments to specify the secondary beneficiary as the beneficiary and the intermediary as the applicant.
- Delivery and Payment: Once the secondary beneficiary fulfils the requirements of the back-to-back LC (which are typically the same as those of the primary LC), they can present the necessary documents to the bank that issued the back-to-back LC. The bank will then make a payment to the secondary beneficiary based on the terms of the back-to-back LC. Simultaneously, the intermediary receives payment from their buyer under the primary LC.
Key points to note about Back-to-Back LCs:
– The primary LC serves as collateral for the secondary LC. It provides assurance to the secondary beneficiary that they will receive payment as long as they fulfil the terms and conditions of the back-to-back LC.
– The use of Back-to-Back LCs can be beneficial when the intermediary does not have the financial means to purchase the goods outright or does not want to take on the risk of holding inventory. It allows them to effectively act as a middleman in the transaction.
– Communication and coordination among all parties involved (primary beneficiary, secondary beneficiary, and banks) are crucial to ensure the successful execution of a Back-to-Back LC transaction.
– While Back-to-Back LCs can be useful, they add complexity to trade transactions, and fees associated with LC issuance and confirmation can impact the overall cost of the transaction.
Overall, Back-to-Back LCs are a financial tool that facilitates trade transactions involving intermediaries or middlemen and suppliers or manufacturers, allowing for smoother and more secure international trade.