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Discrepant documents add to trade finance counterparty risk

As corporate cross-border expansion gathers pace, discrepant trade finance documents remain a risk for corporates.

The incidence of disputes arising in trade finance transactions is known to be very low. The International Chamber of Commerce's (ICC) Trade Register Report 2014 demonstrated that short-term trade finance customer default rates were just 0.033%. 

Daniel Schmand-160x186

 Our clients need to be sure that they know their client. Doing the groundwork is critical when choosing who to work with

Daniel Schmand,
Deutsche Bank

However, disputes over terms can still arise, and can be a lengthy and expensive process to resolve. 

Documentary disputes on trade finance documents can have a notable impact on the counterparty relationship, especially as they often arise when there is not an established partnership between the corporates involved. 

Disputes typically centre on the terms agreed in the transaction, the price of the products and/or the quality of the goods. The majority of disputes relate to letters of credit, but guarantees can also be brought into question.

In the main, disputes arise in sectors with high price-elasticity. 

Daniel Schmand, head of trade finance and cash management corporates, EMEA, at Deutsche Bank, says: “Commodities trades, which are sensitive to fast-moving prices, can be more susceptible to disputes. When an agreement has been made on a price and then the market moves dramatically, it can lead to one party attempting to raise a dispute.”  

Sameer Sehgal, EMEA head of trade finance at Citi, says the issues are most prevalent in transactions involving emerging markets (EM). It opens up greater levels of risk, as there are a number of unknown factors. 

He says: “Since trade operates on a globalized model, there are various issues that can arise between the different markets. It can come down to the differences on culture, law or regulations, actual and perceived, that can then lead to disputes arising.”

In turn, these EM companies can also be more at risk, as they might not have the legal knowledge or financial ability to pursue a dispute that arises against them.

Deutsche's Schmand says: “If a dispute goes to court, it can be very difficult to resolve, and can take years. Depending on the size of the trade in question, one might consider whether it is actually worth the effort.”

Rules expanded

If the outcome cannot be decided between the parties, documentary issues might still go to further mediation. Other than taking the issue to court, there is the option of a tribunal, or of mediation through the ICC’s documentary instruments dispute resolution expertise (Docdex) service.

The ICC expanded its rules on which cases to accept for assessment under Docdex earlier this year. Previously, it had been limited to being used only in cases where the ICC banking commission rules had been applied.

Georges Affaki-160x186

Georges Affaki, ICC

Georges Affaki, chair of the legal committee of the ICC and chair of the Docdex drafting group, says the move was because the organization was seeing increasing numbers of cases it could not become involved in.  “The majority of cases can be resolved through an agreement," he adds. "If not it becomes a dispute, and this can have a disastrous impact not only on the reason for the proceedings but the long-term business relationship.” 

Affaki says the ICC was also missing out large parts of EMs, where its services could be of significant use.

The Docdex system uses three independent industry experts to decide if the documents are discrepant. The Docdex decision will be made within 30 days and the fee is capped at $5,000 for disputes on transactions of under $1 million, and $10,000 for anything above. Either party can take the dispute to Docdex and does not need the approval of the counterparty to do so.

A decision is not binding, unless both parties agree with the outcome. If there is not an agreement, the case can be taken to court. 

However, Citi's Sehgal notes there have been cases of courts referring disputes to Docdex to inform its final decision.

Advisory role

For example, he has seen a case involving a dispute over cotton exports, in which the price had fallen significantly after the time of the original contract. The importer contested the documents and refused to pay. The exporter took them to court and the case took three years to reach a resolution – the agreement only reached when the court requested the assistance of Docdex.

To prevent the issues from arising from the outset, banks are providing an advisory role to their corporates. However, a bank is not party to the commercial contract.

Sameer Sehgal-160x186

 This a digitized world and clients are more aware of each other

Sameer Sehgal,

Schmand says: “Banks can advise the clients to looking out for certain issues, like the wording on contracts from some countries. If it is the first time a buyer is dealing with a particular country, we can let them know of potential issues, what we have seen before from the market, and how to deal with a similar situation.” 

Corporates will have access to the legal system of their home country for guidance, but they might not have in-depth experience of working in cross-border trade or in the counterparty’s jurisdiction.

Although more transactions are completed electronically, the ICC's Affaki does not believe this will influence the number of disputes. “Changing to paper will not lessen or increase the potential for dispute, but it will make resolution more straightforward," he says. "The documents can easily be uploaded into the system for assessment.”

The burden of ensuring the legitimacy of the counterparty largely falls on the corporates themselves.

“We have seen a move to globalization and more companies entering into the open account space, so these disputes are more likely to happen," says Sehgal. "But this a digitized world and clients are more aware of each other.

“They can more easily do background checks on each other and surrogate checks to determine if they should work with the other party or not.”

Schmand agrees, saying: “Our clients need to be sure that they know their client. Doing the groundwork is critical when choosing who to work with.”

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