The Indemnity Risk for Trade Finance Banks and How to Solve It with e-BLs*

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We have talked before about how SECRO solves the letter of indemnity problem in commodity trading, read here.? A key stakeholder with a keen interest in solving the problems associated with letters of indemnity is the financing bank.

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The recent English Court of Appeal case of Unicredit v Euronav [2023] EWCA Civ 471 caused significant concern across the trade finance industry. ?

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The bank was financing the energy business. ?In this sector, it is common for the parties (shipowner and charterers/cargo interests) to effectively undermine the function of a bill of lading as a security document of title.? It occurs by agreeing to the use of letters of indemnity and novation agreements to facilitate the discharge of cargo without the presentation of bills of lading.

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This workaround has developed because of a basic practical problem.? Simply put, often the paper bills of lading took too long to reach the discharge port.? The vessel and its cargo would be waiting for the paper to arrive.? The workaround was for the cargo interests/charterers to allow discharge without handing up the original paper bill. ?That undermines the bill of lading as a security document.

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Now in many energy trades, the risk of default of energy majors may be relatively low.? However – this can create a false sense of security when a cargo interest may experience unexpected financial difficulties. ?If it goes wrong, then the proper holder of the original bill of lading can bring a claim against the shipowner for the full value of the cargo.? A potentially huge exposure.? The shipowner needs to rely on the financial strength of the charterer or other party who issued the letter of indemnity against which the shipowner delivered without original bills.

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In this legal case, the bank was the proper holder of the original bills.? But that was not enough here to save the day.? The bank’s claim ultimately failed on causation grounds.?

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The court found that the bank’s policy had been to allow such cargo to be discharged against the letter of indemnity. Had the shipowner refused to discharge without original bills of lading, the bank would have required the shipowner to discharge without original paper bills.?

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In essence, the court found that the bank’s security interest would have been lost in any event.

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That is a massive problem for financing banks and increases their risk exposure considerably.

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This is where SECRO steps in to solve the problem.? Immediate transfer of electronic bills of lading means that the need for letters of indemnity for non-presentation of original paper bills subsides.? The bank would not get into this scenario in the first place.? The original SECRO e-bill can be transferred so quickly that this whole scenario can be avoided.

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It is a much easier solution than trying to reset, revise, and re-implement all policies for financing banks (although that is something for banks to consider).?? For as long as letters of indemnity and novation agreements remain involved in the energy trade sale process, then there will be security risks for the banks.? Utilizing a technology solution, such as SECRO, goes a long way to reducing this risk for banks.

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(*This, and all SECRO explainers, are general comments and intended as marketing material only.? This is not legal advice or representation – it cannot be relied upon as such).