Law firms have had to evolve to prosper in the new regulatory world in which they find themselves. GTR brought together some of the most important legal figures in trade finance to discuss the issues facing the market.


Roundtable participants

  • Nick Grandage, partner, Norton Rose (chair)
  • Christopher Czarnocki, partner,White and Case
  • Grant Eldred, partner, Thomas Cooper
  • Celia Gardiner, partner, Watson, Farley and Williams
  • Alex Monk, partner, DLA Piper
  • Robert Parson, partner, Reed Smith
  • Michael Sullivan, partner, Sullivan and Worcester
  • Andrew Taylor, partner, Hogan Lovells
  • Geoffrey Wynne, partner, SNR Denton

Law firm Norton Rose kindly hosted this roundtable at the firm’s London offices.


Grandage: There are not many firms who are active in this industry who are not represented around this table. How has the role of legal advisors developed over the last couple of years?

Wynne: Let’s leave 2008 out, but if we look at 2009-10, there were more challenges by banks’ credit and risk committees which analysed elements that before 2008 were perhaps looked at but not asked about in detail.

Now we often have people asking very, very, difficult questions on a “what if” basis. Clients are adding a combination of “what ifs” in a way that those of us who have practiced for a long time can only respond to by saying: “There will never be a fourth ‘what if’. You’d be mad if you were sitting around after three other ‘what ifs’ had already gone wrong.”

A lot of legal systems see security as something that stops… That really is a problem with the mindset of a lot of legal systems.”

Czarnocki: The role of legal advisor has become a more robust role and you have to face those sorts of questions.

Everybody is suddenly becoming an expert in local security and legal and structuring considerations outside the immediate remit of English law counsel that we’re used to. Suddenly you become in many ways the voice and increasingly active interface of the local advisor vis-a-vis your client.


Grandage: Do you think we are being asked to underwrite local advice law?

Czarnocki: Underwrite is probably overstating it, but certainly in terms of giving sensible advice, yes, in the way that questions are being asked that previously perhaps weren’t. Before 2008, people were taking it through to the first limb of questioning and leaving it there. Now there is an element of more extensively thinking through possible circumstances and outcomes – considering “but what happens if ‘X’ occurs, and what happens if ‘Y’ scenario unfolds, and then what happens should ‘Z’ not happen”?

Simply, there is greater sensitivity to the unexpected, which was less considered when economic times were more certain and rosy.

Taylor: Recently there’s been more quality control with the local law issues, hasn’t there? More involvement and being expected to ask more questions and we’re taking more advice on local law enforcement, whereas in the past it was just a focus on technical enforceability.

It’s about quality control, asking the right questions and drawing out the right advice in writing that can be digested by the client.

Parson: There is a generation of credit professionals out there in the market now who have been told or have learned to expect that there will be a perfect credit result and a perfect local security result to every enquiry. So when the local opinions come in, not infrequently, they say, “Well the local lawyers haven’t covered that bit; will you cover it?” and we have to say, “Well, no, they haven’t covered it because it cannot be covered, so how can we?”

[When] defining trade-related transactions it was my understanding the market said: ‘Go away, we want to remain flexible’”

I think that is definitely a feature, in terms of the way the role has changed. Leaving aside the events of 2008 but looking at the regulatory world we’re now living with, it has become an expected part of the lawyer’s role to help make deals more affordable and economical internally and if you cannot come forward with suggestions of structures that will lead to this conclusion you will quickly be told what the imperative is.

That’s certainly changed a lot in the way these things are structured and in the way client’s questions are coming forward, as this is what people are now expecting the transaction lawyer’s role to be.

Gardiner: I also think that as you’ve all noticed, the credit teams are very cautious and asking a lot of formulaic questions. The tension in any deal between the originators who are trying to get a deal to work and the credit side who have got to tick off every box, is more apparent now than it ever has been, particularly when you have a deal coming from an emerging market.

And as you know there are no simple answers to any of the questions which come up.

Czarnocki: Sometimes you can feel stuck in the middle. I’ve had instances where literally you’ve had the commercial side call you, you’ve had a discussion with them and 15 minutes later you get a call from legal, who’ve had a chat with commercial and suddenly they want to square up some horizons which aren’t necessarily aligning from an internal bank perspective.

Gardiner: Much of the skill of the advisor is playing a helpful role to both sides and not getting drawn into a tension between the two of them.


Grandage: Credit committees often forget that trade deals rarely go wrong. The interesting question is whether this greater caution is effectively a box-ticking exercise which results in the right questions not being asked?

Sullivan: I’m on the litigation side so I’m typically working with deals that were done three or four years before I get involved. If a deal goes wrong, that’s when I get called. I’m wondering whether you’re being asked at the front end to comment on practical issues such as: “How difficult will it be to enforce our security interests?” “How efficient are the courts?” “How corrupt are the courts?” “How much will it cost, if there is a default, to enforce the security interest?” I’m curious.

Wynne: Those are exactly the questions we are being asked. They presuppose that in transactions, the position somehow freezes. Then everybody stops and at that moment there is a commodity being transported and cash in the collection account which they want to enforce with people like me saying that when that transaction is running, why are you asking this question? Why do you want to stop the train? Why do you want to take the commodity off the train? It doesn’t make sense because when it gets to the destination, someone buys it.

There’s this obsession with answering these questions and actually, they’re forgetting the structure and they’re forgetting how you stop getting to that point.

If production stopped, 180 days later there would not be a receivable in the collection account. So why are you worrying about a collection account charge? Why aren’t you looking at production?

Sullivan: Sometimes it’s spontaneous combustion. On day one a deal is proceeding perfectly, the lender is monitoring its counterparty, seeing a fully stocked warehouse, and then on day two everything blows up, so that by day three you’re looking to enforce whatever ancillary collateral there is.

Wynne: I don’t know how many people have ever met that deal.

Monk: One tendency is that you have a lot of the enquiry about the specific terms of the documentation at the outset and people start looking at the documentation itself as the security and losing track of the fact that actually it’s the goods or products themselves that need monitoring in order for the security constituted by the documents to retain its value as collateral. Having properly documented security is obviously very important but attention also needs to be focused on what is actually happening with the assets on the ground.

If you want to do a synthetic transaction, don’t stand up and say that when the deal goes wrong that it’s trade and you should get paid.”

Eldred: The problem is that you have a lot of emphasis on the documentation at the outset and people start looking at the documentation as the security and losing track of the fact that actually it’s the goods themselves that provide the security and need monitoring.

Taylor: They do that because it’s a box-ticking exercise.

Gardiner: Yes. I also think there are problems because a lot of legal systems don’t see that things moving around can be security; they see security as something that stops. And of course, in most of our work, we are creating security over trading assets and so the legal analysis forces you to think about stopping things. I have actually sat in discussions with clients and said: “You’re asking me about seizing a cargo in China and trying to sell it; all I can say is good luck to you.”

But I’m also saying: “Look, you’ve got a business with a pre-sold cargo and you’ve got some money coming in to an account. If you can keep that business moving, you’ll probably have a better chance of recovery.”

That really is a problem with the mindset of a lot of the legal systems we’ve had to deal with.

Wynne: People have mentioned box-ticking exercises; Chris [Czarnocki] has mentioned that the role of in-house lawyers on the bank side is growing in importance. This is a policy move within the banks and is a result of pre-2008 conditions across the banking market and not just in our sector, although our sector has been robust. The policy view within banks is that legal must have a stronger role, but there aren’t many in-house lawyers who actually have the expertise in this field.

So you’ve got general finance lawyers or in-house lawyers who are attached to certain sections within banks and they are given these checklists and they run through these checklists without knowing why they’re asking the questions or what the answers mean in practice.

Czarnocki: That’s absolutely one of the central reasons, because the bank will throw out a round of internal regulations in which the questions that they feel need to be asked, the boxes that need to be ticked, will get applied across a spectrum of financial products. Obviously, it will not be applicable in each case nor as relevant as it could be because of the different concerns, different motivations and different underpinning principles of varied financial products.

Wynne: There is a danger of us becoming a slave to a checklist.

Grandage: One of the important roles that security plays is to describe the deal.

Eldred: Yes, it’s a method of focusing on really important things, like when does title change? What’s the risk? When the balloon goes up, is title in the place you’d expect it to be? The process of taking security gives you a way into that discussion.

Grandage: Often the people doing this exercise in the banks will not have experience in trade finance or commodities transactions: their experience will often be from other disciplines like corporate finance, project finance, property financing or maybe capital markets.

Wynne: But it is the fault of this one-size-fits-all checklist. The problem that the trade finance bankers face, and consequently we as trade finance lawyers face, is that running up to 2008, trade finance had an exception which said “I’m outside of these issues”, but this is not being accepted within a bank now.

We have jokes about accepting hospitality, but there is actually something in the Bribery Act that could be interpreted as accepting it.”

If they were to treat trade as being outside then there wouldn’t have to be this whole checklist problem and that’s the issue; we’re all subject to a sign-off which is based on a checklist based on a conventional deal.

Quite often, a conventional deal is a deal within the bank’s jurisdiction. So in other words, an English bank is testing it against a French bank.

Trade finance bankers, and I’ve said this to them, did themselves a disservice by not picking up the differentiation in Basel II. They’ve not had this advantage of remaining “outside” because of that and they should be, not just because their loan loss was low, but also because their structures were resilient.


Grandage: Is the market prepared for the impact of Basel III? Will the wording of Basel III in relation to documentary credits actually survive into bank regulation so that that level of capital will have to be held against genuine documentary credits?

Wynne: Well, it shouldn’t survive. There will continue to be a trend, which to some degree began with Basel II, of forcing the letter of credit into what is effectively a very pricey product area. That will have a severe impact on certain trade, particularly in the southern hemisphere.

It will become a disproportionately expensive item for banks to finance. There are more and more ownership-type structures being put forward in places where they weren’t typically the way people wanted to do them four or five years ago. Part of the reason for that is, if more and more of the risk rating appears on the banks’ balance sheet anyway, it’s only a few steps down the line when banks say, “Hang on, we may as well just own the thing and deal with it that way.” Certain banks are moving down that road.

Looking at the letter of credit position, I can see a position where it’s only oil transactions that will be able to afford to run them, and that’s an odd situation given that pre-global crisis, the letter of credit was looking like it was dead in its tracks. It’s had a fairly good revival as a result of the need for secured payment, and yet here we are in a position where regulation could knock the wind out of it again.

Grandage: A number of banks such as Standard Chartered and HSBC have gone on record that this will adversely impact world trade. People claimed that the banks were scaremongering when they said things like “if regulators do this, it will knock 0.5% off world GDP”. We have a situation where we think that this element of regulation is wrong in principle. Deals are covered by goods with value and we don’t think it makes sense. If it is maintained and it becomes much more expensive just to open a regular letter of credit, then the banks’ claims don’t sound so much like scaremongering.

Often sanctions are intentionally vague, and that’s where you will end up with litigation.

Wynne: It’s not the cost that’s the problem. This is what went wrong with Basel II. Margins were nice and healthy and the fact that it cost a little bit more didn’t matter because you went out and raised the capital. The problem with Basel III is that the capital is not going to be there.

The wording for Basel III is wrong, but we also have to remember that our clients, the bankers in particular, are equally guilty because I don’t think the regulators fully understand letters of credit. Banks played around with letters of credit with products like deferred payment letters of credit, refinancing of letters of credit over three years and so on. Banks claimed that these products should still be considered a trade related letter of credit and they have spooked the regulators. The regulators have said: “Hang on, let’s stop this happening because I don’t want to see three-year transactions being called letters of credit and no real capital being attributed to it.”

Someone’s got to pull this all back and ask: “What do I mean by a letter of credit?” And if a bank does a deferred payment letter of credit for more than, for example, 180 days, it stops getting letter of credit benefits and has to be treated as something else. That’s a sophistication that Basel III just hasn’t got.

Czarnocki: I would certainly agree that the trade finance industry hasn’t done itself any favours, because there seems to be disparate feedback in terms of justifiable and constructive criticism and feedback to potential regulations. There is arguably a lack of understanding by the regulators because the feedback has been disparate as to why regulations should perhaps be justifiably more lax or accommodating in respect of this particular industry.

Gardiner: When you think of the way regulation has gone, trade finance does not seem to be in the minds of the people making the regulations. Obviously the regulators are focusing on the things that went horribly wrong, rather than what didn’t.

Taylor: But is there enough time for the trade finance industry? The people that are setting up Basel III are thinking about the big problems with derivatives and trade is getting drawn in as a by-product. Now the industry is trying to lobby and I wonder if they’re going to run out of time.

Wynne: Many bank teams are either not realising or just accepting Basel III as their fate or they don’t really recognise the fact that they’re losing something internally and should speak to the people who are putting in place regulations internally who have a voice externally. I don’t think any of us expect the lobbying from the trade finance community to be ignored going forwards.

Eldred: The current proposals are already significantly different from what they were at the outset but even if LCs are required to carry a 100% weighting, you should be able to take the value of secured goods as collateral against that weighting.

Grandage: We’ve all come across clients with this mantra that trade finance is somehow treated differently on insolvency and we tell clients that this isn’t the case at all as a matter of law.

Parson: There must be a way of tying down a definition so when you see something that’s genuinely a short-term, self-liquidating transaction collateralised on goods, there’s no reason for that to suddenly be five times riskier and five times more covered in capital than it was last year; there’s no rationale.


Grandage: Who thinks Basel III is going to get changed before it’s implemented?

Wynne: I’m an optimist and think it is.

Gardiner: I’m a pessimist and think it won’t.

Sullivan: I worked on a synthetic letter of credit issue a while back and I’m thinking how it fits into this spectrum of activity that you’re all discussing. It touches on questions that are always in the background for me; what is trade, what is real trade, and what is trade-related? Will market participants ever willingly agree on a definition of real trade versus trade-related?

Don’t you need to define these terms if you want to advance the distinction you’re talking about now? This is imperative if you hope to preserve the perceived efficiencies and advantaged pricing for real trade and for letters of credit related to real trade, and to neutralise the fear that Basel III will cause the demise of LC-based transactions, an incredibly valuable tool in trade finance. Is it a conundrum that can be solved? Is it something that lawyers can address or does it have to be something the businesspeople can stand up and acknowledge?

Eldred: But at the moment, whatever the industry or lawyers think, that distinction is not being drawn by the regulators.

Sullivan: But it’s resisted by market participants, too. When Geoffrey [Wynne] was working on the IFA practice guidelines for the forfaiting community there was a discussion about defining trade-related and it was my understanding that the market said: “Go away, we want to remain flexible and be able to pursue what we want”.

Wynne: It depends who you mean by the market. And that’s what this battle between trade and trade-related is.
The sad thing is that if you want to define true trade, it is a very, very narrow parameter that is essentially defined as the short-term financing of a movement of goods, or possibly the storage, though you might not get away with even that.

That’s why BAFT and all the rest are not best pleased with me because I don’t think that people do want to go down this route. I think it becomes too restrictive and if you narrow it, the insurance market will then only cover true trade and that means deals that are currently being financed with insurance would cease to be financed because it would not be under a trade policy. So you start seeing how you get into an even worse position and the best thing you might do is either fight this battle, because this is a letter of credit battle, or say, well, everyone said that letters of credit would die, and something else will come up in their place.

Sullivan: But you really can’t fight it unless the market, however you want to define it, is prepared to address the distinction.

Wynne: I’m not stopping people doing synthetic transactions. What I’m saying is if you want to do a synthetic transaction, don’t stand up and say that when the deal goes wrong that it is trade and you should get paid, like what happened in Kazakhstan.

Gardiner: What was interesting with Kazakhstan was the definition of trade finance we saw in BTA. I’ve never seen a definition that had so much evidence of heavy negotiation in it. Those of us who had to adjudicate it did have a bit of a struggle, but this is not a comment on the quality of the draft, it is a comment that clearly there were terrible problems which had to be resolved. The BTA restructuring is of no use to regulators in establishing something that can work as a universal definition of “trade finance”. It was very specific.

Parson: We would be in great danger if regulators took their cue for defining trade from BTA; we’re essentially looking at a restructuring with a limited pot of money. If you decided that real trade deals are deals completed on a Tuesday, then it’d probably end up with the same result.


Grandage: How about the bribery act?

Gardiner: For all of us lawyers on the transaction side, the Act is not going to affect us specifically because what we write down is pretty clean. It’s what’s going on around it that we don’t know about which is the frightening thing.

I haven’t seen many deals which have been affected by issues covered by the UK Act or where that is being discussed in the preparation of the documentation, but that doesn’t mean that it’s not going to happen.

Taylor: I suspect that many of the offences in the bribery act already exist, so it’s possibly more a codification of what we already have. It’s part of a global standard I suspect. The US went first with the Foreign Corrupt Practices Act; the bribery act has come out of an OECD initiative and we’re not the only country to put this sort of thing in place.

I think one of the changes for corporate clients is now that they can’t turn a blind eye to their subsidiaries, so they’re at risk of deals that have been sweetened locally. But this could get the parent company in trouble.

Wynne: The number of intermediaries that trade finance has, inevitably there could be problems with this.

Gardiner: There’s also an issue in that the US and UK laws don’t quite match and there are a few areas where compliance with the US law involves creating evidence to show a breach of the English law.

Wynne: We did a comparison with the US equivalent, and the bribery act as it currently stands is much tougher in many ways than the US one and much tougher than the European requirements. We are a trading country and have so many financial institutions sitting in the UK, and you have to ask what possessed them to overreact in this act and thus put the UK at a disadvantage. I don’t disagree with having it, I think it’s pretty much all there anyway and I don’t think any of us would ever turn a blind eye, but I think it has gone too far. That’s why the whole thing is sitting around waiting because the government has realised that is gone too far and they’re trying to work out how they can save face in the guidelines to get out of the mess that should never have been created.

Gardiner: We have these jokes about accepting corporate hospitality, but there is actually something in the act that could be interpreted as including corporate hospitality. There’s always a worry when criminal legislation is drafted in a way that doesn’t really make sense.

Eldred: Also very relevant, with current cut backs, will be the level of resources that are made available to the Serious Fraud Office for enforcement and whether the decision to prosecute will be taken from them.
Grandage: How about sanctions? Our view about the most recent English sanctions is that they are so vague that it’s impossible to advise clients whether or not certain activities are lawful or not. They look like they’ve been deliberately been drafted to be vague and around this table we’ve all, I suspect, had pressure from the US to put sanctions wording in documents and we’ve advised not to put it in.

The normal response is that if an activity is unlawful you don’t do it, but putting something in the document which effectively gives the bank the right to decide whether it thinks something is lawful is generally something that our market is against, because it affects the independence of the letter of credit.

Sullivan: I can confirm that clients I’ve represented tried to install Office of Foreign Assets Control (OFAC) language into a LC and got significant pushback from anyone based in the UK without any explanation, just a simple “no, we don’t do that”.

Wynne: I still maintain the view that this is quite right. If we’re talking about letters of credit, a letter of credit is a instrument that is paid against documents, therefore, there should be no room in a letter of credit to have someone say: “I don’t want to pay this because I think, reasonably or otherwise, that if I were to pay this, I might have a problem with OFAC or whatever”. If it is illegal for you to pay, don’t pay, then you keep the letter of credit as a payment instrument and the law deals with it.

That is all there is to it. I know there is now a view growing from the US and Australia that says we ought to have these points in there just in case.

Sullivan: I can see the advantage of having these points in there.

Wynne: How do you confirm a letter of credit where the issuing bank has the right to say: “I don’t feel like paying because I think OFAC may apply, so I’m not going to pay?” The confirming bank is, to use the technical term, screwed, because it has paid for the documents and is not subject to OFAC.

Sullivan: If we accept your principle that a bank that refuses to pay based on OFAC will be protected by a court of law, then adding this verbiage won’t change anything. On the other hand, letter of credit law is pretty flunky. The independence principle means that the issuing bank isn’t supposed to consider the underlying transaction. Including OFAC language in a letter of credit will protect an issuer from the argument that a refusal to pay based on OFAC somehow violates the independence principle. So, I can see an advantage to including the language and I don’t know that it significantly affects the rights of any other participants to a letter of credit transaction.

Grandage: I’m not sure that you’ve got that many people who would be with you at this table.

Eldred: If the issuing bank is prohibited from paying by sanctions that apply to it, then it cannot pay no matter what’s written in the letter of credit. If it states its own policy at the outset of establishing the letter of credit that says “even if US sanctions don’t apply to us, we have a policy within the bank of complying with US sanctions” and the beneficiary is aware of that term at the outset, then I don’t see a problem with that; it’s another term in the LC that they’ve agreed to accept.

Czarnocki: If that’s encapsulated in the document itself, then yes.

Parson: It would introduce a whole new level to the haircut that you apply to discounting any credit because you’d be discounting it for the diversity of sanctions implementation.

Eldred: Often sanctions are intentionally vague and that is an area where you will end up with a lot of litigation. They include clauses freezing assets that are owned or controlled by individuals.

Well, if you are dealing with a dictatorship, most companies and assets could be said to be owned or controlled by the dictator, so you’ve got to be a bit more specific than that.

Grandage: Who can predict decisions or changes in law that might happen and might impact on our world? I think the sanctions wording in letters of credit will get litigated. Also, the increasing instances of ownership-based transactions are going to get litigated at some point and we will get a judgment hopefully in an English court which does hold up the true sale nature of ownership based transactions in the physical world.

Wynne: The optimists, and I’m in that camp, would actually see a calming down on the trade side and the ability to do trade transactions will become easier. There’s a sort of knee jerk at the moment and sanctions have the ability to turn historic good guys into bad guys at the drop of a hat.

But in Libya we don’t know who the bad guys are so they’ve made everybody the bad guys, and that’s where the problems lie. There’s nothing inherently wrong with sanctions, but it’s bad for trade.

We were involved peripherally in a transaction where somebody shipped arms to Libya when it was perfectly permissible to do so. The ship arrived, sanctions begin and the LC document is presented under letter of credit. The bank finds discrepancies and has not paid.

Sullivan: We’re talking about financing the shipment of arms, it shouldn’t be shocking that there’s a risk associated with that activity.

Wynne: But previously, he was a good guy and we wanted to give him arms. We had delegations galore going to Libya.

Sullivan: Geoffrey, go back to when you and I first started playing with forfaiting. The initial term sheet typically included a carve-out; some sort of statement to the effect that the underlying commercial activity did not involve arms. So, the market has always been sensitive to the extra risk associated with that type of endeavour.

Wynne: If you take that point, banks are going to back to saying that they had better not finance arms at all because they are invariably going to go to an emerging market country and that country might turn sour.

Gardiner: This is a risk that has always been around; it’s not the first time that the US and the West have changed their view on a particular emerging market. I suspect that if you’re in that line of business this is not all that new. GTR