How does it work?
SBLC “leasing” or Collateral Transfer is where a Provider agrees to utilise his assets to the benefit of a third party, namely the Beneficiary (or Principal). This is done through a Collateral Transfer Agreement and involves the ‘transfer’ of the original asset (the ‘collateral’) into a new security that the Beneficiary can utilise. Hence the term “Collateral Transfer”.
This is done by the Provider of the original or underlying asset pledging the asset to the facility bank (the Issuing Bank) in order that the Provider can instruct the remittance of a SBLC to the Beneficiary and his Recipient Bank. The SBLC that results can be used in any way by the Beneficiary. The underlying asset pledged to the Issuing Bank may be cash, bonds, stocks, gold or other assets (or often a combination of many) and is provided by the “Provider”.
The Provider will be a private equity or investment group or a collateral management company making investments on behalf of its clients. A Provider will often receive the assets through private label funds set up for the purpose, or from hedge funds, pension funds or high net worth individuals and family offices.
Provider’s are able to offer its investors good returns on non-liquid assets by offering Collateral Transfer facilities. This makes good opportunity to investors that wish to seek additional returns by placing their assets with the Provider. The Provider then in-turn seeks suitable clients (beneficiaries) to receive Collateral Transfer facilities. The Contract Fees paid to the Provider by the Beneficiary for the use of the SBLC are then divided amongst the investors (the owners) of the original underlying asset as a return. A portion of course retained by the Provider as their management fee. This allows investors to obtain good annual returns on assets they would otherwise not be able to invest. For example, valuable artworks, real estates, stagnant capital, etc.
The Provider will use his bank relationship to pledge these assets to the Issuing Bank and have them issue a SBLC to the Beneficiary for a given term (usually 12 months renewable terms). The Beneficiary will pay to the Provider a Contract Fee for the use of the SBLC over the term.
The facility is governed by a Collateral Transfer Agreement (commonly referred to as a CTA). Each CTA is bespoke to the specific transaction. This Agreement binds the Provider to issue the Guarantee to the Beneficiary for the given term and binds the Beneficiary to accept the SBLC and to pay the Contract Fee to the Provider for its use. It is of course known to all parties that the Beneficiary will use the SBLC to raise credit and will therefore encumber the SBLC (i.e the lending bank will lien it as security). This is referred to as ‘monetisation’ of the SBLC. Whist this is of course acceptable to the Provider, the Beneficiary will need to make a declaration that they adhere to remove any encumbrance over the SBLC 5 days prior to the SBLC expiry date. Therefore the Beneficiary must make his own arrangements with his bank (or the bank lending the credit against the bank guarantee) to repay any loans secured on it. Otherwise the Beneficiary will be in breach of the CTA. This is referred to as the ‘exit strategy’, i.e. how the Beneficiary will exit the contract and repay the debt secured on the SBLC.
Commonly, the Beneficiary will refinance with the lending bank to remove any encumbrance over the guarantee at expiry, or choose to renew the CTA for a further 12 month period. If the Beneficiary fails to repay any loans secured on the SBLC at expiry, the lending bank will call it and the Provider will lose his pledged assets. In these cases, the Provider will take recourse of debt recovery against the Beneficiary. It is therefore required that the Beneficiary is reputable and financially sound and that is why there is the initial due diligence and acceptance period before we are able to offer Terms. Only when the Beneficiary is accepted are Terms offered.
Therefore, to exit the contract successfully, the Beneficiary will utilise loan funds raised on the SBLC for commercial purposes. Rather like a bridge loan, the Beneficiary will need to receive his investment or liquidate his project prior to the expiry of the SBLC, allowing him to clear and remove any encumbrance over it.
It is common to find that a Beneficiary will use Collateral Transfer facilities to either participate in trade positions where his returns are received prior to expiry of the SBLC, or for property development projects where liquidation or refinance of the bricks and mortar once construction is complete will serve as his exit strategy. This fairs well with these types of facilities and are preferred by Providers.