Risk Management

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Don’t Issue Blank Cheques! Experienced treasury professional Patrick Verspecht discusses the risks of issuing bank guarantees and shares seven vital rules to adhere to when doing so.

Don’t Issue Blank Cheques!

Don’t Issue Blank Cheques!

By Patrick Verspecht, Treasury Professional

A few months ago, I got a call from a friend who is the Global Controller of a small Belgian multinational company. He was seeking an opinion on how to prevent one of their customers drawing on two bank guarantees for a quite significant amount, representing almost 40% of the group’s net annual income! Unfortunately, I couldn’t help him, as the wording of these advance payment and performance bonds matched the terms which should never be accepted by any issuer….

This incident, however, led me to think it would be a good idea to share some views and best practices, as experienced during my career, especially when I was confronted with a similar case a few weeks ago.

While there has always been a debate on whether or not trade finance should fall under the umbrella of treasury, I can’t see any better place. The role of treasury has evolved over the last decade and risk is now probably the most important element of the treasurer’s roles and responsibilities, and issuing a bank guarantee has become even more risky today than in the past.

Historically, the company representatives facing the customer during the pre-order negotiation phase are part of the commercial team. Their number one goal is to get the order signed by the customer at a reasonable margin, so they can reach their target and help the company to achieve its aims. So, whether through ignorance or opportunism, they will tend to neglect negotiation over any of the documents annexed to the request for proposal (RFP), such as the required wording of the various guarantees. In my view, however, this not so much the fault of the commercial team as it is of the finance and treasury departments, who are either not implementing the right processes or not making the necessary effort to implement educational programmes for the sales people. I have noted in recent years that more large corporates are rewriting their processes so that these annexes are reviewed by their legal team, and should be considered just as important as the other parts of the contract before the acceptance of the sales order.

There are several non-negotiable rules that an issuer should follow, and they all seem to be a matter of common sense, but the issuance processes (or sometimes the lack of them) too often lead to acceptance of risky terms. 

Seven vital rules

1. Firm expiry date

Without a firm expiry date clearly included in the wording, a bond could be open forever, and on top of the continuing risks of drawdown, the bank will continue to charge bank fees forever… or at least until you finally obtain from the counterparty a release from your liabilities. I have seen bank guarantees open for more than 10 years after the underlying contract was closed.

2. Automatic extension (Evergreen)

Basically, this is the same trap as the previous one. The issuer should explain to the beneficiary that he/shehas the possibility to send an ‘Extend or Pay’ request before the expiry date which is equivalent to an Evergreen format. 

3. Maximum amount

Always insert a maximum capped amount, never accept wording which would transform your originally accepted liability to a variable, unlimited amount (avoid wording such as …. Plus interest, direct and indirect damages costs, legal costs...).

4. Not assignable

Even if you accept this clause (meaning that you authorise the original beneficiary to transfer the bond to another counterparty), your bank will most likely decline to issue a bank guarantee containing an open transferability clause for various reasons, the main one being the danger of it being transferred to an entity which is part of a company or institution on an international blacklist such as that issued by the US Office of Foreign Assets Control (OFAC).

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