Most financial organisations refer to securities as tradeable instruments such as bonds, futures, medium – term notes etc. In the world of Collateral Transfer leased bank guarantees and standby letters of credit are used as security for loans and lines of credit. Hence they are referred to as leased securities.
For more information on Leasing and Collateral Transfer please go to Collateral Transfer.
A bank guarantee is a financial instrument. It is a guarantee to pay by the issuing bank to the beneficiary should they suffer a financial or contractual loss. The issuing bank will obtain sum paid to the beneficiary from the applicant.
The beneficiary is the beneficiary of the bank guarantee. The issuing bank issues the bank guarantee. The applicant is a client of the bank. The applicant will have a contract with beneficiary and will have instructed the issuing bank to issue the bank guarantee.
A standby letter of credit is a financial instrument used to underpin trade finance. It is considered as a payment of the last resort. Two companies, a buyer and a seller will enter into a contract.
The buyer will instruct their bank to issue a standby letter of credit in favour of the seller. If the buyer fails to pay the seller the seller will instruct their bank to claim against the standby letter of credit. The issuing bank will pay the sellers bank the amount owed and then claim the same from the buyer.
The beneficiary of a bank guarantee will take the instrument to their bank and ask for a credit line. However, the only instrument a bank will accept for monetisation is a demand bank guarantee.
The demand bank guarantee has specific and exact verbiage contained within the format. It is governed by ICC Uniform Rules for Demand Guarantees, (URDG 758). Therefore, the beneficiary will enter into a Collateral Transfer Agreement to lease a demand bank guarantee.
For a detailed description of a Demand Bank Guarantee and URDG758 please got to Format.
As advised previously we are referring to securities as bank guarantees. These are leased by companies that are referred to as providers or provider groups. These provider groups are geographically diverse and can be found in most major financial centres.
These companies are serious sophisticated investors with access to billions in assets. These groups are represented by Sovereign Wealth Funds, Hedge Funds, Private Equity Funds and senior family offices.
The provider groups as previously advised have access to billions in assets. Some of these assets are very low risk so the returns are relatively low. These assets are usually represented by government bonds and medium-term notes, (MTN’s), to mention but a few.
In order to increase the return on these assets the providers will use them as security to issue bank guarantees or standby letters of credit. These instruments will be leased into the collateral transfer market. The provider groups can expect a return in the region of 6%. Add this return to the prevailing return on these assets and the overall return has dramatically increased.