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Expertise > Bank Guarantee

           

What is a Bank Guarantee?

Banks guarantees are written obligations of the issuing bank to pay a sum on to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary.It is important to note that these bank guarantees apply only whenever the issuing bank's guarantee is not contingent on the existence, validity and enforceability of its customer's obligation; this is called an "abstract" guarantee (i.e. the bank's obligation is to pay regardless of any disputes between its customer and the beneficiary). 
The issuance of bank guarantees is a private transaction and does not result in the issuance of any publicly tradable instruments.

There are two types of bank guarantees: 

(1) Direct bank guarantees that have the issuing bank guarantee one's of its customer's (called "Obligor") obligations to a third party (called "beneficiary); and


(2) Indirect bank guarantees that are issued in favour of a second bank which has issued a guarantee on behalf of the of the original's bank's customer. With an indirect guarantee, a second bank (usually a foreign bank with head office in the beneficiary's country of domicile) is involved

Assignment of Bank Guarantee Proceeds

The beneficiary can assign the proceeds of a bank guarantee. But this assignment does not assign the rights of the beneficiary as "drawer" on the bank guarantee, and only the beneficiary may exercise the "drawer" rights and present the demand for payment under the terms of the bank guarantee unless the terms of the guarantee provide otherwise.
This means that the assignee may receive the proceeds of the guarantee, but in order to obtain those proceeds, the beneficiary must make the demand for payment. This also means that the beneficiary can sell by assignment at discount the benefits of the guarantee.

An assignment of proceeds requires notice to the issuing bank of this action; otherwise the issuing bank would pay the beneficiary rather than the assignee.

Transfer of Bank Guarantees - Bank guarantees can be transferred to a third party ONLY with the written consent of the issuing bank AND the beneficiary.
No Public Market - There is no public market for the trading of bank guarantees. Beware! Fraudsters or naive brokers are always erroneously representing that there is a public market for the trading of bank guarantees (and standby letters of credit). This is not to be confused with the trading of other bank issued instruments such as medium term notes, etc. Bank guarantees can only be transferred or the proceeds assigned in private transactions. 
No CUSIP or ISIN Numbering - Bank guarantees are not trading securities, trading debt instruments, or trading investment funds, and therefore are not subject to the settlement procedures offered through Euroclear or DTC and most other settlement firms (and not Bloomberg).

Obviously, therefore, they also are not issued CUSIP or ISIN numbers for trading purposes. However, Euroclear may accept such bank guarantees for "safekeeping" purposes only, and it is not assigned an ISN or CUSIP number (though it may have a number for identification purposes). CUSIP stands for Committee on Uniform Securities Identification Procedures. The CUSIP number consists of a combination of nine characters, both letters and numbers, which act as a sort of DNA for the security - uniquely identifying the company or issuer and the type of security. The first six characters identify the issuer and are assigned in an alphabetical fashion; the seventh and eighth characters (which can be alphabetical or numerical) identify the type of issue; and the last digit is used as a check digit. Similarly, ISIN stands for International Securities Identification Number. The ISIN system is an international standard set up by the International Organization for Standardization (ISO). It is used for numbering specific securities, such as stock, bonds, options and futures. ISIN numbers are administered by a National Numbering Agency (NNA) in each of their respective countries and they work just like serial numbers for those securities.
So one has to be careful in understanding the particular legal relationship of a bank guarantee to Euroclear or other settlement entities, especially as to issues of authenticity. A bank guarantee may appear on the "screen", but not for trading. It is also important to note, that a bank guarantee held in safekeeping does not serve to authenticate the instrument. Anything can be the subject of a safe keeping situation. Mixing a metaphor, you can get a safe keeping receipt for a ham sandwich.