01 Jan 2001, Energy Risk glossary , Energy Risk
An instrument or document issued by a bank guaranteeing the payment of a customer’s drafts up to a stated amount for a specified period. It substitutes the bank’s credit for the buyer’s and eliminates the seller’s risk. LCs are used as margin collateral in gas and power trading as well as to underwrite specific commodity cargoes such as oil. There are several types of LC including ‘standby’, which is used purely for guarantees (that is, it is not used except during default), as well as ‘documentary’, where the provider substitutes for the counterparty in settlement. Whether central counterparties (CCPs) will continue accept LCs to satisfy margin requirements is currently in doubt, and depends on the interpretation of European Market Infrastructure Regulation (EMIR).
* see also performance letter of credit