A letter of credit fixes the amount and the currency you will pay or receive, but not the exchange rate that will apply when the payment settles — often weeks or months after the deal is struck. That timing gap is where currency risk sits. UK importers and exporters can remove it by pairing the credit with a forward contract that fixes the sterling value from the outset.
Cambridge Currencies is a UK specialist currency broker that helps importers and exporters convert the foreign-currency amounts behind their letters of credit at a rate they set in advance, rather than whichever rate happens to apply on the day documents are presented. This guide explains where the exposure comes from, who carries it, and the tools used to manage it.
What is a letter of credit, and why does it create currency risk?
A letter of credit, also called a documentary credit, is a bank’s written undertaking to pay a seller a fixed sum in a stated currency once the seller presents documents that comply exactly with the credit’s terms. It replaces the risk of a buyer not paying with the stronger promise of a bank. It is one of several ways to get paid on an export order; UK Export Finance, the government’s export credit agency, sets out the wider options for exporters.
Letters of credit are governed by the International Chamber of Commerce’s Uniform Customs and Practice for Documentary Credits (UCP 600), the rulebook in force since 1 July 2007. Under UCP 600, banks deal only in documents, not in the goods themselves — if the paperwork matches, the bank pays. The credit is typically issued bank-to-bank over the SWIFT network using message type MT700, “Issue of a Documentary Credit,” with any changes sent as an MT707 amendment.
Here is the point that catches businesses out: the credit locks down the currency and the amount, but it says nothing about the exchange rate you will convert at. A credit for USD 500,000 is a promise about dollars. What those dollars cost you in pounds — or what euros you receive turn into in sterling — is decided later, by the market, unless you have fixed it yourself.
When does the exchange-rate exposure on a letter of credit actually begin?
The exposure begins the moment you agree a price in a foreign currency — usually when the sales contract or proforma invoice is signed, well before the credit is even issued. From that point the sterling value of the deal moves with the market every day. Government guidance on payment terms for export orders explains how the timing of payment is agreed between the parties.
The credit then extends the exposure across its whole life. A sight credit pays as soon as compliant documents are checked, so the gap may be a few weeks. A usance or deferred credit pays a set period after presentation — 30, 60, 90 or 180 days — which pushes settlement, and therefore the conversion, further into the future. The longer that tail, the more the rate can move before your money changes hands.
GBP/USD and GBP/EUR are driven largely by the interest-rate differential between the Bank of England and the US Federal Reserve or European Central Bank, alongside inflation and growth data. None of that is knowable months ahead, which is exactly why a fixed shipment date paired with a floating rate is a risk worth managing. You can follow the live pairs on our GBP to USD and GBP to EUR pages, and our currency forecasts set out the drivers in more depth.
Who carries the currency risk on a letter of credit — the buyer or the seller?
Whichever party is dealing in a currency that is not their own carries the risk. For a UK business, that is the side of the trade denominated in dollars, euros or any other foreign currency. The table below shows how the exposure differs for an importer and an exporter.
| Your role | What the credit fixes | Your FX exposure | A weaker pound means |
|---|---|---|---|
| UK importer (pays foreign currency) | The foreign-currency sum you must pay the overseas supplier | The pounds needed to buy that currency at settlement | The goods cost you more in sterling |
| UK exporter (paid in foreign currency) | The foreign-currency sum the overseas buyer will pay you | The pounds you receive when you convert those proceeds | You receive more sterling for the same sale |
Two points are worth separating. Incoterms — the ICC rules that decide who pays for freight, insurance and duties — do not decide who carries the currency risk. That is set purely by the currency named in the contract. And a confirmed letter of credit, where a second bank adds its own guarantee, protects you against the issuing bank failing to pay; it does nothing about the exchange rate. Non-payment risk and currency risk are two different problems, and the credit only solves the first.
How can you manage currency risk on a letter of credit?
There are three main tools, and they are often combined. A specialist broker can hold a rate for a future settlement date, target a better level in the background, or convert on the day, depending on how the credit is structured.
| Tool | How it works | Best suited to | The trade-off |
|---|---|---|---|
| Spot conversion | You convert at the live rate when payment falls due | Very short-dated sight credits, or when you want no commitment | You accept whatever the rate is on the day |
| Forward contract | You fix today’s rate for settlement on a future date | Usance credits and known payment dates | You are committed to the rate even if the market later moves in your favour |
| Market order | You set a target rate to buy or sell automatically, with a protective floor | Flexible timing where you want to aim higher without leaving it unguarded | The target may not be reached before you need to pay |
A forward contract is the tool most closely matched to a letter of credit, because both are built around a future date. It lets you fix the sterling cost, or sterling proceeds, the moment your price is agreed — turning an unknown into a fixed line in your margin calculation. Cambridge Currencies arranges forward contracts for up to 12 months ahead, which covers the settlement window of most trade credits. You can read more in our guides to FX hedging strategies and business foreign exchange.
Worked example: what a 2% move does to a $500,000 letter of credit
Imagine a UK importer opens a letter of credit to pay a US supplier in dollars — USD 500,000, payable 90 days after documents are presented. At an illustrative GBP/USD rate of 1.25, that sum is worth £400,000 on the day the deal is agreed.
- If sterling weakens to an illustrative 1.20 by settlement, the same $500,000 costs about £416,667 — roughly £16,667 more than expected.
- If sterling strengthens to an illustrative 1.30, it costs about £384,615 — roughly £15,385 less.
As a rule of thumb, a 2% move in GBP/USD shifts the sterling cost of a $500,000 credit by around £8,000. On a thin trading margin, a swing of that size can erase the profit on the shipment entirely. A forward contract booked at 1.25 fixes the cost at £400,000 from day one, so the importer knows the exact sterling figure before the goods even leave the supplier’s warehouse.
The mirror applies to an exporter. A UK seller invoicing EUR 600,000 under a credit, worth £500,000 at an illustrative GBP/EUR of 1.20, would receive about £480,000 if the pound strengthened to 1.25 — £20,000 less for the same sale. Fixing the rate protects the sterling proceeds in exactly the same way. The maths here is illustrative; live rates sit on our currency converter.
What mistakes do UK businesses make with letters of credit and FX?
The most common error is assuming the credit itself removes currency risk. It removes the risk of not being paid; the exchange rate is left wide open unless you act. A few others recur often:
- Leaving conversion to the bank on settlement day. The rate is then whatever the market and the bank’s margin produce, with no planning behind it.
- Ignoring the usance tail. A 180-day deferred credit keeps you exposed far longer than a sight credit — the hedge needs to reach that payment date, not the shipment date.
- Mismatching maturities. Documents can be presented early or late within the credit’s expiry, so a forward that matures on the wrong day can leave a short gap. Aligning the forward to the latest payment date, with room to roll it, avoids this.
- Forgetting the fees. Discrepancy charges, confirmation fees and advising costs are often in the foreign currency too, and add to the amount you ultimately convert.
- Amending the currency without re-hedging. If the buyer and seller switch the credit’s currency mid-deal, any existing hedge no longer matches the exposure.
How does a specialist currency broker help with letter-of-credit payments?
A specialist broker sits between your trade contract and the currency market. Rather than converting at the bank’s counter rate on settlement day, you agree a rate with a dedicated dealer who understands the timing of documentary credits and can match a forward to your payment date.
At Cambridge Currencies, every transaction is completed by phone with a named specialist — not through an online form — so the structure of your credit, its expiry and its payment terms are discussed before any rate is fixed. That matters most when a shipment slips or documents are presented early and the hedge needs adjusting. Funds are safeguarded by our FCA-authorised partners Currencycloud and ScioPay, held at a credit institution and kept separate from company funds. The minimum transfer is £5,000, and forward contracts are available for up to 12 months. For related reading, see our guides on UK exporter FX strategy and managing cash flow in foreign currency.
Frequently asked questions
Does a letter of credit protect me against exchange-rate movements?
No. A letter of credit protects you against the other party failing to pay, by substituting a bank’s guarantee. It fixes the currency and amount but not the exchange rate, so any conversion between that currency and sterling remains exposed to the market until you fix it separately.
Can a letter of credit be issued in any currency?
A letter of credit can be issued in any freely traded currency that the buyer and seller agree on — most commonly US dollars, euros or sterling for UK trade. The chosen currency decides which party carries the exchange-rate risk: whoever is not transacting in their home currency.
What is the difference between a sight and a usance letter of credit for currency risk?
A sight credit pays as soon as compliant documents are verified, so the currency exposure is short. A usance, or deferred, credit pays a set number of days after presentation — commonly 30 to 180 — which extends the period during which the exchange rate can move before you convert.
Can I use a forward contract alongside a letter of credit?
Yes. A forward contract fixes the exchange rate for a future date, which pairs naturally with a credit that pays on a known future date. The key is to align the forward’s maturity with the credit’s latest payment date and to allow for the possibility of rolling it if the shipment is delayed.
What happens to my hedge if the shipment is delayed?
If settlement moves back, a forward contract can usually be extended, or rolled, to the new date. Speaking to a dealer before the original maturity means the position can be adjusted in step with the amended credit, rather than being closed out and re-opened at a new market rate.
Is the currency risk different for importers and exporters?
The mechanism is the same but the direction is opposite. An importer paying in foreign currency is hurt by a weaker pound, because the goods cost more in sterling. An exporter receiving foreign currency is hurt by a stronger pound, because the proceeds convert into fewer pounds. Both can fix the rate in advance.
Fix the rate behind your next letter of credit
If you have a documentary credit coming up in dollars, euros or another currency, speak to a Cambridge Currencies specialist about fixing the sterling value before it settles. Every deal is handled by phone with a dedicated dealer who will match the approach to your credit’s terms. Request a currency quote to get started.
