By Kazi Suhel Tanvir Mahmud — Trade Finance & Letter of Credit Specialist
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| Understanding OFAC compliance in Letters of Credit: How sanctions screening, UCP 600, the 50% Rule, and vessel risk affect LC payments and trade finance operations. |
OFAC Compliance in Letters of Credit: Essential Guidance for Trade Finance Practitioners
OFAC: A Mandatory Control Point in the LC Lifecycle
The Office of Foreign Assets Control (OFAC) administers U.S. economic sanctions that apply not only to U.S. banks, but also to non-U.S. banks when:
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Transactions are denominated in USD
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A U.S. correspondent bank is involved
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Clearing occurs through the U.S. financial system
As a result, OFAC compliance becomes unavoidable in LC transactions, regardless of the issuing bank’s jurisdiction. This risk and its practical implications for trade finance are detailed in my Lawyer Magazine publication. For example, a shipment to a seemingly compliant beneficiary may be blocked if the ultimate owner is a sanctioned party under the OFAC 50% Rule. Banks increasingly rely on enhanced screening tools and due diligence procedures to detect these indirect ownership links before accepting documents.n
Where OFAC Intersects with Letters of Credit
Unlike documentary discrepancies governed by UCP 600, OFAC issues are non-documentary but transaction-fatal.
Sanctions screening typically impacts the LC process at multiple stages:
1. LC Issuance
Before issuance, banks screen:
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Applicant
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Beneficiary
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Country of destination
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Goods description
A sanctions hit at this stage may prevent issuance altogether.
2. Document Examination & Negotiation
Even when documents comply fully with UCP 600 and ISBP, banks may still:
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Refuse negotiation
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Suspend processing
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Escalate for sanctions review
Importantly:
A compliant presentation does not override sanctions restrictions.
3. Reimbursement & Settlement
This is where OFAC risk materializes most visibly.
Correspondent banks may:
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Block funds
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Reject MT202 / MT103 messages
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Freeze proceeds pending investigation
This often surprises exporters who believe “documents are clean.”
The OFAC 50% Rule: Hidden Risk for Trade Finance
One of the most misunderstood sanctions rules in trade finance is the OFAC 50% Rule.
Under this rule:
Any entity owned 50% or more, directly or indirectly, by one or more sanctioned persons is itself considered sanctioned — even if the entity is not listed.
Why this matters for LCs
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Beneficiaries may appear “clean” on paper
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Ownership structures are not visible in LC documents
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Screening systems must detect indirect ownership links
This is why banks increasingly rely on enhanced screening tools, not just name matching. In practice, this means operations teams must review ownership structures, incorporate automated ownership analytics, and escalate potential matches to compliance officers. Ignoring these controls can result in blocked LC payments, delayed shipments, or even sanctions violations.
Sanctions screening obligations extend beyond parties to the transaction and may also encompass transportation elements where relevant. Vessel identity, ownership, flag, and trading patterns can become sanctions-relevant after LC issuance, particularly in higher-risk trades. As a result, banks and correspondent institutions may apply vessel-related screening at the time of negotiation or settlement, and adverse findings may lead to payment blocks or delays notwithstanding prior clean screening results.
UCP 600 vs OFAC: No Conflict, Different Authority
A common misconception is that OFAC actions contradict UCP 600 obligations.
They do not.
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UCP 600 governs documentary compliance
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OFAC governs legal permissibility of payment
Banks are legally required to comply with sanctions even if it results in non-payment under an otherwise compliant LC.
This is not a “bank decision” — it is a regulatory mandate.
Practical Implications for Trade Finance Professionals
For practitioners, this means:
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LC structuring must consider sanctions exposure
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Beneficiary due diligence matters beyond documents
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Payment certainty is conditional on regulatory clearance
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Exporters must understand that compliance risk can override contractual expectations
Ignoring OFAC risk is no longer acceptable in professional trade finance operations.
Why OFAC Knowledge Strengthens Trade Finance Expertise
Trade finance today sits at the intersection of:
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Documentary rules
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Payment systems
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Regulatory compliance
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Sanctions enforcement
Professionals who understand only UCP 600 but ignore sanctions risk operate with partial knowledge.
Those who integrate OFAC awareness into LC practice demonstrate:
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Real-world banking competence
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Risk-based thinking
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Operational maturity
Conclusion
OFAC compliance is not an external legal issue — it is a core trade finance control.
In Letters of Credit, sanctions risk can:
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Override documentary compliance
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Delay or block payment
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Impact correspondent banking relationships
Understanding this reality is essential for banks, exporters, and trade finance professionals operating in today’s regulatory environment. Drawing on my 24 years in banking, including 17 years in trade finance, I have seen multiple cases where early identification of OFAC exposure prevented payment blocks and ensured seamless LC execution. Integrating compliance checks with document examination is now standard practice in high-performing trade finance teams.
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