Chapter 7 Trade financing techniques
Forfaiting
Forfaiting is a similar technique to invoice
discounting, and is usually applied to
international trade, although it is possible
to arrange it on domestic transactions as
well. Unlike invoice discounting, the finance
is usually arranged on presentation of a
debt instrument, rather than an invoice.
Instruments suitable for forfaiting include
bills of exchange, promissory notes and
other similar documents that are a legally
enforceable obligation to pay. (In other
words, with invoice discounting the finance
is arranged against an instrument provided
by the seller, usually an invoice; in forfaiting
the finance is arranged against an instrument
provided by the buyer, such as a bill of
exchange.) To be suitable for forfaiting, the
instrument must be transferable.
Because forfaiting is arranged using the
payment obligation as the security, rather
than the invoice itself, forfaiting is always
offered without recourse to the seller/exporter
(which sells the debt to its bank or finance
company, the forfaiter). However, in most
cases the debt is supported by some form of
bank guarantee, providing extra security to
the forfaiter. The bank guarantee can be in a
variety of forms, including a standby letter of
credit facility, an avalised bill of exchange or
an explicit guarantee. The forfaiter assesses
its exposure to risk on the basis of the credit
status of the bank providing the guarantee.
Forfaiting is usually arranged against
receivables over a period of two or more
years, although shorter terms can be
possible. Forfaiting transactions are usually
arranged in an international currency,
typically EUR or USD, with a typical minimum
transaction of EUR 100,000/USD 100,000,
up to a maximum of a few hundred million in
either currency.How it works
As with factoring and invoice discounting,
for forfaiting to be available, the underlying
transaction will need to be arranged on
credit terms.
Whilst in the process of arranging the
transaction with the buyer/importer, the seller/exporter will need to approach a forfaiter
and to disclose the details of the transaction,
shipping and the importer. In addition, the
forfaiter will want to know the credit terms
agreed, including whether any guarantees
support the importer (in the form of a letter of
credit, for example) before offering details of
the likely charges.
The next stage is for the forfaiter to agree
to purchase the debt instruments associated
with the transaction. Once the forfaiter
makes a commitment to do so, the exporter
is also committed to the sale. It is important
therefore that the detail of the sale of the
debt instruments is carefully negotiated. In
particular, care must be taken to describe
accurately the nature of the underlying
transaction in the agreement. This must match
the detail provided in the debt instrument and
other documents the forfaiter will want to see
before settling the commitment.
At the same time, the details of the
forfaiting agreement must be agreed.
This will include the precise detail of the
instrument to be purchased, the process by
which the forfaiter will assess accompanying
documents before releasing funds, any
interest charges (these can be floating or
fixed), the denomination of the payment from
the forfaiter to the exporter, and the deadline
for the submission of documentation by the
exporter.
Once agreement with the forfaiter is
reached, the exporter can agree and finalise
the contract of trade with the importer.
Depending on the nature of the transaction,
a letter of credit or other guarantee may be
used in the contract. After shipping the goods,
the exporter will receive documents from the
importer (or the importer’s agent). On receipt,
the exporter will forward these documents
to the forfaiter. The forfaiter will examine
the documents against the terms of the
commitment to purchase the debt obligation.
If the forfaiter is satisfied, the funds will be
released to the exporter. The forfaiter then
collects payment from the importer, with
the debt obligation (and, where used, bank
guarantee) acting as security.