The word Forfaiting derives from the French “à forfait” or Forfaitierung (German) and Forfetizzazione (Italian) ; an expression implying the idea of a settlement, the terms of which are agreed in advance, and are therefore not liable to later discussion. Forfaiting is the term used to define the practice of buying trade credits/receivables (drafts, bills of exchange, promissory notes, guarantees, Letters of Credit, and other acceptable underlying debt instruments) falling due at some future date, arising mainly from goods and services – mostly export transactions – waiving at the same time, one’s right of recourse to any previous holder of the particular obligation. It is a blueprint for non-recourse financing.
Taking a simple example, an importer and an exporter close a commercial transaction that is embodied in a contract to exchange goods, machinery, key-turn plants, etc., for settlement in the near future. The exporter might decide he is reluctant to accept either the creditworthiness of the importer or the terms and conditions of the payment for the goods to be delivered. Thus, to reduce the credit risk, the exporter would require that the importer find a bank or other first class credit institution, which is willing to irrevocably and unconditionally guarantee his liabilities – upon evidence that the goods have been shipped. The institution would normally be resident in the importer’s country. However, when the buyer is resident in a third world country, the guarantor may well be a European bank.
The method of guarantee can take the following forms:
-
An aval, whereby the guarantor endorses bills of exchange/drafts drawn on the importer, thus becoming liable on them;
-
A separate form of guarantee of the importer’s liabilities. This usually applies when promissory notes are signed by the importer, as opposed to bills of exchange being used, and;
-
When the guarantor is a bank from the United States, the guarantee often takes the form of a Standby Letter of Credit whereby the American bank undertakes to honour bills of exchange drawn in the prescribed way.
The form of the guarantee is unimportant, provided the guarantee is legally binding. What really matters is the status of the guarantor institution.
Provided the guarantor is undoubted, the exporter’s bank, known as the forfaitist or forfaiter, will immediately proceed with the discounting (forfaiting) of the bills or promissory notes, i.e. will pay the exporter, within a few days if not sooner, after the shipment of the goods, the face value less the agreed discount charges, often applying the “discount to-yield method”. Thus, the exporter is able to fully offset his risk exposure and to bridge the deferred payment period, which typically varies between 30 days and seven years and for amounts as little as US$25.000 and up to several million on some large international transactions involving promissory notes.
If the importer is undoubted, then the forfait facility could be provided without the need of a guarantee from another institution.
It is rumoured that a UK football club was able to obtain forfait finance for the transfer of a UK soccer star to Italy. The forfaiting house did not require a guarantee because the Italian club was probably more creditworthy than its bank.
Benefits of Forfaiting to the Exporter:
-
The facility is flexible. The documentation can be set up in a mater of hours and the forfait facility can cover the full amount of the contract price;
-
Forfaiting means fixed-rate, short/middle-term finance: features that seldom go together in credit agreements;
-
Finance is offered with no right of recourse against the exporter. There is no need for any contingent liability on the exporter’s balance sheet. Forfaiting does not affect any other facilities, e.g., overdrafts;
-
The exporter receives cash in full at the outset. This improves liquidity, avoids indebtedness to banks and most important – generates resources available for other investments;
-
All exchange risks, buyer risks, and country risks are removed;
-
Administration and collection problems are also eliminated;
-
Exporters can receive preliminary commitments by the Forfaiters to finance transactions at cost fixed in advance, and, by being able to submit both a commercial and a financial offer to the foreign buyer, exporters have indeed a strong competitive advantage over other manufacturers who cannot make similar offers.
Forfaiting is a highly specialised technique requiring experience people, and expertise in this field can only grow through years of constant practice. Moreover, it has a great potential as an investment tool, and, whilst particularly appreciated in the Transitional Economies and Emerging Markets, many exporters are still scarcely aware of the opportunities offered by this financing technique. The world’s economy would have much to gain from an improvement of export credit through a much wider use of forfaiting.
(Excerpt based on the book”Forfaiting: Specialised Investment Tool” – 1998- Edition, by John Fonseca-Robbins)
