Forfaiting

The term "a forfait" in French means, "relinquish a right". Here, it refers to the exporter relinquishing his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount, passing all risks and responsibilities for collecting the debt to the forfaiter.

Forfaiting is the term generally used to denote the purchase of obligations falling due at some future date, arising from deliveries of goods and services - mostly export transactions - without recourse to any previous holder of the obligation.

The forfaiter will deduct interest (discount) in advance for the whole period of credit and disburse the net proceeds immediately. The exporter thus virtually converts his credit-based sale into a cash transaction. His sole responsibilities are manufacturing and delivery of the goods, thus creating a valid payment obligation of the importer.

In forfeiting generally, the export receivables are guaranteed by the importer's bank. This allows the purchaser to buy the risk "without recourse" to the exporter, thus taking the transaction off the exporter's balance sheet. This can have important benefits in terms of its positive effects on the exporting company's key financial ratios.

Typically the importer's obligations are evidenced by accepted bills of exchange or promissory notes, and the bank adds its guarantee to the paper by way of a "per aval" endorsement. This process is known as avalisation. Equally the receivable may take the form of a term draft drawn under a documentary letter of credit.

Forfaiting is often applied where the exporter is selling capital goods, and having to offer periods of credit up to five years. The forfaiter will then quote a price being a discount rate to be applied to the paper, calculated on the underlying cost of funds (LIBOR) plus a margin.

It is usually possible to have a fixed price quoted for a shipment taking place up to six months forward, and the exporter is thus able to lock into his profit from the outset.

Historical Development of Forfaiting

The origins of the forfaiting market lie in changes in the world economic structure during the early sixties, when trade between Western and Eastern Europe was re-established. The growing importance of trade with developing countries in Africa, Asia and Latin America boosted the forfaiting market to an international level.

Advantages of Forfaiting

1. 100 % Risk Cover

Country Risk (Political & Transfer Risk), could be absorbed without recourse or residual liability.

Currency Risk
Floating exchange rates can have the effect of changing the contract value by a considerable amount when converted into the exporter’s own currency, and can lead to a loss for the eventual holder of the claim.

Commercial Risk
Inability or unwillingness of the obligor or guarantor to fulfil its obligations on due date.

Interest Rate Risk
All forfaiting cost (discount, days of grace, commission) are binding and remain unchanged during the whole financing period.

2. Instant Cash

You could generate instant cash which relieves your balance sheet and improves your liquidity. Your credit sale is transformed into a cash sale.

3. Flexibility and Simplicity

Simple documentation is generally achieved even for tailor-made financing solutions.

Complete credit administration and collection including relevant costs will be handled by the forfaiter.

How to Apply

The following is how forfaiting would normally apply :

1. The forfaiter gives commitment to purchase the export deal.
2. Both exporter and buyer of sign a commercial contract.
3. The product is delivered.
4. Bank gives guarantee to the buyer/importer.

5. Buyer hands over documents to the exporter.
6. Exporter delivers documents (or notes, etc.) to forfaiter.
7. Forfaiter discounts documents and pays exporter.
8. Forfaiter presents documents to the buyer's bank for payment at maturity.
9. Importer/buyer re-pays bank at maturity.

Forfaiting vs. Factoring

The terms factoring and forfaiting have been mixed up frequently. Factoring is suitable for financing several and different smaller claims for consumer goods with credit terms between 90 and 180 days, whereas forfaiting is used to finance capital goods exports with credit terms between a few months and seven years.

Factoring only covers the commercial risk, whereas forfaiting additionally covers the political and transfer risk.

An Overview of Factoring and Forfaiting
	Factoring	Forfaiting
Regional orientation	Monstly domestic in OECD countries. Relatively weak, but growing possibilities to do factoring in/for trade with developing countries.	Mostly international. As the transactions are based mostly on bank guarantees, ability to do business in relative wide spread of countries.
Products covered	Monstly consumer goods, and services	For a large part, equipment (often in large projects) and commodities
Size of market	Domestic factoring: 499 billion US$ International factoring: 31 billion US$ (1998)	Consolidated figures not available; somewhat larger than international factoring
Tendor	Mostly 30-180 days, for contracts which foresee a single payment.	Mostly 1-7 years, for contracts which specify payment in installments
Size of contracts covered	Mostly 2,000 to 100,000 US$ Average contract size in international factoring: US$ 29,000	Minimum deal size: US$ 100,000, with individual maturities > US$ 25,000. Mostly 500,000 to 20 million US$
Timing compared to the contract	Factoring normally follows already established contracts or contractual relations	The contract is often negotiated on the basis of prior commitments from a forfaiting company
Contract selection	Factors will usually want access to a large percentage of a seller's business receivables	Most deals are on a one-contract basis
Secondary market	Very small, as most operations are evidenced only by invoices.	Large, as the receivables are normally avalized and thus negotiable

Documentation

Documentation is usually simple and straight forward. The following will apply to a claim evidenced by drafts:

1. Promissory Notes / Bills of Exchange in international format avalized by a bank
2. Conformed copy of underlying L/C including all amendments (if any)
3. Conformed copy of commercial invoice and shipping documents (Bill of Lading)
4. Confirmation of the authenticity and validity of all signatures appearing on the documentation

In case the claim will be evidenced by a letter of credit, the following will apply:

1. Conformed copy of underlying L/C including all amendments
2. Conformed copy of commercial invoice and shipping documents
3. Letter of assignment of proceeds in favour of the forfeiter
4. Notification of assignment to the L/C issuing and advising bank as well as their relevant acknowledgement
5. Confirmation by the L/C issuing and advising/confirming bank that they accept the forfaiter as the new beneficiary under the L/C and that they will pay at maturity directly to him.
6. Confirmation by the L/C issuing and advising/confirming that documents under the L/C have been taken up without any reserve
7. Confirmation of the authenticity and validity of all signatures appearing on the documentation

Important Requirements

Information Checklist

To be able to submit a firm offer the forfaiter needs the following information from the exporter:

• Currency, amount and financing period
• Country of risk
• Name and location of the guarantor
• Document (promissory note, bill of exchange etc.)
• Form of security (guarantee or aval)
• Tenor and repayment schedule (i.e. amounts and maturities)
• Exporting goods
• Delivery date of goods
• Delivery date of documents
• Necessary approvals and licences (import licence, transfer documents etc.)
• Domicile for payment of the debt
• Name of importer and exporter

Letter of Credit - (L/C) A document, issued by a bank pursuant to instructions of a buyer of goods, authorising the seller to draw a specified sum of money under specified terms, usually the receipt by the bank of certain documents within a given time. In effect, the bank substitutes its credit for that of its customer (the buyer).

Bill of Lading - A document that establishes the terms of a contract between a shipper and a transportation company under which freight is to be moved between specified points for a specified charge. Usually prepared by the shipper on forms issued by the carrier, it serves as a document of title, a contract of carriage, and a receipt for goods.