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Forfaiting

The term ‘forfaiting’ is derived from the French phrase ‘à forfait’, meaning to relinquish the right to something. Forfaiting is a trade finance technique most commonly used in high value, medium term international trade transactions. Unlike some other receivables financing techniques, which are used to raise finance based on outstanding invoices, forfaiting raises finance against instruments such as letters of credit and bills of exchange. The instruments are sold to the forfaiter at a discount and the forfaiter takes on the responsibility of obtaining payment from the importer.

Uses

Forfaiting was first developed by Swiss financiers in the 1950s. The process has primarily found popularity throughout Europe, though it remains relatively uncommon in the US. Suppliers use the method to obtain payment for fulfilled orders earlier than they would otherwise receive it from the customer. Essentially, forfaiting enables exporters to receive funds immediately without the need for importers to pay earlier.

The value of forfaited instruments is usually at least €80,000. Forfaiting is generally used to finance medium term receivables, with a maturity of between 180 days and seven years.

A forfaiting transaction is also usually carried out ‘without recourse’, meaning that should the importer fail to pay the forfaiter, the exporter will not be held liable. Risk of non-payment is therefore transferred from the exporter to the forfaiter; however, the importer will often be required to provide an aval (or guarantee) from a bank in their country to support its obligation.

As an alternative to a bank guarantee, some forfaiting arrangements are now backed by credit insurance. However, in the event of non-payment, a credit insurer will not repay the defaulted sum in its entirety.

The forfaiting process

The parties involved in the forfaiting process are the exporter, importer, forfaiter and the guaranteeing bank. The process works as follows:

  1. Exporter and forfaiter agree terms.

  2. Exporter and importer enter into contract.

  3. Exporter ships goods to importer.

  4. Importer presents notes to bank for avalisation.

  5. Bank sends avalised notes to exporter.

  6. Exporter sends notes to forfaiter.

  7. Forfaiter pays exporter.

  8. Forfaiter presents instruments to guaranteeing bank on due date.

  9. Importer pays guaranteeing bank.

  10. Forfaiter collects payments from guaranteeing bank.

Benefits and disadvantages

Forfaiting is associated with several advantages, particularly for the exporter. For instance, finance is provided without recourse; the exporter can offer extended payment terms to the importer without compromising its own liquidity; payment risks are eliminated; and, unlike some other receivable financing options, the exporter receives 100% of the value of the goods provided. Meanwhile, the forfaiter may sell the instruments on to another investor or keep them until maturity.

However, the costs involved in establishing a forfaiting procedure can be expensive compared to other forms of bank finance. These costs may include a commitment fee and a charge for ‘days of grace’, which reflects the delay usually associated with collecting payment from the country in question. The major cost, however, is the discount rate, which is based on the cost of funds to the forfaiter and the risks associated with the transaction (eg interest rate risk and country risk).

Meanwhile, the importer will be required to pay a fee to obtain the bank guarantee.