SCF and Forfaiting Possibilities
Forfaiting is enjoying a renaissance, after years of being perceived as one of the most traditional disciplines of banking. Since the introduction of more restrictive credit policies, following the Basel II and III regulations, banks and corporates are rediscovering the beauty of forfaiting as a flexible and relatively safe method of providing financing/liquidity .
While plain vanilla lending is increasingly associated with bureaucratic procedures and additional limitations, forfaiting can still enjoy a fairly simple execution. Even more interesting are the recent evolutions in global transaction banking products, where the basic principles of forfaiting are combined with the most modern technologies to come up with more appealing financing solutions for corporate clients.
One of these product trends positions forfaiting as a core component of a bigger product family defined as supply chain finance (SCF). The latter represents the banks’ attempt to embrace the full spectrum of working capital financing along with procurement, production and distribution chain of global corporates. Thanks to the increasing digitalisation of the companies’ business operations and the use of secured internet connections for data transmission, financial institutions are able to synchronise the financing of single commercial transactions with the real-life events taking place in the physical supply chain.
Based on real-time information, a bank can decide to finance a purchase order, a shipment on-transit, or a receivable. As soon as the invoice is used as trigger point for financing, however, forfaiters are required to perfect the transaction. In the grand scheme of things, in fact, achieving valid assignment of receivables remains the single most important aspect of SCF – regardless of the technology used to facilitate the process. The assumption of the buyer’s default risk, the protection from double assignments and the calculation of a fair present value of the receivables to be discounted, as well as the application of proper anti-money laundering (AML) and know your customer (KYC) procedures, are fundamental to forfaiting.
Technological advancements give these competencies a much broader scope, enabling the bank to apply the basics of forfaiting to corporates’ large-scale business processes. The very nature of internet-based systems make it possible for the bank to exchange high volumes of data accurately with many counterparts, which in turn translates into the ability to process hundreds, if not thousands, of financing transactions per day. The efficient interaction with buyers and sellers proves useful in disclosed transactions, since the bank can easily request electronic confirmations and thus mitigate or remove the dilution risk.
Even better, intelligent SCF systems can monitor the history of a transaction and trace back the origin of a receivable to the initial purchase order, keeping a clean and auditable track record for each financed item. This processing power was exactly what the forfaiters were waiting for, in order to multiply their business potential. Thanks to SCF, forfaiting is no longer a bespoke form of financing suitable only for big-ticket receivables, typically long-term and cross-border. Instead, it has become the final step of a mostly automated process, at the end of which the financial institution has collected all relevant business data and can book the purchase of one or more receivables with the click of a mouse.
This product development opens up new business scenarios for banks willing to modernise their forfaiting franchise. Here, the mass of domestic, recurrent, short-term receivables are now the possible target of a financing offer. In metaphoric terms, it is a bit like having an entire iceberg come to the surface after having worked for decades on the tip of it.
Four key characteristics determine whether a bank is ready to upgrade its forfaiting structures to the next generation of SCF: technology, legal documentation, delivery structure and the enhancement of credit capacity.
Web-based information technologies represent an important enabler of SCF. Real-time exchange of transactional data, seamless integration with credit risk and payment systems, as well as transparent financial reporting, are more than just ‘nice to have’ in the current market environment. Smaller companies in particular find it useful to be able to view their invoices online, understand the financing proposals advanced by the bank and then trigger a discounted payment in an ad hoc manner.
The set of legal agreements used to regulate the relationship between the buyer, bank and supplier play a fundamental part in SCF. Developing and fine-tuning a lean legal documentation package is important in the European market, which is characterised by diverse legal regimes.
Although the agreements cover a wide range of complex issues, some of which deal with the true sale of receivables and have implications for corporate auditing and accounting, the documentation could be kept concise and well-structured. The evidence of the quality and accessibility of such documentation was the recent break-through in the small and medium-sized enterprise (SME) segment in Germany, whereby small corporates started to join UniCredit’s SCF programmes.
Regardless of how standardised a bank attempts to make its processes, there are several SCF issues that demand a deep local market expertise. A variety of topics must be mastered, such as the regulatory framework for valid assignments of receivables, the need to provide service support to corporate users in the local language, the access to local payment clearing systems, and the application of the AML and KYC procedures. This is where a bank can leverage the capacity of its large European network to assist clients on the ground and execute deals in multiple countries.
Since it is in effect an automated form of forfaiting, SCF uses credit lines just as much as any other traditional lending activity. As sellers start to appreciate the advantages of the product, volumes can increase rapidly and credit facilities may reach levels that a single bank cannot hold in its books. The regular, short-term, self-liquidating and well-documented character of the assets handled by SCF are attracting new investors: insurers, hedge funds and other financial institutions that do not normally engage directly in lending activities. These external partners can be incorporated into SCF processes for additional sources of credit for the bank’s corporate clients.
To read more from UniCredit, please visit the bank’s gtnews microsite.