Forfaiting is a simple – yet broad – trade financing instrument; basically the non-recourse discounting of export receivables. Participants in a typical transaction are the forfaiter, exporter, importer and the guaranteeing (or avalising) bank. Unlike factoring, which is used for a series of small deals, forfaiting is for one-off, stand-alone deals whose ticket size can range from US$100,000 to millions of dollars.
The forfaiting process is simple enough. In return for immediate payment for its invoiced export order, the exporter forfeits (gives up) or assigns – without recourse – the right to collect the debt to a forfeiter, which might be a bank or a specialised forfaiting agency.
The right to collect the debt or claim may be evidenced by documents such as promissory notes, bill of exchange, receivables, trade acceptances or deferred payments under letters of credit (LCs). The forfaiter, more often than not, requires the assignment or right to collect to be guaranteed (or ‘avalised’) by the buyer’s bank. The forfaiter can retain the claim until payment is due, or sell it in the secondary markets. The right to collect may, accordingly, take a transferable, tradable life of its own
Typical revenue streams from forfaiting are the discount rate – typically the London Interbank Offered Rate (LIBOR) plus a margin, commitment fees and documentation plus handling fees
The benefits for the exporter of forfaiting include mitigation of political, transfer and credit risk, receiving cash upfront for the full value of contract and the opening up of new markets; while the ability to offer finance to their client makes their product attractive and competitive. Further advantages include outsourcing administration of the sales ledger and off-balance sheet treatment, while minimal documentation and accompanying simplicity also makes forfaiting attractive.
The Uniform Rules for Forfaiting (URF 800)
Introduced at the start of 2013, the URF consists of 14 articles, which cover definitions, agreements, documents, the primary and secondary forfaiting market, confirmations, payments and the liabilities of parties
In addition to the primary market, publication of URF is seen as rejuvenating the secondary market for forfeiting; thus forfaiting confirmation is explained as “the secondary market document signed or to be signed by the seller and buyer setting out the secondary sale terms”.
A further rule applicable to forfaiting confirmation in the secondary market: if the buyer on receiving the confirmation disagrees with its terms they should, within two business days of receipt, notify the seller on the point(s) of disagreement. Should the seller fail to then provide a revised forfaiting confirmation – again within two days – the forfaiting transaction cannot proceed.
Other key articles of URF 800 may be briefly summarised as follows:
- The URF becomes applicable to a forfaiting transaction by incorporation (article 1).
- Article 2 defines forfaiting as “the sale by the seller and purchase by the buyer of the payment claim on a without recourse basis on the terms of these Rules’. The buyer “means the party purchasing the payment claim” (i.e. the forfaiter) and the seller “means the party selling the payment claim” (typically the exporter).
- There is provision for payment to be made under reserve (article 12), in which case “points of reserve” are the obligations of the seller that should be complied with “for the payment to become final” and these should be met by the “reserve date”.
- A “primary forfaiter” is defined as “the party that first purchased the payment claim from the initial seller”.
- To remove ambiguity, timelines are prescribed for various scenarios. If the “availability date” – the date by which seller must deliver documents – is vaguely defined, then it is deemed to be within 10 days of the trade date.
- The settlement date, for payment of the purchase price, is fixed at three business days once the buyer has determined that the documents received are satisfactory.
- There is a prescribed period of five days, during which time the seller can require the buyer to complete a review of the documents submitted. Failure to comply with this time limit means the buyer is “precluded from claiming that the documents delivered are not satisfactory documents”.
- Payment of the purchase price is deemed to be notice that satisfactory documents have been received by the buyer from the seller.
- On receipt of payment the buyer must, within five business days, “return to the seller all documents received from the seller” and “take all actions and sign all documents to ensure that the rights to the payment claim and documents are re-transferred to the seller”.
- Article 13 deals with liabilities of the parties involved in forfaiting. URF assumes that each party has the authority to execute and perform their respective obligations, including assigning claims to receive payment. If not, then that party is liable to the other party.
Full disclosure of the facts and circumstances relating to the trade is expected of all participants. URF does not deal with the validity and enforceability of any payment claim and forfaiting transfers are subject to them.
With URF now applying to forfaiting transactions for nearly two years, it has provided a fillip to this burgeoning supply chain-supporting trade finance instrument; deepening the market for tradability of payment claims aiding price discovery.