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Forfaiting

Jun 28, 2022Introduction to Trade

What is a forfaiter?

As an exporter, you may be looking for ways to reduce the risk of non-payment by your importer. One solution is to engage a forfaiter. A forfaiter is a party that facilitates a forfaiting transaction, and can either be an individual or a company. The forfaiter will hold, sell, or guarantee the payment obligations of the importer, in exchange for a margin. This can provide peace of mind and security for exporters, knowing that there is someone else responsible for ensuring payment is received. Forfaiting can be seen as analogous to using a central clearing counterparty on the OTC markets. If you’re interested in pursuing this option, there are several banks and financial institutions that act as forfaiters and can help facilitate your international trade transaction.

What is forfaiting?

For businesses that export goods, forfaiting can be a great way to improve cash flow. With forfaiting, businesses can sell their foreign receivables at a discount and get paid immediately, without having to wait until the payment date. This allows businesses to enter into long financing terms on their sales to foreign buyers. However, it is important to note that forfaiting comes with some risks, including the potential for higher fees. Forfaiting is primarily used by large and medium-sized institutions and government agencies to export capital commodities and goods worth US$ 100,000 or more in the US. In high-risk markets, forfaiting can be especially attractive due to the longer payment periods that are available. For businesses considering forfaiting, it is important to weigh the pros and cons carefully to ensure that it is the right decision for their needs.

Eligibility/Characteristics

If you’re looking to engage in forfaiting, there are a few key things you need to know. For one, you’ll need to be aware of the nationality and identity of the buyer. Additionally, it’s important to have a description of the products being sold, as well as an understanding of the value and currency of the contract. Finally, you should be familiar with the date and duration of the contract, including any interest rate agreed upon. By having this information on hand, you’ll be well on your way to a successful forfaiting transaction.

What causes forfaiting?

Forfaiting can occur for a variety of reasons, but typically it happens when an exporter needs immediate cash or wants to remove the risk of importing goods that might not meet quality standards. If you’re considering forfaiting, it’s important to understand how the process works and what implications it could have for your business.

Features of forfaiting

Forfaiting is a type of financing that is well suited for exports with high value, including capital goods for manufacturing, consumer durables for consumers, vehicles for transport, and even construction contracts for export. Forfaiting allows the exporter to receive the cash immediately after the goods are shipped and only upon submitting the required documents.

Some of the key benefits of Forfaiting include:

  • Forfait transactions are always done at a discount and on a non-recourse basis.
  • There is often a local bank guarantee that backs the importer’s payment obligation.
  • Forfait is ideal for items with a high price tag, such as manufacturing equipment, consumer durables, transportation goods, and building contracts for export.
  • The exporter usually receives the money straight after the items have been sent and simply upon submission of the required paperwork.

How does forfaiting work?

For those in the shipping industry, forfaiting can be a great way to finance transactions. Forfaiting is a process by which an exporter can get paid for a shipment before it is even made. In order to do this, the exporter must find a forfaiter who is willing to finance the transaction. The two parties then enter into an agreement, and the importer secures a guarantee from their local bank. Once the goods are shipped, the exporter submits the required documents to the forfaiter. The forfaiter then pays the agreed upon sum, and obtains control of the shipment documents.

At maturity, the forfaiter presents the documents to the importer’s bank, who collects payment from the importer. The payments are then routed back to the forfaiter.

Documents

Documents required for forfaiting are:

  • A letter of guarantee or aval
  • A copy of the commercial invoice with signature
  • A copy of the sales agreement or payment schedule
  • A letter of assignment and notification to the guarantor
  • A copy of shipping documents, such as receipts, railway bills, airway bills, and bills of lading

In countries that don’t recognize the validity of the aval, an importer may issue a guarantee in its place. It is included in a separate letter. As an alternative, a guarantor may agree to endorse a blank endorsement. There is also the possibility of using a standby LC.

Cost Elements

There are several kinds of costs associated with forfaiting. A fee is charged depending on the connection between the exporter and the investor, trade volume, and funding expense. There are generally three kinds of fees to consider during a forfaiting transaction.

Commitment fees

Commitment fees, for example, are paid by the exporter to the forfaiter in consideration of the agreements to execute specific transactions of forfaiting at certain discount rates and within the determined time frame. These fees are in the range of 0.5-1.5 % per annum, and must be paid regardless of whether the export contract is executed. But even with these costs, Forfaiting is still a great solution for financing your exports.

Discount fees

Discount fees are the cost of credit obtained through a forfaiting agreement. A discount rate is set using the London Interbank Offered Rate (LIBOR) for the time being under consideration. Exporters are compensated almost immediately, but forfaiters must wait until maturity to receive payment from importers. Forfaiters may see their profits wiped out by adverse movements in the foreign currency market. As a result, during the interim period, any possible losses/gains incurred as a consequence of changes in exchange rates are reflected.

Documentation fees

When the legal formalities and documentation involved in a deal are minor, document fees are typically not levied. They are generally charged to cover the expense of legal processes and paperwork in big deals.

Types of Forfaiting

A forfaiter can acquire and convert a variety of financial agreements into debt instruments, including the following:

Promissory notes

Promissory notes are promises made by importers to exporters in the form of money.

Bills of exchange

A bill of exchange is a written order from an importer to an exporter requiring the latter to pay a specified sum. In other words, it’s like a promissory note and is meant to enforce payment.

Account receivables

The total amount of accounts receivable on the balance sheet is greater than zero, as they represent money that has not yet been paid.

Letters of credit

A bank and a guarantee institution issue an LC stating that the debt will be paid even if the importer defaults.

Advantages of forfaiting

If you’re looking for a way to receive payment for your exports without having to worry about the non-payment risk, forfaiting may be the right solution for you. Forfaiting protects exporters by providing them with immediate cash while eliminating the cost of collection. This process can also simplify transactions by converting credit sales into cash sales. Forfaiters have the flexibility to customize offers to meet the needs of capital goods sellers, making it a versatile solution for a variety of international transactions.

Disadvantages of forfaiting

Although Forfaiting reduces the risk for exporters, it also results in a higher export cost. Forfaiting is only permissible on transactions more significant than a definite sum. As the importer is typically responsible for the higher export cost factored into the standard pricing, Forfaiting may not be the best option for everyone.

FAQs

Does forfeiting require an LC?

The answer is yes, Forfaiting does require an LC. This is because Forfaiting is done on a non-recourse basis, and bills of exchange, promissory notes, or a standby LC act.

Who bears the cost of forfaiting?

The exporter is responsible for forfait costs, and they are deducted from the money received by the exporter.

Which parties are involved in forfaiting?

The exporter, importer, and forfaiter are the three parties involved in the forfaiting process.

Conclusion

Forfaiting is a great solution for financing your exports, but it is important to understand the costs involved. Be sure to talk to a Forfaiter about how to customize an offer to meet your needs. Forfaiting can simplify transactions and protect exporters by providing them with immediate cash.

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