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PROJECT REPORT

ON

FORFAITING :-

AN ALTERNATIVE IN EXPORT FINANCE

 

 

 

 

 

 

 

Submitted by :- AMUL M. SHAH

(P.G. D.B. A.)

1995-1997

 

  

Guided by :- Mr M.D.Bhonsle.

VICE PRESIDENT

INTERNATIONAL BANKING DIVISION

Lloyds Finance Limited

 

 

 

I N S T I T U T E F O R T E C H N O L O G Y A N D M A N A G E M E N T

N E R U L , N E W B O M B A Y.

 

 

 

ACKNOWLEDGEMENT

 

 

 I would like to take this oppurtunity for thanking Mr. M.D.Bhonsle, Vice president, International Banking Division, Lloyds Finance Limited. He not only gave me an oppurtunity to work on this project but also guided me for the project.

I would also like to thank Mr. Pushkaraj Gumaste, Mr.Rajesh Nagpal and Miss Archana for their kind heip and co-operation.

I would also like to thank all those who spent their valuable time and helped me in completing my project Successfully..

 

 

 

 

REFERENCES

  

1) Forfaiting :- Credit Suisse Special Publications

Vol 47 II

2) Forfaiting :- An Alternative approach to Export

trade finance By IAN GUILD

& RHODRI HARRIS.

3) Forfaiting :- A New option for Indian Exporters

by EXIM Bank of India.

 

4) All the articles in News-papers and Magazines relating to Forfaiting

 

  

INDEX

1) Introduction : What is Forfaiting ?

2) A Brief History about Forfaiting

3) Characteristic of Forfaiting.

4) Modus Operandi of Forfaiting

a) Flow Chart

5) General Aspects of Forfaiting

6) Technical Aspects of Forfaiting

7) Managing Of Risks to Exporters,Impoters,Guarantor & Forfaiter

8) Forfaiting as an Investment

9) Comparison between Forfaiting & Export Bill Discounting

10) Types Of Contracts Covered

11) Limitations Of Forfaiting

12) Why is Forfaiting not picking up in India ?

13) Difficulties faced by Exporters in the existing Network

14) Findings Of the Survey

15) Conclusion.

16) List of People Interviewed.

17) References

18) Annexures

a) Offer or Commitment Letter

b) Bill Of Exchange

c) Promissory Note

d) Letter Of Guarantee

e) Questionnaire.

 

 

  

QUESTIONNAIRE

 

1) What is the Export turnover of your

Company?

2) Which are the countries where you Export?

3) What proportion of your total export

turnover is on credit terms ?

4) What are generally the credit terms?

5) Are your exports backed by L/C ?

Give breakup : L/C

NON L/C

6) What is your experience of payments of

bills on due date ?

7) What proportion of your credit sales are

Bad-debts? How do you provide for this?

8) What are the problems faced by your

Company with respect to a) collection of

debts.

9) Do you think an outside agency could be of

help to you in regard to your problem of

collection of debts?

10) At present, how do you finance your credit

sales? what is the cost incurred for such

finance?

11) Would your exports turnover increase if

credit limit is extended beyond 180 days ?

by how much percentage.

12) Do you know about "Forfaiting" Services

 

INTRODUCTION

WAITING for payment against export bills for a long time more particularly becausethe financial and political risks often creates worrying situation in export Business. Exporters who sell on deferred beyond 180 days have to ultimately depend on the creditwothiness of the buyer during the span of maturity of bills Against this backdrop, in the competitive environment exporter is always on the look-out for simplicity of Documentation, fixed rate finance, hassle-free credit administration,collection, early liquidity and cash flow

In the current economic situation, no option which can help supplement the country’s abysmally Iow forex resources is to be ruled out of hand. forex receivable are as much an asset as gold except sale of gold is resorted to only in extreme cases. any effort to realise foreign receivable and also to ensure that future exports do not entail any credit is imperative due to established trade practice or to enhance the acceptability of the Indian goods ,a mechanism to hasten the realisation of such credit would be worth exploring. forfaiting offers such a mechanism in the case of export of capital goods which are normally sold with a credit package. forfaiting defined as the purchase of a debt instrument ,with-recourse to any previous holder of the instrument, has gained significant currency in export trade finance in the recent past though its origin can be traced to the early sixties.

Use of forfaiting as an instrument of export finance has seen steep growth in the eighties. the forfaiting market grew by nearly 20% annually since 1982 and reached an estimated level of about us $18-20 billion or about half a percent of the total world trade in the late eighties, before the socialist countries in the East Europe took to the market related economic set up. growth in forfaiting business was attributed to the change in the thinking of government which finance trade through state owned export credit guarantee agencies.

WHAT IS FORFAITING

The word `forfait’ is derived from the French word `a forfait’ which means the ‘surrender of rights’.

Forfaiting is a mechanism of financing exports

Hence, forfaiting is non recourse discounting of export receivable. In a forfaiting transaction, the exporter surrenders without recourse to him, his rights to claim for payment of goods delivered to an importer, in return for an immediate cash payment from a forfaiter thus CONVERTING A CREDIT SALE INTO CASH SALE.

Originating with Zurich, forfaiting has now been established in other financial centers with the City of London occupying the place of pride. More forfaiting business is now conducted than anywhere else. his is not so much because London is the world’s leading financial centre but because of the fewer restrictions on operations and turnover, stampduty on negotiable instruments each time they are bought or sold.

Forfaiting : a little known method of international trade financing

Forfaiting is a method of export financing that is uniquely suited to small to medium -size firms that donot export because of their unfamiliarity with-and the risks associated with -international trade. sometimes called non-recourse financing, forfaiting reduces the exporter’s risk and could do much to raise Exports. The history of forfaiting discusses its advantages and disadvantages, and examines rates structures and the current market.

Forfaiting,or non re-course financing is a type of export financing that has existed since the 1950’s. Infact, the term comes from a French a forfait meaning "with recourse" despite forfaiting 30 years history, little information is available about the exact size of the market. One author has called forfaiting "the world’s least known capital market " this article examines forfaitng by first briefly analyzing its history and presenting the basic example. The advantage s and disadvantages are discussed along with an examination of rate structures and the current market. Finally, implications of this form of trade financing are discussed, based on selected examples of forfaiting.

 

  

HISTORY OF FORFAITING

Forfaiting originated in Switzerland in the 1950’s. The need for non recourse financing resulted from early east-west trade. Eastern nation wanted grain on credit while western exporter needed cash to minimize the risk. Switzerland by way of its neutrality and banking expertise, was able to bridge this gap .

Zurich houses purchased promissory notes from the exporter at a discounted price. The Swiss banking reputation for secrecy may explain why so little information is available about forfaiting. In addition, East European importers needed 3-5 year terms for capital goods imports and , West German exporter would not grant Dutch credit . The importing country risk was unexceptable to the western bank . Thus medium-term paper without recourse - a forfait business - developed.

In short, forfaiting is a form of financing similar to factoring and often used where high risk is inherent in the transaction. The technique is popular in East European and the subsidiaries of large Swiss,, German and Austrian banks are well known as forfait it houses. The main forfaiting centers originally were Switzerland, Germany and Austria. Recently, London has increased its forfaiting business so much so that a forfaiting convention was held in London in 1980. This was the first time when such a meeting was held outside of the aforementioned continental nations. Some American banks also engaged in forfaiting, through European branches. One example is the chasemanhattan branch in Vienna.

A hybrid form of financing

any amount from $1,00,000 to $50 million, with some deals resembling syndicated eurocurrency loans. Forfaiting may also resembles capital goods financing such a medium-term government export credits. Thus a forfait financing may take on many different forms of international financing .

Despite the forfaiting was evolved in German in the 1960s and introduced in India in the year 1992, the majority of exporters are still unaware of this product. In 1994, forfaiting was estimated to be between $75 - $ 110 billion about 2-3% of world trade by value. The major centers for forfaiting are London, Zurich, Frankfurt, Singapore and New York. The Indian exporters could try this product with buyers in South East Asia, West Asia and Latin America. Forfaiters may offer the service for African countries but the quotes could be very high due to perceived risk of forex payments.

The market

Because of the past prejudices against forfaiting-it used to be regarded as finance of last resort- major banks have been hesitant to enter the market. The past image of forfaiting and the absence of large banks have contributed to lack of knowledge about the practice. No one knows who the market makers are or the true size of the market, although volume is estimated to be 4$ billion.this is a small amount compared with the 50%to 60% of world trade paid in cash and the 30% covered by the state export programs.

Market share

west Germany has 40% of the primary forfait market, Switzerland 35%,and Austria 5%.the united kingdom has 10%but has a larger share of the secondary market . London forfeiteurs feel that their share of the primary market may be as much as 40%. This difference of opinion results from different definitions of what constitutes the primary market.

The average forfaiting operation is small compared with the size of other financing operations. tha average forfaited transactions ranges between $500,000 and 1$million.ocassionally,deals of 20$million are arranged. sometimes, there are larger bids, but these are usually attempts by firms to find the lowest cost form of financing. the absolute minimum deal is $100,000,which consists of a series of ten $10,000 notes.

Over time, the geographical composition of forfaiting has changed.originally,90%of the paper being forfaited came from eastern Europe. today, the market is divided in thirds among Latin America, eastern Europe, and north Africa-far east-southern Europe.

growth in the forfait market depends on the demand by less developed countries (ldc) for imports of capital goods and the expansion of the export subsidy programs. most of the growth in this market has come from the need to finance the exports of the capital goods to ldcs. forfaiting involves those transactions that are not covered by export subsidy programs. if these programs are not expanded, forfaiting should increase.

CHARACTERISTICS OF AN A FORFAIT TRANSACTION

Essential Prerequisites of an Forfaiting Transaction

It should be apperent that Forfaiting is a flexble tool in International finance. Essentially there are very few prerequisites of a transaction which can be Forfaited.

1) An Exporter will have agreed to extend credit to his customer for some period of between six months and en years, or longer.

2) The Exporter will have agreed to stage the payment of his receivables so that the bills of exchange or Promissory notes or other instruments evidencing the debt will typically be a series (for example, ten due six-monthly over five years)

3) Unless the Exporter is a Government agency or a multinational company, repayment of the debts will be avalised or guaranteed unconditionally and irrevocably by a bank or state intitution acceptable to the forfaiter.

Advantages to the exporter

  1. A forfait finance is fixed-rate finance.
  2. Finance is provided by the forfaiter without recourse to the exporter.
  3. The exporter receives cash immediately be delivers the goods or provides the services. This results in business liquidity, reducing bank borrowing or freeing financial resources for investment or other purposes.
  4. The exporter need spend no time or money in administering or collecting his debts.
  5. The forfaiter, not the exporter, bears the risks of currency and interest-rate movements and the credit risks associated sovereign default and the failure of the guarantor.
  6. A forfait finance is negotiable for each of the exporter’s trade transactions: he does not need to commit all of his business or any significant part of it.
  7. The exporter can ascertain very quickly whether a forfaiter is prepared to extend finance for any given transaction. In fact, provided that the guarantor is acceptable to the forfaiter, the financial terms of the finance can be agreed within hours.
  8. Because the finance is generally provided against such straightforward debt instruments as bills of exchange and promissory notes, all documentation is simple and can be quickly compiled.
  9. a forfait transactions are confidential, unlike, for example, commercial loans where ‘tombstone’ advertisements are commonplace.
  10. The exporter can obtain an advance option to finance at a fixed rate from the forfaiter. He can therefore build financing costs into his contract price and quote figure including the CIF cost of his goods, the costs of the credit and, if necessary, the costs of any foreign exchange cover he needs to take to swap into his own currency the currency he agrees to charge the importer.

Disadvantages to the exporter

  1. As considered further in Chapter 4, the exporter has a responsibility to ensure that the debt instruments are validly prepared an guaranteed so that there can be no recourse to him in the event of default by the guarantor. He should be conversant, therefore, with the regulations of the importing country as to the form of bills of exchange or promissory notes and guarantees or avals. In practice, however, the responsibility in this respect is generally assumed by the forfaiter.
  2. The exporter may have difficulty in ensuring that the importer can obtain a guarantor satisfactory to the forfaiter.
  3. Because he is accepting all the risks, the forfaiter will expect a higher margin than normally sought by a commercial lender on similar business. This must not, however, be exaggerated, as compensation between the various forms of trade finance and between forfaiters keeps the disparity down. In addition, the exporter does not have the cost of the insurance cover, for example via the

Export Credits Guarantee Department, which he will otherwise take out as security for extending credit himself.

Advantages to the importer

  1. Documentation of the transaction is simple and quickly compiled.
  2. The importer obtains fixed-rate extend credit.
  3. Borrowing to pay immediately for his purchase will use up his credit lines: although the bank guarantee he takes will also count against his available credit, it will generally do so to a lesser degree.

Disadvantages to the importer

  1. As noted above, the bank aval or guarantee he will usually need will probably count to some degree against his credit lines.
  2. The importer will have to pay a guarantee fee.
  3. The legal position of bills of exchange and promissory notes which a forfaiter will accept is clear: they are ‘abstract’ documents giving an absolute obligation to pay. Therefore, any dispute concerning the goods purchased is irrelevant to the payment for them. Payment cannot legally be withheld, so that the importer, in the event of such a dispute, will need to seek recompense from the exporter.
  4. To mitigate his exposure in this respect, however, an importer will sometimes impose conditions upon the payment of a small proportion of the contract value and this proportion will not be forfaited.

  5. The higher margins sought by forfaiters are a disadvantage to the importer as well as the exporter.

 

Advantages to the forfaiter

  1. Again, documentation is simple and quickly compiled: there are no 30-page loan agreements as in commercial lending.
  2. The assets purchased are easily transferable as to title so that trading them in the secondary market is possible.
  3. Although the higher margins associated with a forfait finance are a disadvantage to the exporter and importer, they are naturally attractive to the forfaiter.

Disadvantages to the forfaiter

  1. The forfaiter has no recourse to anyone else in the event of a default in repayment.
  2. As is the case for the exporter, the forfaiter must know the laws and regulations governing the validity of bills of exchange, promissory notes, guarantees or avals in the various countries with whom his exporter clients will be conducting business. Chapter to considers the legal position of the forfaiter who fails to obtain valid bills or notes validly guaranteed or avalised.
  3. The forfaiter also bears the responsibility of checking the creditworthiness of the guarantor.
  4. The forfaiter cannot accelerate payment of bills or notes which have yet to mature merely because a bill or note of the series which has matured has not been paid. Such acceleration clauses are a standard feature of ordinary commercial loan agreements, but the legal position of bills and notes virtually precludes similar treatment for them.
  5. The forfaiter bears all funding and interest-rate risks exist during the opinion and commitment periods as well as during the periods to maturity of the bills or notes. This is far more significant an exposure than is the case in commercial lending because most commercial lending today bears a variable interest rate.

Disadvantages 2 and 3 above for the forfaiter are not of course, exclusive to him. Any financer needs to check the credit-worthiness and bona fides of his debtor and to ensure that all

documentation surrounding the transaction to which he has committed himself is satisfactory. These are listed as particular disadvantages to the forfaiter, however, because there are no hefty loan agreeements prepared by lawyers or additional security which he can fall back on. While simple, quickly compiled documentation is therefore, an advantage in most respects, it does leave a greater onus on the forfaiter.

It must also be appreciated that the forfaiter bears sovereign, political and transfer risks and the risks of currency fluctuations, too. These are not listed as disadvantages of forfaiting, however, because any international lenders has these risks.

Advantages to the guarantor

1. A guarantor has as great an interest in simple documentation as any of the other parties to the transaction.

2. The guarantor earns a fee for his services.

Disadvantage to the guarantor

There is only one disadvantage of a forfait finance, but it is important. The guarantor has an absolute obligation to pay a bill or note that the he has guaranteed and, as is the case with the importer, no contract dispute surrounding the goods or services provided can absolve him from this or, indeed , delay his payment. In just the same way, however, he is absolutely entitled to reimbursement from the importer whose name also appears on the bill or note as an obligor and who, therefore, has the real exposure.

Forfaiting as an additional form of finance

It has often been assumed by those outside the a forfait market that one of the advantages of forfaiting to exporters and importers is its ‘last resort’ characteristic. In other words, a forfait finance can be regarded as additional to other forms of finance because albeit for a greater cost, it can be obtained for those risks, particularly country risks, for which no other source of credit can be found.

This assumption is largely erroneous. In general, a forfaiter will be as chary of lending on poor risks as any prudent financier. In so far as it retains a grain of truth , this is only because the international nature of the secondary a forfait market and syndication within the primary market may, in some cases, permit greater opportunities to ‘lay off’ risk and provide greater ‘placing power’ than is true of, for example, state-guaranteed insurance schemes.

Comparison between forfaiting and other forms of trade finance

In producing a comparison between forfaiting and other forms of trade finance readily available today, it is necessary first of all to appreciate that an importer seeking medium-term credit or an exporter requiring finance to provide medium-term credit for his customers will have comparatively few alternatives in mind. Assuming that his credit rating is satisfactory and that he enjoys good relations with an accommodating bank manager is likely to receive his proposal first. But his bank manager will usually suggest that his borrowing interest rate be fixed for only three or six months at a time with changes in the rate to reflect alterations in marker interest rates at the end of each period.Such variable-rate borrowing will be attractive to a borrower who is confident that interest rates will tend to fall over the period for which he needs the finance.

In recent times, interest rates have shown greater volatility than ever before and this applies not merely to those of less stable countries but even to those of traditionally safe nations such as United States, West Germany and Switzerland. In these circumstances, it is unusual to find a borrower sure enough about future rates of interest to accept happily variable interest rates on his borrowing and the attendant uncertainty has clearly been a constraining influence upon the willingness of traders to undertake costly expansion plans or to fund longer-term research and development projects.

Consequently of the advantages as enjoyed by a forfait finance from the point of view of the importer or the exporter, the most significant is likely to be the fixed interest rate it implies. Indeed, it is probably true to say that one of the reasons for the considerable increases in the use of leasing

and factoring in recent years is the fixed-rate nature of the finance they supply. A comparison of a forfait with other available financing methods must, therefore, concentrate on the limited alternatives for the borrower intent on fixing his interest rates though, in so far as some of these alternatives do not immediately turn debt into cash, even they cannot be regarded as directly competitive in the eyes of the exporter.

1) Commercial Borrowing

Although, as stated above, banks normally lend on a variable interest rate basis, the intrepid borrower may be able to arrange fixed-rate terms. However, the bank will extract a price in terms of the higher margin over base rates, LIBOR, etc., that it will require. In addition, the bank will probably demand security for the loan, perhaps in the form of a fixed or floating charge over the borrower’s assets.Apart from this, an exporter taking a loan will still have the risk of non-payment by his purchaser. This risk can be mitigated by insurance cover such as that provided by the Export Credits Guarantee Department, but the cover is unlikely to extend to 1005 of the debt and payment will, under the terms of the policy, be delayed for, probably, at least six months, and sometimes up to 18 months (usually until legal steps for repayment have failed), although repayment to the lending bank must still be made on the due date. Remember, too, that the insurance premiums are quite expensive and becoming more so as international lending becomes more risky indeed, cover has been withdrawn from a number of countries in the recent past.

as in the United Kingdom, where it is done via the Export Credits Guarantee Department, many countries operate ‘interest make-up’ schemes for specified importing countries whereby the exporter can borrow from his bank at an artificially low fixed rate, the difference between this rate and the market rate for the borrowing being paid by a Government agency. Such fixed-rate finance is normally attractive, but the exporter will still have to take out insurance cover and is still subject to the no-payment or late payment risks outlined above.

2) Leasing and hire purchase

These have proved very popular methods of obtaining fixed-rate finance in a number of countries, notably the United Kingdom and the United States, since 1970. However, they have significant limitations which mean that they cannot be regarded as directly competitive with a forfait finance for most transactions. Specifically, they are limited to the supply of capital goods, they involve complex documentation and, in order to obtain full benefit from leasing, the exporter must have taxable profits against which he can write off the cost of the assets. If his tax capacity is inadequate, the exporter may be able to arrange to sell the assets to a finance house who will enter into the leasing agreement with the importer in his stead, but any financier entering into a leasing or hire purchase agreement on behalf of the exporter will probably require the right of recourse to the exporter in the event of default by the importer.

3) Factoring

Factoring is another form of finance which has achieved popularity recently and it is undoubtedly true that higher borrowing costs and tightened cash flows arising from any downturn in trade in the future will emphasize this trend. Again, however, this is not truly competitive with forfaiting, principally because it is generally used for short-term receivable -90- to 180-day trade credit. In addition, factoring can normally be obtained for debts in relatively few currencies and always leaves a residual risk to the exporter as the factoring house will usually accept only about 80% of the debt and demand recourse to him in the event of default. Also, a factor generally expects to purchase all or a substantial proportion of the exporter’s debts acceptable to him. Finally, discounts in factoring tend to be high.

 

 

FORFAITING - MODUS OPERANDI

[The final export offer (price) is structured in such a manner that the amount receivable in foreign currency by the exporter, after payment of forfaiting, discount and other fees is equivalent to the price of the goods had the goods been sold on cash basis.]

The importer’s banker hand over shipping documents to the importer against his acceptance of bills of exchange and arranging signature of the aval thereon..

 

 

 

 

 

 

FLOW CHART

FORFAITING - CONVERSION OF CREDIT SALE INTO CASH SALE




 

 




 

 



 

 

 


 

 

FA - Forfaiting Agency

LFL - Lloyds Finance Ltd is the link between FA and the Exporter ABC.

ABC - Exporter

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

 


 

 

 

 






 

 


 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GENERAL ASPECTS OF FORFAITING

1) Repayments :

Normally, Repayment by periodic installments is a condition of credit. The creditor’s risk are reduced as a result of a decreased average life. Where the debt is in the form of promissory notes or bills of exchange, this is achieved through a series of bills with several maturities, usually at six month intervals, thus a suitable forfaiting package might include 10 promissory notes of equal amounts, with the first maturity of 6 months after shipment of goods and a final maturity of 5 years.

2) Currency:

The notes and bills are normally denominated in US dollars, German marks or Swiss francs although it is in principle possible to discount notes in any currency. Furthermore, since the cost of forfaiting is predominantly determined by the forfaiters funding costs, the risks involved with weak or unstable currencies would make such a forfaiting transaction extremely expensive. it is of course essential that payments be made in so called effective(i.e. fully transferable)currency. To ensure this, the notes or bills will always carry the effective clause whenever they are denominated in a currency which differs from that of the place of payment.

3) Discounting:

Discount takes place after the forfaiter has received the bills .i.e. the agreed discount is deducted from the nominal amount of the bills for the corresponding maturities.the exporter thus receives cash value for the bills concerned. from the exporter’s point of view, the transaction is now complete since he has received payment in full for the goods supplied and recourse to him is no longer possible in terms of his agreement with the forfaiter. only rarely are forfaiting transactions concluded at variable discount rates.

4) Unaffected Balance Sheet:

Another advantage of forfaiting is probably the reason , right or wrong . many, many small-and medium -size firms use this method. With forfaiting, the balance sheet is not affected by the riskiness of the transaction. Contingent liabilities that would have to be stated in an exporter’s financial statement and also, in forfaiting there are no export credit insurance costs. These costs can be substantial for medium-term credits. Evidence also exists that because of increased competition, rates are low, at least lower than in the past. In the early days, there were margins 5% to 6%. Currently , margins are comparable to the markets. The average discount rate may include a spread of 1,25% to 1.50%per annum above LIBOR.

5) Discount Rates :

There are two types of discount rates, straight and discount to yield. A straight discount is the nominal interest rate which will be charged on the day of discounting. Discount to yield includes the cost of funding and the yield margin required by the forfaiteur. Both rates are functions of the currency denomination of the note, country risk, and importer risk. The rate used is determined by the agreement between forfaiteur and forfaitiste.

In calculating the discount rate, the forfaiteur would want a rate that reflects the variation in interest rates and country risk during the commitment period time between the discounting of the rates and the date of maturity. The exporter, on the other hand, would like a fixed rate so it would know how profitable forfaiting would be.a mode located between these two extremes is the formula rate. this rate is either fixed or floating.

6) Formula Rate:

with a fixed formula rate, both parties agree on a straight discount rate. It consists of a fixed margin which reflects all the risks(country, obligor, etc.)and reduces the cost of funds risk and cost of funds to be specified on the day of forfaiting. For example, a deutsche mark note due six months after availability would have a fixed margin of 1.25% over the six months deutsche mark LIBOR rate on the day of forfaiting. This represents the cost of funds rate.

Under the floating rate, the exporter receives the total face value of the note less the discount calculated to the maturity of the first of a series of notes. after that time ,the exporter has to pay semiannual interest invoices which are calculated at the time of billing. Hence ,this method is seldom used

TYPE OF INSTRUMENT

Promissory Note / Bill Of Exchange

The great majority of forfaitable obligations take the form of either promissory notes issued by the obligor in favour of the beneficiary, or bills of exchange drawn on the obligor by the beneficiary and the accepted by the obligor. the reasons for the predominance of these forms of debt instrument lie, for the most part in two, considerations. the first is a matter of familiarity, these two types of obligations have been in use throughout the world probably since the middle ages. the second advantage is the internationally agreed legal frame work based upon the international convention for commercial bills established by the Geneva conference in 1930.

Book Receivable/Letter Of Credit:

Other credit instruments which may be forfaited are book receivable and deferred letter of credit obligations. These are much less common, since transactions tend to be very complex, requiring an intimate knowledge by all parties of the legal and business practices of the debtor country, both forms necessitate the setting out of all conditions in full. moreover all maturities are incorporated in a single document, made out in favour of the beneficiary and often not transferable without specific permission from the obligor. this restriction on negotiability can be coupled with numerous legal and procedural complications and generally serves to make debts and letter of credit obligations less sttractive, though not inoperable, forms of forfaiting paper.

Legal Significance Of "Without Recourse" Clause:

The endorser of a promissory note has the legal right to free himself of any liability through the without recourse clause in his endorsement. but with a bill of exchange, the creditor signs as maker of the bill and is therefore always legally liable, irrespective of what he may have written on the bill to the contrary. in practice this presents few problems since the drawer will normally be satisfied with a written undertaking by the forfaiter not to take proceedings against him in the event of non-payment, it nevertheless becomes essential that the exporter deals only with forfaiters of the highest reputation who may be replied upon to honor this agreement. it is for this reason that promissory notes are generally favored by exporters as payment instruments, since they permit an easier transfer of risk.

Forms Of Bank Security

Promissory notes or bills of exchange accepted for forfaiting will almost always be accompanied by bank security in the form of a guarantee or aval. the guarantor will normally be an internationally active bank known to the forfaiter, the bank being resident in the importer’s country and able to ascertain the importer’s creditworthiness firsthand. this security is important not only to lessen the risks carried by the forfaiter, but also to make possible the rediscounting of paper in secondary markets, if this proves necessary. guarantees and avals are essentially similar, both being in their simplest form a promise to pay to a certain sum on a given ate in the event of non-payment by the original obligor.

 

1) Guarantee

In the case of guarantee, the promise takes the form of a separate document signed by the guarantor setting out in full all conditions relating to the transaction. it is important that specific

mention is made not just of the total amount, but of each maturity date with its corresponding repayment, since the discount value is calculated directly from this. further-more the guarantee must be fully transferable. finally it is essential that the guarantee be abstract, i.e. completely divorced from the underlying transaction. the guarantee is dependent upon the performance of the exporter, but the forfaiter will normally insist upon clean, irrevocable and unconditional obligations of the guaranteeing bank or may choose to purchase the paper with out recourse to the exporter only when the guaranteeing bank declares the debt as unconditional after the underlying contract has been fulfilled.

2) Aval

An AVAL in international practice as an irrevocable and unconditional guarantee to pay on the due date, as if the guarantor had been the obligor. it is the most suitable form of security and the one which has found the most favour. the aval is written directly onto each promissory note or bill of exchange with the words per "AVAL" and the signature of the availing party (with the name of the original obligor in whose favour the AVAL has been given in the case of a bills of exchange). this simplicity and clarity, together with its inherent abstractness and transferability avoids many of the complications to be found with guarantees, and makes an AVAL the preferred form of security for forfaiting.it must be borne in mind, however, that in some countries the "AVAL" is not a legally recognized term.

 

 

 

 

 

TECHNICAL ASPECTS OF FORFAITING

Costs

The costs of forfaiting are grouped as follows:

Covering of commercial risks: It is the importer than the exporter who must meet the cost of obtaining the bank aval or bank guarantee. No costs, therefore, arise out of this for the exporter. Where the importer is unwilling to provide a guarantee, however, it can be to the exporter’s advantage to take such charges upon himself, thereby reducing the cost of finance.

Covering of political and transfer risks: the costs of covering risks are determined by market conditions; depending on the country they amount to between ½ and 4% p.a.

Charge for use of money and covering of interest rate risks: the cost of funds is based on the Euromarket rates. The price that the forfaiter will charge for covering currency and interest rate risks is reflected in the Euromarket cost covering forward over similar periods for the corresponding currency.

For management, administration and other expenses, the forfaiter takes about ½ % p.a. A rate sheet Published each months giving forfaiting costs by country.

Besides the costs for commercial and country risks, funding and management, further arrangements such as options, commitment periods and penalties can represent additional costs but are relevant where the forfaiting of receivable is to be carried out at a future date

Commitment Fee and Costs for the Commitment Period

Where the delivery of documents is to take place at a later time, commitment commission is calculated from the date of commitment by the forfaiter to discount date ¾ to ½ % p.a. pro rata on the amount to be financed. This is normally payable monthly in advance.

If the discount rate is to be fixed some time before discounting takes place, then attention must be paid not only to the Eurorate at the time of setting up the transaction, but also to the overall trend in interest rates. A discount rate quoted for a forfait transaction with a commitment period is therefore often higher than that quoted for immediately available paper.

Commitment fees and higher discount rates for transaction with commitment periods are justified by the forfaiter having to arrange, at the time of agreement, refinancing and covering of his currency and interest rate risks. He also needs to reserve part of his credit lines for future use.

The forfaiter’s commitment is normally evidenced by a letter setting out all details of the forfaiting transaction, including the form of obligation to be dicounted and all terms and conditions agreed. This commitment is binding and also commits the exporter to deliver the relevant paper to the forfaiter when it is received from the issuing or accepting party in good order.

Penalty and Option Fees

Sometimes one includes in a forfaiting agreement an escape clause to cover the possibility of non -delivery of the paper by the exporter, in terms of which either a penalty fee automatically becomes due or an option fee is paid at the outset of the commitment, enabling the exporter to choose between delivering the documents or not. The basis for a penalty or option fee is naturally similar the place of payment of the promissory notes or bills of exchange to that for the commitment fee and consists mainly of a charge to cover the forfaiter’s costs.

Therefore the cost involved in Forfaiting is as follows

The Government have permitted forfaiting arrangement subject to the condition that the total discounted proceeds that are receivable by the exporter are equal to the amount the exporter would have realised had the transaction been concluded on a cash sale basis.

In other words, all the costs involved in providing credit to the importer by fixing up an arrangement with a forfaiting agency is to be borne by the importer. The exporter thus needs to determine the value of the goods as if he is selling on cash basis and then load into it the cost of forfaiting.

A forfaiting transaction has typically four elements of costs, payable to the forfaiting agency.

[A] COMMITMENT FEE

A commitment fee is payable by the exporter to the forfaiter for the latter commitment to execute a specific forfaiting transaction at a firm discount rate within a specified time (normally not more than one year). The commitment fee ranges from 0.5% p.a. to 1.5% p.a. of the amount to be forfaited and is charged for the period between the date the commitment given by the forfaiter and the date, the discounting takes place or until the validity of the forfaiting contract, whichever is earlier.

The fee is payable at the time of signing the contract with the forfaiting agency regardless of whether or not the export contract is ultimately executed. To enable the exporter to remit these charges a certificate is provided by the forfaiting agency.

[B]. DISCOUNT FEE

Discount fee is the interest cost payable by the exporter for the entire period of credit involved and is deducted by the forfaiter from the amount paid to the exporter against the co-accepted promissory notes or bills of exchange.

The discount rate is based on

The rate is quoted as percentage points over LIBOR/FIBOR etc. It is fixed at the time of executing a forfaiting contract between the exporter and the forfaiting agency.

Here too, a certificate is provided to the exporter detailing the discount fee payable to the forfaiting agency to enable the Indian customs authorities to verify deductions towards forfaiting discounts declared by the exporter on the GR form and shipping bills.

[C] DOCUMENTATION FEE

Generally, no documentation fee is incurred in straight forward forfaiting transactions. However, if extensive documentation and legal work is necessary, a documentation fee may be charged.

[D] OTHER CHARGES

The service charges @ 0.25% are payable in Indian Rupees to the agency in India appointed by the forfaiter.

The service charges are payable to the agency for negotiating a deal on behalf of exporter with forfaiting agency. The agency would ensure troublefree working of the arrangement and receipt of agreed proceeds by the exporter in time.

[E] FORFAITING COST - WORKING

The aggregate indicative cost for bills covering export to Singapore based on current LIBOR works out to 7.1875% p.a. as under :-

Libor For 6 Months

5.7500 % P.A.

As On 22.06.96.

+ Discount Fee

0.5000% P.A.

Deducted From Bill Proceeds

+ Commitment Charges

0.5000% P.A.

Payable In Advance For Committed Period

+ Charges Payable To Exim Bank Of India

0.2500% P.A.

Payable In Rupees In India

+ Service Charges Payable To Agency Between Forfaiting Agency And Exporter.

 

0.2500% P.A.

Negotiable Could Be Reduced To 0.25% For Sizable Business

Total Cost

7.2500% P.A.

 

The Indian banks handle US dollars denominated export bills at the rate of 2% p.a. over ruling LIBOR, which works out to 7.6875% p.a. (based on LIBOR 5.6875% p.a. ). Hence the forfaiting is cheaper compared to bills discounted with Indian banks..

 

Important Requirements

Information-checklist

Before making a firm commitment, the forfaiter will require the following information.

- the currency, amount and period to be financed

- the exporting country

- the name and country of the importer

- the name and country of the guarantor

- the form of debt to be forfaited (e.g. promissory notes, bills of exchange etc.)

- the form of security (e.g. aval or guarantee)

- the repayment schedule (i.e. amounts and maturities of the bills)

- the nature of the goods to be exported

- the date of delivery of the goods

- the date of delivery of the documents

- the necessary authorisations and licences (e.g. import licences, transfer authorisation etc.)

It is of course often possible for a forfaiter to give a non-binding indication of his approximate rates before all the exact conditions of a particular transaction have been agreed upon.

Form of Bills of Exchange and Promissory Notes

Many forms of bills of exchange and promissory notes are issued worldwide but the Finanz AG group regards the examples on pp 18-19 as probably the most acceptable. They take into account the laws of the Anglo-Saxon countries as well as of the Continental Code Napoleon and the lessons of past experience.

The bill of exchange

the draft (the acceptance)

the promissory note

Der Wechsel:

die Tratte (das Akzept)

der Eigenwechsel

I’effet de commerce,

la traite

le billet a order

I’effet de change:

la lettre de change (I’acceptation)

 

la cambiale,

la tratta (I’accettazione)

il paghero

I’effeto commerciale:

 

 

el billete de omercio

la lettera de cambio (la aceptacion)

el pagare

Form of guarantee

Aval

In the case of an aval, all the necessary wording is written directly onto the note or bill:

on a promissory note, this should say:

and on a bill of exchange:

PERAVAL

PERAVAL for (name of drawee)

(name and signature of guarantor)

(name and signature of guarantor)

 

 

 

Checking the Documentation

One of the most difficult and delicate matters for the forfaiter is the precise checking of all documents passed to him. Once the documentation is delivered as agreed and various predetermined requirements (signatures, authorisations, permits imports licences, exchange control approvals, stamp duties etc.) have been fulfilled, then nothing more stands in the way of the payout. Any missing documentation must be immediately requested and any formal defects corrected. It is only with the utmost difficulty that such shortcomings can be rectified later.

Signature verification

When the forfaiter is unable to check the signatures on documents passed to him himself, as is often the case, he can only purchase the paper without recourse when the signatures have been clearly confirmed to him. It is therefore important for the exporter that the bank (usually his house bank), through which the whole documentation is passed, confirmation of signatures on the guaranteeing bank, the exporter runs the risk of having to wait for payment until the confirmation arrives.

Another solution would be an immediate payout made under the proviso that the validity of the signatures be confirmed.

Signature confirmation given by banks are as follows:

1. ‘We hereby confirm the authenticity of the signature of .......................and that the persons signing are authorised to commit the company’ (follows authorised signature of verifying institution).

2. ‘The signature of .......... compares favourably with the specimen on file (follows authorised signature of verifying institutions)

In the first case, the confirming party takes fully responsibility for validity whilst in the second case, which is more usual, the verification is without fully responsibility. The forfaiter must decide in this second case whether he wishes to obtain a binding confirmation from the guarantor.

In the case of documents with a non-binding signature confirmation(‘the signature compares favourably with the specimen on file’), the forfaiter should only pay out to trustworthy sellers of paper.

Alongside its chief function as a form of export finance in which the forfaiter takes over almost all the exporter’s risks, forfaiting also offers interesting possibilities as a medium-term investment. As a consequence of the relatively high risk, which can only be assumed by investors with a strong

capital base, returns are possible which can rarely be achieved by other forms of investment involving similar security, terms and currencies.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Managing A Forfait Transactions-Risks To Exporters,

Importers And Guarantors

The exporter’s risks

  1. An exporter who has sold an amount receivable to a forfaiter has virtually no outstanding risk arising from the transaction. His only risks may arise during the period between the acceptance of his tender or bid for the importer’s customer and the delivery of the goods or services, that is, during a period when he is committed to taking a forfait finance at an agreed discount rate even though the contract with the importer has yet to be completed. Any interest rate risk during this period should not, however, be overemphasised as it only represents an ‘opportunitiy’ risk.
  2. There is the risk, of course, that the importer will arbitrarily cancel the contract during the commitment period or that, for some other reason, the contract will not be completed. In this event, the exporter is obliged to recompense the forfaiter for any cost or loss he suffers. In practice, a forfaiter will generally look upon the problem sympathetically, if only because he wants to maintain his relationship with the exporter. In addition, it is probably fair to say that any question of compensation for the forfaiter is usually trivial compared with the problems which caused the cancellation in the first place and with any sum which the aggrieved party, importer or exporter, is seeking from the other as a consequence. Finally, there is no control which can be instituted by the exporter to protect himself against this risk.

  3. The one true risk that the exporter may run during the commitment period arises when the promissory notes or bills of exchange which he has agreed to sell are denominated in a currency other than his own reporting currency. He will have the risk that currency movements will be unfavourable to him.
  4. Controlling the exporter’s risks

  5. The exporter should maintain a list of his forfaiting commitments by currency so that he can monitor his exposure to currency parity movements and enter into forward currency contracts if appropriate. As in the case the importer and explained below, an exporter with large numbers of commitments exporting at different dates may need to list them by maturity tranche net of any forward currency contracts.

The importer’s risks

Once he is committed to pay a promissory note or bill of exchange, the importer is bound, as an obligator, to make payment at a specific time in the future. The amount involved and the currency in which it is denoted are fixed. He has no risk from fluctuating interest rates, since interest on his debt is already calculated and included in the value of the bill or note itself. Provided that the currency of the bill or note is the same as that in which his accounts are reported, usually his home currency, he has no risk from currency parity movements.

The only risk to the importer is the possibility that he will have insufficient funds available to effect repayment on the due dates. This risk can be minimized by careful monitoring of his cash and debt positions.

Controlling the importer’s risk

1.Currency risk

The importer should maintain an up-to-date list in each currency of outstanding debt commitments and obligations. Any hedging foreign currency transactions should be offset against the currency totals so that the true currency exposures is shown.

2. risk Repayment or liquidity

This is, in essence, the same as any other cash-flow risk that an importer or, indeed, any trader has. All business need to manage and monitor their cash flow. The only slight additional problem in the

case of a forfait finance is that debts are due in the future rather than immediately, so that there is a greater possibility that they will be overlooked.

3. The guarantor’s risks

In any a forfait transaction, the guarantor has a commitment to pay off the promissory notes or bills of exchange at their maturity dates and the right to demand simultaneous payments by the importer. It follows that he has contingent liability and a contingent asset. Provided that both are disposed of simultaneously, he has no risk. To the extent that the importer pays late, he will demand interest for late payment and will thus be unlikely to have a significant exposure to interest charges. However, he has an absolute risk of default by the importer and an absolute sovereign risk if the importer’s country is different from his own (though it is unusual for this to be the case). In the event of either late payment or non-payment, he has a liquidity risk in that he must be sure that he has adequate funds available to pay the bills or notes.

Controlling the guarantor’s risk

1. Risk of default by the importer

Any guarantor must have clear procedures set out in writing which must be followed, that levels of personnel who can approve limits of a particular size must also be specified, and that any breach of limits must be reported at an appropriate level very quickly.

2. Sovereign risk

Sovereign limits will be much larger and often subject to more frequent reconsideration than those for individual customers or particular industry.

3. Liquidity risk

Since most guarantors are major banks, this is seldom a matter for great concern. None the less, any guarantor will wish to maintain an up-to-date list of his contingent assets and liabilities with immediate exception reporting of any repayments that are overdue. Responsibility for reviewing

exception reports and taking appropriate action must be clearly established at an appropriate level of authority.

The forfaiter’s risks

From the moment he grants an option for a forfait finance to the moment the forfaited assets are repaid, the forfaiter is exposed to risk. The various stages giving rise to risk can be charted as followed.

1. Option period

During the option period, the forfaiter runs the risk that interest rates will move against him. Since the exporter is not committed to the transaction at this point, the forfaiter will hardly ever entered into any funding arrangements in respect of it. His exposure is thus absolute.

By the same token, the forfaiter has accepted the credit-worthiness of the guarantor as soon as he grants the option. He is exposed to risk in this respect and to sovereign risk until he is repaid or until the exporter refuses the option.

The only thing that changes, in terms of risk, between the option period and the commitment period is that the forfaiter can assume in the commitment period is that the forfaiter can assume in the commitment period that the a forfait transaction will take place. He can therefore commit himself to funding arrangements and, assuming he can obtain fixed-rate funding, thereby eliminate any interest-rate risk. The most significant reason for not matching funding too closely to the maturities of forfaited assets is the flexibility it enables the forfaiter to retain. If he sees an attractive opportunity to sell some of his assets on the secondary market. the forfaiter does not wish to be drawn into difficult and potentially expensive negotiations to free himself of any related funding.

2. Date of purchase

Until this date is reached, the forfaiter can always back out of the a forfait transaction if he finds irregularities in the asset he is buying or in its guarantee or, indeed, if he is dissatisfied as to the

completion of formalities in respect of the particular transaction, for example failure by the importer to obtain the permission of the relevant authorities for the commitment to transfer the relevant foreign currency at the maturity dates of the bills or notes forfaited.

3. Period during which paper is held

The one very obvious danger that the forfaiter faces while he has the asset is that he will fail to send maturing assets for collection. An oversight in this respect is seldom tragic but any delay in receiving repayment costs the forfaiter money. The other side of the coin is that the forfaiter needs to keep a careful watch on his borrowings to ensure that he has funds available to pay them when they become due, since, as stated earlier, he is unlikely to have matched the repayment of his borrowings to the maturity dates of his assets.

4. Date of maturity of the paper

The only additional risk at this point in the life of an a forfait transaction arises from its late payment because of tardiness or incompetence on the part of the guarantor or his paying agent. It is true that, if this happens, the forfaiter has grounds to make a claim for interest on the offending party, but it is also true that he may have great difficulty in actually obtaining the interest.

Controlling the forfaiter risks

The forfaiter needs to maintain up-to-date list by currency of all items in his portfolio and those for which he has extended an option or to which he is committed.

Because of his general tendency not to match borrowings specifically to the maturity of assets, a forfaiter may well have some assets, purchase at a time of relatively low interest rates, which are earning less than the prevailing cost of borrowing as a result of an increase in interest rates. Since a forfaiter in this position will position will probably be looking upon his portfolio as a pool of assets, this will not disturb him greatly, provided that, overall, his portfolio is profitable.

1. Guarantor credit risk

Just as the guarantor should have set credit limits for individual customers and industries, so the forfaiter should set credit limits for individual guarantors. The forfaiter should have clear procedures set out in writing for establishing these limits, levels of personnel who can approve limits of a particular size must be specified, and any breach of those limits must be reported at an appropriate level very quickly.

2. Risk of inadequate documentation

This risk can best be controlled by the use of a check-list covering such matters as evidence to support the genuineness and legality of the trade underlying the forfaiting transaction, checks which need to be made on the form and connect stipulated by the guarantor’s local law of any letter of guarantee or aval, and checks ascertaining local requirements which are needed to gain permission for the remittance of foreign currency.

3. Exporter and importer risk

A forfaiter will generally examine the competence, credibility and credit-worthiness of these parties to a forfaiting transaction only very superficially, since he will very seldom have need to revert to them because of a problem. To the extent that the exporter or importer is known to him from previous dealings, or from general reputation, any specific steps that he need take to check them out will be further reduced.

4. Currency risk

The forfaiter needs to maintain an up-to-date list by currency of all his forward currency contracts by maturity period.

5. Collection risk

The interest-rate risk report and the foreign currency contract list together provide the forfaiter with most of the cash-flow information he requires to minimize the risk of lack of liquidity.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PROBLEM OF INVESTMENT IN FORFAITING PAPER

The on-selling of forfaiting obligations is beset with problems which restrict the number of potential buyers. An important consideration in forfaiting is the degree of confidence that can be placed in the forfaiter himself (the investor, through his ‘without recourse’ purchase becomes a forfaiter). One must remember that it is possible in law to claim upon the issuer of a bill of exchange, even when recourse is excluded by a separate document. The seller of a forfaited obligation must therefore be sure that in case of default the buyer will not claim upon him and is able to withstand such a capital loss. The principle that forfaiting stands or falls by the trustworthiness of the forfaiter can therefore never be emphasized enough.

A further criterion, already discussed, concerns the financial capacity of the investor. Forfaiting usually involves large sums, even when dealing with a single bill taken from a series. To maintain a prudent spread of risks, such an investment should constitute only a fraction of the investor’s total funds in order to keep exposure within limits and avoid excessive build-up of concentrated risk.

An added difficulty with the on-selling of forfaited obligations or subparticipations lies in the reluctance of parties involved in the transaction to let others know the source of this financing.

It is hardly surprising that an exporter would take a dim view of being approached by a broker in relation to some already existing business association he might have acquired through forfaiting. Nor are exporters overjoyed to discover that obligations they have sold are circulating in a market which they can neither supervise nor influence in the slightest way.

The exporter’s house bank, through which the whole documentation is normally passed, may likewise be concerned, firstly, that this on-selling of the paper may become known to the exporter, and secondly, that a forfaiter may attempt to establish a relationship with their customer, with a view to dealing directly with him in future transactions.

Furthermore, the guarantors of a transaction often attempt to stop trade paper from coming into the forfaiting market.

The negotiability of such obligations is restricted or excluded by clauses in the contract and guarantee which render the paper virtually non-transferable. Ways round such restrictions, such as undisclosed assignments and fidcuiary handling of the paper by the legally-recognised beneficiary, cannot be recommended in most cases, since the buyer takes on a considerable additional legal risk without receiving appropriate compensation for it.

Investments in Forfaiting Paper

The buyer of such obligations enjoys certain important advantages which balance the loss of actual delivery of the paper:

- The fiduciary administration of the documents is normally free of charge. The forfaiter takes care of collection and related responsibilities without deduction of charges for himself (fees charged by third parties must, however, be met by the investor).

- The forfaiter checks the documentation and, to the extent of confirming it to be in order, takes responsibility for its validity.

The problems of on-selling paper demonstrate the fact that reputable forfaiters are attuned to a forfaiting market which will function well in future, and do not aim to promote brokerage in this area, or to pass on risks with the greatest haste, without taking on any risk themselves.

Important Criteria for Investment in the Forfaiting Market

Investment in forfaiting paper cannot be categorised with simple purchases of securities on the stock market. Owing to the volume of business transacted, the forfaiting market is too small and only available to a few professional forfaiters. Investment in this paper is furthermore made with the intention of keeping such obligations in portfolio until maturity and allowing, if necessary, investors to participate in them. Forfaiting is not suitable for brokering, which brings the dealer fast risk-free

forfaiting merely as a vehicle for business which brings the dealer fast risk-free profits without any commitment, through a high turnover of purchases and sales. It is contrary to good faith if an institution claims to buy receivable ‘for its own account’ with the intention of selling them subsequently to a third party.

Attractive of Investments in Forfaited Paper

The most important criteria for capital investment are undoubtedly fulfilled:

- The yield of such paper exceeds that obtainable in the fixed-rate securities markets for similar terms and currencies.

- The risk or security through first-class bank guarantees is as goods as, and in many cases better than that normally accepted by investors. A prerequisite for the investor is that he makes himself familiar with the pecularities of this form of investment in order to avoid unexpected disillusionment brought about by misconceptions.

Business Policy of Forfaiters

Because of the problems mentioned above, reputable forfaiters (amongst them Finanz AG Zurich and Finanz AG London) have developed a commercial policy which places the greatest emphasis on serving the interest of all parties to a forfaiting transaction.

- The sellers of forfaitable obligations, including banks, are protected in the sense that the forfaiter usually neither passes on the name of the exporter to third parties nor approaches him directly for future transactions.

- Exporters can assume that documents representing contractual undertakings on their part which they have forfaited, will not under normal circumstances appear on the market but will remain with the forfaiter.

Larger transactions are carried out on a syndication basis, or are subparticipated to prime investors. It is only very rarely that promissory notes are on-sold with the ‘without recourse’ endorsement.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FORFAITING - COMPARISON WITH EXPORT BILL DISCOUNTING

 

 

BILLS DISCOUNTING

FORFAITING

A. RISK FACTOR

Under discounting the Indian banks (who discounts the bill) has recourse to the exporter. Thus in effect the cross border political and other commercial risks are borne by the exporter.

In sharp contrast the forfaiting agency has no recourse to the exporter.

To cover himself from the above mentioned risk, the exporter has to insure the receivable (thru ECGC) without which the banks are not ready to discount the bills. This adds to the cost of the exporter.

Under forfaiting insuring the receivable are not required and hence the exporter saves the insurance costs.

B. CREDIT PERIOD

The exporter can extend credit to his buyer for a maximum period of 180 days

Under forfaiting the exporter can if needed by the buyer extend credit even for more than 180 days (1-2 yrs) . Even project exports requiring 7-8 yrs credit can be forfaited.

C. DOCUMENTATION

Documentation involved under discounting is troublesome as the exporter has to submit documents as per L/C terms which gives rise to frequent discrepancies

Documentation is comparatively far easier and simpler.

D. FUNDING LIMIT

The exporter cannot discount bills over and above the limit set up by his bankers.

Forfaiting acts as an additional source of funding and hence does not have any impact on the exporters borrowing limits.

E. EXPORTS TO HIGH RISK COUNTRIES.

Discounting export bills to high risk countries like African countries or countries like Russia is very difficult

Export bills to high risk countries can also be forfaited by paying a higher discount fee.

 

 

 

 

TYPES OF CONTRACT COVERED

Forfaiting evolved from the need to finance the export of capital goods, but can today be used for all the following different types of contract.

1) Export of goods from one country to another

The goods may comprise commodities, capita; euipment,spare parts or services. Indeed,forfaiting can be used to finance every thig including raw materials,aircraft, engines and even footballers!

goods can be sourced from an y country as, unlike export credit agencies.forfaiters face no restrictions concerning the orogin of the goods.

2) Internal transactions

Forfaiting is still applicable even when an export does not take place and the goods are sold to another entity in the seller’s country.

3) Project finance

With credit periods considered of upto 8 years. forfaiting has been used to finance many projects, including , for example, a civil engineering contract in Turkey and an irrigation system in Africa.

4)Pre export finance

A typical example would be the sale of soya beans by a company in South America to a variety of commodity traders in Europe. We can provide pre-shipment finance to enable the seller to purchase hte soya-beans from the local farmers. finance can be arranged to cover the period between the purchase of the goods and the eventual receipt of funds from the buyers.

 

 

 

5) Working Capital finance

Where the purpose of the funds is definable, forfaiting can be used for working capital finance, such as the construction of a hotel. This method is frequently used in Turkey and the Far East.

The other type of contracts which can be covered are as follows

a). Capital goods

b). Consumer Durables

c). Bulk drugs

d). Gems & Diamonds

It can be helpful to Public sector units like STC,MMTC etc. because they follow the system of Channelised Exports i.e. few Commodities like sugar,cotton, jute etc.are being restricted to export by the Government of India and can be exported by this trading corporations only.So they can export to high risk countries and get their money refunded with out any loss.

 

 

 

 

 

 

 

 

 

 

 

FORFAITING - LIMITATION

I. An exporter unable to fix forfaiting cost until he receives firm quote. If sometime has elapsed since the exporter taking indicative quote, the firm quote could be significantly different due to changed perception of the country risk.

II. The minimum size of the transaction for forfaiting, internationally has to be at least US$ 250,000/- (RS. 87.5 lacs). However, to adapt to the Indian situation minimum size of $ 100,000 - $ 150,000 could be tried.

III. The exporter, sometimes unable to pass on full cost of forfaiting to the buyer as per RBI requirement and thus lacks competitiveness.

IV Litigation problems arise from making sure that the "aper is clear" -unconditional

irrevocable, and clearly unrelated to any performance of commercial goods. different

nations have different interpretations of what is "unconditional, irrevocable, etc."

when things go Wrong, it is difficult to determine which law is applicable. since the

paper is transferable and independent of other legal documents, there is no clear

indication of what law is applicable-the exporter’s or the importers national law.

V Another Limitation is funding, of the discount rates. Most of the time, the size of

forfaiting agreements are for small amounts that mature at different intervals. Notes that

involve funding for five years (considering a long time in forfaiting).cause funding

problems for the small banks that are typical forfeiruers. larger banks, which could fund

these long term notes, will not do so because these banks might have their images

tarnished by going after the small amounts in the forfaiting market.

 

 

WHY IS FORFAITING NOT PICKING UP IN INDIA ?

There are various reasons for forfaiting not picking up in India and they are as follows:-

  1. Depreciating Rupee :- A major drawback for Forfaiting not picking up in India is that Rupee is depreciating continuously as a result of which the exporters get the benefit by not converting the receivables into Rupee they get better gains. Every six months make that 30/ 35% of exports receivable are due.
  2. E.C.G.C. cover not provided :- As a E. C. G. C. cover is not needed in the following transaction the exporters are not keen to rely on the forfaiter or the importers bank guarantee. E. C. G. C. does not want to take up because not agency has been set up to provide creditworthiness of the buyers over-seas and as a result, It becomes very difficult for E. C. G. C. to judge. In case of some countries like Vietnam, Iran the conduct of trade becomes very expensive,therefore to make the option more attractive and safe for the exporter, the arrangment of forfaiting needs a review. E. C. G. C. must be able to provide some cover to the exporters for intervening uncovered period risks.
  3. Recovery of Debts by forfaiter: Though the transaction is backed by a Bill Of Exchange or promissory note but the recovery of debt should be backed by some act like negotiable instrument act.
  4. Quantum of Export :- The minimum size of a forfaiting contract should be $ 100 000 million and that is not possible in a country like India. There are many small exporters with deals worth
  5.  

    50000 $ U.S.Dollar but cannot go for forfaiting. The transactions of the minimum amount is a complsion.

  6. Guide Lines by RBI :- No guidelines has been provided by RBI till date, except for circular no.3 which mentions that Exim is permitted to undertake forfaiting. All the documentation
  7. should be done through Exim bank, no guideline or steps have been taken by RBI to improve the export credit limit above 180 days. There is a lack of full fledge legal frame work on the part of RBI.

  8. Lack of Awareness among Exporters/Bankers :- There is a lack of awareness among exporters and Bankers about forfaiting, very few are aware and they are not keen to take up the business due to some reasons or the others.
  9. Lack of Expertise and Knowledge :- There is not much expertise in this area because nobody is aware of forfaiting. EXIM has taken a few steps by educating some of the bankers and by giving lectures to the bankers trainning staff camp. But the major disadvantage is that the person who is aware of this term thoroughly gets transferred to another job very soon. The required quality staff is not there to operate such sophisticated servicies.
  10. Trustworthiness on the part of banker overseas :- There should be proper information available about the trustworthiness on the part of banker overseas because the importers banker may accept the bills but it should be acceptable by the forfaiting agency. The agency has to receive money and would not to go in few certain bankers guarantee whom they don’t consider worthit because sometimes, even letter of credit is not cleared & even the foreign banks default.
  11. Re/Dollar Parity :- The rupee is available at a concessional rate as a result forfaiting cannot take place because the forfaiting transaction gets completed with the acceptance by the banker and takes time to finish the same and hence the rupee may further depreciate in the same time.
  12. Role of RBI :- No Guideline has been provided by RBI because exporter in India require RBI permission and if RBI issues any guidelines the exporter feels that the market is regulated and they do not want to enter.
  13. Cost of Funds is High :- Export to countries like Iran, Africa is not possible due to the high amount of risk prevailing in this countries. As a result the premium for discounting may go upto a max of 20% as compared to other countries & which is very expensive for a normal forfaiting transaction.
  14. Availability of agency offering such services :- There are very few agencies which offer this option. In India. EXIM Bank has got the monopoly to undertake this transactions.
  15. Awareness among the Bank :- The international branches of the Indian banks are actively involved in this business but these Bank in India are not ready to take up due to lack of awareness & many such other reasons.
  16. Exchange control to be relaxed :- The Exchange control is neede to be relaxed because the cost of Forfaiting is very much dependant on the exchange rates so they need to be stabilised.
  17. Forward cover cannot be taken :- The forward cover can be taken only till the date of receivable of payment by the exporter and hence the exporter may loose its premium for the remaining period which it would have got in case of a post shipment credit.
  18. Premium Þ 13% received

    Post shipment credit Þ upto 90 days 13%

    Þ above 90 days 19%.

    hence, the cost of finance may only be 6% , in this case where as in forfaiting, its minimum cost will be 8%.

     

  19. Credit not beyond 180 days :- Forfaiting can be useful for those contacts for which the payment is to be received for more than 180 days. Otherwise it may become expensive for the exporters
  20. Cost of Finance to be borne by importer :- The cost is included in the contract amount and the importer should be ready to pay the cost. The cost should be borne equally by the exporter & the importer.
  21. Secondary Market Operations :- For forfaiting to become successful, existence of secondary market is an essential pre-requisite this is because a forfaiter may not be inclined to hold the discounted bills/notes upto maturity date because his own funds are gettting blocked. The forfaiter may buy or sell such papers in the usual manner of tradable securuties.However, every transaction in the sec-market is done on without recourse basis i.e. the holder of the paper can go to the guarantor & not the previous owner or to the exporter.
  22. FERA Regulations:- Possible amendment in Foreign Exchange Requation Act 1973 in terms of documentation, procedural mechanism the liability of the exporter to realise the export proceeds.
  23. Resource Mobilisation :- Resources are mobilised in more efficient manner because in case of forfaiting the money is refunded with in a short span and so the exporter is able to utilise its funds more efficiently by going in for more production and vice-versa.
  24. Cost of Finance Not Known :- In forfaiting the major problem is that the cost of finance is not known like in the case of Pre-Shipment Credit Finance,Post-Shipment Credit Financesch, which is 13% & 19% respectively. In forfaiting the cost varies according to the political certainity & the Bank Co-accepting the bills of the importer hence the cost varies from transaction to transaction as a result a fixed rate of finance is not know to the exporter, he has to ask for a quote and decide its shipments based on the quotes.

VIEW OF EXPORTERS

  1. Exports to Highrisk Countries not possible :- E.C.G.C. provide cover to only those countries which are poiticallly & commercially sound. Countries like Iran, Africa, Malaysia, Thailand are not politically sound and hence even if the cover is provided by E.C.G.C. it is not for the full amount. It covers only a part of receivables as a result the cost goes high & it becomes difficult difficult to export to such high risk countries.
  2. Export credit of max 180 days :- As per the rules laid donw by RBI the credit given to the overseas buyer should not exceed a maximum of 180 days and if it does it stands as outstanding in the books. Only in case of capital equipment which involves a high cost a special permission is given by RBI to extend the credit limit and that too after following the guideline issued by it.
  3. Documentation :- Documentation in the normal framework involves a lot of paperwork and which makes the job of Exporter very difficult.
  4. No Problem in collection of debts :- The exporters had no problem in the collection of debts because they exported only to the parties with whom they have been dealing in past,and any problem with regards to the goods was solved mutually. So they never faced any problem as regards to the collection of debts and didnot have any bad debts.
  5. Limited Export Turn Over :- The exporters could not export anything more beyond a certain limit because of limited liquidity availability as a result of which they were not in a position to roll over the money. They exported only twice or thrice in a year depending upon the time of receivable of money. After they get the money they produced goods.
  6. Cash rich countries :- Cash rich countries were of the view that they never had only problem as regards to the collection of debts. They exported to their counter parts overseas so they had
  7. no problem as well as for a cash rich company ½ to 1% here and there makes no difference. Thus companies exporting to its counter part didnot require any kind of credit.

  8. Lack of awareness :- There is a Lack of awareness among the exporters about forfaiting. Majority of them were not aware and did not know that such a concept prevailed. They were not able to break the mind frame of 180 days credit & hence. more and more people used to be educated about the same.
  9. With recourse export :- The exports in India is always with recourse to the exporter and hence the entire risk is passed on to the exporter. Incase of any problem by the overseas buyer it may reflect the exporter & hence the exporter not very keen to export.
  10. L/C Backed Transactions :- Majority of the transactions are L/C backed & if they are not backed by L/C i.e. on non L/C basis they either go for usance bill,demand bll or sight bill as a result the exporters are not worried about their payments even if the transaction is a non L/C.

 

 

 

 

 

 

 

 

 

 

FINDINGS OF SURVEY

A survey was conducted of about 10-12 exporters varying from 5 crores -150 crores. Thus mainly exported to politically & commercial sound countries like USA, Germany, Singapore, Hong Kong, Europe, Japan, France, Hungary, Italy, Mauritius, Taiwan, Phillipines etc. The proportion of their total export turnover varied from 20% to 100% but majority of the companies had nearly 50% of their export turnover on credit & the credit terms were 3-6 months, minimum 3 months & maximum 180 days. The exports were normally backed by L/C and if not L/C the export were made to counter parts abroad or relation with the overseas party was good. The experiece of payments of bills on due date was prompt. The exporter never had any problem in their collection of debts. There were sometimes delay in payment but only due to political uncertainity and it is a rare phenomenon. The proportion of credit sales that were bad debts were nil. They never had any bad debts. The answer about an outside agency helping in the collection of debts was a pure denial on their part and were of the view that it could be helpful only to companies who were lack of computer facilites. The cost of finance was the same for all 13% pre-shipment credit and 19% post shipment credit. They said that their export turnover will definitely increase by 15 to 25% if they availed forfaiting as their financing alternative. Mostly all the exporters were not aware of the concept of forfaiting except for a few of them. Hence,forfaiting is a concept which the exporters were really interested in to increase their export turnover by receiving the payment in a very short time. In India in respect of deferred payment export, post shipment credit is available from banks on susidised terms. further, EXIM Bank also has its own finance schemes for medium/long term project exports. ECGC cover is also available for such finance.however, in tune with national policy of export promotion, export projects especially for capital goods, turnkey projects etc. are showing an increasing trend. Therefore, forfaiting if introduced in India, may open up on alternate window for availing finance as well as debt protection especially for export projects from small and medium enterprises.

CONCLUSION

Forfaiting is a most appropriate for firms that are not experienced in judging risk, not particularly liquid & cannot get help from the export subsidy program. This type of financing merits the needs of large segment of middle sized firms which do not export because of their misconception & fears of international trade. Thus, forfaiting can pick up in India by educating exporters about the same.

1) A few changes to brought about in the existing network.

2) Rupee to stabilize.

3) Proper guide lines to be issued by RBI.

4) At present only exim has the so called monopoly of forfaiting more & more nationalised banks should be allowed to take active participation.

5) Exchange control be relaxed.

6) The minimum 1 million $ contract is still a drawback because in India mainly the exports transaction are not as big as 1 million $ and hence people with exports 30000 $ & 40000 $ cannot avail the facility hence the size should be brought down further.

Forfaiting in India has a tremedous future because the first deal in India took place in 1993 & till then it has gone up successively in the respective years the market aborad is 100 to 125 billion$ as compared to which India is not even 1% but with more & more awareness people are definitiely going for it. And Hence, forfaiting fulfills the need of an Indian exporter who is increasingly exploring non traditional products and non traditional markets or bigger unknowns. Catch on it will, the only question being how soon and to what extent. This will depend on how rapidly the players involved sell the concept.

 

 

So, forfaiting if, undertaken

can lead to

1) immediate inflow of foreign exchange.

2) transfer of export risk to the Forfaiter.

3) Augmentation of exports from the country.

Forfaiting as an alternate source of finance especially for deferred exports is likely to get popularity over a period of time. The present thrust of the country is to move towards an era of export promotion in the process of which forfaiting has a very important role to play with the likely srevice by EXIM Bank the movement would obviously receive the required impetus.forfaiting is most appropriate for transactions between 1$million and $5million,"where the capital goods are likely to be of an off the shelf nature." firms that are not experienced in judging risk, not particularly, and cannot get help from export subsidy programs should use forfaiting. this type of financing meets the needs of the large segment of middle-sized u.s. firms which donot export because of their misconceptions and fear of international trade. forfaiting could remove the risk that keeps most of this business from exporting.

Forfaiting could do much to increase exports. the advantages noted like -speed, liquidity, removal of risk-make forfaiting profitable to bureaucratic programs. since it is structured to handle middle to small-size deals, it is perfectly suited to the needs of the mass of us. businesses whose only reason for not exporting is lack of knowledge of international trade and risk.

 

 

 

 

 

 

 

 

 

 

 

 

The list of Exporters & Bankers interviewed.

1.

I.G. Petro Chemicals Ltd.

Mr. O.P. Ganeriwala

Secretay & V.P. (Finance)

2.

Garware Polyesters

Mr. Parag Bhuleshkar

Dy. Manager Banking

3.

Gulab Impex Enterprised Ltd.

Mr. S.K. Kashib

Vice President Finance

4.

GTN Textiles

Mr. Arun Walekar

V.P. Finance

5.

Zenith Ltd.

Mr. A.R. Beriwal

Ass V.P. (Corp. Finance)

6.

Shree Digvijay Cement Co. Ltd.

Mr. J.P. Bang

General Manager (Finance)

7.

Gujarat FlouroChemicals Ltd.

Mr. Manoj Desai

Dy.Manager Fiance

8.

Voltas International

Mr. Bakshi

V.P. Fiance

9.

Dharamsee Morarjee Chemicals Ltd.

Mr. Madhusudan Kukian

V.P.Finance

10.

Khatau Junker Ltd.

Mr. Manjerakar

Finance

 

 

11.

 

Krishna Filaments Ltd.

Mr. Hiten Mehta

V.P. Finance

12.

Ciba Geigy

Mr. M.L. Kalmane

Executive Finance

13.

Bank of India

Mr. G. Narayanan

Chief Manager Foreign Business Dept.

14.

Bank.of.India.

Mr. S. Sampat

Chief Manager Bills Dept.

15.

Banque Indosuez

Mr. R. Venkatesh

Asstt. Manager

16.

Mr. N.K. Bandodkar

M/s. Priscila John

Asstt. Managar

E.C.G.C

 

 

17.

 

 

Mr. R.K. Pandey

R.B.I.

Deputy Geneal Managar

18.

Mr. David Rasquinha

EXIM Bank of India.

Manager

19.

Mr. Manish .Haria

Haria Exports

Board of Directors

 

 

 

 

 

 

 

 

 

APPENDIX 1

1. Offer or commitment letter

London EC4

30 January 1985

Dear Sirs,

Re: A Forfait Finance-Ruritania

Thank your for your letter of 25 January 1985 in which you outlined a trade-backed transaction for which you seek quotations for a forfait finance.

In response, we make the following offer for the purchase, without recourse, of the related promissory notes.

Buyer:

Ruritania Engineering

Goods:

Lathes

Total sum to be financed:

DM2, 068,000 by a series of six promissory notes maturing semi-annually

Period:

Last maturity not later than 30 April 1988

Delivery:

Goods-April 1985

Documents-by 25 April 1985

Security:

Aval of Development Bank of Ruritania

Domicile of payment:

Ruritania

Interest:

9% per annum, compounded semi-annually, calculated on 365/360 basis and allowing five days of grace

Expiry of offer:

1 February 1985

Option period:

30 days from your acceptance of this offer

Option fee:

0.125% flat, payable immediately

Commitment fee

Payable only if you are successful in obtaining the contract. 0.1% per month, payable monthly in advance from expiry of the option period until delivery of documents

Special requirements:

Evidence of approval of foreign currency transfer by the State Bank of Ruritania and completion of promissory notes in accordance with the requirements of the Foreign Trade Documents Regulations 1981 issued by the Ruritanian a Ministry of Foreign Trade

We hope that these terms meet with your approval.

Please signify your acceptance of these terms by signing and returning to us the copy of this letter attached.

 

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