Forfaiting is a method of trade finance that allows exporters to obtain cash by selling their medium and long-term foreign accounts receivable at a discount on a “without recourse” basis. A forfaiter is a specialized finance firm or a department in a bank that performs non-recourse export financing through the purchase of medium and long-term trade receivables. “Without recourse” or “non-recourse” means that the forfaiter assumes and accepts the risk of non-payment by the importer or obligor. Similar to factoring, forfaiting virtually eliminates the risk of non-payment once the goods have been delivered to the importer or obligor in accordance with the terms of sale.
However, unlike factors, forfaiters typically work with exporters who sell capital goods, commodities, or large projects and need to offer extended periods of credit from 180 days to seven years or more. In forfaiting, receivables are often guaranteed by the importer’s bank, which allows the exporter to take the transaction off the balance sheet to enhance key financial ratios.
The current minimum transaction size for forfaiting is $100,000, but forfaiters normally prefer deals in the $250,000 to $500,000 range or more. The average value of forfaiting transactions is $2 to 5 million, but some transaction sizes can be as high as $200 million. In the United States, most users of forfaiting are established medium-sized and large corporations, but U.S. exporters of all sizes are slowly embracing forfaiting as they become more aggressive in seeking financing solutions for countries considered “high risk”.
Characteristics of Forfaiting
Applicability: Suited for exports of capital goods, commodities, and large projects on medium and long-term credit (180 days to seven years or more).
Risk: Risk inherent in an export sale is virtually eliminated.
Pros: Eliminates the risk of non-payment by importers. Offers strong capabilities in emerging and developing markets.
Cons: Cost is often higher than commercial lender financing. Limited to medium- and long-term transactions valued over $100,000, although the $250,000 to $500,000 range is normally preferred by forfaiters.
Key Points
• Forfaiting eliminates virtually all risk to the exporter, with 100 percent financing of contract value.
• Exporters can offer medium and long-term financing in markets where the credit risk would otherwise be too high.
• Forfaiting generally works with bills of exchange, promissory notes or letters of credit.
• In most cases, the importers must provide a bank guarantee in the form of an “aval”, letter of guarantee, or letter of credit.
• Financing can be arranged on a one-off (transaction-specific) basis in any of the major currencies, usually at a fixed interest rate, but a floating rate option is also available.
• Forfaiting can be used in conjunction with officially supported credits backed by export credit agencies such as the Export-Import Bank of the United States.
Three Additional Major Advantages of Forfaiting
• Volume: Forfaiting can work on a one-off transaction basis, without requiring an ongoing volume of business.
• Speed: Commitments can be issued within hours or days depending on details and country.
• Simplicity: Documentation is usually simple, concise, and straightforward.
How Forfaiting Works
The exporter approaches a forfaiter before finalizing a transaction’s commercial structure. Once the forfaiter commits to the deal and sets the discount rate, the exporter can incorporate the discount into its selling price. The exporter then accepts a commitment issued by the forfaiter, signs the contract with the importer, and obtains, if required, a guarantee from the importer’s bank that provides the documents required to complete the forfaiting.
The exporter delivers the goods to the importer and delivers the documents to the forfaiter who verifies them and pays for them as agreed in its commitment. Since this payment is without recourse, the exporter has no further interest in the financial aspects of the transaction and it’s the forfaiter who must collect the future payments due from the importer.
When to Contact a Forfaiter
Forfaiting is widely used by exporters and financial institutions throughout Europe because their sales and financing professionals work very closely together to develop a contract price proposal in order to make the cost of financing competitive and attractive to importers. This approach is not widely embraced or practiced in the United States. Thus, exporters should contact a forfaiter at the earliest point in formulating their sales and financing proposals. Doing so will help exporters better understand the subtleties and complexities of dealing in certain markets, including how to create a financing proposal at interest rates that are competitive, without reducing the margin on their sales.
Cost of Forfaiting
The cost of forfaiting to the exporter is determined by the rate of discount based on the aggregate of the LIBOR (London Inter-Bank Offered Rate) or base rate equivalent for the tenor of the receivables and a margin reflecting the risk being sold. In addition, there are certain costs that are borne by the importer that the exporter should also take into consideration. The degree of risk varies based on the importing country, the length of the loan, the currency of the transaction, and the repayment structure – the higher the risk, the higher the margin, and therefore the higher all-in discount rate. However, forfaiting can be more cost-effective than traditional trade finance tools because of the many attractive benefits it offers to the exporter.
Forfaiting Industry Profile
Forfaiting was developed in Switzerland in the 1950s to fill the gap between the exporter of capital goods, who would not or could not deal on open account, and the importer, who desired to defer payment until the capital equipment could begin to pay for itself. Although the number of forfaiting transactions is growing worldwide, there are currently no official statistics available on the size of the global forfaiting market.
Industry sources estimate that forfaiting transactions worth $60 to $75 billion are outstanding at any given time, that the total annual volume of new transactions worth around $30 billion, and that two percent of world trade is financed through forfaiting, of which three percent takes place in the United States.
Forfaiting firms have opened around the world, but the Europeans maintain a hold on the market, including in North America. Although forfaiting firms remain a few in number in the United States, the innovative financing they provide should not be overlooked as a viable means of export finance for American exporters.
Where to Find a Forfaiter
The International Trade and Forfaiting Association (ITFA) is a useful source for locating forfaiters willing to finance exports. Headquartered in Switzerland, ITFA is the worldwide trade association for over 300 financial institutions engaged in global trade, forfaiting, supply chain, and receivables financing.
To locate U.S.-based members of ITFA’s Americas Regional Chapter, go to: https://itfa.org/
These links updated: 4/23/18. This website has been funded in part by the U.S. Commercial Service. Copyright (c) All Rights Reserved by the District Export Council of Georgia. Image:: Fotolia_47136361_Subscription_XL .