Forfaiting should not be overlooked as an innovative means of export finance

Business America, Feb, 1995 by Elnora Uzzelle

For more than 30 years, forfaiting has been a familiar financing tool for European exporters. However, American exporters have been slow to embrace this technique. As U.S. companies become more aggressive in emerging markets and other developing countries, they are encountering situations in which traditional financing methods often prove insufficient to accommodate the credit requirements of their clients. Competitive finance is a crucial element in export strategies, especially for small- and mid-size companies. To that end, exporters are looking at non-traditional financial options that allow them to extend export credit to their buyers, while eliminating as much of the financial risk as possible.

Forfaiting is one such financial technique that allows exporters to maximize cash flow and eliminate the payment risk inherent in an overseas sale. Its strength is its flexibility that can be applied to short-, medium-, and long-term contracts. And, because the exporter receives the cash shortly after shipment, he shows a cleaner and stronger balance sheet.

This article reviews the concepts and advantages of forfaiting and provides concrete examples of how this financing method can support U.S. exports.

Forfaiting, Its

Origin and Description

Why is forfaiting such an unknown technique for U.S. exporters? The most obvious explanation is that its origins lie elsewhere. Swiss financiers developed the forfait market after World War II to finance sales of West German capital equipment to Eastern Europe. London has since replaced Switzerland as the world's forfaiting center. And while London remains the center of the forfait market today, many of Europe's leading forfait houses have opened subsidiaries and representative offices in the United States where exporters can seek financial assistance.

The term "forfait" originates from the French term "a forfait," meaning to surrender or relinquish rights to something. As such, an exporter surrenders possession of export receivables by selling them at a discount to a forfaiter in exchange for cash. Forfaiting is also referred today as "a forfait," "non-recourse discount finance," and as a form of "structured finance."

To receive the maximum benefit from this technique, it is better to approach a forfaiter before beginning negotiations with a buyer so that a portion of the forfaiting cost can be incorporated into the contract with the buyer.

Commonly used trade instruments include promissory notes, bills of exchange (with a bank guarantee or "aval"), and more recently, letters of credit. An aval is a form of guarantee, whereby an endorsement with the words "PER AVAL" OR "GUARANTEED PER AVAL" is stamped or written directly onto the notes or bills by the guarantor bank, and is signed by authorized signatories of the guarantor bank. The aval represents an unconditional irrevocable and freely assignable obligation of the bank, not only as guarantor, but as co-obligor as well.

In a typical forfaiting transaction, the repayment of financing is completed in a series of semiannual installments with each of the installments being evidenced by a single negotiable instrument, such as promissory notes or bills of exchange. The forfaiter will know the regulatory requirements in the exporter's target country, and as such will be able to advise the exporter on the documentation and guarantee format required to ensure enforceability of the debt instruments. Once a forfaiter buys the negotiable instruments from an exporter, the forfaiter can either hold the instruments until maturity and collect the debt, or re-sell the instruments into a secondary market. In either case, since the exporter sold the instruments to the forfaiter on a without recourse basis, the exporter has effectively passed all of the risks associated with the foreign debt to the forfaiter, and is now completely removed from any risk associated with financing.

An Example of This Process

Consider this example. A U.S. manufacturer of construction equipment obtains a buyer in Argentina who requests a three-year credit for the sale. The exporter (or exporter's bank) contacts a forfaiter in the United States and provides the forfaiter with details of the proposed transaction. The forfaiter evaluates the transaction details and provides the exporter with a preliminary indication of feasibility and pricing within 48 hours. The exporter can then build the indicated discounting rate into the sale price. As a means of securing the financial ability of the importer to pay, the forfaiter usually requires a guarantee or aval from a bank in the importer's country. In most cases, the forfaiter will provide the exporter with the names of local guarantor banks deemed acceptable by the forfaiter. The U.S. exporter ships the equipment to the Argentine importer and endorses the negotiable instruments in favor of the forfaiter, without recourse. The forfaiter then pays the discounted net proceeds in cash to' the exporter.

The U.S. construction equipment exporter, having been paid in cash, is at this point out of the transaction enjoying the benefits of a cash sale and the marketing advantage of giving the importer the deferred payment terms that made the transaction possible. The forfaiter who purchased the instruments has now assumed all of the payment risk, which includes the credit risk of the guarantor bank, the interest rate risk, as well as the Argentine country risk. The only time a forfaiter has recourse to the exporter is in the event of a fraud or misrepresentation by the exporter. The exporter is, of course, responsible for the quality and reliability of the goods shipped.