What is Forfaiting?
Forfaiting is the provision of medium-term financial support for the import and export of capital goods. The forfaiter is a third party to transactions that takes on certain risks from importers and exporters in return for a margin. The forfaiter operates similarly to a central clearing counterparty in the OTC markets.
Forfaiting is originally a French word, meaning to relinquish a right. The term implies a transaction where the forfaiter purchases claims (receivables) from the exporter in return for cash payment.
- Forfaiting is the provision of medium-term financial support for the import and export of capital goods.
- Major sources of export financing are working capital financing, countertrade, factoring, and forfaiting.
- Forfaiting is a mechanism where the exporter surrenders his rights to receive payment against the goods and services rendered to the importer, in exchange for a cash payment from the forfeiter.
Characteristics of a Forfaiting Transaction
The common characteristics of a forfaiting transaction could be:
- The minimum bill size is either $250,000 or $500,000
- The length of credit extended to the importer ranges from six months to seven years
- It is receivable in any major convertible currency, e.g., USD, CAD, EUR, etc.
- A contract for goods and services
- A written letter of credit or a guarantee is made by a bank, usually in the importer’s country
Major Sources of Export Financing
1. Working Capital Financing
Banks may provide short-term loans that finance the working capital cycle from the purchase of inventory until the eventual conversion to cash. It is a way to access debt financing through a loan that is taken to finance a company’s everyday operations. Such a form of debt financing restricts the deployment of capital on long-term assets, such as property, plant, and equipment (PP&E), or other long term investments.
Countertrades are foreign trade transactions where the sale of goods to a country can be linked to the purchase of exchange of goods from the same country. The most common types include bartering, product buy-backs, and counter-purchase. Such a method of international trade is more common in developing countries with limits on foreign exchange or credit facilities.
Factoring is an arrangement that can help increase liquidity for transactors by offering the conversion of receivables into ready cash. In factoring arrangements, trade receivables on ordinary goods are sold, with financing up to 90% with or without recourse. The factoring arrangements do not involve negotiable instruments or take place in the secondary market.
Factoring refers to a method of managing book debt, in which a business receives advances against the account’s receivables, from a bank or financial institution. The three parties involved in factoring are the seller, customer, and the factor.
Forfaiting is a mechanism where the exporter surrenders his rights to receive payment against the goods and services rendered to the importer in exchange for a cash payment from the forfaiter. Through forfaiting, the exporter can easily convert a credit sale into a cash sale, without recourse to him or his forfaiter.
In forfaiting arrangements, the trade receivables must involve capital goods and are financed up to 100% without recourse. The arrangements can involve dealing with negotiable instruments.
What Information Does a Forfaiter Need?
The forfaiter requires the following information to participate in the transaction:
- The identity of the buyer
- Buyer’s nationality
- Nature of goods sold
- Detail of the value
- Currency of contract
- Date and duration of the contract
- Credit terms
- Payment schedule
- Interest rate
- Know what evidence of debt will be used, e.g., promissory notes, bills of exchange, letter of credit, etc.
- The identity of the guarantor of payment
Documents Required by the Forfaiter from the Exporter
- Copy of supply contract, or its payment’s terms
- Copy of shipping documents, including airway bill, bill of lading, certificates of receipt, railway bill, or equivalent documents
- Copy of signed commercial invoice
- Letter of assignment and notification to the guarantor
- Letter of guarantee
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