CHAPTER : 1

INTRODUCTION TO FORFAITING

WAITING for payment against export bills for a long time more particularly because the

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 credit worthiness

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 countrys

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 realize

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 realization 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.

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1.1 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

Available by discounting export receivable

Evidenced by bills of exchange or promissory notes

Without recourse to the seller (viz. exporter)

Operated on a fixed rate basis (discount)

Available upto 100% of the contract value.

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 worlds 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

exporters 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.

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Forfaiting,or non re-course financing is a type of export financing that has existed since

the 1950s. 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 worlds 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.

1.2 HISTORY OF FORFAITING

Forfaiting originated in Switzerland in the 1950s. 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

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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 chase Manhattan

branch in Vienna.

A hybrid form of financing

Forfaiting can be classified as a hybrid technique in export financing . As the following

analysis shows , forfaiting is done at fixed interest rates, similar to Eurobond trading. At

is medium term financing or longer, involving a series of six month notes, spread over a

five to eight year period. The market risks are bank and government related, as are those

of the eurocurrency market. The documentation is based on trade bills and letters of credit

financing, Transactions can be of

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

4
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.

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1.3 CHARACTERISTICS OF FORFAITING

It converts deferred payment exports into a cash transaction, improving liquidity

and cash flow.

It absolves exporter from cross-border political or commercial risk associated with

export receivable.

It finances upto 100% of the export value as compared to 80-85% financing

available under conventional export credit.

It acts as an additional source of funding and hence does not have any impact on

the exporters borrowing limits. It does not reflect as debt in exporters balance

sheet.

It provides fixed rate finance and hence automatically hedges against interest and

exchange rate fluctuation arising from deferred export credit.

Exporter is freed from credit administration.

It enables exporter to extend credit to the importer for more than 6 months (say

upto 1-2 years) which under normal condition is not possible and thus can act as a

marketing edge.

It saves on insurance costs as the need for export credit insurance viz. ECGC is

eliminated.

Exporter Exporter are liquidate pre-shipment finance from export proceeds

received from Forfaiting Agency.

CHARACTERISTICS OF AN A FORFAIT TRANSACTION

Essential Prerequisites of an Forfaiting Transaction

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It should be apparent that Forfaiting is a flexible tool in International finance. Essentially

there are very few prerequisites of a transaction which can be Forfeited.

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 availed or guaranteed unconditionally and irrevocably by a bank or state

institution acceptable to the forfeiter.

Advantages to the exporter

1. A forfeit finance is fixed-rate finance.

2. Finance is provided by the forfeiter 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 exporters trade transactions: he does

not need to commit all of his business or any significant part of it.

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 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

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 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.

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.

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

as the exporter.

Advantages to the forfaiter

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 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.

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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 agreements 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.

1.4 COMPARISON BETWEEN FORFAITING AND OTHER FORMS

OF TRADE FINANCE

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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

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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 borrowers 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

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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 exporters debts acceptable to him. Finally, discounts in

factoring tend to be high.

1.5 LIMITATION OF FORFAITING

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 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 exporters 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.

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 CHAPTER : 2

FORFEITING PROCEDURE

2.1 FORFAITING - MODUS OPERANDI

Indian exporter initiates negotiations with the prospective overseas buyer with

regard to order quantity, price, currency, delivery schedule and credit terms.

At this stage exporter approaches LFL(an agency between the Exporter and the

Forfaiting agency) to obtain an indicative quote from the forfaiting agency. LFL

obtains indicative quote of discount, commitment and documentation, if any, and

advises to the exporter.

Exporter finalizes the terms of the contract with the buyer.

[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.]

If terms are acceptable to the buyer the Indian exporter informs LFL, who

arranges for a firm commitment from the forfaiting agency to the exporter (which

need to be confirmed) within a specified time limit through his bankers.

Indian exporter confirms acceptance of forfaiting terms and enters into a

commercial contract with the buyer and also the contract with the forfaiting

agency through their Indian agency.

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 On execution of the forfaiting contract, certificates as indicated in III (A) & (B)

above are issued to the exporter.

The export contract stipulates that the overseas buyer to arrange for co-accepted

bills of exchange or promissory notes.

The exporter can draw a series of bills of exchange and submit them along with

shipping documents to his bankers for presentation to importer for acceptance

through latters bankers.

The importers banker hand over shipping documents to the importer against his

acceptance of bills of exchange and arranging signature of the aval thereon..

Such co-accepted bills of exchange are returned to the exporter through his

banker.

Exporter endorses avalised bills of exchange with the word "WITHOUT

RECOURSE" and forwards them through this banker to forfaiters agents in India,

who in turn sends them to the forfaiting agency.

The forfaiting agency effects payment of the discounted value in accordance with

the agreement, after verifying the signature and other particulars.

Normally the forfaiter credits the amount to the nostro account of the bank in the

country where the forfaiter is based. The bank receiving the discounted proceeds,

arranges to remit the funds to India. The exporter is issued a certificate of foreign

inward remittance. The GR form is released by the bank.

An export contract which provides for more than one shipment can also be

forfaited under a single forfaiting contract.

Where the export is effected in more than one shipment, avalised promissory

notes/ bills of exchange in respect of each shipment could be forfaited subject to

the minimum value requirement say US$ 100,000/- laid down by the forfaiter.

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 On maturity of the bills of exchange / promissory notes the forfaiting agency

present the instrument to the AVAL for payment to complete the transaction.

2.2 GENERAL ASPECTS OF FORFAITING

1) Repayments : Normally, Repayment by periodic installments is a condition of credit.

The creditors 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

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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

exporters 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 exporters 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%.

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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.

2.3 TYPE OF INSTRUMENT

Promissory Note / Bill Of Exchange

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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

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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 importers country and able to ascertain the importers 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.

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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.

2.4 TECHNICAL ASPECTS OF FORFAITING

A. Cost

Discount Rate

The claims will be discounted at an all-in discount rate. The rate is usually quoted

asmargin over Libor (funding cost) and is made up of the following:

- Cost of covering commercial, country and interest rate risk

- Cost of funds based on the Euromarket rates (LIBOR)

Grace Days

Grace days are added to each maturity when calculating interest. These will compensate

for delays in payment that are common in certain countries.

Commitment Fee

Exporters will often need a forfaiters firm commitment to purchase a claim long before

the delivery of goods. A commitment fee will then be charged from the day of

commitment until disbursement.

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B. Documentation

As mentioned earlier, documentation is usually simple and straight forward. The

following will apply to a claim evidenced by drafts:

Promissory Notes / Bills of Exchange in international format avalized by a bank

Conformed copy of underlying L/C including all amendments (if any)
Conformed copy of commercial invoice and shipping documents (Bill of Lading)
Confirmation of the authenticity and validity of all signatures appearing on the

documentation.

In case the claim will be evidenced by a letter of credit, the following will apply:

Conformed copy of underlying L/C including all amendments

Conformed copy of commercial invoice and shipping documents
Letter of assignment of proceeds in favour of the forfeiter
Notification of assignment to the L/C issuing and advising bank as well as their

relevant acknowledgement
Confirmation by the L/C issuing and advising/confirming bank that they accept

the forfaiter as the new beneficiary under the L/C and that they will pay at

maturity directly to him.

Confirmation by the L/C issuing and advising/confirming that documents under

the L/C have been taken up without any reserve

Confirmation of the authenticity and validity of all signatures appearing on the

Documentation

C. Guarantee Obligation of the Exporter

The exporter is obliged to meet all terms and conditions agreed to in the forfaiting

agreement, i.e.:

- to duly fulfill the basic agreement (delivery of forfaited goods)

- to deliver authentic documents to the forfaiter

D. Important Requirements

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Information Checklist

To be able to submit a firm offer the forfaiter needs the following information from the

exporter:

- Currency, amount and financing period

- Country of risk

- Name and location of the guarantor

- Document (promissory note, bill of exchange etc.)

- Form of security (guarantee or aval)

- Tenor and repayment schedule (i.e. amounts and maturities)

- Exporting goods

- Delivery date of goods

- Delivery date of documents

- Necessary approvals and licences

(import licence, transfer documents etc.)

- Domicile for payment of the debt

- Name of importer and exporter

The forfaiter can often quote his indicative risk premium, even if not all the details of the

deal are known.

CHAPTER : 3

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 RISKS INVOLVED IN FORFEIT TRANSACTION

THE EXPORTERS RISKS

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 importers customer and the delivery of the goods

or services, that is, during a period when he is committed to taking a forfeit 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.

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.

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.

THE IMPORTERS RISKS

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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.

THE GUARANTORS 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 importers 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.

THE FORFAITERS RISKS

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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.

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.

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.

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

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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.

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.

CHAPTER : 4

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 WHY FORFAITING IS NOT POPULAR IN INDIA ?

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

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.

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 arrangement of forfaiting needs a review. E. C. G. C. must be able to provide

some cover to the exporters for intervening uncovered period risks.

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.

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 50000 $ U.S.Dollar but cannot go for forfaiting. The transactions of the

minimum amount is a complsion.

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 should be done through Exim bank, no guideline or steps have been taken

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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.

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.

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.

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 dont consider worthit because sometimes, even letter of credit is not cleared & even

the foreign banks default.

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.

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.

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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.

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.

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.

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.

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

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.

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.

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.

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 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.

Forfaiting in India has a tremendous future because the first deal in India took place in

1993 & till then it has gone up successively in the respective years the market abroad is

100 to 125 billion$ as compared to which India is not even 1% but with more & more

awareness people are definitely 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.

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.

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 BIBLOGRAPHY

BOOKS :

Forfaiting:An Alternative approach to Export trade finance by ian guild & rhodri harris.

"Factoring for Exporters" :Practical Solutions for Global Trade Finance, RipileyAndy,

London International Tompson, 1996.

Sengupta A K, " Introduction of Forfaiting in India" :Issues,Problems and Prospects,

Unpublished Thesis submitted to the University of Poona for the award of Ph.D. degree,

pune, 1996.

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

WEBSITES :

www.google.com

www.scribd.com

http://en.wikipedia.org/wiki/Forfaiting

http://business.gov.in/business_financing/forfaiting_inindia.php

http://www.pwc.com/in/en/publications/india-tradefinance -11-feb.jhtml

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