Trade & Supply Chain Finance 2011: Forfaiting


By Paula L. Green

Thanks to new technology that improves information flow, traditional trade finance tools such as forfaiting are now being used more frequently as part of a broader supply chain finance program.


Camerinelli, Aite Group: Electronic transactions are growing in use

The age-old mechanism of forfaiting is regaining its shine as new technologies make it more alluring and tighter credit conditions demand a broader suite of tools for financing global trade.

Forfaiting is the sale of receivables at a discount on a non-recourse basis. It isusually used by exporters for longer-term receivables—for products such as heavy machinery or other goods paid for in installments over long periods of time. It offers exporters the security of immediate payment—albeit at a discount—for deferred payment receivables.

As web-based technologies allow information to move more efficiently through complex supply chains around the globe, it is making it easier to revisit and increase efficiency of tools such as forfaiting—allowing it to be used more broadly within larger supply chain finance programs.

Paolo Provera, chairman of the International Forfaiting Association in Zurich, says any company in any industry carrying out transactions of all sizes can benefit from its use.

“We see an increase of deferredpayments instruments on corporate risk, and forfaiting gives suppliers a competitive tool to better negotiate their contracts abroad by offering better conditions,” says Provera, who is also general manager of the Milan branch of Arab Banking Corp of Bahrain. Forfaiting allows a seller to reduce its days sales outstanding while providing their buyers with the longer payment terms that they are demanding.

Eugenio Cavenaghi, head of global trade and supply chain finance products development and facilitation at UniCredit, says new web technologies and automation hasvemade the exchange and processing of large volumes of information much more efficient than in the past.

The resulting simplification and increased efficiency has helped expand its use beyond traditional long-term receivables and eased minimum dollar value limits of transactions. “Forfaiting can now be applied to the ‘flow’ business, the day-to-day open account business activity consisting of many small-ticket transactions in small amounts,” says Cavenaghi.

Enrico Camerinelli, senior analyst for Europe, Middle East and Africa at consultancy Aite Group, agrees that forfaiting is benefiting from the greater use of technology. “One of the trends in trade finance is the acceleration of electronic transactions to remove paperwork,” he adds.

Tighter Credit Conditions

Credit conditions are tightening in many markets. With traditional working capital more difficult to come by, it could spark corporate treasurers’ interest in forfaiting.

Michael Quinn, managing director, product development, global trade, at J.P. Morgan Treasury Services, says that this, combined with the greater capital requirements of Basel III—which may further restrict traditional trade finance capacity— could make forfaiting a more useful trade finance mechanism because it is done on a non-recourse basis.

The without-recourse nature of forfaiting gives exporters the opportunity to sell the obligor risk to a forfaiter and gain immediate liquidity.

Plus it allows them to shift transactions off their balance sheet. It can be used for promissory notes or bills of exchange, and now is also commonly used for discounting deferred payment letters of credit and receivables financing.

Cavenaghi of UniCredit says the Basel III regulations could encourage banks to use forfaiting more frequently as a means to improve the management of their risk-weighted assets. “And forfaiting in the secondary market is definitely a most efficient tool for the portfolio management of a bank,” he adds.

But, according to Quinn a bank must maintain a book of business in forfaiting and be engaged for the long haul to make it financially viable.

New Rules May Increase Appeal

The International Forfaiting Association is working with the International Chamber of Commerce to develop informal rules that would make forfaiting more appealing to banks and companies by standardizing processes.

Don Smith, principal of US consulting firm Global Trade Advisory, says the creation of a set of uniform rules should reduce the effort involved and lower the accompanying costs.

Today, most forfaiting transactions are “heavily lawyered,” which adds time and expenditure to the transactions, says Smith, who chairs a chamber group that is drafting the new rules. Standardization should reduce the amount of time and legal involvement in deal structuring—and thus reduce costs. Smith says he hopes the rules will be completed in about three years.

Cavenaghi believes that forfaiting can help corporate executives manage their supply chain by reducing days sales outstanding and freeing sellers from their buyers’credit risk.

“The seller [can] access markets where clients are demanding tough payment terms”

“Forfaiting can now be applied to the…day-to-day open account business… of many small ticket transactions” – Eugenio Cavenaghi, UniCredit

“This allows the seller also to access markets where clients are demanding tough payment terms or it lets them expand their business without incurring working capital bottle-necks,” he adds.

While trade banks are increasingly interested in adding forfaiting solutions to their suite of supply chain finance products, that does not necessarily mean that traditional forfaiters should be moving into SCF, notes Provera.

He says that supply chain financing transactions tend to be short-term, high-volume, highly tailored structures. These transactions also frequently involve large investments in technical booking systems to support the business.

“I believe there is pressure for forfaiters to develop their product offerings, but I do not necessarily think that supply chain structures are the most obvious move,” adds Provera. “I do not think that [SCF] is necessarily a natural area for forfaiters to move into.”

Forfaiting adds another layer of transactional complexity to trade finance even as it lets exporters pass on risk to a third party or a central corporate treasury, notes Patrick Coleman, general manager of the United Kingdom and Ireland, Benelux, France, the Middle East and Africa at IT2 Treasury Management Solutions. He says that treasurers have shown interest in the tool.

Yet even with the expanded array of technology and information that corporate treasury hubs have to help them navigate the complexity of supply chain finance, forfaiting is still a secondary tool that will be useful to some, but not all, companies in managing their global trade.