project report.docx forfaiting

8/2/2019 PROJECT REPORT.docx Forfaiting

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PROJECT REPORT

ON FORFAITING :-

AN ALTERNATIVE IN EXPORTFINANCE

Submitted by :- AMUL M. SHAH

(P.G. D.B. A.)

1995-1997

Guided by :- Mr M.D.Bhonsle.

VICE PRESIDENT

INTERNATIONAL BANKING DIVISION

Lloyds Finance Limited

I N S T I T U T E F O R T E C H N O L O G Y A N D M A N A G E M E N T

N E R U L , N E W B O M B A Y.

ACKNOWLEDGEMENTI would like to take this oppurtunity for thanking Mr.M.D.Bhonsle, Vice president, International Banking Division,Lloyds Finance Limited. He not only gave me an oppurtunity

to work on this project but also guided me for the project.
http://adtrack.ministerial5.com/clicknew/?a=637394


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I would also like to thank Mr. Pushkaraj Gumaste, Mr.RajeshNagpal and Miss Archana for their kind heip and co-operation.

I would also like to thank all those who spent their valuabletime and helped me in completing my project Successfully..

REFERENCES

1) Forfaiting :- Credit Suisse Special Publications

Vol 47 II

2) Forfaiting :- An Alternative approach to Export

trade finance By IAN GUILD

& RHODRI HARRIS.

3) Forfaiting :- A New option for Indian Exporters

by EXIM Bank of India.

4) All the articles in News-papers and Magazines relating toForfaiting

INDEX

1) Introduction : What is Forfaiting ?

2) A Brief History about Forfaiting

3) Characteristic of Forfaiting.

4) Modus Operandi of Forfaiting

a) Flow Chart

5) General Aspects of Forfaiting


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6) Technical Aspects of Forfaiting

7) Managing Of Risks to Exporters,Impoters,Guarantor &Forfaiter

8) Forfaiting as an Investment

9) Comparison between Forfaiting & Export Bill Discounting

10) Types Of Contracts Covered

11) Limitations Of Forfaiting

12) Why is Forfaiting not picking up in India ?

13) Difficulties faced by Exporters in the existing Network

14) Findings Of the Survey

15) Conclusion.

16) List of People Interviewed.

17) References

18) Annexures

a) Offer or Commitment Letter

b) Bill Of Exchangec) Promissory Note

d) Letter Of Guarantee

e) Questionnaire.

QUESTIONNAIRE

1) What is the Export turnover of your


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Company?

2) Which are the countries where you Export?

3) What proportion of your total export

turnover is on credit terms ?

4) What are generally the credit terms?

5) Are your exports backed by L/C ?

Give breakup : L/C

NON L/C

6) What is your experience of payments of

bills on due date ?

7) What proportion of your credit sales are

Bad-debts? How do you provide for this?

8) What are the problems faced by your

Company with respect to a) collection of debts.

9) Do you think an outside agency could be of

help to you in regard to your problem of

collection of debts?

10) At present, how do you finance your credit

sales? what is the cost incurred for such

finance?

11) Would your exports turnover increase if

credit limit is extended beyond 180 days ?

by how much percentage.

12) Do you know about "Forfaiting" Services


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INTRODUCTION

WAITING for payment against export bills for a long time more particularlybecausethe financial and political risks often creates worrying situation in exportBusiness. Exporters who sell on deferred beyond 180 days have to ultimately depend onthe creditwothiness of the buyer during the span of maturity of bills Against thisbackdrop, in the competitive environment exporter is always on the look-out forsimplicity of Documentation, fixed rate finance, hassle-free creditadministration,collection, early liquidity and cash flow

In the current economic situation, no option which can help supplement the countrysabysmally Iow forex resources is to be ruled out of hand. forex receivable are as much anasset as gold except sale of gold is resorted to only in extreme cases. any effort to realiseforeign receivable and also to ensure that future exports do not entail any credit is imperativedue to established trade practice or to enhance the acceptability of the Indian goods ,a

mechanism to hasten the realisation of such credit would be worth exploring. forfaiting offerssuch a mechanism in the case of export of capital goods which are normally sold with a creditpackage. forfaiting defined as the purchase of a debt instrument ,with-recourse to anyprevious holder of the instrument, has gained significant currency in export trade finance inthe 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. theforfaiting 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.

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 goodsdelivered to an importer, in return for an immediate cash payment from a forfaiter thusCONVERTING 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 conductedthan anywhere else. his is not so much because London is the worlds leading financial centre


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but because of the fewer restrictions on operations and turnover, stampduty on negotiableinstruments 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 -sizefirms that donot export because of their unfamiliarity with-and the risks associated with -international trade. sometimes called non- recourse financing, forfaiting reduces the exportersrisk and could do much to raise Exports. The history of forfaiting discusses its advantagesand disadvantages, and examines rates structures and the current market.

Forfaiting,or non re-course financing is a type of export financing that has existed since the1950s. Infact, the term comes from a French a forfait meaning "with recourse" despiteforfaiting 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 articleexamines forfaitng by first briefly analyzing its history and presenting the basic example. Theadvantage s and disadvantages are discussed along with an examination of rate structures andthe current market. Finally, implications of this form of trade financing are discussed, basedon selected examples of forfaiting.

HISTORY OF FORFAITING

Forfaiting originated in Switzerland in the 1950s. The need for non recourse financingresulted from early east-west trade. Eastern nation wanted grain on credit while westernexporter needed cash to minimize the risk. Switzerland by way of its neutrality and bankingexpertise, was able to bridge this gap .

Zurich houses purchased promissory notes from the exporter at a discounted price. The Swissbanking reputation for secrecy may explain why so little information is available aboutforfaiting. In addition, East European importers needed 3-5 year terms for capital goodsimports and , West German exporter would not grant Dutch credit . The importing countryrisk was unexceptable to the western bank . Thus medium-term paper without recourse - aforfait 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 subsidiariesof large Swiss,, German and Austrian banks are well known as forfait it houses. The mainforfaiting centers originally were Switzerland, Germany and Austria. Recently, London hasincreased its forfaiting business so much so that a forfaiting convention was held in Londonin 1980. This was the first time when such a meeting was held outside of the aforementionedcontinental nations. Some American banks also engaged in forfaiting, through Europeanbranches. One example is the chasemanhattan branch in Vienna.

A hybrid form of financing

Forfaiting can be classified as a hybrid technique in export financing . As thefollowing analysis shows , forfaiting is done at fixed interest rates, similar toeurobond trading. At is medium term financing or longer, involving a series of sixmonth notes, spread over a five to eight year period. The market risks are bank and


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government related, as are those of the eurocurrency market. The documentation isbased 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 syndicatedeurocurrency 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 year1992, the majority of exporters are still unaware of this product. In 1994, forfaiting wasestimated to be between $75 - $ 110 billion about 2-3% of world trade by value. The majorcenters for forfaiting are London, Zurich, Frankfurt, Singapore and New York. The Indianexporters could try this product with buyers in South East Asia, West Asia and LatinAmerica. Forfaiters may offer the service for African countries but the quotes could be veryhigh due to perceived risk of forex payments.

The market

Because of the past prejudices against forfaiting-it used to be regarded as finance of lastresort- major banks have been hesitant to enter the market. The past image of forfaiting andthe absence of large banks have contributed to lack of knowledge about the practice. No oneknows who the market makers are or the true size of the market, although volume isestimated to be 4$ billion.this is a small amount compared with the 50%to 60% of worldtrade 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%.theunited kingdom has 10%but has a larger share of the secondary market . London forfeiteursfeel that their share of the primary market may be as much as 40%. This difference of opinionresults from different definitions of what constitutes the primary market.

The average forfaiting operation is small compared with the size of other financingoperations. tha average forfaited transactions ranges between $500,000 and1$million.ocassionally,deals of 20$million are arranged. sometimes, there are larger bids, butthese are usually attempts by firms to find the lowest cost form of financing. the absoluteminimum 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 thepaper being forfaited came from eastern Europe. today, the market is divided in thirds amongLatin America, eastern Europe, and north Africa-far east-southern Europe.

growth in the forfait market depends on the demand by less developed countries (ldc) forimports of capital goods and the expansion of the export subsidy programs. most of thegrowth in this market has come from the need to finance the exports of the capital goods toldcs. forfaiting involves those transactions that are not covered by export subsidy programs. if these programs are not expanded, forfaiting should increase.

CHARACTERISTICS OF FORFAITING


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

It absolves exporter from cross-border political or commercial risk associated withexport 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 theexporters borrowing limits. It does not reflect as debt in exporters balance sheet.

It provides fixed rate finance and hence automatically hedges against interest andexchange 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 amarketing edge.

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

Exporter Exporter are liquidate pre-shipment finance from export proceeds receivedfrom Forfaiting Agency.

CHARACTERISTICS OF AN A FORFAITTRANSACTION

Essential Prerequisites of an Forfaiting Transaction

It should be apperent that Forfaiting is a flexble tool in International finance. Essentially thereare very few prerequisites of a transaction which can be Forfaited.

1) An Exporter will have agreed to extend credit to his customer for some period of betweensix 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 aseries (for example, ten due six-monthly over five years)

3) Unless the Exporter is a Government agency or a multinational company, repayment of thedebts will be avalised or guaranteed unconditionally and irrevocably by a bank or stateintitution acceptable to the forfaiter.

Advantages to the exporter

1. A forfait finance is fixed-rate finance.2. Finance is provided by the forfaiter 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 freeingfinancial resources for investment or other purposes.

4. The exporter need spend no time or money in administering or collecting his debts.


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5. The forfaiter, not the exporter, bears the risks of currency and interest-rate movementsand 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 doesnot need to commit all of his business or any significant part of it.

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 tothe forfaiter, the financial terms of the finance can be agreed within hours.

8. Because the finance is generally provided against such straightforward debtinstruments as bills of exchange and promissory notes, all documentation is simpleand can be quickly compiled.

9. a forfait transactions are confidential, unlike, for example, commercial loans wheretombstone 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 figureincluding the CIF cost of his goods, the costs of the credit and, if necessary, the costsof any foreign exchange cover he needs to take to swap into his own currency thecurrency 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 thedebt instruments are validly prepared an guaranteed so that there can be no recourse tohim in the event of default by the guarantor. He should be conversant, therefore, withthe regulations of the importing country as to the form of bills of exchange orpromissory notes and guarantees or avals. In practice, however, the responsibility inthis respect is generally assumed by the forfaiter.

2. The exporter may have difficulty in ensuring that the importer can obtain a guarantorsatisfactory to the forfaiter.

3. Because he is accepting all the risks, the forfaiter will expect a higher margin thannormally sought by a commercial lender on similar business. This must not, however,be exaggerated, as compensation between the various forms of trade finance andbetween forfaiters keeps the disparity down. In addition, the exporter does not havethe cost of the insurance cover, for example via the

Export Credits Guarantee Department, which he will otherwise take out as security forextending 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 willgenerally 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 countto some degree against his credit lines.

2. The importer will have to pay a guarantee fee.


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3. The legal position of bills of exchange and promissory notes which a forfaiter willaccept is clear: they are abstract documents giving an a bsolute obligation to pay.Therefore, any dispute concerning the goods purchased is irrelevant to the paymentfor 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 imposeconditions upon the payment of a small proportion of the contract value and thisproportion will not be forfaited.

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

Advantages to the forfaiter

1. Again, documentation is simple and quickly compiled: there are no 30-page loanagreements as in commercial lending.

2. The assets purchased are easily transferable as to title so that trading them in thesecondary market is possible.

3. Although the higher margins associated with a forfait finance are a disadvantage tothe 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 inthe 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 ornotes validly guaranteed or avalised.

3. The forfaiter also bears the responsibility of checking the creditworthiness of theguarantor.

4. The forfaiter cannot accelerate payment of bills or notes which have yet to maturemerely because a bill or note of the series which has matured has not been paid. Suchacceleration 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 lendingbecause most commercial lending today bears a variable interest rate.

Disadvantages 2 and 3 above for the forfaiter are not of course, exclusive to him. Anyfinancer needs to check the credit-worthiness and bona fides of his debtor and to ensure thatall

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 nohefty loan agreeements prepared by lawyers or additional security which he can fall back on.

While simple, quickly compiled documentation is therefore, an advantage in most respects, itdoes leave a greater onus on the forfaiter.


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It must also be appreciated that the forfaiter bears sovereign, political and transfer risks andthe 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 tothe 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 anabsolute obligation to pay a bill or note that the he has guaranteed and, as is the case with theimporter, no contract dispute surrounding the goods or services provided can absolve himfrom this or, indeed , delay his payment. In just the same way, however, he is absolutelyentitled to reimbursement from the importer whose name also appears on the bill or note asan obligor and who, therefore, has the real exposure.

Forfaiting as an additional form of finance

It has often been assumed by those outside the a forfait market that one of the advantages of forfaiting to exporters and importers is its last resort characteristic. In other words, a forfaitfinance can be regarded as additional to other forms of finance because albeit for a greatercost, it can be obtained for those risks, particularly country risks, for which no other source of credit can be found.

This assumption is largely erroneous. In general, a forfaiter will be as chary of lending onpoor risks as any prudent financier. In so far as it retains a grain of truth , this is only becausethe international nature of the secondary a forfait market and syndication within the primarymarket may, in some cases, permit greater opportunities to lay off risk and provide greater placing power than is true of, for example, state -guaranteed insurance schemes.

Comparison between forfaiting and other forms of trade finance

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-termcredit or an exporter requiring finance to provide medium-term credit for his customers willhave comparatively few alternatives in mind. Assuming that his credit rating is satisfactoryand that he enjoys good relations with an accommodating bank manager is likely to receivehis proposal first. But his bank manager will usually suggest that his borrowing interest ratebe fixed for only three or six months at a time with changes in the rate to reflect alterations inmarker interest rates at the end of each period.Such variable-rate borrowing will be attractiveto a borrower who is confident that interest rates will tend to fall over the period for which heneeds 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 suchas United States, West Germany and Switzerland. In these circumstances, it is unusual to find


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a borrower sure enough about future rates of interest to accept happily variable interest rateson his borrowing and the attendant uncertainty has clearly been a constraining influence uponthe willingness of traders to undertake costly expansion plans or to fund longer-term researchand development projects.

Consequently of the advantages as enjoyed by a forfait finance from the point of view of theimporter 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 theuse of leasing

and factoring in recent years is the fixed-rate nature of the finance they supply. A comparisonof a forfait with other available financing methods must, therefore, concentrate on the limitedalternatives for the borrower intent on fixing his interest rates though, in so far as some of these alternatives do not immediately turn debt into cash, even they cannot be regarded asdirectly competitive in the eyes of the exporter.

1) Commercial Borrowing

Although, as stated above, banks normally lend on a variable interest rate basis, the intrepidborrower may be able to arrange fixed-rate terms. However, the bank will extract a price interms of the higher margin over base rates, LIBOR, etc., that it will require. In addition, thebank will probably demand security for the loan, perhaps in the form of a fixed or floatingcharge over the borrowers assets.Apart from this, an exporter taking a lo an will still have therisk of non-payment by his purchaser. This risk can be mitigated by insurance cover such asthat provided by the Export Credits Guarantee Department, but the cover is unlikely to extendto 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 repaymenthave 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 asinternational lending becomes more risky indeed, cover has been withdrawn from a numberof 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 countrieswhereby the exporter can borrow from his bank at an artificially low fixed rate, the differencebetween 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

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, theyhave significant limitations which mean that they cannot be regarded as directly competitivewith 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 fromleasing, the exporter must have taxable profits against which he can write off the cost of theassets. 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


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will probably require the right of recourse to the exporter in the event of default by theimporter.

3) Factoring

Factoring is another form of finance which has achieved popularity recently and it isundoubtedly true that higher borrowing costs and tightened cash flows arising from anydownturn in trade in the future will emphasize this trend. Again, however, this is not trulycompetitive 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 inrelatively few currencies and always leaves a residual risk to the exporter as the factoringhouse will usually accept only about 80% of the debt and demand recourse to him in theevent 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.

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. for thispurpose, the exporter is required to provide the information as shown in appendix I.

LFL obtains indicative quote of discount, commitment and documentation, if any, andadvises 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 amountreceivable in foreign currency by the exporter, after payment of forfaiting, discountand other fees is equivalent to the price of the goods had the goods been sold on cashbasis.]

If terms are acceptable to the buyer the Indian exporter informs LFL, who arrangesfor a firm commitment from the forfaiting agency to the exporter (which need to beconfirmed) within a specified time limit through his bankers.

Indian exporter confirms acceptance of forfaiting terms and enters into a commercialcontract with the buyer and also the contract with the forfaiting agency through theirIndian agency.

On execution of the forfaiting contract, certificates as indicated in III (A) & (B) aboveare issued to the exporter.

The export contract stipulates that the overseas buyer to arrange for co-accepted billsof exchange or promissory notes.

The exporter can draw a series of bills of exchange and submit them along withshipping documents to his bankers for presentation to importer for acceptance throughlatters bankers.

The importers banker hand over shipping documents to the importer again st hisacceptance 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.


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Exporter endorses avalised bills of exchange with the word "WITHOUTRECOURSE" and forwards them through this banker to forfaiters agents inIndia,who in turn sends them to the forfaiting agency.

The forfaiting agency effects payment of the discounted value in accordance with theagreement, after verifying the signature and other particulars.

Normally the forfaiter credits the amount to the nostro account of the bank in thecountry 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 foreigninward remittance. The GR form is released by the bank.

An export contract which provides for more than one shipment can also be forfaitedunder 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 theminimum value requirement say US$ 100,000/- laid down by the forfaiter.

On maturity of the bills of exchange / promissory notes the forfaiting agency presentthe instrument to the AVAL for payment to complete the transaction.

FLOW CHART

FORFAITING - CONVERSION OF CREDIT SALE INTO CASH SALE

FA - Forfaiting Agency

LFL - Lloyds Finance Ltd is the link between FA and theExporter ABC.

ABC - Exporter


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GENERAL ASPECTS OF FORFAITING

1) Repayments :

Normally, Repayment by periodic installments is a condition of credit. The creditors risk arereduced as a result of a decreased average life. Where the debt is in the form of promissorynotes 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 might include 10 promissorynotes of equal amounts, with the first maturity of 6 months after shipment of goods and afinal maturity of 5 years.

2) Currency:

The notes and bills are normally denominated in US dollars, German marks or Swiss francsalthough it is in principle possible to discount notes in any currency. Furthermore, since thecost of forfaiting is predominantly determined by the forfaiters funding costs, the risksinvolved with weak or unstable currencies would make such a forfaiting transactionextremely 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 effectiveclause 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 isdeducted from the nominal amount of the bills for the corresponding maturities.the exporterthus receives cash value for the bills concerned. from the exporters point of view, thetransaction is now complete since he has received payment in full for the goods supplied andrecourse to him is no longer possible in terms of his agreement with the forfaiter. only rarelyare 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 bythe riskiness of the transaction. Contingent liabilities that would have to be stated in anexporters financial statement and also, in forfaiting there are no export credit insurancecosts. These costs can be substantial for medium-term credits. Evidence also exists thatbecause of increased competition, rates are low, at least lower than in the past. In the earlydays, there were margins 5% to 6%. Currently , margins are comparable to the markets. Theaverage 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 thenominal interest rate which will be charged on the day of discounting. Discount to yieldincludes the cost of funding and the yield margin required by the forfaiteur. Both rates are


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functions of the currency denomination of the note, country risk, and importer risk. The rateused is determined by the agreement between forfaiteur and forfaitiste.

In calculating the discount rate, the forfaiteur would want a rate that reflects the variation ininterest 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 soit would know how profitable forfaiting would be.a mode located between these twoextremes 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 fixedmargin 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 notedue six months after availability would have a fixed margin of 1.25% over the six monthsdeutsche 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 discountcalculated to the maturity of the first of a series of notes. after that time ,the exporter has topay semiannual interest invoices which are calculated at the time of billing. Hence ,thismethod is seldom used

TYPE OF INSTRUMENT

Promissory Note / Bill Of Exchange

The great majority of forfaitable obligations take the form of either promissory notes issuedby the obligor in favour of the beneficiary, or bills of exchange drawn on the obligor by thebeneficiary and the accepted by the obligor. the reasons for the predominance of these formsof 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 probablysince the middle ages. the second advantage is the internationally agreed legal frame work based upon the international convention for commercial bills established by the Genevaconference 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 thedebtor country, both forms necessitate the setting out of all conditions in full. moreover allmaturities are incorporated in a single document, made out in favour of the beneficiary andoften not transferable without specific permission from the obligor. this restriction onnegotiability can be coupled with numerous legal and procedural complications and generallyserves to make debts and letter of credit obligations less sttractive, though not inoperable,forms of forfaiting paper.

Legal Significance Of "Without Recourse" Clause:


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The endorser of a promissory note has the legal right to free himself of any liability throughthe without recourse clause in his endorsement. but with a bill of exchange, the creditor signsas maker of the bill and is therefore always legally liable, irrespective of what he may havewritten on the bill to the contrary. in practice this presents few problems since the drawer willnormally be satisfied with a written undertaking by the forfaiter not to take proceedings

against him in the event of non-payment, it nevertheless becomes essential that the exporterdeals only with forfaiters of the highest reputation who may be replied upon to honor thisagreement. it is for this reason that promissory notes are generally favored by exporters aspayment 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 beaccompanied by bank security in the form of a guarantee or aval. the guarantor will normallybe an internationally active bank known to the forfaiter, the bank being resident in theimporters country and able to ascertain the importers creditworthiness firsthand. thissecurity is important not only to lessen the risks carried by the forfaiter, but also to makepossible the rediscounting of paper in secondary markets, if this proves necessary. guaranteesand avals are essentially similar, both being in their simplest form a promise to pay to acertain 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 theguarantor setting out in full all conditions relating to the transaction. it is important thatspecific

mention is made not just of the total amount, but of each maturity date with its correspondingrepayment, since the discount value is calculated directly from this. further-more theguarantee 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 theperformance of the exporter, but the forfaiter will normally insist upon clean, irrevocable andunconditional obligations of the guaranteeing bank or may choose to purchase the paper without recourse to the exporter only when the guaranteeing bank declares the debt asunconditional after the underlying contract has been fulfilled.

2) Aval

An AVAL in international practice as an irrevocable and unconditional guarantee to pay onthe due date, as if the guarantor had been the obligor. it is the most suitable form of securityand the one which has found the most favour. the aval is written directly onto eachpromissory note or bill of exchange with the words per "AVAL" and the signature of theavailing party (with the name of the original obligor in whose favour the AVAL has beengiven in the case of a bills of exchange). this simplicity and clarity, together with its inherentabstractness and transferability avoids many of the complications to be found withguarantees, and makes an AVAL the preferred form of security for forfaiting.it must be bornein mind, however, that in some countries the "AVAL" is not a legally recognized term.

TECHNICAL ASPECTS OF FORFAITING


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Costs

The costs of forfaiting are grouped as follows:

Covering of commercial risks : It is the importer than the exporter who must meet the cost of

obtaining the bank aval or bank guarantee. No costs, therefore, arise out of this for theexporter. Where the importer is unwilling to provide a guarantee, however, it can be to theexporters a dvantage to take such charges upon himself, thereby reducing the cost of finance.

Covering of political and transfer risks : the costs of covering risks are determined bymarket conditions; depending on the country they amount to between and 4% p.a.

Charge for use of money and covering of interest rate risks: the cost of funds is based on theEuromarket rates. The price that the forfaiter will charge for covering currency and interestrate risks is reflected in the Euromarket cost covering forward over similar periods for thecorresponding currency.

For management, administration and other expenses, the forfaiter takes about % p.a. A ratesheet Published each months giving forfaiting costs by country.

Besides the costs for commercial and country risks, funding and management, furtherarrangements such as options, commitment periods and penalties can represent additionalcosts but are relevant where the forfaiting of receivable is to be carried out at a future date

Commitment Fee and Costs for the Commitment Period

Where the delivery of documents is to take place at a later time, commitment commission iscalculated from the date of commitment by the forfaiter to discount date to % p.a. prorata on the amount to be financed. This is normally payable monthly in advance.

If the discount rate is to be fixed some time before discounting takes place, then attentionmust be paid not only to the Eurorate at the time of setting up the transaction, but also to theoverall trend in interest rates. A discount rate quoted for a forfait transaction with acommitment period is therefore often higher than that quoted for immediately availablepaper.

Commitment fees and higher discount rates for transaction with commitment periods are

justified by the forfaiter having to arrange, at the time of agreement, refinancing and coveringof his currency and interest rate risks. He also needs to reserve part of his credit lines forfuture use.

The forfaiters commitment is normally evidenced by a letter setting out all deta ils of theforfaiting transaction, including the form of obligation to be dicounted and all terms andconditions agreed. This commitment is binding and also commits the exporter to deliver therelevant paper to the forfaiter when it is received from the issuing or accepting party in goodorder.

Penalty and Option Fees


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Sometimes one includes in a forfaiting agreement an escape clause to cover the possibility of non -delivery of the paper by the exporter, in terms of which either a penalty feeautomatically becomes due or an option fee is paid at the outset of the commitment, enablingthe exporter to choose between delivering the documents or not. The basis for a penalty oroption fee is naturally similar the place of payment of the promissory notes or bills of

exchange to that for the commitment fee and consists mainly of a charge to cover theforfaiters costs.

Therefore the cost involved in Forfaiting is as follows

The Government have permitted forfaiting arrangement subject to the condition that the totaldiscounted proceeds that are receivable by the exporter are equal to the amount the exporterwould have realised had the transaction been concluded on a cash sale basis.

In other words, all the costs involved in providing credit to the importer by fixing up anarrangement with a forfaiting agency is to be borne by the importer. The exporter thus needsto determine the value of the goods as if he is selling on cash basis and then load into it thecost of forfaiting.

A forfaiting transaction has typically four elements of costs, payable to the forfaiting agency.

[A] COMMITMENT FEE

A commitment fee is payable by the exporter to the forfaiter for the latter commitment toexecute a specific forfaiting transaction at a firm discount rate within a specified time(normally not more than one year). The commitment fee ranges from 0.5% p.a. to 1.5% p.a.of the amount to be forfaited and is charged for the period between the date the commitmentgiven by the forfaiter and the date, the discounting takes place or until the validity of theforfaiting contract, whichever is earlier.

The fee is payable at the time of signing the contract with the forfaiting agency regardless of whether or not the export contract is ultimately executed. To enable the exporter to remitthese charges a certificate is provided by the forfaiting agency.

[B]. DISCOUNT FEE

Discount fee is the interest cost payable by the exporter for the entire period of credit

involved and is deducted by the forfaiter from the amount paid to the exporter against the co-accepted promissory notes or bills of exchange.

The discount rate is based on

The currency involved the credit period the buyers and avalising bankers credit rating. the credit rating of the country in which avalising bank is located.

The rate is quoted as percentage points over LIBOR/FIBOR etc. It is fixed at the time of executing a forfaiting contract between the exporter and the forfaiting agency.


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Here too, a certificate is provided to the exporter detailing the discount fee payable to theforfaiting agency to enable the Indian customs authorities to verify deductions towardsforfaiting discounts declared by the exporter on the GR form and shipping bills.

[C] DOCUMENTATION FEE

Generally, no documentation fee is incurred in straight forward forfaiting transactions.However, if extensive documentation and legal work is necessary, a documentation fee maybe charged.

[D] OTHER CHARGES

The service charges @ 0.25% are payable in Indian Rupees to the agency in India appointedby the forfaiter.

The service charges are payable to the agency for negotiating a deal on behalf of exporterwith forfaiting agency. The agency would ensure troublefree working of the arrangement andreceipt of agreed proceeds by the exporter in time.

[E] FORFAITING COST - WORKING

The aggregate indicative cost for bills covering export to Singapore based on current LIBORworks out to 7.1875% p.a. as under :-

Libor For 6 Months 5.7500 % P.A. As On 22.06.96.

+ Discount Fee 0.5000% P.A. Deducted From BillProceeds

+CommitmentCharges

0.5000% P.A. Payable In AdvanceFor Committed Period

+ Charges PayableTo Exim Bank Of India

0.2500% P.A. Payable In Rupees InIndia

+ Service ChargesPayable To AgencyBetween ForfaitingAgency AndExporter.

0.2500% P.A. Negotiable Could BeReduced To 0.25% ForSizable Business

Total Cost 7.2500% P.A.

The Indian banks handle US dollars denominated export bills at the rate of 2% p.a. overruling LIBOR, which works out to 7.6875% p.a. (based on LIBOR 5.6875% p.a. ). Hence theforfaiting is cheaper compared to bills discounted with Indian banks..


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Important Requirements

Information-checklist

Before making a firm commitment, the forfaiter will require the following information.

- the currency, amount and period to be financed

- the exporting country

- the name and country of the importer

- the name and country of the guarantor

- the form of debt to be forfaited (e.g. promissory notes, bills of exchange etc.)

- the form of security (e.g. aval or guarantee)

- the repayment schedule (i.e. amounts and maturities of the bills)

- the nature of the goods to be exported

- the date of delivery of the goods

- the date of delivery of the documents

- the necessary authorisations and licences (e.g. import licences, transfer authorisationetc.)

It is of course often possible for a forfaiter to give a non-binding indication of hisapproximate rates before all the exact conditions of a particular transaction have been agreedupon.

Form of Bills of Exchange and Promissory Notes

Many forms of bills of exchange and promissory notes are issued worldwide but the FinanzAG group regards the examples on pp 18-19 as probably the most acceptable. They take into

account the laws of the Anglo-Saxon countries as well as of the Continental Code Napoleonand the lessons of past experience.

The bill of exchange the draft (the acceptance) the promissory note

Der Wechsel: die Tratte (das Akzept) der Eigenwechsel

Ieffet de commerce, la traite le billet a order

Ieffet de change: la lettre de change (Iacceptation)

la cambiale, la tratta (Iaccettazione) il paghero


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Ieffetocommerciale:

el billete de omercio la lettera de cambio (laaceptacion)

el pagare

Form of guarantee

Aval

In the case of an aval, all the necessary wording is written directly onto the note or bill:

on a promissory note, this should say: and on a bill of exchange:

PERAVAL PERAVAL for (name of drawee)

(name and signature of guarantor) (name and signature of guarantor)

Checking the Documentation

One of the most difficult and delicate matters for the forfaiter is the precise checking of alldocuments passed to him. Once the documentation is delivered as agreed and variouspredetermined requirements (signatures, authorisations, permits imports licences, exchangecontrol approvals, stamp duties etc.) have been fulfilled, then nothing more stands in the wayof the payout. Any missing documentation must be immediately requested and any formal

defects corrected. It is only with the utmost difficulty that such shortcomings can be rectifiedlater.

Signature verification

When the forfaiter is unable to check the signatures on documents passed to him himself, asis often the case, he can only purchase the paper without recourse when the signatures havebeen clearly confirmed to him. It is therefore important for the exporter that the bank (usuallyhis house bank), through which the whole documentation is passed, confirmation of signatures on the guaranteeing bank, the exporter runs the risk of having to wait for paymentuntil the confirmation arrives.

Another solution would be an immediate payout made under the proviso that the validity of the signatures be confirmed.

Signature confirmation given by banks are as follows:

1. We hereby confirm the authenticity of the signature of .......................and th at thepersons signing are authorised to commit the company (follows authorised signature of verifying institution).

2. The signature of .......... compares favourably with the specimen on file (followsauthorised signature of verifying institutions)


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In the first case, the confirming party takes fully responsibility for validity whilst in thesecond case, which is more usual, the verification is without fully responsibility. The forfaitermust decide in this second case whether he wishes to obtain a binding confirmation from theguarantor.

In the case of documents with a non- binding signature confirmation(the signature comparesfavourably with the specimen on file), the forfaiter should only pay out to trustworthy sellersof paper.

Alongside its chief function as a form of export finance in which the forfaiter takes overalmost all the exporters risks, forfaiting also offers interesting possibilities as a medium -terminvestment. As a consequence of the relatively high risk, which can only be assumed byinvestors with a strong

capital base, returns are possible which can rarely be achieved by other forms of investmentinvolving similar security, terms and currencies.

Managing A Forfait Transactions-Risks To Exporters,

Importers And Guarantors

The exporters risks

1. An exporter who has sold an amount receivable to a forfaiter has virtually nooutstanding risk arising from the transaction. His only risks may arise during theperiod between the acceptance of his tender or bid for the impo rters customer and thedelivery of the goods or services, that is, during a period when he is committed totaking a forfait finance at an agreed discount rate even though the contract with theimporter 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 duringthe commitment period or that, for some other reason, the contract will not becompleted. In this event, the exporter is obliged to recompense the forfaiter for anycost or loss he suffers. In practice, a forfaiter will generally look upon the problemsympathetically, 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 forthe forfaiter is usually trivial compared with the problems which caused thecancellation in the first place and with any sum which the aggrieved party, importer orexporter, is seeking from the other as a consequence. Finally, there is no controlwhich can be instituted by the exporter to protect himself against this risk.

2. The one true risk that the exporter may run during the commitment period arises whenthe promissory notes or bills of exchange which he has agreed to sell are denominatedin a currency other than his own reporting currency. He will have the risk thatcurrency movements will be unfavourable to him.

Controlling the exporters risks


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3. The exporter should maintain a list of his forfaiting commitments by currency so thathe can monitor his exposure to currency parity movements and enter into forwardcurrency contracts if appropriate. As in the case the importer and explained below, anexporter with large numbers of commitments exporting at different dates may need tolist them by maturity tranche net of any forward currency contracts.

The importers risks

Once he is committed to pay a promissory note or bill of exchange, the importer is bound, asan obligator, to make payment at a specific time in the future. The amount involved and thecurrency in which it is denoted are fixed. He has no risk from fluctuating interest rates, sinceinterest 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 arereported, 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 toeffect repayment on the due dates. This risk can be minimized by careful monitoring of hiscash and debt positions.

Controlling the importers risk

1 .Currency risk

The importer should maintain an up-to-date list in each currency of outstanding debtcommitments and obligations. Any hedging foreign currency transactions should be offsetagainst the currency totals so that the true currency exposures is shown.

2. risk Repayment or liquidity

This is, in essence, the same as any other cash-flow risk that an importer or, indeed, anytrader has. All business need to manage and monitor their cash flow. The only slightadditional problem in the

case of a forfait finance is that debts are due in the future rather than immediately, so thatthere is a greater possibility that they will be overlooked.

3. The guarantors risks

In any a forfait transaction, the guarantor has a commitment to pay off the promissory notesor bills of exchange at their maturity dates and the right to demand simultaneous payments bythe importer. It follows that he has contingent liability and a contingent asset. Provided thatboth 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 significantexposure to interest charges. However, he has an absolute risk of default by the importer andan absolute sovereign risk if the importers country is different from his own (though i t isunusual for this to be the case). In the event of either late payment or non-payment, he has aliquidity risk in that he must be sure that he has adequate funds available to pay the bills ornotes.

Controlling the guarantors risk


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1. Risk of default by the importer

Any guarantor must have clear procedures set out in writing which must be followed, thatlevels of personnel who can approve limits of a particular size must also be specified, andthat any breach of limits must be reported at an appropriate level very quickly.

2. Sovereign risk

Sovereign limits will be much larger and often subject to more frequent reconsideration thanthose for individual customers or particular industry.

3. Liquidity risk

Since most guarantors are major banks, this is seldom a matter for great concern. None theless, any guarantor will wish to maintain an up-to-date list of his contingent assets andliabilities with immediate exception reporting of any repayments that are overdue.Responsibility for reviewing

exception reports and taking appropriate action must be clearly established at an appropriatelevel of authority.

The forfaiters risks

From the moment he grants an option for a forfait finance to the moment the forfaited assetsare repaid, the forfaiter is exposed to risk. The various stages giving rise to risk can becharted as followed.

1. 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 hardlyever 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 ashe grants the option. He is exposed to risk in this respect and to sovereign risk until he isrepaid or until the exporter refuses the option.

The only thing that changes, in terms of risk, between the option period and the commitmentperiod is that the forfaiter can assume in the commitment period is that the forfaiter canassume in the commitment period that the a forfait transaction will take place. He cantherefore commit himself to funding arrangements and, assuming he can obtain fixed-ratefunding, thereby eliminate any interest-rate risk. The most significant reason for not matchingfunding too closely to the maturities of forfaited assets is the flexibility it enables the forfaiterto retain. If he sees an attractive opportunity to sell some of his assets on the secondarymarket. the forfaiter does not wish to be drawn into difficult and potentially expensivenegotiations to free himself of any related funding.

2. Date of purchase


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Until this date is reached, the forfaiter can always back out of the a forfait transaction if hefinds irregularities in the asset he is buying or in its guarantee or, indeed, if he is dissatisfiedas 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 transferthe relevant foreign currency at the maturity dates of the bills or notes forfaited.

3. Period during which paper is held

The one very obvious danger that the forfaiter faces while he has the asset is that he will failto send maturing assets for collection. An oversight in this respect is seldom tragic but anydelay in receiving repayment costs the forfaiter money. The other side of the coin is that theforfaiter needs to keep a careful watch on his borrowings to ensure that he has funds availableto pay them when they become due, since, as stated earlier, he is unlikely to have matched therepayment of his borrowings to the maturity dates of his assets.

4. Date of maturity of the paper

The only additional risk at this point in the life of an a forfait transaction arises from its latepayment because of tardiness or incompetence on the part of the guarantor or his payingagent. It is true that, if this happens, the forfaiter has grounds to make a claim for interest onthe offending party, but it is also true that he may have great difficulty in actually obtainingthe interest.

Controlling the forfaiter risks

The forfaiter needs to maintain up-to-date list by currency of all items in his portfolio andthose for which he has extended an option or to which he is committed.

Because of his general tendency not to match borrowings specifically to the maturity of assets, a forfaiter may well have some assets, purchase at a time of relatively low interestrates, which are earning less than the prevailing cost of borrowing as a result of an increase ininterest rates. Since a forfaiter in this position will position will probably be looking upon hisportfolio as a pool of assets, this will not disturb him greatly, provided that, overall, hisportfolio is profitable.

1. Guarantor credit risk

Just as the guarantor should have set credit limits for individual customers and industries, sothe forfaiter should set credit limits for individual guarantors. The forfaiter should have clearprocedures set out in writing for establishing these limits, levels of personnel who canapprove limits of a particular size must be specified, and any breach of those limits must bereported at an appropriate level very quickly.

2. Risk of inadequate documentation

This risk can best be controlled by the use of a check-list covering such matters as evidenceto support the genuineness and legality of the trade underlying the forfaiting transaction,checks which need to be made on the form and connect stipulated by the guarantors local


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law of any letter of guarantee or aval, and checks ascertaining local requirements which areneeded to gain permission for the remittance of foreign currency.

3. Exporter and importer risk

A forfaiter will generally examine the competence, credibility and credit-worthiness of theseparties to a forfaiting transaction only very superficially, since he will very seldom have needto revert to them because of a problem. To the extent that the exporter or importer is knownto him from previous dealings, or from general reputation, any specific steps that he needtake to check them out will be further reduced.

4. Currency risk

The forfaiter needs to maintain an up-to-date list by currency of all his forward currencycontracts by maturity period.

5. Collection risk

The interest-rate risk report and the foreign currency contract list together provide theforfaiter with most of the cash-flow information he requires to minimize the risk of lack of liquidity.

PROBLEM OF INVESTMENT IN FORFAITINGPAPER

The on-selling of forfaiting obligations is beset with problems which restrict the number of potential buyers. An important consideration in forfaiting is the degree of confidence that can

be placed in the forfaiter himself (the investor, through his without recourse purchasebecomes a forfaiter). One must remember that it is possible in law to claim upon the issuer of a bill of exchange, even when recourse is excluded by a separate document. The seller of aforfaited obligation must therefore be sure that in case of default the buyer will not claimupon him and is able to withstand such a capital loss. The principle that forfaiting stands orfalls by the trustworthiness of the forfaiter can therefore never be emphasized enough.

A further criterion, already discussed, concerns the financial capacity of the investor.Forfaiting usually involves large sums, even when dealing with a single bill taken from a

series. To maintain a prudent spread of risks, such an investment should constitute only afraction of the investors total funds in order to keep exposure within limits and avoidexcessive build-up of concentrated risk.

An added difficulty with the on-selling of forfaited obligations or subparticipations lies in thereluctance of parties involved in the transaction to let others know the source of thisfinancing.

It is hardly surprising that an exporter would take a dim view of being approached by abroker in relation to some already existing business association he might have acquiredthrough forfaiting. Nor are exporters overjoyed to discover that obligations they have sold are

circulating in a market which they can neither supervise nor influence in the slightest way.


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The exporters house bank, through which the whole documentation is normally passed, may likewise be concerned, firstly, that this on-selling of the paper may become known to theexporter, and secondly, that a forfaiter may attempt to establish a relationship with theircustomer, with a view to dealing directly with him in future transactions.

Furthermore, the guarantors of a transaction often attempt to stop trade paper from cominginto the forfaiting market.

The negotiability of such obligations is restricted or excluded by clauses in the contract andguarantee which render the paper virtually non-transferable. Ways round such restrictions,such as undisclosed assignments and fidcuiary handling of the paper by the legally-recognised beneficiary, cannot be recommended in most cases, since the buyer takes on aconsiderable additional legal risk without receiving appropriate compensation for it.

Investments in Forfaiting Paper

The buyer of such obligations enjoys certain important advantages which balance the loss of actual delivery of the paper:

- The fiduciary administration of the documents is normally free of charge. The forfaitertakes care of collection and related responsibilities without deduction of charges for himself (fees charged by third parties must, however, be met by the investor).

- The forfaiter checks the documentation and, to the extent of confirming it to be in order,takes responsibility for its validity.

The problems of on-selling paper demonstrate the fact that reputable forfaiters are attuned toa forfaiting market which will function well in future, and do not aim to promote brokerage inthis area, or to pass on risks with the greatest haste, without taking on any risk themselves.

Important Criteria for Investment in the Forfaiting Market

Investment in forfaiting paper cannot be categorised with simple purchases of securities onthe stock market. Owing to the volume of business transacted, the forfaiting market is toosmall and only available to a few professional forfaiters. Investment in this paper isfurthermore made with the intention of keeping such obligations in portfolio until maturityand allowing, if necessary, investors to participate in them. Forfaiting is not suitable for

brokering, which brings the dealer fast risk-free

forfaiting merely as a vehicle for business which brings the dealer fast risk-free profitswithout any commitment, through a high turnover of purchases and sales. It is contrary togood faith if an institution claims to buy receivable for its own account with the intention of selling them subsequently to a third party.

Attractive of Investments in Forfaited Paper

The most important criteria for capital investment are undoubtedly fulfilled:

- The yield of such paper exceeds that obtainable in the fixed-rate securities markets forsimilar terms and currencies.


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- The risk or security through first-class bank guarantees is as goods as, and in many casesbetter than that normally accepted by investors. A prerequisite for the investor is that hemakes himself familiar with the pecularities of this form of investment in order to avoidunexpected disillusionment brought about by misconceptions.

Business Policy of Forfaiters

Because of the problems mentioned above, reputable forfaiters (amongst them Finanz AGZurich and Finanz AG London) have developed a commercial policy which places thegreatest emphasis on serving the interest of all parties to a forfaiting transaction.

- The sellers of forfaitable obligations, including banks, are protected in the sense that theforfaiter usually neither passes on the name of the exporter to third parties nor approacheshim directly for future transactions.

- Exporters can assume that documents representing contractual undertakings on their partwhich they have forfaited, will not under normal circumstances appear on the market but willremain with the forfaiter.

Larger transactions are carried out on a syndication basis, or are subparticipated to primeinvestors. It is only very rarely that promissory notes are on- sold with the without recourseendorsement.

FORFAITING - COMPARISON WITH EXPORT BILL DISCOUNTING

BILLS DISCOUNTING FORFAITING

A. RISK FACTOR

Under discounting the Indian banks (whodiscounts the bill) has recourse to theexporter. Thus in effect the cross borderpolitical and other commercial risks areborne by the exporter.

In sharp contrast the forfaiting agency hasno recourse to the exporter.

To cover himself from the above

mentioned risk, the exporter has to insurethe receivable (thru ECGC) without whichthe banks are not ready to discount thebills. This adds to the cost of the exporter.

Under forfaiting insuring the receivable

are not required and hence the exportersaves the insurance costs.

B. CREDIT PERIOD

The exporter can extend credit to hisbuyer for a maximum period of 180 days

Under forfaiting the exporter can if neededby the buyer extend credit even for morethan 180 days (1-2 yrs) . Even projectexports requiring 7-8 yrs credit can be

forfaited.


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C. DOCUMENTATION

Documentation involved underdiscounting is troublesome as the exporter

has to submit documents as per L/C termswhich gives rise to frequent discrepancies

Documentation is comparatively far easierand simpler.

D. FUNDING LIMIT

The exporter cannot discount bills overand above the limit set up by his bankers.

Forfaiting acts as an additional source of funding and hence does not have anyimpact on the exporters borrowing limits.

E. EXPORTS TO HIGH RISK COUNTRIES.

Discounting export bills to high risk countries like African countries orcountries like Russia is very difficult

Export bills to high risk countries can alsobe forfaited by paying a higher discountfee.

TYPES OF CONTRACT COVERED

Forfaiting evolved from the need to finance the export of capital goods, but can today be usedfor all the following different types of contract.

1) Export of goods from one country to another

The goods may comprise commodities, capita; euipment,spare parts or services.Indeed,forfaiting can be used to finance every thig including raw materials,aircraft, enginesand even footballers!

goods can be sourced from an y country as, unlike export credit agencies.forfaiters face norestrictions concerning the orogin of the goods.

2) Internal transactions

Forfaiting is still applicable even when an export does not take place and the goods are soldto another entity in the sellers country.

3) Project finance

With credit periods considered of upto 8 years. forfaiting has been used to finance manyprojects, including , for example, a civil engineering contract in Turkey and an irrigationsystem in Africa.

4)Pre export finance

A typical example would be the sale of soya beans by a company in South America to avariety of commodity traders in Europe. We can provide pre-shipment finance to enable the


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seller to purchase hte soya-beans from the local farmers. finance can be arranged to cover theperiod between the purchase of the goods and the eventual receipt of funds from the buyers.

5) Working Capital finance

Where the purpose of the funds is definable, forfaiting can be used for working capitalfinance, such as the construction of a hotel. This method is frequently used in Turkey and theFar East.

The other type of contracts which can be covered are as follows

a). Capital goods

b). Consumer Durables

c). Bulk drugs

d). Gems & Diamonds

It can be helpful to Public sector units like STC,MMTC etc. because they follow the systemof Channelised Exports i.e. few Commodities like sugar,cotton, jute etc.are being restricted toexport by the Government of India and can be exported by this trading corporations only.Sothey can export to high risk countries and get their money refunded with out any loss.

FORFAITING - LIMITATION

I. An exporter unable to fix forfaiting cost until he receives firm quote. If sometime has elapsed since the exporter taking indicative quote, the firmquote could be significantly different due to changed perception of the countryrisk.

II. The minimum size of the transaction for forfaiting, internationally has to beat least US$ 250,000/- (RS. 87.5 lacs). However, to adapt to the Indiansituation minimum size of $ 100,000 - $ 150,000 could be tried.

III. The exporter, sometimes unable to pass on full cost of forfaiting to thebuyer 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.


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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.

WHY IS FORFAITING NOT PICKING UP IN INDIA ?

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

1. Depreciating Rupee :- A major drawback for Forfaiting not picking up in India isthat Rupee is depreciating continuously as a result of which the exporters get thebenefit by not converting the receivables into Rupee they get better gains. Every sixmonths make that 30/ 35% of exports receivable are due.

1. E.C.G.C. cover not provided :- As a E. C. G. C. cover is not needed in the followingtransaction 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 toprovide creditworthiness of the buyers over-seas and as a result, It becomes verydifficult for E. C. G. C. to judge. In case of some countries like Vietnam, Iran theconduct of trade becomes very expensive,therefore to make the option more attractiveand safe for the exporter, the arrangment of forfaiting needs a review. E. C. G. C.must be able to provide some cover to the exporters for intervening uncovered periodrisks.

1. 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 actlike negotiable instrument act.

1. Quantum of Export :- The minimum size of a forfaiting contract should be $ 100000 million and that is not possible in a country like India. There are many smallexporters with deals worth

50000 $ U.S.Dollar but cannot go for forfaiting. The transactions of the minimumamount is a complsion.

1. Guide Lines by RBI :- No guidelines has been provided by RBI till date, except forcircular no.3 which mentions that Exim is permitted to undertake forfaiting. All thedocumentation

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

improve the export credit limit above 180 days. There is a lack of full fledge legalframe work on the part of RBI.


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1. Lack of Awareness among Exporters/Bankers :- There is a lack of awarenessamong exporters and Bankers about forfaiting, very few are aware and they are notkeen to take up the business due to some reasons or the others.

1. Lack of Expertise and Knowledge :- There is not much expertise in this areabecause nobody is aware of forfaiting. EXIM has taken a few steps by educating someof the bankers and by giving lectures to the bankers trainning staff camp. But themajor disadvantage is that the person who is aware of this term thoroughly getstransferred to another job very soon. The required quality staff is not there to operatesuch sophisticated servicies.

1. Trustworthiness on the part of banker overseas :- There should be properinformation available about the trustworthiness on the part of banker overseas becausethe importers banker may accept the bills but it should be acceptable by the forfaitingagency. The agency has to receive money and would not to go in few certain bankersguarantee whom they dont consider worthit because sometimes, even letter of creditis not cleared & even the foreign banks default.

1. Re/Dollar Parity :- The rupee is available at a concessional rate as a result forfaitingcannot take place because the forfaiting transaction gets completed with theacceptance by the banker and takes time to finish the same and hence the rupee mayfurther depreciate in the same time.

1. Role of RBI :- No Guideline has been provided by RBI because exporter in Indiarequire RBI permission and if RBI issues any guidelines the exporter feels that themarket is regulated and they do not want to enter.

1. Cost of Funds is High :- Export to countries like Iran, Africa is not possible due tothe high amount of risk prevailing in this countries. As a result the premium fordiscounting may go upto a max of 20% as compared to other countries & which isvery expensive for a normal forfaiting transaction.

1. Availability of agency offering such services :- There are very few agencies whichoffer this option. In India. EXIM Bank has got the monopoly to undertake thistransactions.

1. 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 dueto lack of awareness & many such other reasons.

1. Exchange control to be relaxed :- The Exchange control is neede to be relaxedbecause the cost of Forfaiting is very much dependant on the exchange rates so theyneed to be stabilised.

1. Forward cover cannot be taken :- The forward cover can be taken only till the dateof receivable of payment by the exporter and hence the exporter may loose itspremium for the remaining period which it would have got in case of a post shipmentcredit.

Premium 13% received


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Post shipment credit upto 90 days 13%

above 90 days 19%.

hence, the cost of finance may only be 6% , in this case where as in forfaiting, itsminimum cost will be 8%.

1. Credit not beyond 180 days :- Forfaiting can be useful for those contacts for whichthe payment is to be received for more than 180 days. Otherwise it may becomeexpensive for the exporters

1. Cost of Finance to be borne by importer :- The cost is included in the contractamount and the importer should be ready to pay the cost. The cost should be borneequally by the exporter & the importer.

1. Secondary Market Operations :- For forfaiting to become successful, existence of secondary market is an essential pre-requisite this is because a forfaiter may not beinclined to hold the discounted bills/notes upto maturity date because his own fundsare gettting blocked. The forfaiter may buy or sell such papers in the usual manner of tradable securuties.However, every transaction in the sec-market is done on withoutrecourse basis i.e. the holder of the paper can go to the guarantor & not the previousowner or to the exporter.

1. FERA Regulations:- Possible amendment in Foreign Exchange Requation Act 1973in terms of documentation, procedural mechanism the liability of the exporter torealise the export proceeds.

1. Resource Mobilisation :- Resources are mobilised in more efficient manner becausein case of forfaiting the money is refunded with in a short span and so the exporter isable to utilise its funds more efficiently by going in for more production and vice-versa .

1. Cost of Finance Not Known :- In forfaiting the major problem is that the cost of finance is not known like in the case of Pre-Shipment Credit Finance,Post-ShipmentCredit Financesch, which is 13% & 19% respectively. In forfaiting the cost variesaccording to the political certainity & the Bank Co-accepting the bills of the importerhence the cost varies from transaction to transaction as a result a fixed rate of finance

is not know to the exporter, he has to ask for a quote and decide its shipments basedon the quotes.

VIEW OF EXPORTERS

1. Exports to Highrisk Countries not possible :- E.C.G.C. provide cover to only thosecountries which are poiticallly & commercially sound. Countries like Iran, Africa,Malaysia, Thailand are not politically sound and hence even if the cover is providedby E.C.G.C. it is not for the full amount. It covers only a part of receivables as a resultthe cost goes high & it becomes difficult difficult to export to such high risk countries.

2.

Export credit of max 180 days :- As per the rules laid donw by RBI the credit givento the overseas buyer should not exceed a maximum of 180 days and if it does it


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stands as outstanding in the books. Only in case of capital equipment which involvesa high cost a special permission is given by RBI to extend the credit limit and that tooafter following the guideline issued by it.

3. Documentation :- Documentation in the normal framework involves a lot of paperwork and which makes the job of Exporter very difficult.

4. No Problem in collection of debts :- The exporters had no problem in the collectionof debts because they exported only to the parties with whom they have been dealingin past,and any problem with regards to the goods was solved mutually. So they neverfaced any problem as regards to the collection of debts and didnot have any bad debts.

5. Limited Export Turn Over :- The exporters could not export anything more beyonda certain limit because of limited liquidity availability as a result of which they werenot in a position to roll over the money. They exported only twice or thrice in a yeardepending upon the time of receivable of money. After they get the money theyproduced goods.

6. Cash rich countries :- Cash rich countries were of the view that they never had onlyproblem as regards to the collection of debts. They exported to their counter partsoverseas so they had

no problem as well as for a cash rich company to 1% here and there makes nodifference. Thus companies exporting to its counter part didnot require any kind of credit.

7. Lack of awareness :- There is a Lack of awareness among the exporters aboutforfaiting. Majority of them were not aware and did not know that such a conceptprevailed. They were not able to break the mind frame of 180 days credit & hence.more and more people used to be educated about the same.

8. With recourse export :- The exports in India is always with recourse to the exporterand hence the entire risk is passed on to the exporter. Incase of any problem by theoverseas buyer it may reflect the exporter & hence the exporter not very keen toexport.

9. L/C Backed Transactions :- Majority of the transactions are L/C backed & if theyare not backed by L/C i.e. on non L/C basis they either go for usance bill,demand bllor sight bill as a result the exporters are not worried about their payments even if thetransaction is a non L/C.

FINDINGS OF SURVEY

A survey was conducted of about 10-12 exporters varying from 5 crores -150 crores. Thusmainly exported to politically & commercial sound countries like USA, Germany, Singapore,Hong Kong, Europe, Japan, France, Hungary, Italy, Mauritius, Taiwan, Phillipines etc. Theproportion of their total export turnover varied from 20% to 100% but majority of thecompanies had nearly 50% of their export turnover on credit & the credit terms were 3-6months, minimum 3 months & maximum 180 days. The exports were normally backed byL/C and if not L/C the export were made to counter parts abroad or relation with the overseasparty was good. The experiece of payments of bills on due date was prompt. The exporternever had any problem in their collection of debts. There were sometimes delay in paymentbut only due to political uncertainity and it is a rare phenomenon. The proportion of creditsales that were bad debts were nil. They never had any bad debts. The answer about anoutside agency helping in the collection of debts was a pure denial on their part and were of

project report.docx forfaiting

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