Clearer definitions of forfaiting are being developed to make it easier for people to answer this question and understand forfaiting’s risks and opportunities. Sofia Lotto Persio reports.
Any conference with a session on supply chain finance (SCF) will invariably invite the speakers to upload a PowerPoint slide with a definition of the term – a challenging task due to the number of instruments to consider and the lack of a standardised common reference.
This may soon change, as a coalition has come together to define SCF in all its forms. The International Chamber of Commerce (ICC), along with the Bankers Association for Finance and Trade (BAFT), Factors Chain International (FCI), Euro Banking Association (EBA), International Factors Group (IFG) and International Trade & Forfaiting Association (ITFA) have joined the effort to create SCF definitions once and for all.
Forfaiting is described by the Global SCF Forum’s draft publication released in June this year as “a form of receivables purchase, consisting of the without recourse purchase of future payment obligations represented by a negotiable or transferrable financial instrument or claim, at a discount or at face value in return for a financing charge”.
Sean Edwards, head of legal at SMBC and ITFA’s Chairman, is one of the people involved in the drafting process. He explains that, with the development of the new definition, his intention has been to show that forfaiting is very much part of SCF techniques, and a very important instrument for managing trade receivables. “What I wanted to draw out was the wide variety of underlying instruments that could be used with forfaiting. Where forfaiting and factoring start to blur together is in the discounting of book or invoice receivables. Traditionally it was hard for a pure forfaiter to do this without recourse, as book receivables contain contract performance risk, and a factor would traditionally have had recourse in those situations. If you can amend the terms of the receivable, however, so that it is unconditional, then you can purchase a book receivable or invoice without recourse,” he tells GTR.
Edwards adds that while usage of SCF instruments is on the increase, it has become less easy to ascertain which category they fall under, particularly in emerging economies where forfaiting, factoring and receivables discounting often merge into one another in some hybrid forms. He mentions as examples: short-term loans accompanied by standby letters of credit; bank payment obligations (BPO) forfaited between recipient and obligor banks; and banks under a supplier finance arrangement selling an obligor’s irrevocable payment undertaking as a separate instrument into the forfaiting market.
Professionals in the forfaiting market, however, warn against restricting the definition to too narrow a meaning. “The key unique selling point of forfaiting is that it is a very flexible product which can be tailored to the client’s requirements,” says Simon Lay, deputy CEO of Fimbank. “Forfaiting is a word people use, but it covers different meanings for different institutions. The forfaiting entities, those who provide the services, tend to be those that have a structure which allows them to give quick, flexible financing solutions to the client. The client does not really want to know what you are going to call the financing technique, he just wants to know you can finance that contract for him in an efficient way,” he adds.
Edwards acknowledges that there is a certain overlap between the definitions of forfaiting, factoring and receivables discounting: “There is a lot of common ground between all three techniques and I think that one of the big benefits of the definitions is to set out the commonalities and differences in one document. From that more effective hybrid, structures and arrangements may become apparent and be created, which will assist innovation.”
The draft of the SCF definitions is available online for feedback, with the release of a final version expected by the end of the year.
According to Lay, it is now the banks’ responsibility to ensure these are enforced. “The rules will only become fully adopted when banks apply them in their regular dealings with each other, rather than adopting a ‘wait and see’ approach.”
Commenting on the forfaiting definition itself, he says: “Although this is a new definition, it really gives a very traditional explanation of forfaiting but also adds the interpretations of the universal rules for forfaiting (URF 800). Whilst a lot of effort has been put in producing these rules, they are still not a major component in discussions between primary and secondary market participants. Forfaiting tends to operate under fairly traditional customs and practices. However, the rules serve as a useful reference document to interpret such practices and to give structure and guidance in any dispute.”
Creating awareness in emerging markets
Associations such as ITFA are doing their part to promote awareness of forfaiting and its rules. Adding to its historical partnerships with the ICC, BAFT, the Asian Development Bank and the European Bank for Reconstruction and Development, ITFA signed an agreement with Afreximbank in April 2015 to promote best practices, attract non-bank funding and develop a primary and secondary market for African-traded debt papers, among other initiatives.
It is believed that having clearer definitions of SCF instruments would increase not only the awareness but also the availability of different trade finance products in emerging markets. “It will make it easier for people to do transactions, especially for banks in Africa,” says Benedict Oramah, Afreximbank’s incumbent president. “It makes it easier for them to adopt it, and the common language of risk would be accepted by everybody. Without this you have problems. We see it ourselves because people may not understand trade finance risk, or the difference between conventional trade financing and forfaiting.”
Sean Edwards, head of legal at SMBC and ITFA’s Chairman, is one of the people involved in the drafting process. He explains that, with the development of the new definition, his intention has been to show that forfaiting is very much part of SCF techniques, and a very important instrument for managing trade receivables. “What I wanted to draw out was the wide variety of underlying instruments that could be used with forfaiting. Where forfaiting and factoring start to blur together is in the discounting of book or invoice receivables. Traditionally it was hard for a pure forfaiter to do this without recourse, as book receivables contain contract performance risk, and a factor would traditionally have had recourse in those situations. If you can amend the terms of the receivable, however, so that it is unconditional, then you can purchase a book receivable or invoice without recourse,” he tells GTR.
Edwards adds that while usage of SCF instruments is on the increase, it has become less easy to ascertain which category they fall under, particularly in emerging economies where forfaiting, factoring and receivables discounting often merge into one another in some hybrid forms. He mentions as examples: short-term loans accompanied by standby letters of credit; bank payment obligations (BPO) forfaited between recipient and obligor banks; and banks under a supplier finance arrangement selling an obligor’s irrevocable payment undertaking as a separate instrument into the forfaiting market.
Professionals in the forfaiting market, however, warn against restricting the definition to too narrow a meaning. “The key unique selling point of forfaiting is that it is a very flexible product which can be tailored to the client’s requirements,” says Simon Lay, deputy CEO of Fimbank. “Forfaiting is a word people use, but it covers different meanings for different institutions. The forfaiting entities, those who provide the services, tend to be those that have a structure which allows them to give quick, flexible financing solutions to the client. The client does not really want to know what you are going to call the financing technique, he just wants to know you can finance that contract for him in an efficient way,” he adds.
Edwards acknowledges that there is a certain overlap between the definitions of forfaiting, factoring and receivables discounting: “There is a lot of common ground between all three techniques and I think that one of the big benefits of the definitions is to set out the commonalities and differences in one document. From that more effective hybrid, structures and arrangements may become apparent and be created, which will assist innovation.”
The draft of the SCF definitions is available online for feedback, with the release of a final version expected by the end of the year.
According to Lay, it is now the banks’ responsibility to ensure these are enforced. “The rules will only become fully adopted when banks apply them in their regular dealings with each other, rather than adopting a ‘wait and see’ approach.”
Commenting on the forfaiting definition itself, he says: “Although this is a new definition, it really gives a very traditional explanation of forfaiting but also adds the interpretations of the universal rules for forfaiting (URF 800). Whilst a lot of effort has been put in producing these rules, they are still not a major component in discussions between primary and secondary market participants. Forfaiting tends to operate under fairly traditional customs and practices. However, the rules serve as a useful reference document to interpret such practices and to give structure and guidance in any dispute.”
Creating awareness in emerging markets
Associations such as ITFA are doing their part to promote awareness of forfaiting and its rules. Adding to its historical partnerships with the ICC, BAFT, the Asian Development Bank and the European Bank for Reconstruction and Development, ITFA signed an agreement with Afreximbank in April 2015 to promote best practices, attract non-bank funding and develop a primary and secondary market for African-traded debt papers, among other initiatives.
It is believed that having clearer definitions of SCF instruments would increase not only the awareness but also the availability of different trade finance products in emerging markets. “It will make it easier for people to do transactions, especially for banks in Africa,” says Benedict Oramah, Afreximbank’s incumbent president. “It makes it easier for them to adopt it, and the common language of risk would be accepted by everybody. Without this you have problems. We see it ourselves because people may not understand trade finance risk, or the difference between conventional trade financing and forfaiting.”
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