Introductory Guide to Forfaiting

This comprehensive introduction to forfaiting will help you better understand this method of purchasing accounts receivable.

The guide explains what forfaiting is, its main characteristics, and how it works in practice; it includes diagrams and examples of transactions with and without forfaiting, so you can easily see the impact it has on international trade.

What is Forfaiting?

Forfaiting is a trade finance method in which a forfaiter purchases, without recourse, receivables arising from the supply of goods and/or services.

In the Glossary of Supply Chain Finance, forfaiting is defined as “a form of purchasing accounts receivable. The purchase without recourse of future payment obligations represented by negotiable or transferable financial instruments; at a discount or at face value in exchange for a financing fee“.

In a forfaiting transaction, the exporter agrees to assign their rights to receive payment for goods or services supplied to the importer under a sales contract in exchange for a cash payment from a bank or finance provider.

In exchange for the payment, the forfaiter assumes the exporter’s debt instruments and takes on all the payment risk of the importer. Thus, the exporter is relieved of any financial risk in the transaction and is responsible only for the quality and reliability of the goods and/or services provided.

Brief History

The word forfaiting comes from the French word “forfait,” meaning the transfer of rights to accounts receivable. For example, the exporter transfers their rights to accounts receivable to the forfaiter.

Forfaiting was initially developed in the 1950s in Switzerland. The original goal was to assist exporters of capital goods. While importers of capital goods wanted to defer payment until the capital goods were operational and thus paying for themselves, the exporter did not want to sell goods on open account terms.

What are the Key Features and Which Organizations Act as Forfaiters?

Forfaiting is a flexible discounting method that can be tailored to the needs of a wide range of counterparties in domestic and international transactions.

Its key characteristics are:

• 100% financing without recourse to the seller of the debt;
• The payment obligation is often, but not always, backed by a bank guarantee;
• The debt is usually evidenced by a legally enforceable and transferable payment obligation, such as a bill of exchange, promissory note, letter of credit, or debt purchase agreement;
• Transaction amounts can range from $100,000 to $200 million;
• Debt instruments are usually denominated in one of the major world currencies, the most common being euros and US dollars;
• Financing can be arranged on a fixed or floating interest rate basis;
• The discounted receivables can have maturities ranging from 6 months to 10 years;
• Quick deal execution;
• Tailored financial solutions;
• Simple documentation requirements;
• Relieves the exporter from administration and collection issues;

A forfaiter can be a specialized financial firm or a department of a commercial bank that provides non-recourse export financing by purchasing medium- and long-term trade receivables.

Recently, we have seen new players entering the market. These include asset managers, pension funds investing in this product, and specialized fintech companies that are showing a growing appetite for this asset class.

How Does Forfaiting Work?

Here are two step-by-step examples of how forfaiting works.

1. Forfaiting terms are agreed upon between the exporter and the forfaiter;
2. The importer and exporter agree to conclude a commercial contract to carry out the underlying transaction;
3. The importer instructs their bank to issue a letter of credit (LC);
4. The LC is issued to the exporter’s bank, which must be advised and/or confirmed by the importer’s bank;
5. The LC is issued to the exporter by the exporter’s bank;
6. The exporter ships the goods;
7. The exporter presents the shipping documents to their bank for acceptance;
8. The exporter’s bank sends the documents to the importer’s bank;
9. The exporter assigns their rights to the forfaiter;
10. The importer’s bank accepts the assignment of the claim;
11. The forfaiter discounts the letter of credit and pays the exporter;
12. Upon maturity, the importer’s bank pays the forfaiter;
13. The importer pays their bank;

1. Forfaiting terms are agreed upon between the exporter and the exporter’s bank, which in this case is the forfaiter;
2. A commercial contract is concluded to carry out the transaction;
3. The exporter supplies the goods;
4. The debt instruments are presented to the guaranteeing bank for avalization. Transactions are evidenced by negotiable debt instruments such as bills of exchange or promissory notes;
5. The avalized debt instruments are delivered to the exporter for acceptance;
6. The fully endorsed documents are delivered to the exporter’s bank;
7. The exporter’s bank pays the exporter the discounted value of the contract;
8. Upon maturity, the exporter’s bank presents the debt instrument to the guarantor;
9. The guaranteeing bank pays the exporter’s bank;
10. The importer pays their bank;

To visually illustrate how forfaiting works, here’s an example of what a transaction looks like with and without forfaiting.

Here’s what a typical foreign trade transaction looks like using a bank-guaranteed promissory note. The buyer and seller of goods are in different countries.

Step 1: A German automotive company (importer) and a Turkish auto parts manufacturer (exporter) agree on the product details, shipment, and payment terms, and decide not to use a confirmed letter of credit. However, since the importer still prefers to pay later, the exporter does not want to bear the payment risk of the importer and requests a bank guarantee in any form.

Step 2: The importer approaches a German bank, informs them of the details of their contact with the Turkish company, and issues a promissory note (P/N—a debt acknowledgment).

Step 3: The German bank avalizes the P/N.

Step 4: The importer sends the original P/N to the exporter.

Step 5: The exporter ships the goods according to their agreement.

Step 6: According to their agreement, the avalizing bank pays the net amount specified in the P/N to the exporter on the agreed date (December 15, 2021).

In this type of transaction, during the 6-month period, the exporter bears the risk of:

• The avalizing bank; risk of the German bank.
• The exporter’s country risk; risk of Germany.
• Currency fluctuation.
• Interest rate.
• Financing costs for further production during these 6 months.

Here’s what a typical forfaiting transaction looks like. The buyer and seller of goods are in different countries, and during negotiations between the exporter and importer for the supply of goods, the importer requests credit terms.

Step 1: The exporter approaches a forfaiter (this could also be a third-party commercial bank) and asks whether they will accept the risk of the German bank for 6 months and how much it will cost. At this stage, the forfaiter needs to know:

• The importer’s country.
• Basic information about the transaction (e.g., importer’s name, type of goods, value of goods, expected shipment date).
• The repayment terms requested by the importer.
• What format the bank guarantee will be in (LC, PN, BE, etc.).

Step 2: The forfaiter provides the exporter with information about the relevant costs.

Step 3: The exporter may ask the forfaiter to provide a commitment to discount the P/N. The forfaiter issues a commitment, which is accepted by the exporter and is binding on both parties. This commitment will include the following points:

• Details of the underlying transaction.
• The nature of the debt instruments to be acquired by the forfaiter.
• The applicable discount (interest) rate and any other costs.
• The documents the forfaiter will require to ensure the purchased debt is valid and enforceable.
• The latest date by which the exporter can deliver these documents to the forfaiter.

Step 4: In turn, the importer obtains a guarantee (this can be a promissory note, bill of exchange, etc.) from their bank; the German bank avalizes the P/N and provides the documents required by the exporter to complete the forfaiting.

Step 5: The importer sends the avalized P/N to the exporter.

Step 6: The exporter ships the goods according to the contract.

Step 7: The exporter endorses the P/N to the forfaiter and informs the importer’s bank of the endorsement.

Step 8: The German bank acknowledges the forfaiter as the new bona fide holder and confirms that on the payment date, payment will be made directly to the forfaiter, not the exporter.

Step 9: The forfaiter discounts the P/N and sends the net amount to the exporter’s account.

Step 10: On the agreed payment date, the German bank pays the net amount to the forfaiter.

In this transaction example, there are some clear advantages of forfaiting for the exporter:

• Since transactions are done without recourse, it eliminates political, transfer, and commercial risk of the importer;
• Protects the exporter from future increases in interest rates or currency fluctuations;
• Allows the exporter to offer longer payment terms while still receiving cash proceeds;
• Enables the exporter to do business in countries where country risk would otherwise be too high;
• No accounts receivable, bank loans, or contingent liabilities appear on the exporter’s balance sheet;
• No administrative and legal costs that usually accompany other financing schemes;
• The importer receives additional credit through forfaiting from the supplier/exporter.

Forfaiting vs. Factoring – What’s the Difference?

“Without recourse” means that the forfaiter assumes the risk of non-payment. Similar to factoring, forfaiting virtually eliminates the risk of non-payment after the goods have been delivered to the foreign buyer under the terms of sale.

However, unlike factors, forfaiters usually work with exporters who sell capital goods and commodities or participate in large projects and therefore need to offer extended credit terms ranging from 180 days to seven years or more.

In forfaiting, unlike factoring, the accounts receivable are usually guaranteed by the importer’s bank, allowing the exporter to remove the transaction from the balance sheet to improve key financial indicators.