Forfaiting emerges popular among UAE's trading firms

DUBAI — Forfaiting is emerging a major trade financing instrument in UAE's fast growing international and intra-regional trade, according to a senior executive from London Forfaiting Company, now a part of FIMBank Group.

By Babu Das Augustine (Assistant Editor)

Published: Sun 13 Aug 2006, 10:30 AM

Last updated: Tue 14 Nov 2023, 9:46 AM

The construction boom in the region and the growing volume of trade in capital goods such as construction equipment, heavy machinery and manufactured items through the country is expected to benefit from this method of trade financing.

In forfaiting, the importer's bank guarantees promissory notes or bills of exchange, which cover repayment of a supplier's credit, for a period from 180 days to seven years. The notes are initially given to the exporter at the time of shipment and become his property. The notes represent the commitment of the buyer and/or its bank to pay the notes at maturity. Once the exporter becomes the bona fide owner of the notes, he can sell them to a third party at a discount from their face value for immediate cash payment. This sale is without recourse to the exporter, and the buyer of the notes assumes all of the risks.

Forfaiting as a trade financing tool provides generic hedge against a host of trade related risks including payment risk, interest rate risk, exchange rate risks and political risks associated with trade related payments. Currently, more than $100 billion worth trade around the world are financed through forfaiting.

Forfaiting allows exporters to obtain cash and be free of all risks by selling their medium to long-term receivables on a 'without recourse' basis. It is a flexible product and can be modified to suit the exporters' requirements and allows them to receive up to full value of the exports shortly after delivery. Traditionally it has been an export financing tool, however, in today's context its scope has been extended to all trade related financing.

Forfaiting is normally sought against bills of exchange, promissory notes, book claims, letters of credit or a deferred payment. The buyer's obligation is usually supported by a local bank guarantee. Documentation includes evidence of underlying transaction such as bills of lading, airway bills, copies of shipping documents; and confirmations from the guaranteeing bank.

Suitable for small to medium-sized export transactions, with tenure of three months to 10 years depending on the discretion and risk perception of the banks (forfaiter). Under forfaiting, up to 100 per cent of the value of the transaction is financed and is available in all major currencies. While banks offer both fixed and floating interest rates.

Usually the forfaiter assumes the full risk of financing, thus the margins are variable, depending on the credit standing of the borrower, the guarantor and their countries of origin. Forfaiting is getting very popular with most exporters because it transfers almost all perceivable risks such as political, transfer and commercial risk, interest rate volatility and exchange rate fluctuations to the financing banks.

“Seamless cash flow is its key advantage. Forfaiting converts a credit-based transaction into a cash transaction and balance sheet is not burdened by accounts receivables, bank loans or contingent liabilities. Absence of insurance premium, effective vendor financing and ability to do business in riskier countries are some of its indirect benefits,” said a trade finance consultant with an international bank.

Compared to many other trade financing instruments, forfaiting is faster and its documentation is clearer and simpler. Depending on the country of origin, banks can issue commitment within hours or days.