Forfaiting explained: mechanics and documentation

Forfaiting is the without recourse purchase, at a discount or at face value against a financing charge, of future payment obligations arising from an export of goods or services. Those obligations are evidenced by negotiable or transferable instruments such as bills of exchange, promissory notes, letters of credit or related payment claims. The forfaiter takes on the credit, country and transfer risk attached to the claim, subject to limited reserved recourse events set out in the trade documentation. The forfaiting glossary term covers that basic definition; this article works through the primary and secondary market mechanics, the without recourse structure and the documents a forfaiting trade actually runs on.

Definition and instruments

The International Trade and Forfaiting Association describes forfaiting as a form of receivables purchase consisting of the without recourse purchase of future payment obligations represented by financial instruments or payment obligations, normally in negotiable or transferable form, at a discount or at face value in return for a financing charge. Typical underlying paper includes bills of exchange, an unconditional order in writing addressed by the exporter to the importer, and promissory notes issued by a buyer promising to pay the seller at a future date. Both forms are usually transferable by endorsement unless the instrument itself prohibits it.

In export distribution, forfaiting often monetises medium term supplier credit granted by the exporter to the buyer: the exporter delivers goods, receives notes or accepted bills, and sells those claims to a forfaiter for cash. A buyer credit loan follows a different institutional path, since the bank lends directly to the overseas buyer rather than purchasing the exporter's receivable, though both can finance the same underlying capital goods export.

URF 800 and the governing rules

Forfaiting trades are increasingly documented under the ICC Uniform Rules for Forfaiting, published as ICC Publication 800 and known as URF 800. URF 800 has been in effect since 1 January 2013, developed jointly by the International Chamber of Commerce and the forfaiting industry association now known as ITFA, to give the market its first common contractual rule set. The United Nations Commission on International Trade Law endorsed URF 800 at its fiftieth plenary session in Vienna on 14 July 2017, an endorsement the ICC cites as encouragement for wider use of without recourse financing of international receivables.

URF 800 applies only when the parties to a trade expressly state that their agreement is subject to it. Once incorporated, the rules cover forfaiting agreements and conditions in the primary market, forfaiting confirmations and conditions in the secondary market, satisfactory documents, payment and payment under reserve, and the allocation of liability between sellers and buyers of the claim. The published rules run to fourteen articles with annexed model agreement and confirmation forms, so that a bilateral trade does not need bespoke drafting each time.

Primary market mechanics

In the primary market, the exporter or another initial seller agrees trade date terms with a primary forfaiter: the payment claim to be purchased, the price, and the conditions and documents the forfaiter requires before it will settle. Satisfactory documents typically include the negotiable instrument itself, evidence of shipment or delivery, and any aval, guarantee or other credit support that the pricing assumed. Settlement follows once those conditions are met and the documents are delivered in the agreed form.

Secondary market mechanics

A primary forfaiter, or a subsequent holder of the claim, can sell it on to another buyer through a forfaiting confirmation, which is how the secondary market provides liquidity to the asset class. URF 800 standardises the timing and content of that confirmation and the document delivery that goes with it, so that a bank buying a claim from another institution is not reinventing the transfer contract for every trade. Payment under reserve provisions let settlement proceed while a specified documentary defect is being cured, allocating the interim risk expressly in the rules rather than leaving it to be argued after the fact.

Without recourse scope and pricing

Without recourse in forfaiting means the forfaiter accepts the risk of non-payment on the claim once the agreed conditions are satisfied. It does not extend to fraud, forged instruments or misrepresentation, which typically remain reserved recourse events against the seller. Bank avalisation or confirmation on the instrument often drives pricing, because it lets the forfaiter look primarily to the avalising or confirming bank rather than to the importer alone. ITFA lists the resulting benefits as working capital optimisation for the exporter, financing raised against a strong buyer or bank credit rather than the exporter's own balance sheet, support for sales into markets where open account terms would not otherwise be available, and relief from ongoing collection administration once the claim is sold.

Where agency cover and buyer credit sit

An export credit agency may insure or guarantee the underlying supplier or buyer exposure that a forfaiting trade later purchases, and members of the Berne Union provide credit insurance products that can sit beside, or instead of, a pure forfaiting sale. Official cover and forfaiting remain conceptually distinct even where both apply to the same export: forfaiting is a purchase of a payment claim, while agency cover is an insurance or guarantee contract written against defined risks on that same underlying transaction.

Reading a forfaiting file

A forfaiting file built around URF 800 records which rules apply, the identity and ranking of the obligor and any avalising or confirming bank, the documentary conditions the primary trade was priced against, the reserved recourse events carved out of the without recourse sale, and any restrictions on further secondary market transfer. That combination, rather than the interest rate or discount alone, is what distinguishes a clean without recourse forfaiting purchase from a secured working capital loan that leaves the ultimate credit risk with the exporter.