Exporters in emerging markets are increasingly adopting forfaiting to boost their working capital so that they can export more – and reduce counterparty risks. Liz Salecka reports.
Although forfaiting has been available on a global basis for several decades, today it is witnessing some of its greatest traction in emerging markets, where corporates need access to affordable liquidity outside their core banking relationships.
While Asian companies, led by Chinese exporters, are becoming prime users of forfaiting to boost their working capital and finance growing volumes of exports, there is also growing interest in other developing regions.
Simon Lay, managing director of the London Forfaiting Company, identifies strong demand for traditional forfaiting from exporters in emerging markets in Asia, Africa and the Middle East.
“In reality, the markets where forfaiting remains popular are those which have limited access to, or are currently developing their presence in, the more sophisticated international debt finance markets,” he says. “Africa and China remain important users of traditional forfaiting, driven by a combination of lack of availability – or the high cost – of local funding.”
Asia leads the way
Aside from China, forfaiting is now also becoming more widely accepted in Indonesia, India, Singapore, Korea and Taiwan.
“There are two reasons why they are using the forfaiting model – one is to cover counterparty risk and the other is to get early access to funds – thus helping them to more effectively manage their working capital,” says Luiz Simione, global head of forfaiting and risk distribution at HSBC.
“Asia is now witnessing the fastest growth in forfaiting from a small base and this type of financing is now becoming much more widespread,” adds Ashutosh Kumar, global head of corporate cash and trade at Standard Chartered. Kumar notes that aside from letters of credit-based transactions there has been a huge amount of forfaiting where the underlying instruments are bills of exchange.
He explains that global banks are the main providers of forfaiting, but that local banks in countries like China, India, Malaysia and Singapore now also offer this type of financing.
“For banks, one of the biggest advantages of forfaiting is that there is a good secondary market – and this automatically creates a larger and wider market,” he says. “As banks can offload these transactions to other banks and take them off their books this makes the market much more robust and the pricing is very competitive.”
Similarly, Silja Calac, head of trade risk management at UniCredit and an International Forfaiting Association (IFA) board member, acknowledges growing demand for forfaiting in Asia – mostly driven by China. The IFA held an educational seminar on forfaiting in Shanghai in June in which approximately 100 trade financers from Chinese member banks took part.
“A number of Chinese banks are keen to explore different ways of supporting their customers’ export activities and are particularly interested in forfaiting,” she says. “Many of them have recently joined the IFA and the North Asia Regional Committee has become one of the most active in the Association.”
However, emerging markets in both the Middle East and Africa are also witnessing increased take-up.
Calac identifies demand for forfaiting products in the Middle East, where there is considerable product expertise because trade finance falls in line with the way of doing business in this region. “There are several projects underway in the Middle East for which liquidity needs to be released. But more importantly, banks in the Middle East dispose of liquidity and are thus very active investors in the secondary market,” she says.
The Middle East and Asian experience with forfaiting is also now rubbing off in Africa. HSBC’s Simione explains that North African countries have strong trade links with the Middle East, where the use of traditional trade instruments and forfaiting is increasing. Forfaiting is therefore drawing businesses’ interest in this region too.
Meanwhile, Sub-Saharan African countries are increasingly engaging in trade with Asia, where traditional documentary credits and forfaiting are also widely used. “Asian companies are now referring to forfaiting as a ‘new’ alternative financing mechanism to their African trade counterparts,” says Simione.
“Over the last year, corporates in emerging markets have continued to be strong users of forfaiting. Especially interesting is a relatively recent trend in African markets such as Angola, Ethiopia and Nigeria, where we did not typically see this level of demand before,” says Calac. There are several large projects in these countries today which require major investments and this is driving the need, she explains.
Although forfaiting is relevant to open trade account financings, it has really come into its own as a financing solution for trade transactions backed by letters of credit and other types of guarantees.
“Forfaiting transactions are typically evidenced by assignment of letter of credit proceeds, bills of exchange, promissory notes and bilateral and syndicated loan agreements,” says Lay at LFC, pointing out that the type of documentation used varies from one market to another.
“In Russia and Turkey, local banks will often seek to refinance their clients’ imports through bilateral loans. In African countries, meanwhile, banks continue to issue deferred payment letters of credit in support of imports, leaving the financing to be arranged by the exporter through its bank or a forfaiting house.”
Exporters in emerging markets are the biggest users of guarantee-backed forfaiting products for a number of reasons including their ongoing dependence on traditional trade finance instruments and, in many cases, the obligation to use them.
“In western countries it is easy for claims to be enforced on open account transactions, but in regions such as Africa there is limited open account financing and transactions need to be backed by trade instruments,” says Calac. In some countries, open account transactions are not even permitted to be financed by non-resident banks.
Since the start of the year, UniCredit has seen a 9% increase in overall forfaiting activity, including corporate receivables (open account), and a 14% increase in forfaiting where transactions are backed by guarantees such as letters of credit, compared to the same period last year. The bank’s forfaiting portfolio is now split 40:60 between direct forfaiting and guarantee-backed forfaiting.
Calac explains that one of the advantages of forfaiting where traditional trade instruments are involved is the cost. “When transactions are on open account a company typically arranges financing against its assets for a period of time from its own local bank, which can be more expensive – especially for companies in emerging market economies.
“If a transaction is backed by a trade finance instrument which can be bought and sold, liquidity can be arranged with a different investor at better pricing,” she says.
“Corporates do not always have access to competitively-priced funding in emerging markets,” adds Simione. “Forfaiting could be of great use to them – but different solutions are available and much depends on individual corporate needs.”
Taking forfaiting forward
While there may be variations in the precise definition of forfaiting, it has developed over the years to embrace a wide range of products where financing is arranged on a non-recourse basis.
Simon Lay at LFC explains that forfaiting evolved into its ‘classic’ form – the discounting of international trade receivables on a without-recourse basis – during the 1960s, when the economies of Eastern Europe needed to finance their imports of capital equipment from Western Europe.
“In order to remain relevant and competitive, financial institutions had to progress beyond the traditional forfaiting business of discounting international supplier credit trade receivables on a without-recourse basis to incorporate a much wider range of trade finance products. These are gathered collectively under the ‘forfaiting’ banner,” he says.
This is also acknowledged by the International Chamber of Commerce (ICC) in the Uniform Rules for Forfaiting (URF) 800: “Modern forfaiting has evolved considerably over the last 20 years and now encompasses many more instruments, structures and concepts.”
However, there is still a general consensus among providers of forfaiting services that greater efforts are needed to encourage more widespread adoption of forfaiting globally.
“Much more can still be done to promote corporate awareness and acceptance of forfaiting by both banks and regulators, including making it simpler for companies to obtain this type of financing,” says Ashutosh Kumar at Standard Chartered. “Banks are happy to offer instruments that help to support trade flows – this is important because it leads to economic growth. However, the widespread acceptance of forfaiting will vary from country to country in line with the evolution of their supply chains.”
There are also calls for a greater emphasis on ironing out any irregularities in the precise definition of forfaiting in different parts of the world.
Luiz Simione at HSBC explains that the adoption of a consistent terminology for forfaiting across regions is very important in order to comply with the regulatory and legal framework in different jurisdictions.
“We need to pursue a common definition that is globally consistent – and the market as a whole then needs to adopt this definition – although we are conscious about the complexity involved to achieve this. The definition also needs to be supported by the legal framework that prevails in each and every jurisdiction.”
He adds: “Corporates rely on the forfaiting contracts they enter and match them against the local regulation that prevails in their jurisdiction: if the local legislation is different this can create a dilemma.”
The need for a common global definition is also acknowledged by Silja Calac at UniCredit, who is chairperson of the ICC URF task force and a member of the Global Supply Chain Finance Forum drafting group.
“In order to make forfaiting more acceptable we need more transparency and standardisation. The Uniform Rules for Forfaiting are available but few banks have yet adopted them – this can take time,” she says.
The Global Supply Chain Finance Forum, which brings together six major associations involved in trade finance including the IFA, the ICC, Bankers Association for Finance and Trade, Euro-Banking Association and the two major factoring associations (Factors Chain International and International Factors Group), is seeking to address these needs by drafting definitions for the different types of trade finance products available.