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On Thursday, the International Chamber of Commerce (ICC) approved new Uniform Rules on Forfaiting (URF) to govern the international market, taking effect from January 1, 2013.
Essentially, forfaiting involves selling a bill of exchange without recourse. It frees the exporter from political or commercial risks. It does not affect his borrowing limits/capacity and relieves him from the botheration of credit administration and collection problems. It does not require a long-term relationship with the forfaitor and eliminates the need for export credit insurance.
Typically, the transaction involves an exporter who approaches a forfaitor, who collects details about the importer, supply, credit terms, documentation, etc, and after ascertaining the country risk and credit risk involved, quotes a discount rate. If this is acceptable, the exporter signs a contract with the forfaitor and after the export, sells his bills of exchange to the latter. The exporter saves on costs of interest, credit insurance and, sometimes, the letter of credit but still might find the discount rate unattractive. But he gets the convenience of selling the debt without recourse, unlike a post-shipment credit facility, where banks can recover the money from the exporter if the importer does not pay.
Invariably, there are counterparties with whom the forfaitor covers his risk, usually a bank which issues a letter of credit or guarantee or co-accepts the bill of exchange In very exceptional cases, the forfaitor may proceed with only the assurance of the importer. There is also a fairly developed secondary market, of transactions between banks and other financial institutions. However, standard disciplines had not evolved for forfaiting transactions and so, the ICC and the International Forfaitors Association collaborated to create new rules, suitable for modern practices.
ICC says the rules do not change the nature of the payment claim being originated or on-traded; these can be used with the full and ever-expanding range of instruments used to finance trade. The URF’s major advantage is the standardisation of practices, the way Uniform Customs & Practices for Documentary Credits developed by ICC has standardised the way the banks handle transactions in letters of credits, to make it the most used set of private rules in the commercial world.
In India, forfaiting as an export financing option has been approved by the Reserve Bank of India. The facility is to be provided by an international forfaiting agency through an authorised dealer (see RBI Circular 42 A. D.(M.A.) series dated October 27, 1997). Forfaiting proceeds, on a without recourse basis, are to be received in India as soon as possible after shipment but within the period specified by RBI for realisation of export proceeds.
A transaction is to be routed through an authorised dealer who, apart from handling documentation, will also provide certification for GR Form purposes.
ICC estimates that the URF will help grow the forfaiting business significantly from the annual turnover of $300 billion. In India, forfaiting has not caught on significantly, due to preferential interest rates for export credit and reasonable guarantee cover costs from the Export Credit Guarantee Corporation.