Emerging and Developing of Forfeiting.

Transcription

1 Emerging and Developing of Forfeiting. Some specific characteristics. Human And Social Sciences at the Common Conference Adamova Karine Docent (Lecturer) at The Department of Financial Markets and Financial Engineering, Financial University, Moscow, Russia Abstract - Nowadays in the modern conditions of economic development and with the advent of competent managers on the enterprises and financial managers who manage the financial flows and production with such high efficiency, we are already talking about the existing trend of growth of production in the country. Credit institutions are entering in the market of financial services with well forgotten old, new or combined banking products. Forfeiting is for Russian banks profitable and simultaneously high risk operation, the nature of which comes from financing with assignment of the monetary claim, in other words, factoring. The word Factor means the broker, agent, intermediary. Key words: Forfeiting, forfeiting company, Factoring, factors, Russian economy, recievables, Convention on international factoring operations (UNIDROIT Convention or the Ottawa Convention),, promissory notes, letter of credit, securities. I. Introduction In business relations quite often there is a situation when under a contract one party receives payment for delivered goods or provided services not concurrent with the execution of his obligations, but after some time after this, for example, delivery goods in installments. In conditions of the Russian economy today is such a difference in the time after delivery of goods and payment is also connected with the pressing problems of payment delays and non-payments between companies in different industries. Thus, a large number of companies appears the need for the replenishment of the lack of financial resources from other financing sources. And such financing the enterprises can obtain by selling cash requirements to their borrowers. Such a deal has received the name of financing with assignment of monetary claim (or factoring). In the period of formation and rapid development of market relations a significant role in the business sphere and, in particular, in trade, both domestic and foreign, played commissioners and trading agents, called factors. Almost in their functions included not only the sale of goods, produced by the principal, but giving him cash advances and loans for its production. At a later stage of the historical evolution some comissioners have refused from commercial functions, and focused on the financial side of customer services. Gradually factors also started direct purchase from the supplier of its payment requirements/recievables (offered to the buyers of invoice). In this period, it is considered the modern factoring was born. Thus, the relations that arose as a pure trading activities, are being changed into a financial transaction of providing and guaranteeing the loan and become an integral part of the activities of commercial banks. Abroad the first factoring operations were used in the 50-th years of XX century by American banks such as BANK OF AMERICA, the FIRST NATIONAL BANK OF BOSTON and TRUST COMPANY OF GEORGIA. However, they were formally legalised in the USA in 1963, when a government organization the controller of money circulation decided that factoring operations represent the legal form of banking. Currently factoring became widespreaded in the West. Partly widespreading and the appearance of factoring depended on the Convention on international factoring operations (UNIDROIT Convention or the Ottawa Convention), contributed to strengthening of the world trade integration. This Convention was developed by the specialists of the International Institute for the unification of private law and proposed to the international community for consideration and accession. The UNIDROIT Convention was already signed by the following countries: Ghana, Guinea, Nigeria, the Philippines, Tanzania, Morocco, France, Czechoslovakia, Finland, Italy, Belgium, the USA and Panama. For the Convention's entry into force it requires ratification by at least three signatory countries. Today the Convention is ratified only by France. According to the UNIDROIT Convention, to which Russia is not party up to the present time, the factor should provide at least two of the following operations under the factoring agreement: a) Funding of the supplier, including the provision of advances and loans; b) Accounting processing of vendor invoices, relating to claims for money became the subject of the assignment of rights of claim; c) revenue from the debtors; d) protection of interests of supplier in connection with the insolvency of his debtors. The Convention establishes a special legal regime, which should be adequate to the tripartite relations in factoring. Theory of factoring quite sparse and vague in other words, the basis of factoring operations is buying by factoring

2 company client s invoices under the immediate payment of approximately 80% of the value of supply under such invoices and payment of the remaining part (minus the interest on a loan) in a strictly deadlines....[1] In theory everything is quite clear. In practice it turns out differently. International experience has established principles for factoring financing and developed methods of evaluation of the lending limits, as well as analysis of factoring operations of the company and analysis of the creditworthiness of the client and its debtor. Due to the same novelty of legal relations in factoring for the Russian economy and the lack of the respectively regulatory framework, transmitting the entire economic sense of this type of financial agency, the principles which were set in the Civil Code [2] have multi-interpretation sense and do not limit the factoring relationship by clear framework of law. And at the same time we have lack of adequate experience in conducting factoring in the practice of doing business in Russia. There are no established principles of business turnover in this area. This leads to the presence of different interpretations of the essence, types and capabilities of factoring services, and also increase of risks assumed by the factor. Since factoring operations are high risk (as mentioned above), factor-company (or factor-banks) have always sought to structure the factoring transaction in such way when they can decline the risk. Thus, many foreign factor-companies and factor-banks determine as assigned monetary claim consider a debt under a promissory note, which, by definition, is an unconditional obligation and any transactions which are fully protected except for the factoring of the legal and bill legislation, which has much deeper roots rather than legislation on trade mediation. So, in practice, foreign factoring companies there is a new kind of deals with the assignment of the debt, as a rule, under the notes or other securities, which may be ordered without recourse inscription, which received the title of forfeiting. The name comes from the French a forfeit, that means waiver. II. The emergence of forfeiting Forfeiting emerged after the second world war. Several banks in Zurich, which had rich experience in international trade finance, started to use this technique to finance the purchase of grain from Western Europe to the United States. In those years, the supply of production and competition between suppliers have increased so much that buyers required an increase in the terms of the loan granted to 180 days against the usual 90. In addition, a change occurred in the structure of world trade in favor of expensive goods with a relatively long term of production. Thus, the role of credit in the development of international economic changes, and suppliers were forced to look for new ways to finance their deals. As falling barriers to international trade and many African, Asian and Latin American countries became more active on the world markets, Western entrepreneurs harder to grant credits for its own sources, that why the suppliers were forced to use new methods of financing their deals. The greatest development the forfeiting received in countries where relatively poorly developed state export credits. Originally forfeiting operations were carried out by commercial banks, but as the volume of operations a forfeit raised up there were established specialized institutions. Currently one of the main centers of forfaiting is London, since the exports of many European countries for a long time is financed from the city which is never slow for the development of new banking technologies. A significant part of forfeiting business is concentrated in Germany. Thus forfeiting develops in various financial centers, and there is an annual increase of such transactions. However, it would be a mistake to link the increasing number of transactions a forfeit with the growing number of such centres. This is explained by the increase of risks borne by exporters, as well as the lack of adequate sources of financing in connection with the increased risk. Forfeiting has significant advantages, which makes it an attractive form of medium-term financing. The main advantage of this form is that forfeiting company assumes all risks associated with the activity. In addition, its attractiveness increases in connection with the refusal in some countries from the fixed interest rates, the chronic lack in many developing countries currency to pay for imported goods, increased political risk and some other circumstances. If you want to give to the forfeiting the professional definition, it will sound as follows: Forfeiting financial operation, similar to factoring, connected with discounting (purchase) of documentary or non-documentary receivables without recourse to the party from whom these receivables were bought.[3] Typically during the forfeiting opereation it is also sold negotiable instruments (for example, bills of exchange) on which you can easily arrange inscription without recourse. But suppose if we have forfeiting in respect of the rights of claim, not having the form of reverse of security. In this case in the economic literature it is indicated that debt, suitable for forfeiting, can not be only issued promissory notes. Pets purchase of accounts receivable and deferred liabilities under letters of credit with payment by installments. [4] Simplifying all the above about forfeiting it can be summarized: Forfeiting lending of provider by purchase of promissory notes or other debt claims. To some extent this is a form of transformation of commercial credit in the Bank. In foreign practice of forfeiting most often used in the making of international factor transactions, the seller which is normally the exporter who has complied with its obligations under the contract and trying to collect settlement documents from the importer to get cash, and as a buyer (forfeiting company) usually there is a Bank or specialized factoring company. Buyer (the Bank) undertakes commercial risks associated with the insolvency of importers without recourse of these documents to the exporter. In case the importer does not have a first-class solvency the transaction becomes unconditional guarantee of the Bank of the importing country on the purchase of these debt obligations. The forfeiting company purchases the receivables at a discount equal to the

3 amount of interest for the whole term to maturity of these claims. The forfeiting company can completely dispose of the purchased documents: either by treating them as investments, keep and upon the occurrence of payment term to present them to the debtor (payer according to the debt obligations); or to sell the purchased documents to the other forfeiting firm or Bank also without recourse basis, and now the final holder of the documents submits them for payment to the debtor. The mechanism of forfeiting is used in two types of transactions: in financial transactions to the quick implementation of the long-term financial liabilities; in export transactions to facilitate entry of cash to the exporter, provided a loan to a foreign buyer. III. Financial instruments suitable for forfeiting The main type of securities suitable for forfeiting are promissory notes - transferable and simple. Transactions with this kind of securities are normally carried out quickly and simply, without any unexpected complications. In addition to the notes the subject of forfeiting obligations may be in the form of a letter of credit. Letter of credit, as it is known, is the current or money document that represents an order of one of the Bank (credit institution) to another to make due to specially reserved funds payment of commoditytransport documents for the shipped goods or to pay to the bearer of the letter of credit a certain amount of money. Documentary letter of credit may be revocable and irrevocable. Irrevocable letter of credit is a firm obligation of the issuing Bank to make payments on providing him with a commercial documents stipulated in the letter of credit, and compliance with all of its conditions. In Russia letters of credit are used in the calculation between nonresident suppliers and buyers, as well as in international payments. In world trade documentary letters of credit are used in the calculations mainly in foreign operations. As the object of forfeiting operations letters of credit are rarely used. This is due to the complexity of the operation, which consists primarily in the fact that in the letter of credit must first and discuss at length the terms of the deal, that leads to increase in periods of the whole procedure. Meenvile the market of forfeiting services requires high speed conclusion and settlement of a transaction, as well as simplicity of document circulation. From the point of view the forfeiting company the principal disadvantage of operations with the letter of credit is the following. The point is that the participant of this transaction assumes that the refund would be made periodically and approximately equal shares. It is convenient for him and for others participants for the debtor and foe the guarantor. However, the partial redemption of the notes may be issued as separate documents, each of which easily handles optionally by the wish of the forfeiting company to sell them. But when th forfeiting company makes deal on letters of credit, all combined into a single document in favor of the beneficiary, and this document often can not be sold without special resolution of the debtor, which greatly complicates the whole operation. IV. Main directions of development of forfeiting In recent years the development forfeiting services in the countries with developed market economies went along the following main lines. A. Secondary market and investments in forfeiting assets By buying assets, the forfeiting company makes investments. Perhaps he does not want to keep their funds in a similar form for a long time, but on the contrary, strives for resale investments the other person who also become the forfeiting company. On the basis of the subsequent resale of debts occurs secondary forfeiting services market. The forfeiting company can resell a portion of the assets owned because the nature of the transaction allows to split up the duty into any number of parts and each of which is issued in promissory notes with their maturity. One or more of these notes may be sold. You should not think that primary and secondary forfeiting services markets are highly differentiated. Actually some forfeiting companies, operating on the secondary market, are holders of a particular portfolio of securities suitable for forfeiting, and the other, a little connected to the primary market, can be active traders on the secondary. Legal entities as a rule act on both markets. Investments in forfeiting assets of private individuals are fairly rare, because not every investor has a solid portfolio, allowing to carry the related transactions of this kind of political and economic risks. Often the immediate transfer of securities suitable for forfeiting to a new owner does not occur. He knows the value of securities, their maturities, knows guarantor, but not the original issuer. In this case the previous owner of the expired securities collects payments and transfers them to the new owner. What is the reason for such secrecy in the secondary forfeiting services market? First of all there are considerations of confidentiality. The exporter is interested in the non-disclosure of information on the methods of financing its transactions and does not want to buyer (or any third person) knew about his financial needs and used the funding mechanism for its transactions. Any sale of securities suitable for forfeiting involves risk involuntary extension of the circle of business relationships, which makes it difficult to control by the exporter. To avoid this, the latter seeks to establish certain restrictions in the contract, which would prevent the free circulation of such securities. Despite all the difficulties, secondary forfeiting services market is flourishing. This can be explained by the following circumstances. The primary holder of securities may, for example, find that buying any of the new paper will exceed the credit limits set by him for a given country. Even if the return on these securities is very attractive, he will be forced to withdraw from the contract,

4 if not authorized to exceed this limit. Solution of the problem can be resale or already available in the portfolio of securities of this country, or those that are offered at the moment. The same thing happens at exceeding of the established credit limits to a specific Issuer. The primary holder may be held on the secondary market simply because interest rates have fallen and he can buy on the market of paper with great discount than purchasing the same securities on the primary market. There are other reasons for primary holder to participate in trading on the secondary market. For example, he wants to ensure greater liquidity of its portfolio in anticipation of changes in interest rates or make use of greater income or lower risk level of certain securities and therefore gets them on the secondary market. Or even easier: may appear on the market buyer, offering discounted price (this can happen if the purchaser anticipates possible rise in interest rates in the future and is ready to buy these securities with lower discount than with a primary selling them). So, for forfeiting company secondary market has the following attractive features: income on forfeiting securities usually higher than what you can get in other securities (at the same level of risk, the same terms and currency); any investor interested in reducing the risks and guarantees forfeiting securities or aval first-class banks best providing payment. Despite all the attractiveness of investment in securities suitable for forfeiting, the volume of such transactions and the number of forfeiting companies are still small. Forfeiting services market is not developed up to the size of the brokerage market. Many forfeiting companies, especially trading on the primary market, believe that this development could scare many exporters and their banks, so as to lead to loss of control issued on the market of securities. B. Syndication Another important direction forfeiting services market was the consolidation of buyers in syndicates. This trend is consistent with the process of Association of banks as creditors. The process of unification takes place on the basis of mutual agreement between forfeiting companies about which part of the forfeiting securities will acquire each of them. Usually different securities are bought by different forfeiting companies. But if the amounts are very large, even individual securities can be divided between forfeiting companies with the help of the contract of participation. However, this method complicates treatment of securities, which in turn reduces the possibility of their falling on the secondary market. In addition, still not fully defined legal status of such agreements. Therefore, in practice they are rarely used. There is another way. If the exporter is ready to use it, he will have to significantly increase the number of documents, each of which now is prepared for a smaller amount using the change of the terms (for example, the usual 6 months can be divided into 2 interval 3 month etc). This is the preferred method that does not provide for the drafting of the contract of participation between the holders of securities. It is important to note the fundamental difference between forfeiting company which is the participant of the syndicate and the buyer in the secondary market. Participant of the syndicate is a buyer on the primary market and its job is to audit the legality and correctness of registration of all purchased securities and guarantees and aval of security to be attached to the securities. The buyer in the secondary market does not have a similar duty. C. Funding based on the floating rate An important direction of development forfeiting services market is the expansion of financing, which involves the calculation of the discount is based on a floating interest rate. This practice is due to the higher volatility of interest rates and reflects the reluctance of many banks conclude transactions at fixed rates. From the point of view of the exporter of any sale on the basis of the floating rate of interest affects the possibility of obtaining the maximum of cash. The fact is that the primary forfeiting company sells on the secondary market of paper with a discount based on the prevailing interest rate and sale is made with a condition of final financial settlement to date, and taking into account the subsequent movements of the interest rate. In fact, until the expiry of the term promissory notes of such dates may be several. Thus, the agreement implies a high degree of risk and may lead to unpredictable obligations, which, of course, is a cause for concern not only forfeiting company, but his auditors. V. The size of the forfeiting services market Any estimation of the size of the world forfeiting services market is no more than a guess. This market has grown significantly in recent years but still remains a small part of the market of medium-term financial resources. The reasons which led to its emergence and growth will continue in the foreseeable future, however, there are limitations to access for the new forfeiting companies. These restrictions are as follows: Because we are talking about a mid-term (in the Western sense) financing, banks often difficult to reconcile the date of redemption forfeiting assets with maturity dates own borrowings. Thus, there is high risk in case of changes in interest rates, which significantly inhibits the activity the participants of this market. During conducting forfeiting operations it uses a special technique requiring a highly qualified service. Specialists in this field are very few, and their training takes a long time. Few banks are engaged in research and formation of the forfeiting services market. *** Over the last half-year policy of Russian banks has markedly changed. Losing the opportunity to earn quick money on the stock market, banks were forced to engage in active credit activity. However fallen sharply after the crisis of solvency of many traditional borrowers made more carefully choose those who can give money. Thus, banks started paying

5 much attention to small and medium enterprises, because large enterprises have long served in huge banking corporations and lure them into another even with the help of loan is almost impossible, to lend to a customer of such huge bank is unprofitable operation in this case the bank is deprived of the possibility to use the remnants of funds on the settlement account of the enterprise. And the majority of small and medium enterprises, namely, producing import-substituting goods after the crisis strengthened its financial position. This is mainly pharmaceutical companies, household chemistry, food industry, because with the decline in effective demand for their products is steadily going to conquer the Russian market. Considering the prospects of development of small business, some banks have regarded it as a separate line of credit policy. Primarily on the borrower made a wager medium banks. In some banks, 80% of the customer base consists of companies of small and medium business. Moreover, banks are developing new products and introducing old, already well known to all but forgotten, such as factoring and project financing, as enterprises still reluctant credited in banks. However, in spite of the existing in the Russian economy potential of financial activity of small business, many banks are reluctant to work on new banking products with small businesses. They focus more on medium and large enterprises, the banking operations that can bring greater profitability. In addition, small enterprises have yet to go in banks in search of borrowed financial resources, such as financial resources remain expensive for their link of economy despite the reduction in the refinancing rate, which entails a reduction in market prices for money. REFERENCES: [1] Finance and credit dictionary, Moscow, FIS, 1998, Vol.3, page 281. [2] Paragraph 43 Civil Code of Russian Federation. [3] Concession in financing receivables. Discussion and preliminary draft of uniform rules. Report of the UN Secretary General at the XXVIII session of the UN Commission on international trade law. Vienna may 1995, P.8. [4] Pavlov V.V., Khominich I.P. Crediting of foreign-economic activity. - p