The written word: Uniform Rules for Forfaiting (URF)

When the International Forfaiting Association (IFA) announced at its annual conference in Prague in 2009 that it would be working with the International Chambers of Commerce (ICC) to establish the Uniform Rules for Forfaiting (URF), the hope was that they would finally put forfaiting on the map.

No longer would it be a fringe activity predominantly associated with German and Swiss financing houses (as well as a particularly well-known one in London), it would have the imprimatur of the ICC, and the URF would be able to stand shoulder-to-shoulder alongside the widely known Uniform Customs and Practice (UCP) for Documentary Credits.

However, after some 18 months of negotiations, the resulting first draft, released in March 2011, caused something of a stir among veteran forfaiters, with many voicing disappointment. None were more outspoken than Sal Chiappinelli, the founder and CEO of SFC Swiss Forfaiting Company. “The philosophical approach behind the rules, the concept of forfaiting that they have tried to express with these rules, does not match with the reality of what forfaiting is,” says Chiappinelli.

The problems are manifold, he says. First and perhaps most important of all, they would appear to offer far too many grounds for recourse that could leave a forfaiter open to payment disputes affecting the underlying trade.

Second, Chiappinelli feels that the rules are insufficiently neutral and have been written from the perspective of the major banks’ interests. And third, they seem to assume that the letter of credit (LC) will

be the main forfaitable instrument, when promissory notes and bills of exchange can also be used to structure a forfaiting transaction. Indeed, for Chiappinelli, they are the preferred forfaitable instrument, not LCs.

Can pay, won’t pay
 

Of course, Chiappinelli has endured well-publicised problems with letters of credit, most notably when Portuguese bank BPN refused to pay a LC worth €100,000 that it had earlier endorsed. Even after nationalisation in 2009, it refused to pay, forcing the issue all the way to court, where Chiappinelli recently won what looks like a Pyrrhic victory. BPN was ordered to pay the contested €100,000 LC but, in a peculiar twist, SFC Swiss Forfaiting was ordered to pay all the costs arising from the case – in any other court in the world, the loser would be compelled to pay the costs.

But Chiappinelli is supported in his claims by a number of other independent forfaiters who are also concerned over the level of recourse that the draft rules would appear to allow, as well as what they regard is the incomplete nature of the draft rules as they currently stand.

There are three basic principles that a forfaiting transaction needs to adhere to, says Chiappinelli:

• The abstraction of the financial flow of future payments;
• The free negotiability of the future cash flows: the financial instruments on which these deals are structured must be negotiable – there must be an ability to resell on the secondary market;
• The future cash flows/payments must be irrevocable and unconditional.

Under the draft rules, claims Chiappinelli, the underlying instrument is assumed to be a LC and a payment will be conditional on the success of the underlying trade deal – even if the underlying LC is supposed to be irrevocable, with documents accepted by the obligor’s bank.

That is not just Chiappinelli’s interpretation over the level of recourse that the draft rules permit, as they currently stand. “The big issue is the ‘recourse’ part included in the draft rules. There are a lot of ways to have recourse and I find it amazing that it’s written in the way that it is,” says Edmondo de Picciotto, General Manager at Intesa Soditic Trade Finance.

Another long-standing forfaiter, who did not want to be named, said: “I don’t see the point of them [the URF] the way that they have been written. Mainly because they basically leave out a lot of the points that I thought ought to be considered in them... There really are a lot of parts that are not acceptable from my point of view,” he says.

The problem, he adds, is that the draft URF simply omits too much. “There are a lot of items that have not been addressed, such as the kind of documents and what to expect on documents. If they are going to involve an organisation as important as the ICC and make real rules, then it has to contemplate many more things that it does. The way it has been done is only a little bit more in-depth than the guidelines established by the IFA a few years ago, which nobody uses. So I don’t see the point of them.”

They might be satisfactory for a bank, suggests Chiappinelli, because any losses that it may incur in forfaiting as a result on the one hand will, on the other hand, be balanced by the ‘right’ not to pay an LC. But it could spell the end for independent forfaiters because most simply could not risk bearing too many non-payments, especially by powerful banks with deep pockets or in jurisdictions where the courts will automatically prefer their own.  

True sale
 

By failing to be absolutely clear over the issue of recourse, the rules create a minor divergence from the clarity of the UCP rules, suggests a second forfaiter, who preferred to remain anonymous, but who was present in at the ICC meeting in Zurich.

He suggests that there seemed to be an acceptance that the rules as they currently stand are far from perfect, but that it would be better to get something – maybe even anything – passed first, which could be refined later. “All the bankers present at the meeting were pretty cold about it, but there was a very strong feeling that there was a strong agreement between the ICC and the IFA on the project,” says the source.

However, Sean Edwards, European Legal Counsel at SMBC and one of the IFA committee members on the negotiating panel, stresses that the URF is still very much at a draft stage and its contents open to discussion among the whole forfaiting community. “There’s an internal draft now, then the main comments when they come in, there’s another meeting at the end of May in London, a drafting meeting, and then we will be looking through those,” says Edwards.

In other words, it will be a busy summer for the drafting committee and the URF that emerges out of that process will no doubt be very different from the draft they started with. The big issues that have emerged, he says, include the concept of ‘true sale’ and recourse, which are inter-linked. Even so, despite the debate they have aroused, Edwards is hopeful that the URF is still on track for a spring 2012 launch. “The actual drafts following comments from the ICC Consulting group, which contains a number of forfaiters” he says, “are looking in very good shape.”

One criticism that he has picked up in the consultation process so far, he says, has boiled down to the use of terminology. “There was some concern that there would be a confusion over the use of the term ‘confirmation’, which is what’s used in the secondary market… Most of the other points were really drafting points.”

In addition, says Edwards, a major sticking point has been around the degree of recourse to the seller. “The other big issue is that of ‘true sale’, which is a much more substantive issue because [for a bank] to get it off the balance sheet, it has to show that it has got essentially all the risks and rewards off-balance-sheet,” says Edwards.

With Basel III looming that, perhaps, is more of a concern for the major trade banks than it is for independent forfaiters. “The other big concern was, because it is designed to achieve a true sale, does the wording of these ‘recourse events’ really interfere? Do they upset the concept of true sale?” says Edwards.

“The basic concept is that, right at the beginning, the sale is without recourse. But the market would always expect some recourse to the party that first sold the claim into the market. That, I suppose, is the biggest debate because it ties into the ‘true sale’. If there’s too much recourse, there’s no sale, that’s what it basically boils down to. There’s always a degree of recourse, and it’s the degree of recourse that counts which depends on the nature of the seller.”

A distinction ought to be made, he believes, between the primary market and the secondary market. “With the initial seller – that will usually be the exporter or the obligor itself – there does need to be a high degree of recourse because if you buy from an exporter and it doesn’t give you the right instrument, then you would want some recourse against that. It, after all, has originated the deal and had a hand in creating the instrument if it is not the actual issuer itself,” says Edwards.

“But in the secondary market that degree of recourse will be less. Where anybody other than the primary forfaiter is concerned that recourse is very limited, essentially he must have sold something he didn’t own. Primary forfaiters, the first forfaiters on the scene, as it were, should have a higher duty of care. That is where the opposition is coming from as many people who source deals from exporters and importers believe that they should have no duty of care at all. That cannot be right.”

Nevertheless, given the debate that has been ignited, these areas of the URF will need to be nailed down more firmly to satisfy the community at large if the URF is to stand a chance of broad adoption. Indeed, such sentiments leave the IFA and the ICC with a challenge: do they lock horns and endeavour to produce a comprehensive URF that could become as pervasive as UCP – which may take two further years – or do they do something lighter and more accessible?

The problem as it stands at the moment, says De Picciotto, is that if the rules are not considered up to the task, then they will simply be ignored. “For LCs, it’s become standard that all LCs are issued under UCP 500 or 600. But at the beginning it was a lot more difficult and it was more of a commercial decision at the time, because so many banks eventually said that they would only work with banks that would do deals under UCP rules,” he says. “With this, I don’t see it happening yet,” he adds.

While Chiappinelli accepts that the URF is still a draft – and a first draft at that – he argues that it is fundamentally flawed because it started from the wrong point. Either way, though, it will be the market that decides the success or failure of the URF and there are still much more debate to be heard before they reach their conclusion.