Igor Zaks, Editorial Board Member of TRF News and President of Tenzor Ltd, describes below the key considerations for receivables finance platforms.
Recently, we saw significant growth of receivables based platforms. Several major trends contributing to its growth are:
Covid-19 move to digitalisation. With less face-to-face contact and perceived reduction of relationship component, more companies consider digital platforms as an alternative to traditional banks and factoring companies, ABL lenders, and other providers.
Investor’s appetite. In a low interest rate/low return environment, many investors are looking for short term, relatively high return, and low correlated assets. Receivables are increasingly considered as valuable asset class.
Credit insurance appetite. Despite initial concerns, low claim environment during COVID-19 lead to continuing sufficient supply of credit insurance and competitive pricing in most of the markets. There is still significant price arbitrage between the insurance market and debt market meaning financing companies receivables, adding insurance, and selling the package to investors, remains highly profitable.
Relatively basic technology and low development costs allowed to build platforms quickly and relatively cheap, with operating costs significantly lower than a “traditional” factor.
Some high-profile collapses such as Greensill (and multiple smaller cases before like Urica) raised concerns but are often dismissed as narrow issues. Some founders and investors have limited experience in the factoring/trade finance world and can easily overlook major pitfalls.
Fraud and performance risks
Financing accounts receivable has multiple risks. One of them is the existence and validity of the invoice. Situations like fresh air invoicing are well familiar in the industry. The invoice may do not exist in the first place, may be sold more than once, or may be subject to an infinite number of potential frauds.
In many markets, the invoices may be previously pledged (UCC filings in the US, fixed and floating charges in the UK, etc.), meaning its sale may be considered invalid. And clearly, the fact that a supplier thinks somebody owe him money may not be what the buyer considers based on contractual performance clauses (the performance risk is the one supply chain finance/approved payables finance intends to address through buyer’s irrevocable payment undertaking).
Using the recourse to a seller can mitigate some risks (in theory the seller needs to buy back ineligible receivables, pay back wrongly received funds, etc.) however it shifts the risk form often higher quality (and sometime insured) buyer to often less creditworthy seller, removing the core advantage of the structure.
Over many years the industry learned the hard way how to mitigate some of these risks, but even the most experienced operators occasionally suffer frauds and other mishaps. And the most important thing about fraud is once the weakness is explored, they become a target, meaning fraud cases behave exponentially, not just linearly.
There is clearly room for multiple technology solutions to address parts of these issues – the problem with any technology is if the problem is not well defined, so will be the solution.
I believe credit insurance is a great tool if used appropriately. It has a significant risk transfer capability, global presence and large database for efficient decision making. It also normally prices the risk lower than financiers. It is, however, critically important to understand why such competitive pricing exists.
One popular topic is the ability to cancel the limits (there are also some policies/providers with non-cancellable limits), or not to renew the terms. This will be an equivalent of non-committed facility in financing structures, that is also commonly used (so the insurers and financiers behave in relatively similar ways in this regards). Providing the terms match between insurance and financing (i.e., both are non-committed) this can have some business implications, but relatively few risk impacts (Greensill example looks different precisely because of such mismatch – between terms of financing and terms of insurance).
Far more important is the fact that the insurer only gets a real exposure once the claim is fully examined (i.e., the invoice is valid, the policy compliance is fulfilled, there is a correct customer, there are no disputes, etc.) based on what is eligible risk at the time, while financier has all the exposure upfront. This means due diligence requirements are also very different between the insurer (that only cares about buyer ability to pay) and the financier that bears all the other risks (in some structures they may be moved to a supplier, but these would not be insured in any case).
To take it to an extreme (aside from reputational risk) week controls of the insured are even beneficial to the insurer as they receive premium from all sales while insuring only compliant ones. Handling of other types of risk (for itself and for investors) should be handled outside of the credit insurance through transaction structuring, due diligence, and additional risk mitigations.
Receivable finance platforms have a great opportunity, and with efficient structuring, stringent operational controls and high-quality due diligence may help to create an efficient market. However, there are no shortcuts, and a lot of expertise needs to be deployed internally or externally to avoid predictable failures.
Receivable’s platforms- key considerations – article in TRF News by BCR Publishing