In this 2020 interview series, TFG spoke to 20 experts in trade, receivables and supply chain finance.

An Interview with FCI

Name: Peter Mulroy

Position: Secretary General

Organization: FCI

Interviewed by Nikhil Patel (NP), Analyst, Trade Finance Global

2019 – Payment Terms and the Great Liquidity Crunch

Nikhil: Thank you so much for doing this with us! What were the key highlights and opportunities of 2019 from an industry perspective in trade, receivables and supply chain finance?

Peter (PM): Certainly the impact of the Trade War was felt far and wide within the factoring industry.  Chinese exporters were hampered by the import duties imposed on a wide variety of Chinese goods.  The increased import tariffs by the Trump administration has had a severe and chilling effect on trade from China, as the increased costs could not be absorbed by either the supplier, importer or end customers/retailers.  The factoring industry witnessed a significant decline in trade volume in domestic and cross border factoring, not just between these two giants but also between those markets that support the supply chains that ultimately are exported from China (especially from neighbouring markets).  Many were looking for alternative suppliers in other markets, but this process is time-consuming and challenging. The repercussions are increased stress on SMEs engaged in trade, a reduction in credit availability, and loss of business confidence, creating both liquidity and overall financial pressure on clients.

Turkey witnessed one of the harshest years economically, which translated into a significant reduction in factoring volume, both domestically but especially internationally, which witnessed a nearly 40% drop in volume in 2019.  The reasons are stemming from the very challenging geo-political environment, an economic slowdown, and a reduction in business in two of the largest corporate clients using export factoring due to a slowdown in their business. Also, this stems from some import FIs who have taken a cautionary approach to Turkey, due to the above.  

Based on this falloff, I was anticipating other challenging news on volume growth this year but was pleasantly surprised to receive the EUF report on total volume reported in the EU in the 1H2019, which shows factoring and commercial finance volumes grew by 9.3%. This continued growth is on the backdrop of a slowdown in GDP growth across Europe this year.  The European Central Bank in their July 2019 bank lending survey, credit standards tightened in the second quarter of 2019 for loans to enterprises, marking the end of the net easing period started in 2014, as concerns about the economic outlook and increased risk aversion translated into tighter internal guidelines and loan approval criteria. Hence, the very impressive factoring growth in the EU bucks this trend proving once again the importance factoring is playing in providing the necessary liquidity to SMEs, supporting the real economy.

NP: What were the highlights from FCI’s perspective?

PM: FCI held our first FCIreverse Forum and Users Conference in Madrid on 17-18th of October. During this conference, an article appeared in the local press in Spain about the negative impact and abuse of companies using RF.  It was taken from a recent article by Moodys entitled “RF is increasingly popular but can weaken liquidity at a time of stress”. The article discusses the impact of RF on finance in general, and raises alarm bells:

• Greater Transparency:  Many buyers are not required to make public their RF programs, so users of financial statements may not be aware, despite the potential material consequences
• Extension of Terms: There is a leverage impact of hidden debt like obligations where RF allows payments to suppliers to be stretched beyond normal commercial terms
• Impact on Future Liquidity:  Because of the potential size of these RF programs, where one funder is taking a significant percentage of the payables on the buyers balance sheet as direct exposure, if the corporate is experiencing challenges, the cancellation of such programs can lead to a sudden working capital outflow over a short period of time, leading to a liquidity crunch

The Carillion and Abengoa bankruptcies have been used as examples of such negative practices.  Moody’s concerns stem from what they refer to as balance sheet window dressing, when the buyer requests their suppliers to extend terms of payment.  The supplier is generally indifferent because they are being paid days after the invoice issuance in any case, but by lengthening the due date, the customer is able to run up large working capital related liabilities with the bank.  And even though this is a date-certain payment obligation to a bank, current accounting practices appear to allow the balance sheet liability to be reported as trade payables rather than bank debt.

And it is this question that is being put to the test.  A letter sent to the US Financial Accounting Standards Board (FASB) in early October from the big four accounting firms said that while typical payment terms with suppliers historically might have been 60 to 90 days, some entities are now trying to negotiate payment terms with suppliers of up to 180 days or greater.  The big four pointed out that because there are no specific disclosure requirements under US accounting regulations, there has been limited disclosure of supply chain financing schemes. They have asked FASB to require more disclosure to increase the schemes’ transparency and clarify whether the owed invoices should be classified as trade payables or debt. Under international accounting practices, companies do not have to report the owed invoices as debt on their balance sheet and can instead account for them under trade payables, boosting cash flows.

There are also forces against the trend of extended payment terms, viewed by some governments as manipulation by large buyers against SMEs.  The EU’s Late Payment Directive is one example. The Directive was created in 2011 and attempts to combat late payment in commercial transactions. Under the directive, public authorities have to pay for the goods and services they procure within 30 days, or in exceptional cases 60 days. Outside the public sector, businesses have to settle their invoices within 60 days, but a longer period can be agreed between the parties “providing it is not grossly unfair to the creditor”. Other initiatives are shining a spotlight as well: 

• The UK government recently set up new rules, which require companies that bid for government contracts to pay 95 per cent of their invoices within 60 days and to work towards a payment term of 30 days.
• The EU Commission initiated a study which FCI participated in, intending to obtain a comprehensive analysis of the supply chain finance market with the intention to identify barriers to finance SMEs.
• The Australian government’s small business Ombudsman has announced it will also investigate whether reverse factoring is being used by big business to manipulate the reporting of working capital and cash reserves.  They state that while reverse factoring could be “a good product if used properly”, in some cases it is being used by companies to make their own cash flow look better.

FCI shares this last opinion. We agree and encourage the creation of specific minimum standards and norms. FCI serves on the Global Supply Chain Finance Forum (GSCFF), an industry body together with the ICC, BAFT, ITFA, and European Banking Authority (EBA). The Forum is in the process of creating a white paper, with the support and leadership of its Chairman, Christian Hausherr, Deutsche Bank on these challenging questions.  FCI will make this White Paper available to all members in due time.

2020 Predictions in Trade, Receivables and SCF – An FCI Perspective

NP: What are your top predictions for trade, supply chain and receivables in 2020?

PM:

Rise of Capital in the Factoring/Receivables Finance Space

Hedge funds have been increasing their investments into the accounts receivable field over the past decade, providing debt capital to factoring companies against their receivables pool. Banks are still the most active form of debt capital for factors.  The attraction by investors in funds in this asset class is appealing to investors due to their relatively high yields, good performance and track record in terms of repayment/low loss given default, and regulations making them more appealing to foreign investors. So expect to see this continue in 2020.

Further development of factoring laws around the world

FCI sees a strong demand by countries for model laws for factoring, and we currently are working on projects underway in Nigeria, Bangladesh, Pakistan and Jordan to help create a proper legal framework. Some countries have started to reform secured transaction laws. The US just recently approved the UN Convention on the Assignment of Receivables, which will help elevate this eventually into a formal treaty.  Other than a convention which is binding on countries after ratification, and subject to deviations only to the extent allowed by the convention itself, a Model Law is a suggestion for the harmonization of domestic law. The UNIDROIT has approved the launch of a new Model Law on Factoring which we expect will be launched in 2020. This will help efforts in many emerging coutnries looking to adopt such laws to support the funding of capital to SMEs.

Most developed countries have adequate laws protecting investors in factoring.  However, most of the largest countries in terms of population are either considered low, lower and middle income as defined by the World Bank (Tier 1-3, representing countries with per capita income of less than US$12K).  As you can see below most of these countries are deemed “emerging”. If you look at expected population growth and estimates by 2060, over 40 years from now, all of these countries except for the US and India have proper factoring laws in place to protect investors.  However, in most of these markets, factoring is just getting started. They represent our industry’s future, and FCI is making numerous inroads to help develop factoring in all corners of the world. This is why the question of supporting a FML is of paramount important to FCI, our members and stakeholders.

1. the platformization of trade, in particular through marketplaces,

2. the explosion of data combined with the unprecedented possibilities offered by data science, and

3. the gap between the capabilities of incumbents who mostly run on outdated technologies and the quasi limitless funding offered to startups to disrupt the industry.

Challenges in trade 2020 – looking ahead

NP: What are the biggest challenges in trade, receivables and supply chain finance you predict for 2020?

PM:

Supply Chain Finance: Certainly the impact of the FAT-F accounting question relating to treatment of liabilities (payables versus bank debt) outcome that is described above. This could have signficant consequences and ramifications on the bank’s business dealings with their corporate clients relating to reverse factoring programs.

Receivables Finance: The Trade war, as described above, has had far-reaching implications.  As there seems to be the making of a phase one agreement between the US and China, this will ultimately have a major impact on all trade volume.

Other challenges and opportunities lie around e-invoicing, Basel regulation and New Factoring

Podcast: TFT Live Lounge: Is E-Invoicing The Giant on Our Doorstep?

Read our trade finance 2020 predictions here