Thursday 16th August 2018

    Interview with Peter Mulroy, secretary-general, Factors Chain International

    Peter Mulroy, secretary-general, Factors Chain International (FCI), in a recent visit to India, spoke to Tradebriefs about the concept of factoring; how it could help the small and medium enterprises sector and how he believes it is poised to play a major role in trade finance in the coming times. Excerpts:

    Can you trace the growth of the factoring industry?
    The concept of factoring came into existence sometime in the late sixties. It was available only domestically in North America when it first started and a few European countries. The concept of cross-border factoring was also new, considering the industry itself was just taking shape. A few companies got together at that time to set up an industry body, Factors Chain International, which I represent today. Since those early days, FCI has now grown to over 400 members in just over 90 countries with an extensive network that allows factoring companies in the country of an exporter to work closely together with an importer across continents.

    Simply put, how exactly does it work and what are the advantages of factoring?
    Factoring basically bridges the gap between a buyer and a seller, either domestically or across borders; but especially for exports, for a buyer who may be a small enterprise, the collections of export receivables is mostly a challenge. A factoring company turns the seller’s invoices into cash and gives the seller an instant access to his dues, instead of waiting until the payment is received from the buyer. The factor then takes up the task of regular follow-ups of collection and/or overdues, with the debtors as per the terms mutually agreed upon with the seller. In fact, factoring helps the seller to avoid the embarrassment of having to directly seek payment from the buyers. Using management information systems (MIS) reports and with the help of technology, a factor provides a range of services like management of accounts receivables, planning cash flows, etc.

    Since you are dealing with the small and medium enterprises (SME), how do you keep it cost-effective for them?
    From the standpoint of cost of funds, it all comes down to the risk-reward analysis. The further you drill down in the SME sector, obviously the risk is higher. One of the challenges for them is that banks traditionally view them as high-risk. However, factoring is focused on the controls; on controlling the receivables, controlling the cash that is generated from those receivables and the end customer. Factors control that money; they control those receivables through systems, proper technology, rules, contracts, legal enforcement, etc. Therefore, to answer your question about the cost, it is based on the risk-reward analysis. One has to analyse the strength of the SME because a lot of them are under-capitalized. So then, what do you do? You then have to turn to their receivables and check on how good are their receivables? There are two components to that. One is their own capability of producing the product and on the buyer’s side, the factor analyses the buyers because that is the source of the repayment. Unlike in a loan where I give you money and you give it back to me, in factoring, I give the money to the seller, to the creator of the invoice but my source of repayment is their end customers, their buyers. If the buyers are strong, that reduces the cost of factoring because the risks are also lower. So, just to recap, we take into consideration the capability of the SME to produce the goods; we look at the buyer risk; we look at the historical transactions and then we come up with a price.

    This price is borne by the supplier, by the SME?
    Yes.

    How does this compare to the costs if a company were to opt for bank financing?
    Well, as I said, a number of SMEs don’t get bank financing, so it’s like comparing apples to oranges. What I can tell you is from the standpoint of the SME, if the factor bank is comfortable providing capital based on the receivables, and the receivables are strong, that is going to influence and lower the cost. However, I’d also like to let you know that a factoring company undertakes a transaction based on the quality of the receivables unlike a bank which takes credit decisions based on a company’s financial history, cash flow and collateral. Empirically speaking, factoring companies are able to turn around a funding proposal within days as compared with weeks for banks, in general.

    Since this is pretty much new in India, what are the challenges here today?
    Well, the laws were a challenge. Those were put in place over the last two-three years with the Factoring Law and Reserve Bank of India’s policy. These were all new initiatives that helped the factoring industry. When you’re trying to do factoring, you have to distinguish between a loan and factoring. The point is this industry was set up decades ago but there was no legal or regulatory support, but now there is. There are protections that are afforded to the factoring industry with the passage of the India Factoring law and I believe it is time for the factoring industry to grow here, similar to other parts of the world.

    Can you substantiate with numbers how the industry has grown and what do you expect in future?
    Most of the factoring activity that is done today globally is backed by banks. Their funding comes from banks or there are banks themselves that are doing factoring. In India, there is ICICI Bank among others who have a factoring division. In all these cases, they avail their own bank funds so the liquidity for the factoring industry comes directly from the banking industry. A study conducted by consultants shows the growth in open account trading from 82% to over 91% between 2011 and 2020. Most financial institutions are expected to grow their open account receivables business nearly three-fold in this time.

    In fact, factoring and receivables finance has been the fastest growing trade finance product offered by banks and institutions. In the last 20 years, factoring volume has grown from 400 billion euros to 2.4 trillion euros, according to our own study at FCI. If you look at China, although factoring was introduced there only around the turn of the century around 2000, China became the second largest factoring market in the world behind the UK in just 12 years, in 2012. In 2000, Asia accounted for less than 3% of global receivables finance volume. Today, it accounts for over 23% of the global volume, especially driven by the rise of China. In India, it is still nascent although it was introduced in 1991. At that time, though, the laws weren’t in place as I pointed out earlier. Those were recent developments. Imagine, once corporate companies and MSMEs begin to see the benefits of factoring receivables finance, a market especially like India has the potential to surpass most global markets. I believe with India’s rise, Asia will take over Europe as the largest receivables finance region in the world.

    What do you believe are the growth drivers for this industry in India?
    I’d say three primary drivers of growth that are converging which will further escalate the growth of receivables finance in India is the advent and rise of open account trading. This has required many banks and financiers to expand their offering to include open account trade finance services, especially factoring. In India, progress has picked up and the time is right for the explosion of receivables factoring. Second, we are living in extremely fast changing times in an interconnected world, especially when it comes to trade finance. Factoring protects the assets on your balance sheet, your accounts receivables, whether the debtor is located domestically or internationally, and provides immediate liquidity and protection against debtor bankruptcy. Third, technology continues to create greater efficiencies and new deliverables like we’ve seen with the TReDS platform in India, pushing trade towards increased automation. New and faster channels of finance have also created destabilization in the banking industry, including factoring. However, these new threats are also creating new channels for SMEs to access finance, create new channels for sales, increase jobs and contribute to the economy.

    Last but not least, governments, central banks and regulators around the world view this service as a safe and secure method of financing trade and an instrumental tool to support the growth of SMEs by financing their business through their receivables, using factoring. The future for factoring in this role is immense and this is where FCI will see many new members in the coming decades, more so in countries like India.

    - TradeBriefs Bureau