[co-author: Andrew Thompson]
At the latest Trade & Export Finance webinar, partners Geoffrey Wynne and Sam Fowler-Holmes delved into the topic of receivables financing. Given the manner in which COVID-19 has impacted businesses’ cash flow and supply chains, financing receivables has, perhaps unsurprisingly, accelerated over the past year. With the recent fallout of Greensill, the ideal opportunity arose to discuss the nature of receivables finance, the challenges facing the industry and key factors in mitigating risks and achieving the benefits the industry has to offer.
Key points from the webinar included:
Financing receivables is a broad concept, and those interested may justifiably lose themselves in the varying terminology in this area. The Global Supply Chain Finance Forum (GSCFF) has provided helpful guidance, the “Standard Definitions for Techniques of Supply Chain Finance”, which aims to harmonise terminology to ensure a common understanding across the market. Striving towards achieving greater harmonisation in both terminology and structures will help to mitigate some of the risks and to address some of the criticism raised around the nature and use of receivables finance products.
Under a basic receivables discounting structure, the owner of the receivable (typically being a seller of goods or services) will sell that receivable to a financier at a discount to its face value. Variations on this model will be determined by the level of recourse involved and whether the buyer will be notified of the arrangement, among other things. While the benefits to the seller should be clear, such as earlier access to cash and risk mitigation, financiers should be mindful of the various risks they are assuming by virtue of the arrangement—due diligence and transaction monitoring are key.
Known by many names, including “reverse factoring” and “buyer led financing”, payables finance is perhaps seen (in our view wrongly) as the most controversial of all receivables structures, particularly following the recent Greensill insolvency proceedings. In contrast to receivables discounting, payables financing is led by the buyer (being the customer of the financier).
Whilst a payables finance arrangement also involves a sale by the seller to the purchaser pursuant to a receivables purchase agreement, key to the whole structure is the buyer’s (i.e. the debtor’s) irrevocable undertaking to pay the receivable in full without set-off, deduction or counterclaim on its due date. A payables finance structure should offer commercial benefits to both seller and buyer, although the purchaser of the receivable should exercise caution if one of the benefits is an extension of payment terms that exceeds what would typically be considered to be market standard for the transaction in question.
A key consideration for a seller is often whether it can achieve a legal and accounting true sale, with the aim of removing the receivable from its balance sheet. Although there are similarities, the legal and accounting true sales are different analyses. It is important to consider a legal true sale analysis from a holistic perspective, taking into account the sale arrangements and those factors that weigh for and against a true sale. There is no one-size-fits-all approach.
Trade finance on the whole is experiencing great disruption from financial technology, and receivables finance is no exception. The growing use of digital platforms to facilitate transactions and improve operational efficiencies also carries new risks. Users should understand their rights and obligations regarding the use of a platform, the role of the platform provider and the liability of the platform provider, including the consequences of the provider’s insolvency. This is especially the case given the lack of standard terms and conditions across the market.
Special Purpose Vehicles
SPVs may be used in receivables finance deals and many of the legal, tax, accounting and commercial drivers are similar to those for other types of finance transactions. While an SPV may offer a number of benefits, it is important to be aware of potential risks, such as fund mismatches between investors’ expected returns and the SPV’s cash flows.
Supply Chain Finance under fire
First Abengoa and Carillion, now Greensill—supply chain finance has been, and continues to be, under fire from the regulators, auditors, credit agencies and the media. However, the hasty labeling of all things receivable as “supply chain finance” has perhaps skewed the boundaries between what is a true supply chain receivable and what is not. The over-structured, exposed and longer-term arrangements singled out by the press emphasise the need to defend supply chain finance products. If parties can be clear about what is being sold and, more importantly, understand what is being sold, the industry may avoid further regulation, although needing to agree disclosure obligations seems likely. The key will be properly drafted legal documentation that clearly identifies risk allocation between the parties. If the industry can make the clear distinction between what receivable represents true trade debt and what is bank debt, supply chain finance—a product which we know benefits all parties involved—can continue to thrive.
Please click here for a link to a video of the seminar to find out more about receivables finance.