In a post-COVID world, the only thing that is certain is uncertainty, and nowhere is this truer than in the supply chain. As COVID-19 took centre-stage in Europe and the Americas in March 2020, not only was economic output significantly reduced, but the ability for goods and services to be moved across international borders was hit hard as countries battened down the hatches and pulled up the drawbridges in an attempt to contain the virus. Uncertainty in the supply chain was further exacerbated by the struggles faced by many firms due to the pandemic, associated lockdowns, and social distancing measures implemented by many governments. Long-term suppliers, in many cases, simply ceased to exist. The past 18 months have not been easy for supply chain planning.
In turn, working capital forecasting for Corporate Treasurers has also become more difficult, especially as government-supported financing is phased out. Two sources of financing which stand out among the confusion, however, are Factoring and Securitisation, both of which are highly dynamic and have wide provision. However, the two products cover different techniques.
The first recognisable examples of Factoring date back to ancient Rome, where wealthy producers employed an agent, or factor, to manage the sale and delivery of their products. Indeed, the word ‘factor’ originates from the Latin word ‘facere’, meaning ‘to do’, or ‘to get things done’. The factor would typically receive a payment equating to a small percentage of the value of the products sold.
Typically, factors were given the products on consignment, however advances in communication and transportation no longer made it necessary for an exporter to send his goods to someone on consignment, and instead, goods eventually were sold directly to factors. In conjunction with the development of Factoring, many Factoring houses have become subsidiaries of banks, and the product offered typically involves three main services:
- The direct purchase by a Factoring house of receivables disclosed to the debtors. However, Factoring programmes don’t necessarily always have to be disclosed to customers, and confidential Factoring is now commonplace.
- The debtor credit risk cover, often supported by trade credit insurance policies.
- The servicing of receivables, i.e., the collection and recovery of the receivables.
Initially, Factoring was generally offered at a local level. However, the product has now evolved as the demands of customers have changed, and now cross-border Factoring is a widely used product.
Modern Securitisation really kicked off in the United States when the first mortgage-backed securities were introduced by Ginnie Mae in 1970. However, early variations of the product were used by Dutch merchant bankers as early as the 18th century, when they packaged mortgages into securities and sold them to West Indian plantation owners.
Securitisation is a more complex Receivables Finance product than its Factoring cousin, due to the number of moving parts and the structures involved. Like Factoring, it consists of the sale of receivables, however the buyer in the case of Securitisation is a Special Purpose Vehicle (SPV). This is the case for two key reasons:
- The SPV ensures that the assets are legally separated from the sellers and owned by an entity, the SPV, that is bankruptcy-remote.
- The SPV also pulls all receivables together and provides a homogeneous basis for the financing.
The risks of the portfolio may be allocated to different investors, depending on the nature, ratings or priorities. Investors in Trade Receivables Securitisation are often conduits vehicles, owned or sponsored by banks, that place securities on the capital markets at attractive conditions.
Securitisation transactions have both expanded in size and scope and are now often worldwide. In parallel with this trend, new investors have come to invest in more risky tranches, hence providing more financing to the corporate originators. Finally, over time, the minimum transaction size has decreased to around $50m or less.
The two solutions have much in common and have even started to converge. Over recent years, many corporates have sought our help to provide proposals for both products, allowing them to compare the benefits, the limitations, and the costs of both Factoring and Securitisation to find the right solution for them.
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In our next article of this series, we will address the critical differences in term of scope, advance rate, capacity to deconsolidate, and costs.
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Johannes Wehrmann joined Demica in July 2018 having previously worked at GE Capital and Targo Commercial Finance. Johannes brings over a decade of origination experience in structured finance transactions across Germany and Western Europe. He was Head of Structured Finance at GE Capital Germany and responsible for sponsor coverage and international factoring efforts.