The role of a corporate treasurer is evolving, with risk increasingly one of the primary concerns for professionals in the field. In today’s global marketplace of ever-changing business landscapes, there has been a noticeable shift in treasury responsibilities. Once viewed as the custodian and manager of the company’s cash flow, treasurers now cover a new dimension of responsibility and in some instances are expected to act as financial advisors and risk managers.
Due to their day-to-day dealings with financiers and knowledge in the area, corporate treasurers are increasingly being asked about means of releasing working capital and risk-related matters, on top of their traditional objective of effective cash management. At multinational corporations (MNCs), the treasurer faces the added complexity of handling cross-border transactions and sometimes extended financial supply chains (FSCs).
Effective Cash Management is Critical to Release Working Capital
The consequences of poor cash management are detrimental and can have a major impact on a corporate’s profits. From additional interest expenses due to over-borrowing, to fraud arising from inadequate financial controls, there are many areas that could potentially mean a company incurring more expense and greater losses than are necessary. What is interesting to note is that not only are treasurers looking to manage cash more effectively; there is also an increased drive to derive value from their FSC via the use of factoring and other solutions.
Unlocking trapped liquidity from accounts receivables (A/R), while looking to extend their days payables outstanding (DPO) seems to be a key priority for corporate treasurers, who increasingly look to enhance their firms’ working capital for efficiency, funding or other business reasons. Trade receivables, in particular, receive greater focus due to the fact that it is more within a treasurer’s control than the company’s payables.
A Comparison of Trade Receivables Securitisation and Factoring
Trade receivables securitisation (TRS) refers to a process whereby working capital can be raised by selling trade receivables to a special purpose vehicle (SPV) on a revolving basis. This SPV, which can either be managed by the corporate or a third party, will then use the trade receivables as collateral to raise financing either through loans or the issuing of notes backed by financial institutions (FIs). Some benefits of this structure include being able to raise working capital at a cost lower than the company’s cost of funds – especially true for a company selling to a buyer with a better credit rating than itself – mitigation of counterparty risk and also achieving true sale if structured right.
What is Factoring?
Factoring refers to the sale and purchase of receivables by a company. Receivables are sold to a purchaser, usually an FI, in exchange for a discounted value commensurate to both the credit rating of the obligor and the tenure of the receivables. Upon repayment, the party who has purchased the receivables will receive payment from the obligor of the receivables. Factoring transactions are usually flexible and can be structured either with or without recourse to the seller, notified or not notified to the buyers, and may be packaged with credit insurance.
Some comparisons that can be drawn from the two receivables financing structures (but not limited to) are:
- SPV: Required for TRS but not for factoring. One SPV can possibly encompass the receivables of multiple sellers, whereas factoring facilities are usually granted to each seller bilaterally.
- Used By: TRS is usually employed by larger corporates, whereas factoring is used across the spectrum of large corporates to SMEs.
- Rated By Ratings Agency: TRS structures need to be publicly rated, whereas factoring transactions are usually credit evaluated by the FI conducting the factoring transaction.
- Funding Mechanism: TRS structures largely depend on a test of collateralisation to determine the funding availability, whereas factoring transactions usually depend on the receivables being approved and within the limits set by the FI purchasing the receivable.
- Risk Mitigation: Both forms of financing use a combination of proper credit evaluation and trade credit insurance to mitigate credit risk. TRS also uses reserves to manage losses, dilutions, yields and fees whereas factoring transactions use a more transactional approach such as controlling the funding quantum or getting buyer acceptance to reduce incidental risk.
Developments in TRS and Factoring Markets
Before the financial crisis, it was common for large corporates to have TRS structures in place. Besides having manpower to service the SPV and expertise to manage credit risk effectively, large corporates also had sufficient scale in terms of receivables to run a successful structure. The financial crisis has caused investors to shun away from securities, as a result, affecting the TRS market.
As they are backed by trade receivables, TRS notes should have been differentiated from other securities, but as investors looked to invest in other asset classes, the number of securitisation structures also decreased. However, in the years after the 2008-09 financial crisis and with the recovery of markets, there is a re-emergence of TRS structures. A notable example would be food producer Bunge’s US$700m TRS structure of June 2011 in the US, which was structured and serviced by a third party, and funded by commercial paper conduit backed by a few international banks.
Factoring in recent years has seen continued, strong growth, especially in Asia. Factors Chain International (FCI) figures put towards total global factoring turnover for 2012 of US$2.81 trillion, with a 3 year Compounded Annual Growth Rate (CAGR) of 15%. Across Asia, the 3 year CAGR stands at 36%, powered by China which alone accounted for 16% of the global factoring turnover.
This Asian growth can be attributed to both the rise of trading on open account terms and also corporates exploring alternative forms of securing working capital other than bank borrowing. Once dubbed as the preferred financing tool for small to medium-sized enterprises (SMEs), large MNCs are now embracing the notion of factoring, selling off A/R and converting them to cash to lighten their balance sheets and reduce counterparty risks. There is an increasing large-scale acceptance of factoring among corporates in the technology and telecommunications sectors across Asia.
As global trade gradually shifts to transactions on open account terms, receivables will continue to remain as the largest asset class on the books of corporates. TRS and factoring facilities serve as proper receivables financing and risk mitigation tools that corporate treasurers can employ to manage their balance sheet in conjunction with their financial partners.
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