From old school to young guns –
Old-school it may be, but factoring is one area of trade finance that’s entering 2007 with all guns firing, writes Helen Castell.

The concept of turning sales into instant cash is as attractive as ever, while bigger corporates are increasingly seeing the appeal of balance sheet beautification. And as emerging markets get their exports into gear – and regulators slowly lift restrictions – a whole new breed of clients is clamouring to use factoring.

Active in China

As in other sectors, the Far East is where it’s all happening, says Jeroen Kohnstamm, secretary general at Factors Chain International in Amsterdam. As more importers in Western Europe refuse to open letters of credit, this is forcing exporters to switch to open-account terms, he says.

“The triangle between Hong Kong, Taiwan and [mainland] China is the hotbed for cross-border factoring.” As Taiwanese companies set up production facilities in mainland China, they are bringing with them an experience of – and expectation for – factoring. “These joint ventures are now going to the market and asking where they can find factoring.”

“So that will push Chinese international factoring, which eventually will spill over in Chinese domestic factoring.”

However, apart from HSBC, which “has a very healthy and growing factoring operation out of its Shanghai office”, and Royal Bank of Scotland, which might develop its factoring business in China, the international banks currently active in China happen to be those that are not big in factoring, Kohnstamm says.

A fall in factoring pricing is driving growth in emerging markets in general, he notes.

Machinery shift

A shift in Ukraine towards export of machinery and manufactured products, from minerals and metals, is driving growth in international factoring, says Natalya Tihovskaya, head of factoring services at Ukrsotsbank in Kiev. Ukraine’s biggest export factoring markets are Russia and Belgium, although import factoring for automobile parts, chemicals and raw materials for the food industry from China is also growing.

Ukrsotsbank’s international factoring turnover is expected to have surged fivefold to €7.2m in 2006, from €1.47m, while its domestic factoring has doubled to €338.5m. The country’s total factoring portfolio is expected by January 2007 also to have doubled year-on-year to around €120m, she says.

Russia’s factoring market has meanwhile been roughly doubling year-on-year since the early 2000s, and at US$5.5bn now represents around 1% of GDP. Some 30% year-on-year growth in Russian exports, largely to Western Europe, certainly helps, says Vyatcheslav Ivanov, international operations manager at National Factoring Company in Moscow.

Within Eastern Europe, Poland’s large population and supportive regulatory environment – separate factoring companies are allowed – is attracting interest among factors, Kohnstamm says.

Another triangle, this time in southern Europe, links Greece with Bulgaria and Turkey, says Demetris Zouzoukis, forfaiting and international projects manager at EFG Factors in Athens. Trade between the three is surging, meaning cooperation between factors in each country is on the rise.

EFG Factors expects to post a 23% growth in its business in 2006, helped by a strong focus on international factoring, the growth of which is far outpacing that of domestic factoring, Zouzoukis says. According to FCI statistics in October, EFG held 63% of the country’s export factoring market.

Greece’s total factoring market will however fall short of its predicted 5% growth this year, following the losses and subsequent closure of two factoring companies, says Zouzoukis. The market is now expected to reach around €4.5bn by end of 2006, up around 3% from 2005’s €4.37bn.

In Germany, a growth in discount stores has built business for factors, says Albert  Traunthaler, director, trade receivable finance, at Deutsche Bank in Frankfurt. Long payment cycles – often around 90 days – leave discount supermarket suppliers for example with big trade receivables on their books.

Electrical goods discount retailers have their Christmas boom just ahead of the end of the German financial year, meaning that come year-end their suppliers are left with a huge exposure. Without factoring, “it could ruin their balance sheet ratios. They would be sitting on all those receivables, which would, due to their long tenors, only be repaid in January, February or March”.

UK and US fight back

Excellent Asian sourcing skills, as well as traditional strengths in oil, telecoms and now fast fashion, are helping UK manufacturers and exporters fight back against competition from abroad, says John Beaney, head of international fnvoice finance at HSBC in London. In the year to October 2006, HSBC’s factoring business supported £1.4bn of UK exports – 18% up year-on-year, he says.

And although not experiencing the same boom as Europe and Asia, factoring in the US is engaged in its own quiet revolution.

As traditional manufacturing industries such as apparel and textiles lose ground to Asian competitors, factors need to think on their feet, being alert to potential new export markets – and how to capture them, says Louis Barrone, international managing director at GMAC Commercial Finance in New York.

“Because obviously export is good business, we need to get outside some of the traditional industries that have lent themselves to factoring,” he adds. “You need to educate your domestic sales force on how to look for those opportunities. So that’s what we’re in the process of doing now.”

Unexpected client finds include North Carolina furniture companies, importing in bulk and then exporting smaller quantities to South America. “Where traditionally the companies down there were manufacturers, many of them have gone to importing. But by virtue of the product, obviously shipping costs are a big concern, so many of them ship in full container loads. So they do warehousing in the US – it’s not made here but they’re still purchasing it.” GMAC has similarly found opportunities for exports of automobile parts to South America.

While it seems that factors need not be having sleepless nights, one issue that future growth can hinge on is legislation.

A key regulatory issue in many markets is whether or not factors are allowed to operate as independent companies. Even in markets where both are allowed, the way they do business is very different, says Zouzoukis.

A bank’s factoring department primarily follows the company’s financial data, often already a year out of date. “They don’t analyse the shelf ledgers to see the product flows, they don’t analyse commercial behaviour,” he says.

Within a 45-day credit period, several factors can change a company’s business. And with Greece’s four or five-month payment cycle, this is even more the case. “So that affects the relationship you have purchased.”

Facing restrictions

Vietnam’s central bank has finally opened the doors for factoring departments in banks, but not yet separate companies, and Chinese authorities are now deciding whether to permit independents.

“And as long as they don’t allow the creation of separate companies, it’s very difficult for a foreign factoring company if they want to establish a 100%-owned Chinese subsidiary or want to go the route of a joint venture,” says Kohnstamm.

In Ukraine, it is prohibitively difficult – if not outright barred – for independent companies to offer factoring services, says Tihovskaya.

In Russia and other CIS countries, restrictions on currency transactions – now in the slow process of being liberalised – rather than legal hurdles, make international factoring difficult, says Ivanov. Meanwhile, the lack of a ban on assignments makes domestic factoring relatively easy.

The implementation of Basel II is one regulatory change that seems good news for factors.

“Basel II, and the need for corporates to have the best possible rating, will continue the pressure on mid-caps – and large-caps – to look at their balance sheet very carefully. And not only look at the pricing of their funding but also at the consequence of their funding,” says Traunthaler.

“Because it’s a regulation that’s just about to be implemented, it’s unpredictable and not everyone will treat it the same,” Beaney says. “I personally think it’s an opportunity. The output of it should be that we’ll be able to give a better service.”

A current consultation about enforcement of legal actions across the European Union should also make it easier for factors, Beaney says. “My costs would be lower, my service would be better if everybody’s legal system was as efficient as the UK’s .”

What’s in a name

One area where there consistency is virtually non-existent is the definition of factoring itself.


“I travel all over the world and the word ‘factoring’s has different connotations everywhere you go,” says Barrone. “There’s just the straight invoice discounting, which is very prevalent in the UK and Europe. For us, we call that off-premise with advances, because the client is controlling and servicing the receivables. Traditionally in the US we buy a book of business, not just receivables.”

“There are still many misconceptions as to what constitutes factoring,” says Kohnstamm. “If a bank introduces a new financial service and they are dealing with receivables, they call it factoring. And there is normally no one to stop them? Central banks don’t normally go much further than to say ‘you are allowed to do factoring’s or not.”

In Mexico, ‘factoring a la mexicana’s – a form of bank lending, mainly offered to larger companies, where the receivable is used as the only form of collectible – was developed by lenders to wriggle free from central bank control, which banks, but not factoring companies, fell under.

“They were basically lending money and in the event of a problem with the client they would have the receivables as collateral, but they wouldn’t check the receivables, and therefore they were doing what to a certain extent is invoice discounting in the UK.”

Although factoring a la mexicana still goes on, its users now acknowledge that it is quite different from classical factoring, which is on the rise in Mexico.

In Russia, factoring is taken to include services where the buyer is a private consumer, rather than the strict business-to-business model usually adhered to in the west, Kohnstamm continues. “So when there are stories about growth figures of factoring in Russia, one has to question if this is factoring or if it is Russian-style factoring.”

As Ivanov says when describing the 100 or so banks offering domestic factoring in Russia, “what they offer isn’t real factoring – it’s more like invoice discounting. There’s only about 30 serious players in the market.”

In Greece similarly there used to be a form of factoring that was actually factoring of white goods, Kohnstamm says. “So that is really a form of consumer finance.”

“Yes, you are dealing with receivables but the debtor is a very different type of entity than a corporate entity,” he says. “They did not have the right mechanisms either to handle this business correctly.”

Factoring’s brush with consumer finance was damaging for the Greek market, and more potential problems lie ahead as factors face mother bank pressure to purchase public hospital receivables, says Zouzoukis. “It’s a risky relationship.”

Greek differences

As well as inconsistencies in regulations and definitions, factoring also differs depending on the business practices from country to country.

Although the best practitioners adhere to classic factoring, the Greek market has an unusual risk profile for factors, says Zouzoukis. Credit periods average around four months – far longer than the 45-60 days typical in northern Europe – and post-dated cheques are a standard part of business life.

“It’s difficult to monitor because a company may have thousands of post-dated cheques from the buyers, so you have to be very careful with the management of these accounts. You have to follow up and see these cheques are covered at the maturity date,” he says. “It’s not like a promissory note. A cheque can be withdrawn. So you’re out in the cold.”

In many markets, international factoring remains dominated by a handful of players, or fewer. In Russia, for example only three companies engage in international factoring, and are members of the international chains. In others however, competition is becoming more cut-throat.

Although some barriers to entry remain, more banks in Ukraine are entering the factoring market, as the product becomes a make-or-break part of their product offering for clients, says Tihovskaya. Some companies are moving the rest of their business elsewhere if a bank cannot provide them with factoring, she notes.

“Competition makes it hard to make money out of factoring,” she says. The market is far from saturated though. “Even if the competition is big, the market is much bigger.”

Despite strong growth, factoring has suffered a nosedive in pricing over the past two years, driven down by aggressive appetite from the banking and factoring world for trade receivables, Traunthaler says.

The involvement of commercial banks is largely to blame for this, argues Kohnstamm. Their focus on factoring as finance has created a climate where climates resent paying commission and prefer to pay only interest, he says.

Prices have in some cases become comparable with a client’s borrowing rates, meaning factoring is attracting bigger and better converts.

“In the old days factoring, at least here in Germany, was considered to be an instrument for the smaller and weaker mid-caps,” Traunthaler says. “So that’s all of a sudden opening up new market segments, and I think that’s a self-feeding growth.”

“Factoring in the US, going back 30 or 40 years, had bad connotations – in that the companies that used factoring where typically not financially sound enough to get a bank line of credit,” says Barrone. “But that’s certainly not the case any more.”

GMAC typically improves its clients’s collection cycle by 10 to 14 days, says Barrone. And while this creates savings for a business of any size, for larger companies the attractions can be striking. “If you can improve your collection cycle by 10 to 14 days, on several millions of dollars a year of turnover, the interest saving is substantial.”

Germans offer independence

While invoice discounting, as practiced in the UK, is driven by generating funds and liquidity, the German without-recourse model attracts clients for its ability to improve their balance sheet, cut risk and give them an element of independence from their bank lenders, Traunthaler says.

The reluctance of German banks to lend to mid-caps over the past few years sent them looking for alternatives, and factoring was happy to step in, says Traunthaler. “[Banks] are now rediscovering their love for the mid-cap so at the moment we have a bit of a clash between the factoring world and the banks, which are opening up the lending floodgates again.”

However, long-memoried mid-caps relish their new independence and are likely to keep at least some of their business with factors, he argues.

Ultimately, it is in government’s interests to support classical factoring, with its emphasis on SMEs rather than larger corporates, says Kohnstamm. “The support to small and medium-sized companies is in many economies the most vital interest, because SMEs provide employment, and there are far more people employed in the SME sector than in the few very large companies in the corporate sector.”

Innovation is often born through necessity and the pressures of competition can give rise to some interesting new structures – some of them controversial.

As asset-backed securitisation has seen the size of transactions it is used for whittled ever smaller, it has “invaded the traditional factoring turf,” Traunthaler says.

“We have seen a strong convergence concerning the structure of factoring and asset-backed securitisation, so what you are seeing nowadays are sort of hybrid structures,” he says. “ABS as it was originally created would be too expensive to apply to the normally smallish amounts in factoring. But ABS learned quite quickly what it had to shed in order to be more cost-effective and therefore can price lower than a typical ABS structure.”

Similarly, competition with insurers has spawned ‘maturity factoring’s structures. “It’s a kind of replacement for credit insurance, a kind of factoring where you really just cover the risk,” he says. “You call it factoring but it’s done without any proceeds being paid to the seller.” The advantages are that, unlike with classic insurance, clients receive 100% cover.

Even in the US, cradle of classic factoring, asset-backed structures are gaining ground – and factors are getting quicker to respond.

“Client requirements, especially on the west coast of the US, are moving more towards what we would call the asset-based lending type, which is similar to invoice discounting in Europe,” says Barrone. “We’re trying to unbundled the products, trying to perhaps eliminate letters of credit.” Instead of focusing on its all-in product, “we try to go out and listen to the client’s needs, what their particular business cycles are.”

And herein may lie the future of factoring. Like it or not, the product is evolving. When old-school stalwarts start speaking like young guns, you know that change is here to stay.