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An international legal reform body has launched a new model law for factoring, aiming to boost access to trade finance for small businesses in emerging markets through solid regulatory foundations.

Until now, there has been no widely accepted international law underpinning factoring, or the purchasing of receivables from firms who want to free up cash flow. The value of the global factoring and receivables finance market swelled to €3.66tn in 2022 following a sustained period of record growth, according to industry statistics.

Unidroit, an intergovernmental body dedicated to harmonisation of private international law, adopted the factoring model law in May this year after being urged by the World Bank to develop one in 2018.

The model law was formally launched last month at the annual conference of FCI, the global factoring industry association. It is aimed at countries that do not currently have a comprehensive legal framework for secured transactions.

Peter Mulroy, FCI’s outgoing secretary-general, says adoption of the law will help close the estimated US$2.5tn trade finance gap, measured as the mismatch between supply and demand.

“The fastest way to address the trade finance gap for SMEs is to deploy factoring and increase the level of factoring, because it is the easiest way to get capital into the hands of SMEs,” he tells GTR. “If you don’t have a law, if you don’t have a regulation in place to allow factoring to propagate in a country, then it’s a detriment to SMEs. It adversely impacts the growing trade finance gap.”

While factoring is a robust and long-established global market, Europe is responsible for around two-thirds of global factoring volumes, according to an annual FCI market survey published in May.

But the product is also rapidly gaining traction in some emerging markets, including growth of more than 50% in Turkey and Serbia and 41% in Chile during 2022. Factoring volumes in Mexico and Ukraine more than doubled during the same year.

“This model law will become a game changer,” says Mulroy. “It will introduce the concept of creating stability, creating confidence for investors. In a way, a model law is a guide, but it’s also an educator – it defines what factoring is. It brings a kind of institutional knowledge to a country that has no institutional knowledge [of factoring].”

In Mulroy’s view, the biggest impact of the model law will come from ending bans on the assignment of receivables. The ability for debtors to ban assignment of receivables to third parties, such as factoring providers, has hampered appetite for financiers to provide factoring.

India Factoring CEO Ravi Valecha says widespread adoption of the model law will make it easier for global factoring providers such as Fimbank – India Factoring’s parent – to offer the product in more markets.

Buyers and sellers will also be more open to cross-border factoring if the laws in the country of their counterparty are the same as in their own jurisdiction, Valecha adds.

“The acceptance at the buyer and seller levels across segments is uniform in the mature markets, but it may not be so in developing markets where factoring is not established.”

Unidroit previously developed a convention on international factoring in the 1980s, which was adopted by nine countries and used primarily to govern cross-border factoring arrangements. The Rome-headquartered organisation says the new model law is targeted at enabling domestic factoring.

Mulroy says it will also help encourage cross-border factoring by providing financiers with assurances on the safety of their security and by having local legislation in place when disputes arise.

Of 90 countries surveyed by FCI in a legal study this year, just over a third had no specific regulation for factoring.

African Export-Import Bank (Afreximbank) launched its own model law on factoring in 2016, which has since been adopted by legislatures in countries such as Burkina Faso, Niger, Republic of the Congo and Togo.

The central bank of the West African Monetary Union also adopted a factoring model law, based on Afreximbank’s document, in 2020.

India adopted a factoring law in 2011, but eased lending requirements in 2020 and again in 2022, helping fuel an 83.4% year-on-year jump in market size to €15.7bn last year, according to FCI figures.

The law, which standardised rules on assignment across India’s states was instrumental in boosting the use of factoring in India over the last decade, Valecha says.

India Factoring is currently studying whether there are any major differences between Indian legislation and the model law. Depending on the results, the company may discuss potential changes with the government to align New Delhi’s legislation with the Unidroit rules.

Unidroit officials did not respond to requests for an interview on the model law.