EU Federation for the factoring and commercial finance industry

The EUF is the industry body and voice for the European factoring industry. The EUF’s members consist of 13 national factoring and commercial finance associations (representing 15 EU-member states, namely [in alphabetic order] Austria, Belgium, the Czech Republic, Denmark, France, Germany, Greece, Ireland, Italy, the Netherlands, Poland, Portugal, Spain and the UK) and the international factoring association FCI.

Commercial Finance is a generic term for a range of asset based finance services which inter alia include factoring, invoice discounting, international factoring, supplier finance or reverse factoring. There are many variations on each of these product sets (and the precise nomenclature varies from market to market) but all exist to provide working capital funding solutions to businesses. The nature of the services provided by the commercial financier will vary according to the clients' particular requirements but all of these solutions have in common the idea that funding may be offered based upon the debt invoicing created by the client company. Hereinafter, we will generically use the term factoring for ease of reference.

In 2018, the factoring industry in the EU provided over €242 billion of working capital financing to more than 200,000 businesses. According to the results published in the EUF White Papers of 2016 and 2019 on Factoring and Commercial Finance (cf. https://euf.eu.com/what-is-euf/whitepaper-factoring-and-commercial-finance.html), mostly SMEs and principally businesses in the manufacturing, services and distribution sectors used factoring. The amount of working capital provided by the European factoring industry has to be seen in relation to the total factoring turnover, which in 2018 was over € 1.7 trillion. In relation to the total GDP of Europe, the factoring industry turnover represented around 11% of EU GDP in 2018. Our members account for 97% of the total European factoring market, and comprise of both regulated and non-regulated factoring companies. Over half of the factored volume conducted within the EU is generated by factoring companies that are banks or part of consolidated banking groups, but there is also a significant number of independent factoring companies, some of which also specialize in B2C-factoring, i.e. where the debtor of the receivable is a consumer.

It is in its role as the representative body of the European factoring and commercial finance industry that the EUF wishes to make a contribution to the ongoing consultation of EBA Guidelines on loan origination and monitoring by raising awareness for and pointing out some factoring-specific issues, in particular in relation to the information on debtors in factoring relationships.

Factoring and commercial finance (FCF) are generic terms for a range of asset based finance services which include factoring, invoice discounting, international factoring, supplier finance/reverse factoring and asset based lending. Due to differences between national laws, especially in civil or contract law, there are many variations on each of these product sets and the precise nomenclature varies from market to market, but all exist to provide working capital funding and financing solutions to businesses, particularly SMEs. These FCF services also have in common the idea that funding is offered based upon the accounts receivables created by the client company: With a factoring solution, the FCF company agrees to pay an agreed percentage of approved debts/receivables as soon as the receivables are assigned or (in some jurisdictions) pledged to it. If credit protection is part of the factoring agreement, it is referred to as “non-recourse” factoring, while a factoring agreement where the credit risk on the debtor remains with the seller is called “with-recourse” factoring. The factoring company will often also undertake all credit management and collections work. Factoring is therefore simply a unique blend of services designed to ease the traditional problems of selling on open account terms, mainly aimed towards SMEs.
Understandably, the (credit) risk management of factoring companies depends upon the kind of factoring solution in each case. In general, factoring is a short term, self-liquidating activity, usually with no retail deposits1. It is a safe and secure financing solution that has shown a long history of low credit losses and very low Loss Given Default (LGD) statistics compared to traditional lending (cf. the EUF’s Whitepaper on Factoring and Commercial Finance of May 2019 at https://euf.eu.com/what-is-euf/whitepaper-factoring-and-commercial-finance.html).

It is against this background that the EUF wishes to stress that the aforementioned EBA Guidelines need to take into consideration risk adequacy and product specificities also for factoring.

In the following notes, we provide suggestions on how to effectively adapt the Guidelines with specialized business that are characterized by peculiar credit risk features and, therefore, peculiar credit risk underwriting and monitoring practices.

General remarks on Guidelines

The language used in the consultation implies that the guidelines will be de facto regulation; we trust that there will be a clear linkage between these guidelines and the corresponding primary regulation.
The EBA’s proposed Guidelines are too prescriptively worded, in a way that would not allow a flexible and risk sensitive implementation according to the proportionality principle as regards to product types, lending channels, amount of borrowing…They are too much risk adverse and pro-cyclical.
The proportionality principle should apply as regards to the nature, size and complexity of the institutions and as regards to the types of products, in particular factoring which is not a service provided to consumers. References to proportionality in introduction to the Guidelines are too light and general. It should be made clear that the supervisors may adapt their use of the Guidelines.
The requirements are to be understood as examples of requirements, allowing institutions to use only part of it, as there is no point to issue universal requirements that would fit all types of lending and institutions
We exhort the EBA to express this view more explicitly in the drafting of the Guidelines so that national competent supervisory authorities find the margin of manoeuvre to agree sound governance, loan origination, pricing and monitoring procedures and organisations as of equivalent value, even if they diverge from the strict list of requirements.
We notice a high use of the term “at least” or similar (e.g.: “should” interpreted as mandatory), which can be read as contradictory with any proportional application of the Guidelines. Using a wording such as “for example” and “where relevant” and “or equivalent” to introduce the requirements would probably ease a reasonable application of the proportionality principle.

Although the guidelines looks like a collection of good and sound practices in underwriting and monitoring credit exposures, the level of detail is very high and not necessarily adaptable to all kinds of financial services.

Factoring companies, due to the limited credit risk of the factoring transactions thanks to the purchase of trade receivables (which represents a powerful and highly secure collateral), are able to serve riskier businesses without undertaking larger risks than banks. Thus, the client portfolio of factoring companies is normally made of smaller and sometimes riskier businesses. Their underwriting process takes into account not only the credit worthiness of the client (the supplier in a trade transaction) but also the credit worthiness of the account debtors (the buyer), as well as the quality of the trade relationships and of the aggregate portfolio of receivables underlying). While we understand the merits of pushing objective methods to assess the quality of a client, we highlight that the top down application of stiff credit decision policies (which are strongly related to bank lending) might be detrimental to the real economy to the extent it might limit the access to factoring for those business, especially SMEs, who do not qualify for traditional lending but could benefit from factoring, having a strong receivables portfolio.

We therefore suggest to explicitly state that the Guidelines focus on traditional bank lending, while for specialized forms of financial services, such as factoring, a lower client quality might be compensated by the strong quality of the assets purchased or pledge. In general, we feel there is not enough attention in the Guidelines to the assessment of asset based lending transactions, and in particular self-liquidating transactions, whose risk needs to be assessed properly taking into consideration all the components of the transaction, namely the client, the assets (in the case of factoring: receivables), and all the risk mitigation tools normally included in the agreements (e.g. limits to the transfer of risks to the factor, credit insurance ...).
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In addition to the abovementioned pitfalls of the approach set by the Guidelines in the case of specialized factoring transactions, we also highlight that factoring companies generally do not have direct contractual relationships with the debtors of the purchased receivables (there is no loan or advance made to the benefit of these debtors) and hence they have only limited direct access to detailed information.

Therefore, factoring companies should be able to continue to rely on external information on credit risk and creditworthiness, provided directly by the client (who shares, among other things, the sales ledger and the payments behaviour of the buyer) and sourced by third parties (e.g. from credit enquiry agencies). The creditworthiness assessment on account debtors made by the factoring companies are complete and thorough even if they do not collect information directly from them, and should thus not be required to obtain the detailed level of information about debtors as stated in e.g. points 5.1 (collection of information and documentation, in particular no. 83-86) and 5.2.5 (specificities for assessment of the financial positon of SMEs, no. 138) of the aforementioned draft EBA Guidelines as these would set disproportionately high and not risk adequate requirements for factoring.

In conclusion, in the unexpected case where debtors would be included within the scope of application, we suggest, at least, confirmation that analysis and monitoring of such debtors will follow lightened guidelines or, preferably, customized requirements. This would be in line with ECB work related to the treatment of factoring for AnaCredit where data required for debtors are limited compared to those required for clients. As stated in the AnaCredit Reporting Manual – Part III – Case studies, chapter 5 Factoring : “ Meanwhile, in cases where the counterparty is the account debtor, some of the counterparty reference data required for AnaCredit reporting (i.e. data on the debtor) are not available to factors as there is generally no contractual relation between the factor and the debtor (i.e. the factoring client’s customer). Therefore, the following data attributes are reported as “Non-applicable” “.

While the EUF does want to see responsible provision of finance, it also thinks that the proposals do not reflect a market that is diverse and tailored to the different operating models relevant to different sizes of business, different products and innovative processes. It could actually be counterproductive in discouraging adaptation and flexibility and harmful to access to finance and competition.
In addition to the abovementioned pitfalls of the approach set by the Guidelines in the case of specialized factoring transactions, we also highlight that factoring companies generally do not have direct contractual relationships with the debtors of the purchased receivables (there is no loan or advance made to the benefit of these debtors) and hence they have only limited direct access to detailed information.

Therefore, factoring companies should be able to continue to rely on external information on credit risk and creditworthiness, provided directly by the client (who shares, among other things, the sales ledger and the payments behaviour of the buyer) and sourced by third parties (e.g. from credit enquiry agencies). The creditworthiness assessment on account debtors made by the factoring companies are complete and thorough even if they do not collect information directly from them, and should thus not be required to obtain the detailed level of information about debtors as stated in e.g. points 5.1 (collection of information and documentation, in particular no. 83-86) and 5.2.5 (specificities for assessment of the financial positon of SMEs, no. 138) of the aforementioned draft EBA Guidelines as these would set disproportionately high and not risk adequate requirements for factoring.

In conclusion, in the unexpected case where debtors would be included within the scope of application, we suggest, at least, confirmation that analysis and monitoring of such debtors will follow lightened guidelines or, preferably, customized requirements. This would be in line with ECB work related to the treatment of factoring for AnaCredit where data required for debtors are limited compared to those required for clients. As stated in the AnaCredit Reporting Manual – Part III – Case studies, chapter 5 Factoring : “ Meanwhile, in cases where the counterparty is the account debtor, some of the counterparty reference data required for AnaCredit reporting (i.e. data on the debtor) are not available to factors as there is generally no contractual relation between the factor and the debtor (i.e. the factoring client’s customer). Therefore, the following data attributes are reported as “Non-applicable” “.

While the EUF does want to see responsible provision of finance, it also thinks that the proposals do not reflect a market that is diverse and tailored to the different operating models relevant to different sizes of business, different products and innovative processes. It could actually be counterproductive in discouraging adaptation and flexibility and harmful to access to finance and competition.
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Diego Tavecchia
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