‘How factoring can improve SMEs’ access to finance’

Peter Mulroy is the Secretary General, FCI, a network of global factoring companies. In this interview with FEMI ADEKOYA on the sidelines of the recently concluded trade finance seminar by African Export-Import Bank (Afreximbank), he talks about the need to embrace innovative finance solutions like factoring and credit insurance to aid the growth of small and medium-sized enterprises (SMEs) in Nigeria and other African countries as well as enhance regional integration. Excerpts.

Can you give an overview of what Factoring is all about?
Factoring is a product that is designed for SMEs. When you think of factoring, you think of SMEs. Let me just start with the basics of Factoring. When you are doing a traditional loan from a lender to a borrower, it is a two-way street/two parties, a bank and a borrower.

The money is given to the borrower and the money is repaid to the bank. In Factoring, it is similar. There is fund being advanced to a seller, but the difference is that it is a three-man affair whereby funds are given to the seller and you have a sale assignment of the seller’s account receivable on their balance sheet through the factor. The question is, why account receivable? The account receivables are created when a seller is shipping on open account terms.

There are predictions that over 90 per cent of global trade will be open account. So that means that the vast majority of businesses that will be transacted in the future will be on open account, which means receivables will be created on the seller’s balance sheet‎ exponentially as well. We see this as of one those assets classes that are intangible, because you cannot touch them or feel them, they are not like real estate where you can go and put up a lien on a property. These are intangible assets, but if the laws are perfected in a way that it protects the factor, the financier when they purchase that receivable, ownership rights, then the factor can knowingly finance that SME with the assurance that they will get repaid. Repayment is not from the client, but from the client’s buyers, their customers. This is because when you purchase receivables, you are purchasing the rights of that receivable. Factoring is the transferring of those receivables from the seller to the factor and all the rights underneath those receivables.

Why the interest in Nigeria and other African countries at the moment?
Africa as we all know is a land of businesses predominantly that are considered as small and medium sized enterprises and one of the perceptions around the world is that they have a harder time getting traditionally bank funding so they are left out of the economy thus pushed to the black economy. They go underground. So, one of the values of factoring is the controls that are in place and again to ensure that the factor gets paid. The factor is not looking to the seller, the small and medium enterprise for green payment, but looking for the seller’s customers, their buyers and it could be investment rated companies, strong buyers; it could also be SMEs. But the point is that instead of having all your risk in one entity, you can have your risk in multiple baskets of risk by having multiple buyers so your risk is spread therefore improving your chances of getting repaid. This is the strength of factoring. I will have to go back to the point that you have to have laws in place. There is a need to have the rights to assign the receivable, be it property or any other asset. There is a need for laws to protect your rights and your interest. This is because you do have rights for instance, to get to the buyer but those rights are only good if the government protects you when you have to exercise those rights. That has to be embedded in law as well and that is why the Africa Export Import Bank is pushing the African Model Law, because they want to raise the standards of creating a strong legal foundation for the development of factoring which will ultimately develop and support SMEs.

What are the challenges affecting penetration of factoring in Africa and what can be done to make it work better?
This is not specific to Africa, but to the emerging markets in general. The first hurdle is culture. There is a struggle to change from what used to be done to a new culture. So here, you have a world that has been forced upon them to change, because 20 years ago, there was very little international trade ‎on open accounts. By 2020, they are expecting about 90 per cent of transactions to be done on such platforms. So this is forcing the banks, the Central Bank of Nigeria (CBN), the regulators to look at this product—Factoring in a new light. This is happening everywhere not just in Africa. We have the same issues in the South East Asia, the Caribbean, Central America. The mentality of financing trade beyond the traditional forms of trade financing, but using Factoring as a new tool to provide liquidity to SMEs requires a change in culture. The second challenge is the legal framework and that requires having proper legal infrastructure. Cameroun has passed the Factoring Law, same as Egypt. So there are countries on the move creating their infrastructure on their own and that is great. Thanks to the African Export Import Bank and I will also say that the World Bank is also pushing  reforms and trying to support governments to create a legal infrastructure for the financing and securing transactions. They also have a matter law that incorporates Factoring in receivable finance as well. Factoring in matter law is a little easy to develop because it is just one matter law and it is secured as many other different types of oversight relating to all different types of asset classes.

How do you hope to deal with issues of low intra-African trade, national ratings, regulatory environment and trust?
Nigeria is the largest economy in Africa. Ghana is also growing in leaps and bounds, but in these countries, Factoring does not exist. However, we have started seeing the green sheets of Factoring in these markets, but it is just green sheet at this point. The Export Import Bank is pushing the matter law in Nigeria and it is possible to say that by the end of the year or middle of next year we will have an announcement of a new law for Factoring in Nigeria. To your second question which has to do with political risks and ratings, what I will say is that in some aspects, it does not matter because every country has its environment and you have to deal with the environment that you are handling. The cost of factoring for example in a high risk market is almost equivalent to the cost of capital for a company that is approaching a bank. Many have to pay a little more based on the level of risk, but it is not necessarily due to the country risk or the rating of the country itself. When I mentioned reverse factoring for example, if an anchor buyer is located in a developed country and if they are a strong company, you can leverage the strength of the balance sheet of the buyer and pass on that strength to the supplier no matter where they are. I was in Bangladesh recently and a number of suppliers are now using reverse factoring as suppliers and the cost of their capital for their factoring programmes is half of the cost of their traditional financing cost to a bank. So there are also ways to reduce that cost through reverse factoring. I will not say that the ratings and the political risk from the stand point of the environment will prohibit the growth of factoring I do not think that is going to be the biggest issue.

What are the benefits of Factoring and the interest rates compared to banks’ funds?
Our first member in Nigeria, the NEXIM bank, joined FCI last year and they are trying to develop a factoring solution for exporters. Using the Export Import Bank of Mexico as an example, they started with FCI and factoring five to six years ago and today they are the largest international factoring company in Mexico. Over time, they have developed this product and viewed it as a policy decision, because they know that if they can provide factoring and get financial institutions to provide factoring, they will help their SMEs and what helps the SMEs helps the economy.

They viewed factoring as a policy instrument and that is why the Africa Export Import Bank, Asian development bank, the European Bank for Construction and Development are using factoring as a tool to bring liquidity to their markets to help develop SMEs. Factoring is just a natural product for developing countries, because capital is so important. To the SME, capital is king; liquidity is king and that is what they need. If credit insurance can be used to provide and create capital, they will be interested in credit insurance and if it does not provide capital, they are not interested and it speaks to the point that liquidity in capital is everything and it is the life blood for the SME and without it, they will die.

One of the first countries to deploy Factoring was South Africa. They developed Factoring  in the 1960s, that was about 50 years ago. They were the first to deploy Factoring and now you have other countries in the 90s. Factoring was kind of popular in the North and South Africa region. The real word is that we are catching up and I think we are going as fast as we can to support the African Export Import Bank who has been such a friend to SMEs and Factoring, as well as to the development of Factoring in the sub- Saharan African region. They want to increase the number of factors in Africa from 30 to 100 by 2021; they want to increase cross border Factoring. There are very aggressive calls and we are going to do everything to support that growth and help them achieve these realistic and obviously impressive targets.

In countries where Factoring is already working, do they exist as part of banks or independent of them?
At least, half of Factoring globally is in the hands of banks and about 25 per cent is in the hands of subsidiaries of banks and the rest are commercial factors, non bank financial institutions and entrepreneurs that have established small commercial operations. If you look at FCI itself, out of our 400 members in our 90 countries, almost 80 per cent of the members are bank related. They either bank themselves or subsidiaries of banks. FCI is a reflection of that. Our members account for something like 70 per cent of the global Factoring volume. So, the 2.4 million Euros that are generated each year, our members account for 70 per cent of that volume and for cross border it is nearly 90 per cent. We are the voice for the industry and that is why we are here, FCI wants to help to support the growth of Factoring. It is a challenge that I have to admit, but we are very excited.