Opinion: Factoring as a complementary force for growth

Cagatay Baydar, Vice Chair, FCI, and Executive Chairman of TEB Faktoring Board of Directors discusses the complementary, not competitive, nature of factoring and insurance and how both tools can best be used for growth.

With the COVID crisis, the definition of force majeure risk, which we had all forgotten about for a long time, came onto the agenda again both in receivables finance and in the insurance sector. The re-emergence of political risks following the COVID pandemic has further increased the importance of credit insurance in the world of trade finance. Although the factoring and insurance industry may have been understood to be competing for many years, these two sectors can work as complementary products. First and foremost, it is necessary to understand and describe how factoring and insurance are complementary rather than competing.

Especially under today's competitive conditions where access to finance is difficult, companies need to know both products' weaknesses and strong sides and understand how they work together. Unlike credit insurance, which insures against the risk of non-payment of the buyers, factoring allows you to obtain working capital for your business by utilising your outstanding invoices as collateral. Essentially, the factoring contract provides three major services: receivables financing, coverage of the risk of non-payment, and management of accounts receivable.

As an association, FCI provides the infrastructure for international factoring, and transactions are handled directly between the members.

The two-factor system means a cooperation between two factoring companies, the export factor, and the import factor.

In summary, the two-factor system allows a seller to take advantage of the three constituent parts of factoring:

• Sellers can obtain funding against outstanding invoices – usually between 80% and 90%.
• It allows sellers to obtain a 100% guarantee against buyer default through insolvency or inability to pay.

Through the FCI network, the seller receives local expertise in each of their export countries.

Specialist insurance companies in several countries offer credit cover to foreign importers and buyers in the domestic market. Below is a comparison of the features of credit insurance and international factoring.

Feature	Credit Insurance	Two-Factor System
Assignment of receivable	Not required	Yes
Whole turnover	Normally yes but specific exceptions can be agreed	Dependent upon the agreement between the factor and the client. The seller is however obliged to factor all credit sales invoices on agreed buyers as per the GRIF
Maximum terms	Normally 180 days	Normally 150 days
Level of credit cover given	Generally 90%	100%
First loss deductible – not applicable in some countries / insurers	Yes – the value will vary but the lower the first loss level is, the higher the premium will be. Not mandatory	No
Aggregate annual first loss – not applicable in some countries / insurers	This is a value that the insured must take as a first loss before the insurer will pay out anything. Again, the lower the loss agreed the higher the premium will be. In many cases this figure can be so high that the client company still has a substantial risk to take before the cover will be effective. It is an area that many clients do not fully appreciate. Not mandatory. Not very common	No
Maximum annual total claims	In some cases the insurer will set a maximum value calculated on the basis of X times the value of the insurance premium paid. This can be very restrictive. The maximum liability of the insurer must at least cover the largest credit limit	Not applicable
Payment under guarantee	Partial payment immediately on proof of insolvency with balance when liquidation is complete although in some cases a full payment is made upon proof of insolvency. Approximately 180 days for delayed payments	90 days past due date
Administration of claims	Formal claim required within specified times. The client is also obliged to regularly advise of debts that go beyond a certain age and to follow specified collection procedures. Failure to comply with requirements may result in the claim being rejected	No administration necessary
Political risk cover	Optional	Dependent upon the contract with the export factor and the exporter
Pre-shipment cover	Optional	No
Debtor can make payments locally – no foreign transfers	No	Yes
Debt collection service	No, until the claim is made at which point the insurer will normally take over	Yes
Financing	No (A financier can be arranged via a ‘Loss Payee Clause’)	Yes
Speed of response to credit limit requests	Normally faster than the two factor system depending upon the country	Variable depending upon the factor and the country
Geographic coverage	Normally more countries covered than through the two factor system	Limited to the countries where we have members that are prepared to offer import factoring services
Premiums (charges)	Varies depending upon country etc. Generally speaking the premiums are lower than factoring but it is difficult to make a direct comparison because of the big differences in the services being offered and the level of coverage being obtained. Normally premiums are paid annually in advance	Varies
Costs for credit limits	Usually yes	Usually no

The international factoring system: Strengths and weaknesses

Strengths

1. Import factors provide on-the-spot expertise in the buyers’ market, which is particularly important in the event of a major problem
2. Importers are dealt with in their own language, their own time zone, and according to their normal customs and practices
3. Import factors have access to local sources of credit information and the experience of their debtor portfolio
4. Import factors can provide valuable assistance in resolving disputes with importers.

Weaknesses

1. The network is not yet fully developed in all markets in the world. Compared with insurance, which has a global presence and risk appetite, the insurance industry may provide wider coverage to the buyers
2. Import factors may be too conservative in providing credit lines. Compared with the risk appetite of the credit risk of the insurance industry, companies may find larger credit limits with their insurance companies
3. Methods of assessing/approving credit lines differ from country to country and factor to factor. Depending upon local infrastructure, etc, answering credit requests may be (very) slow.

If we compare these two products in terms of price, we have to say that the insurance industry can offer more competitive prices. However, this comparison with the services they offer is not an accurate one. Insurance is only one of the products offered by the factoring process. It would be more accurate to compare the financing cost of the insured factoring transaction with other funding costs. The divergence here is due to the fact that the transaction is funded by factoring companies.

The factoring company is in contact with the buyer on each invoice in the factoring transaction, which provides a highly developed follow-up opportunity in terms of credit risk. The factoring industry expertise to monitor the buyers' payment behaviour provides prevention of buyer fraud and early warning of the bankruptcy of the buyer.

We see that many insurance companies do not have the facility for funding their receivables and also, they prefer not to offer that facility. At this point, with the synergy created, these two sectors can offer their customers a combined service in receivables financing. The important point here is to increase synergy, to get a higher share from world trade, to insure more receivables, and provide funding for these insured receivables. The joint work of these two intertwined services will facilitate efficiency and access to finance.

In conclusion, insurance and factoring help countries to grow, support sellers to be more profitable with fewer risks and provide an efficient cash flow to companies for healthy development. So let’s combine our forces and our talents for a better future.