The Rise of Receivables Finance
Receivables finance has grown in prominence to become a flexible financing solution for working capital efficiency that could be critical for post COVID-19 recovery.
Sanjeev Ganjoo, Global Head of Trade Receivables Finance and Kunal Bist, Head of Cross Border Solutions, Treasury and Trade Solutions, Citi, explain how and why banks are using their networks, cross-business capabilities and the collective skills at their disposal to offer an end-to-end receivables solution for clients.
Global Head of Trade Receivables Finance,
Treasury and Trade Solutions, Citi
Global Head of Cross Border Solutions,
Treasury and Trade Solutions, Citi
Receivables are the lifeblood of any organization, which makes receivables finance an important tool within trade finance. By freeing up working capital to increase trade volumes and tidying up balance sheets, financing receivables has long been crucial to the smooth running of the supply chain – particularly when it comes to financing transactions between buyers and sellers in different countries. In recent years receivables finance has taken on a far greater role and interest in this space is growing, with banks expanding their offerings to provide clients with new ways to finance their receivables. Citi specifically has looked to introduce greater innovation in this space by introducing automation, the use of machine learning techniques and improving client service.
A change in the way transactions are evaluated has enabled this. A bilateral lending approach used by banks – whereby a client’s buyers are individually assessed and selected for financing based on their risk profile – is being replaced by a portfolio approach. This enables banks to take on a corporate’s entire network of buyers – regardless of their size or jurisdiction. For clients, such an approach helps them not only offload their entire receivables, it also provides financial flexibility and operational convenience.
This does not mean that banks now have the appetite to cover the entirety of their clients’ portfolios. Rather, by partnering with other industry players – as well as combining internal capacities and expertise from within their own trade and cash management business lines – it is possible to offer clients comprehensive working capital solutions based on the majority of their buyers. Clients can manage and transfer risks while ensuring end-to-end coverage thanks, in large part, to their banks’ implementation of such market-based solutions.
One method is to offset risk via an insurance provider. By carrying out an evaluation on a portfolio, insurers are able to assess the corporate’s buyers and then relay information to a bank on the feasible limit-allocations of each. This portfolio-based approach enables time and cost savings compared with assessing each buyer separately. From here, the bank is able to organize the portfolio into different tranches according to risk.
Banks with a global reach, as well as access to a large pool of financial institution investors, can distribute their client’s receivables to these investors within their networks – a service that not only increases the market for receivables finance but streamlines the process for corporates that previously have been forced to approach a number of different institutions in order to ensure coverage of their wider portfolios.
Another emerging trend is offsetting risk via an export credit agency (ECA). We have seen increased interest from ECAs in this space – particularly the past 12 months, with government mandates encouraging the support of local exporters.
ECAs provide support in the financing of buyers in medium- to higher-risk markets by offering guarantees to cover issues of either non-payment on the part of the underlying buyer or, on occasion, covering some of the seller’s performance risks. By assessing a portfolio after due diligence checks have been carried out on both the buyer and the seller, ECAs are able to provide short-term, comprehensive guarantees on these buyers to the financing bank. In turn, this enables the bank to cover parts of the portfolio that it may otherwise have been restricted from financing.
Return on invested capital (ROIC) is one of the key metrics used by CFOs, CEOs and analysts, and the key component behind the metric is free cash flow. Therefore, days sales outstanding (DSO), working capital efficiency and receivables turnover ratio (which reflect the pace at which receivables are converted into cash) are prioritized. Institutional investors are increasingly using working capital as a proxy for companies’ resilience of receivables, therefore may have an impact on a company’s valuation and share price performance.
Not only is the receivables finance industry being enhanced through banks’ partnerships with external parties, leading banks are now collaborating across their treasury management organizations to provide embedded receivables solutions for clients. These value-adding integration initiatives are largely focused on workflow digitization and foreign exchange (FX) risk intermediation, rather than in the area of financing.
For example, in addition to providing end-to-end coverage of clients’ portfolios, banks with an international presence are increasingly offering cross-currency support when it comes to receivables. As supply chains continue to expand across a growing number of jurisdictions, the result is an ever-increasing volume of cross-currency payments. This means buyers are distributing in different currencies to the one used for purchases from suppliers, which exposes them to potentially unfavourable exchange rate fluctuations. And that can significantly impact their ability to repay the supplier at the end of the contract.
Citi®Global Collect, for instance, integrates FX capabilities at the invoicing stage, which provides corporates with the flexibility to offer their invoicing terms in their buyers’ domestic currency. This creates a local-currency experience for the client’s buyer while preserving the client’s functional currency invoicing process, with the bank intermediating the inherent cross-currency risks. Coupled with a robust electronic invoicing platform and granular reconciliation, Citi®Global Collect provides an integrated receivables platform that optimizes clients’ days sales outstanding (DSO), and transparency into the receivables cycle.
Demand for this “domestic experience” within international transactions is growing, and suppliers that have the ability to pay in local currencies will be an attractive option for buyers. In turn, the collections process for the supplier is streamlined and corporates are able to more quickly integrate their businesses in new jurisdictions.
Despite its increasing potential, of the roughly US$20 trillion of annual global trade in goods, receivables finance currently accounts for only US$3-3.5 trillion. As such, there is a significant opportunity for growth – particularly as economies across the world continue to recover from the coronavirus pandemic.
As trade flows return to normal, we will inevitably continue to see changes occurring within the receivables finance space. In the short-term, insurance companies – many of which have reduced their exposure to heavily impacted industries such as travel, entertainment, retail, and oil and gas – will likely increase their participation in the sector as watch-listed industries, including airlines and airports, begin to recover their revenue.
Meanwhile, corporates are expected to look to receivables finance as a way of repairing the damage done to their balance sheets during the pandemic. This is especially true as the levels of government support across the globe seen in 2020 are likely to decrease this year, with insolvencies predicted to be around 13-14% higher than in 2019 – considerably more than in 2020. As a result, it will be more important than ever for corporates to secure coverage for their debtor books.
With an international presence, industry-leading FX capabilities, access to a global network of investors and a partnership approach, Citi is actively supporting receivable solutions. Continuously investing in digitizing trade flows and offering integrated solutions, by providing a diversified portfolio approach.
Trade is a global business. And as supply chains continue to evolve and expand into new jurisdictions, receivables finance will continue to present an effective, comprehensive way of optimizing working capital.