Fraud Evolution: Are We Capable of Dealing with It? | FCI
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Fraud Evolution: Are We Capable of Dealing with It?
Fraud Evolution: Are We Capable of Dealing with It?

This article was written by Peter Mulroy, Secretary General, in cooperation with Mr Christopher Hart and Mr Mark Watkins from EQ Riskfactor, a member of FCI, offering its client a risk management tool to manage account receivables and other asset-based collateral

In 2022, we saw the world return to normal after the pandemic. Then we saw the world change irrevocably with the war in Ukraine, leading to a raft of new trade sanctions and increased trade tensions between some of the world’s major economies. Both of these factors will likely continue to influence world trade in 2023, with consequent effects on the factoring market.

Supply chains are being strained and, in many cases, redesigned; inflation is remaining stubbornly high in many markets; energy costs, in particular, are rising; it seems unlikely that the credit policies of funders are likely to be loosened any time soon; and there is the more pressing requirement in many parts of the world to pay back a tremendous amount of State support from the Covid era.

As we have seen, turbulent times bring many opportunities and consequent risks. Chief among these risks is the resurgence of fraud, and we have already seen anecdotal reports that fraud is increasing. A significant question for the industry over the course of this year, and perhaps beyond, is: are we ready? Are we capable of dealing with an increase in levels of fraud?

There are two aspects to this question. As factoring volumes continue to grow and the rate of increase is likely to quicken, do we as an industry have the experience within our operations to spot and deal with fraud, and how much can technology help?

We have to distinguish between two types of fraud, pre-meditated and circumstantial. In essence, these two types of fraud are very different in nature and require different approaches to combat. The former usually involves a pre-planned attempt by criminals to target a funder to steal money. Such schemes can be highly elaborate and may involve collusion between a client and its customers, making it even harder to identify.

It is the utopia of invoice financiers to find a system that will alert them to a fraudulent invoice before it is paid, thereby avoiding a loss. This is particularly key in jurisdictions that do not have ‘whole turnover’ arrangements or cross[1]collateralisation capability. Traditionally, this has been a manual process, but technology is beginning to be used to combat such situations. Such tools draw information from various sources, not just internal to a funder’s systems. Relevant data can also be extracted from other sources and combined with the funder’s information to look for pre-defined warning signs. Early iterations of such transactional item tools have tended to generate many false positives. However, as these tools are refined over time, they may significantly impact addressing pre-meditated fraud.

More common is circumstantial fraud, where a business under pressure may, for example, seek to use funding obtained via a receivables finance facility to cover what are perceived to be short-term cash issues by, for example, pre-invoicing a debt or creating fresh air invoices. The economic, geopolitical, and social landscape we are all experiencing is ripe for businesses and in particular, business owners, to be put under significant pressure that will demonstrate behaviours of circumstantial fraud.

Example of Circumstantial Fraud Case

Start of the Business

The seller in question is a significant player in the textile market, having commenced production nearly three decades ago, and earned a reputable standing. The company has been a client of the EF’s parent bank for almost half a decade and has maintained a positive track record. The EF’s credit committee approved a €1 million funding limit based on the positive financials and outstanding intelligence report about the seller’s existing relations with other banks, factoring companies, and creditors. Meanwhile, the Import Factor granted a credit limit of €500.000 to a buyer. At that time, the EF was unaware that the buyer and the seller had not transacted any business.

Development of the Relationship

The EF received its initial assignment in September, and over the subsequent two and a half months, the EF financed the seller multiple times. As a result of the high turnover, the buyer limit was increased thrice within this period.

Disclosure of the Problem

In November, two months after the first assignment, the EF’s parent bank noticed the receipt of an indirect payment from the buyer coincidentally. The bank cautioned that the buyer directly paid to the seller’s account. This was the first buyer payment after the factoring relationship started. However, the EF immediately contacted the seller and informed the IF about the indirect payment requesting that all measures be taken to prevent further indirect payments. At the same time, the EF’s risk department received some adverse information that reported the seller had severe liquidity problems.

A follow-up email was promptly dispatched to the IF, urging them to refrain from making indirect payments and to cross-check the ledger with the buyer. The IF notified the EF of discrepancies between their invoice records and that of the buyer. Immediately after discovering the discrepancies, the EF contacted the seller to arrange a visit. All the information was very vague and smelled like fraud.

Finally, the EF decided to call the local liaison office of the buyer and learned that the buyer usually purchased a maximum of €500k - €600k from each supplier annually. The office also mentioned that the purchase orders involved were not genuine. A couple of days later, the EF heard that the major shareholder of the seller had left the country.

Analysis of the Case

Fraud usually starts as an act of desperation. At this stage, the seller who turns crooked is an amateur in the psychology of crime. He is not sure of the factor’s blind spot yet. The weaknesses in the factor’s organisation or system are unknown to him. He does not have a plan yet.

Moreover, he thinks some extra money will carry him through the difficult time. A commonly used tactic is to generate a single fraudulent invoice, ideally from a high-profile and reliable debtor, and secure financing of up to 80% based on its value. The perpetrator can then clear the invoice by presenting a credit note or indirect payment notification in a few weeks. The first time it works, and sometime later, the client does it again, but with a variation. Instead of covering invoice X with a credit note before its maturity date, he issues a larger invoice Y to maintain his available funds. Using the financing from invoice Y, he makes a payment to the factor in settlement for invoice X, disguising it as a payment from the “real” debtor to deceive the factor. The process repeats itself, and what started with a small fraud is gradually becoming more extensive. The client is paying the factor back with the latter’s money on an ever-increasing scale.

Are funders ready to combat these behaviours?

Utilisation of Technology to Reduce Risk and Help Prevent Fraud

The Digital strategy and focus of many funders during the Pandemic era were in the main customer-facing in its nature, ensuring the customer experience was pain-free and access to funds was quicker than previous credit approval processes, especially with the impact of Covid on businesses.

With the above-mentioned influencers to a rise in potential Fraud and Risk within a Factors Portfolio, the need to focus on internal systems and processes to manage Risk and prevent fraud is a necessity. Technology can once again help to mitigate and remove these problems.

In conjunction with the skilled and experienced analyst, data[1]led decision-making will drive and implement best practice Fraud and Risk assessment across a Funder’s ongoing Operations.

Technological Tools are already available to help automate and capture significant amounts of information across the whole life cycle of the client and its ongoing facility movements: -

  • KYC and KYS Tools – Risk identifies issues across the prospect and ongoing client, its debtors, and their wider supply chain.
  • Upfront Due Diligence of the Business
    • Types of data being obtained: -
      • Financial data – balance sheet information, P&L data, calculated ratios.
      • Open Banking – bank statement data/transaction level detail.
      • Debtor, creditor, and item-level transactional data.
      • Credit Reference data across the business
      • Nominal activity and audit trail data extracted directly from entity account packages.
      • Obtain a 360-degree view of the potential client to fund.

This upfront analysis helps Benchmark the client’s expected behaviours and debtor performance during the facility’s life.

Funders can automatically be alerted to any changes in the behaviour of facilities by utilising Risk Management software, such as Equiniti Riskfactor, to prioritise and focus resources on the cases that need direct attention.

A risk-based approach to Portfolio Monitoring.

Some example Metrics that are automatically utilised and calculated within Riskfactor daily are:

  • Sales Movement - % levels
  • Cash Movement - % levels
  • Debt-turn trends - the potential impact of clients’ debtors stretching payment terms
  • Dilution/Erosions - potential pre-invoicing and fresh-air concerns.
  • Risk Score Metrics – Financial and Collateral

Utilising the technology tools available will empower staff to tackle any ‘real-time’ changes in expected behaviours head-on, with data-driven evidence, to back up their investigations.

Being proactive, not reactive, is the Key.

Technology Ecosystems

The Covid pandemic has, in many cases, forced funders to consider new technological options in a much faster timescale than might traditionally have been the case. Now, with the effects of the pandemic fading in many places, a question is: are Funders still embedded into ‘building their own,’ or is it the time to expand their technological ecosystem and exploit further the benefits of 3rd party solutions?

There is a need to manage the interface between finance and technical people, which can sometimes be more complex. But, funders that are open to exploring a Partner approach with a number of 3rd Party Suppliers are the ones that will benefit from access to various tools and functionality that will close the gaps in their current internal processes. Moving into a world that utilises API and Cloud technology is one to embrace, not push back on.

That having been said, the requirement for industry experience will remain. Funders will continue to need people to interpret the data and understand what the system is telling them about real-world issues. Closing gaps in processes and improving efficiencies are benefits of utilising technology. However, Funders will always need the experience of their staff to manage the relationship and challenge the client if potential fraud is the concern.

The next generation of our industry is experiencing challenging times. And it will continue to experience it, but it is in challenging times that factoring as a product finds excellent opportunity. Greatly enlarging the size of the market is the prize, but fraud is a significant danger we must counter as we grow. With the right technological tools, the experience and enthusiasm of its people, and ongoing support and education, the industry can continue to drive forward into 2024 and beyond in great shape.

Fraud in the most recent of times

In the most recent years, FCI has published articles and shared panel discussions on the Greensill case. Last month John Basquill, Global Trade Review (GTR) Senior Reporter, shared an article on the latest developments from Greensill, titled “Regulator blasts Credit Suisse over investment in Greensill future receivables”.

Credit Suisse failed to recognise the growing risks associated with Greensill’s financing of future receivables, according to a damning review by Switzerland’s financial regulator.  The Swiss Financial Market Supervisory Authority (Finma) announced today that following an investigation into Credit Suisse’s relationship with collapsed financier Greensill, the bank “seriously breached” its duty to manage risks. If you wish to read more, click here.

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