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Fraud in Receivables Finance

In challenging times, financial institutions should more than ever pay high attention to prevent fraud. That's the reason why on 12 May, FCI held a webinar in Chinese on Fraud in Receivables Finance. The webinar was part of FCI free webinars series in response to these challenging times.

This article is an extract from FCI In-Sight May

More than 220 participants from Singapore, Taiwan, Hong Kong, and Mainland China joined the webinar. The speakers, Mr. Zhao Yongjun of Fortune International Factoring, Mr. Typhoon Wen of Vteam Financial, and Mr. King Tak Fung of Stephenson Harwood analyzed typical fraud cases in the region during the recent years.Mr. LIN Hui, FCI NE Asia Director moderated the event and concluded with a speech as follows.

Restructuring receivable finance within the framework of trade finance
Accounts receivable relates to transactions, payments and settlements between two businesses. As a third party, you must have a good understanding of both the buyer and the seller, or you risk being the most vulnerable one within this triangle of relations. Not only do you have to know both sides, you have to be able to know the seller better than the buyer, or the buyer better than the seller – depending on the arrangement, which is the reason and value of your participation. This is a trade finance relationship, and a core requirement is to be able to effect KYC on both sides simultaneously.
However, most of the current receivable financing models on the market do not provide for KYC on both sides. In fact, they are pseudo trade finance structures which is in essence a lending structure. It’s fine if a financial institution treats it just as pure lending business. But a pseudo trade finance structure always creates a false impression to financial institutions, which can be exploited by the unscrupulous.
A lending business can be seen like driving on land, while trade finance is sailing on the sea. Not only do you need to look out for the icebergs on the surface of the sea (KYC), but you also need to detect the shape of the iceberg under the surface (KYCC). Over 70 per cent of our planet is water. Trade finance does allow us to reach out to a wider market. But, to conquer the oceans, we must restructure our receivable financing model with a trade finance framework, supporting not only liquidity management for clients, but also risk mitigating solutions for them; managing not only client risk, but also counter-party risk; having not only solid KYC on both sides, but also sound KYT (know your transactions). Trade finance means advances based on the settlement of transactions, rather than just lending money.

The Two-factor model as the standard structure for trade finance frameworks
In the context of the globalization of supply chains, it is not easy for a bank to achieve KYC for both buyers and sellers. Although technology has brought things closer, there are still geographic limits to practicing due diligence and field audits. In the complex market environment of supply chain shocks caused by the coronavirus epidemic, we need to strengthen the two-factor cooperation mechanism to control the spread of risk.
In police movies, we see the police patrolling in pairs. In a dangerous situation, they both stand back to back holding their guns in opposite directions. This is because human physiology dictates that our maximum field of view is only 180 degrees - you can never see what’s going on behind you. With two people against each other’s backs, it’s the safest position in a complex environment.
It is in this way that the two-factor model ensures that in a complex market environment, both financial institutions are able to keep a close watch on their respective clients, ensuring that the payment of transactions between the two companies remain within the normal orbital range, and acting immediately on any deviations to prevent fraud or other risks.
The two-factor scheme advocates a cooperative mechanism of global financial institutions, and avoids a one-man battle or unhealthy competition.
This doesn’t necessarily mean that single factoring is the wrong model. Just like the square vs. rectangle relationship, single factoring is a special form of two-factoring and is only established if one financial institution can meet the conditions for simultaneous KYC of the buyer and seller.

The global supply chain is a multidimensional B2B complex system
Businesses from different countries, regions, cultures, races, industries, and sizes are like countless stars, planets, moons, and asteroids scattered throughout the vast universe of global supply chains. The relationships between these supply chains are complex and multidimensional, and it is simply not possible for one financial institution to provide a total solution for all businesses in the supply chain on the same plane. However, it is possible for two financial institutions to link any two businesses in different dimensions through a standardized cooperation mechanism. This is the value of the two-factor scheme in the complex global supply chain system, providing financial support to supply chains by structuring in a way that allows for synergistic risk control in the most efficient manner.

Digital synergy is at the heart of supply chain finance
In the ecosphere of digital supply chain finance, the outer circle includes 

  • Fintech: Financial technology service providers providing technology infrastructure for supply chain financial institutions.
  • Logistech: The digitalization of logistics, through the Internet of Things, to provide supply chain financial institutions with more visible and accurate logistics data, to control supply chain risks.
  • Regtech: Enables the compliance of financial institutions accurately with dynamic regulatory data to ensure the healthy operation of the whole receivable finance industry and reduce systemic risks and costs.

The core component in the ecosphere includes two value chains:

  • • One is the B2B value chain (SUPPLY CHAIN), which, in simplified terms, includes the chain from suppliers to the anchor business, and to distributors.
  • The other is the financial value chain, which is exactly the role of FCI (created 52 years ago as Factors Chain International), in that it is composed of the financial institutions with the closest KYC radius to the businesses respectively on the SUPPLY CHAIN.

These financial institutions are in fact acting as the financial factors for the B2B value chain. Through these FACTORs, the B2B value chain is matched with the financial value chain by providing liquidity support and risk mitigation for each supply chain business. A supply chain financier can be a trade finance bank or a commercial factoring company. Whether a bank or commercial factoring company, the reason for being accepted into this chain of factors is because you know your customers better than any other financial institution. Secondly, you agree to abide by the standardized rules of the chain, and be able to take responsibility and finally, to be accepted by all the financial institutions peers in the chain. Such a synergistic supply chain financial ecosystem is the global trade finance system for the post letter of credit era. The FCI GRIF rules provide global trade financiers with a solid two-factor framework. We just need to integrate financial technology, logistics technology, regulatory technology, and jointly establish a much more digital two-factor business environment, so that we can have our system play out it’s magic market efficiency.