How companies do business internationally is changing fundamentally. Whether it is circumnavigating tariffs and actual wars, diversifying procurement, coping with inflation and credit tightening, sustainability, and conditions favourable to fraud, factors are under pressure.
In this Roundtable, we are fortunate to have insights from a far-flung panel on the Environmental, Social, and Governance (ESG) criteria used to support sustainability and best workplace behaviours, the ongoing impact of fraud, risk management and the outlook for factoring in light of an expected stagnation in global trade.
To discuss these topics, Tony Brown (TB), President of The Trade Advisory, based in New York, has been talking to:
- Jean-Mee Ernest (J-ME)
General Manager, MCB Factors Ltd, Mauritius - Zhixian Tang (ZT)
Deputy General Manager Transaction Banking Department, Industrial and Commercial Bank of China (Macau) Limited, China - Alfredo Bresciani (AB)
General Manager, UniCredit Factoring, Italy - Victor Ignacio Portillo Sanchez (VP)
Head Corporate Banking Products, Banco Monex S.A, Mexico
TB: How are ESG factors impacting the factoring business?
AB: Since the Paris Agreement (2015), the European Union has issued several sustainability and finance regulations, aiming to reach the agreed ambitious targets of emission reduction. These seek to encourage the flow of capital towards sustainable investments, integrating ESG factors into risk management, promoting transparency on the sustainability of financial products, and acknowledging finance as leverage to reach results.
In 2020, the European Union introduced the EU taxonomy for sustainable activities: classifying which investments are environmentally sustainable in the context of the European Green Deal (a set of policy initiatives by the European Commission with the overarching aim of making the EU climate neutral in 2050).
ESG rating has become an essential tool to evaluate potential counterparties and investments, which opens new opportunities for factors, assignors, and debtors to optimise supply chains by offering ESG-linked financial products, thereby enhancing market positioning and reputation.
Supply Chain Finance is driving ESG transformation due to the buyers’ focus on sustainability improvement, involving their whole supply chain. Consequently, sustainability practices have become part of supplier evaluation, offering access to credit and pricing conditions based on ESG rating.
This practice relies on third-party certification and fintech offering platforms that integrate these new requirements. In a constantly evolving market, ESG is becoming an increasing opportunity for factors that recognise it and adapt.
ZT: Although still in the early stages, there is broad affirmative consensus in Greater China about ESG. Some banks have launched innovative green factoring products to reduce environmental and social risks, while many others are also exploring green factoring options.
Undoubtedly, the ESG philosophy has influenced the promotion of factoring in many ways, from pricing to compliance. For example, traded products that are ESG-compliant qualify for lower-cost factoring, while those that are not face stricter audit requirements, both internally and externally.
The ESG compliance standards vary from industry to industry. Compliance criteria for factoring clients focus on climate adaptation, payment transparency, disclosure of ownership information, economic inclusiveness, and labour standards.
I believe technology innovation is of great importance to the standardisation and promotion of ESG. Concurrently, technology allows assessment agencies to continuously enhance the objectivity and analytical efficiency involved in evaluating ESG compliance. Technology also lets lenders and clients quickly measure the benefits of progressive ESG adoption over time.
J-ME: More African countries are implementing environmental, social, and governance policies and offering sustainable financial products, according to a survey by the Official Monetary and Financial Institution Forum (OMFIF).
Out of 26 countries surveyed on the continent, 17 have some sustainability-focused policies – up from 12 last year – with South Africa, Mauritius, Kenya, and Egypt topping the report’s sustainability policy rankings.
Climate change has had a significant continental impact, evidenced by rising sea levels, increased frequency of extreme weather events, health risks, crop failure, and food insecurity, all resulting in socio-economic hazards.
ESG factors are influencing African factors, especially those operating within large financial services groups. Some ESG schemes encourage sustainability, while others encourage clients to promote the growth of the local industry.
VP: Albeit still in the early stages, ESG is a reality in Latin America. Its development is uneven, reflecting various levels of awareness and maturity in the ESG arena. The most important ESG factors affect not only the credit assessment of receivables financing/factoring but also, increasingly, regional bank/factor credit assessment models.
Credit assessments now include obligors’ and clients’ ESG factors, and the type of goods is more relevant than before. The impact of ESG factors on an obligor’s creditworthiness, for example, can help manage downside risks and identify suitable business opportunities. Some factors and banks, for example, have decided to leave the oil and gas sector and favour those businesses linked to sustainable energy sources.
Through the adoption of ESG criteria by factors and banks, they will be better equipped to manage sensitivity analysis for stress testing and financial projections and to allocate capital to clients with superior ESG compliance beneficially.
TB: How has your region been affected by fraud, and what steps are you taking to prevent it?
ZT: Fraud mitigation measures are diverse, starting with KYC to understand our customers’ history, equity structure, operating performance, public reporting, and more, followed by background checks, such as understanding the reasonableness of the transaction and verifying trading history. Finally, continuous tracking of customers’ financial health includes the proper use of financing proceeds.
Data technology can be used effectively to prevent fraud via corporate and individual data analytics. Underlying transactions can be authenticated by integrating a variety of data. For example, big data technology can analyse whether financing needs to match trade volume, whether there is double financing, and whether commodity and cargo pricing is reasonable.
VP: In my view, the sophistication of fraud has evolved at the same pace as technological advancement. In Latin America, we have broadly adopted electronic invoicing with different degrees of success, which has helped immensely to minimise ‘plain-vanilla’ fraud. Nonetheless, the creation and further development of public registries across the region has been uneven and has yet to reach its potential. In Colombia, Costa Rica, Mexico, Chile, and Perú, registries have been installed, with some still in premature stages. More robust (digital) functionality is needed, especially to streamline pre-invoice assignment due diligence.
Accounting standardisation for Supply Chain Finance is another topic requiring urgent action, not only in Latin America. Its harmful absence was evident in recent events in our region, such as the financial debacle of Lojas Americanas in Brazil, Oceanografia in Mexico, and Abengoa in Spain – causing widespread ‘collateral’ damage to Latin American subsidiaries. Efforts to improve clarity for SCF will benefit creditors and factors, as well as the SME suppliers to the large buyers participating in these programs.
J-ME: Fraud has recently been one of the main threats affecting the receivables finance industry. Unfortunately, fraud cases rarely become publicly known as factors that shy away from legal action because of unfavourable costs and benefits.
While it seems that premeditated fraud cases have not increased drastically on the African continent, fraud risk due to higher reliance on AI and technology is likely to increase as factors are pressed to provide quick decisions and same-day financing. Given the robustness of its financial institutions and only recent adoption of the cybercrime law, South Africa is a target for fraud.
On the other hand, circumstantial fraud has risen since the pandemic caused by the combination of struggling businesses and the relaxation of some factors of underwriting standards due to competitive pressures to close more deals.
To mitigate fraud on the continent, many factors have adopted a ‘back to basics’ approach that invests in training in factoring, knowledge sharing, deeper due diligence/monitoring, better internal governance (ensuring segregation of sales, risk, and operations), and the use of IT to identify inconsistencies.
Finally, I see greater collaboration with fintech to accelerate operational tasks, help in risk management, and smartly run Payables Finance solutions.
AB: Well, we should consider that notified factoring is one of the most secure transactions of short-term financing, given that we provide financing to the supplier with the repayment by a third party (the assigned debtor). However, with an industry turnover representing 12.5% of Europe’s GDP in 2022, factoring is an appealing sector for criminals. Organised crime exploited the pandemic health emergency and the initiatives to promote economic recovery.
Generally, frauds can be both internal (such as accounting fraud, corruption, money laundering, asset misappropriation) or external, such as fake accounts receivable, false debtors, non-performing credits qualified as performing, receivables assigned to a factor but already paid by the debtor or collected twice or also assigned to more than one factor.
To mitigate fraud, an ongoing collection of detailed information on counterparties, monitoring of internal processes, and the introduction of specific preventive controls are compulsory. Digital factoring platforms can offer further protection against fraud, for example, by checking counterparts’ identities via double authentication systems and digital signatures together with other security checks on individual receivables.
Finally, I would say that Artificial Intelligence might quickly detect unusual (and potentially malicious) customer behaviours.
TB: Do you see another surge coming in cross-border trade and international factoring, or has it peaked or even diminished?
J-ME: For 2023, we expect real GDP growth in Mauritius to be around 5%, but the outlook is cautious in view of global uncertainties, the ramifications of higher interest rates, and the prolonged inflationary pressures.
It is worth noting that Mauritius, a WTO member since 1995, has signed trade agreements with several regional blocs and countries, including India, China, Turkey, and Pakistan. Through increased trade, these trade agreements create opportunities for import and export factoring growth.
Reverse Factoring is growing significantly. The immediate benefit to international factoring volume could come from the cross-selling factoring to the large database of suppliers enrolled in a buyer’s Reverse Factoring programme.
AB: Increased inflation has triggered aggressive monetary tightening by EU monetary authorities, increasing interest rates to over 3%. This increases financing costs for the real economy, with companies often preferring internal liquidity instead of factoring. Consequently, cross-border business represents an opportunity to be developed further by factors, leveraging risk sharing with other players. With global uncertainty, dialogue with industry peers is essential.
My view is that Supply Chain Finance can help reduce the problem by decreasing risks for the factor while suppliers can benefit from the Buyer’s rating to secure lower cost receivables discounting.
VP: During the pandemic, a new word has become popular: ‘nearshoring’. In Latin America in general, and specifically in Central America and Mexico, nearshoring has been a new source of business for cross-border invoice financing because of our proximity to the United States. The restructuring of supply chain hubs and vendor networks has proved to be an investment boon for our countries and will gain pace as regional supply chains strive for greater resiliency.
There are many reasons behind this diversification strategy. Among them, to mitigate delivery and logistics bottlenecks risks (e.g., Coronavirus) stemming from public policies in faraway countries and mitigate the disruptive effect of wars and other conflicts, such as the one in Ukraine.
In this new international trade order, Latin America could play a new and fundamental role given its proximity to the United States as well as positive factors associated with demographics, logistics, and costs. However, to capitalise on this mammoth business opportunity, Latin America needs to stand up to corruption, government bureaucracy, the lack of infrastructure, and better professional education.
ZT: I believe that, at least in the short term, the share of international factoring in the global factoring business will continue to remain steady and will not grow significantly – mainly due to the slowdown in global trade. In addition, in recent years, traditional international factoring has been challenged by technology platforms providing better conditions for direct trade financing.
Reverse factoring can positively impact the growth of international factoring volume. However, it is tough to estimate by how much and depends on customer acceptance as well as the operational capabilities of financial institutions to handle cross-border reverse factoring business. As the largest international factoring organisation, FCI can play a greater role in this process.
TB: Risk management is even more important in these challenging times. Do you foresee taking more actions to mitigate risks?
VP: Among the good lessons learned during the Covid-19 pandemic was that our risk management model was put into ‘stress test’ mode. The Greensill saga showed what harm one company’s practices could have on accounts receivable and supply chain financing, emphasising the importance of due diligence and transparency.
A possible credit crunch resulting from uncertain economic circumstances has reduced credit appetite throughout Latin America, but we are gradually returning to normal. Some economic sectors have not fully recovered and are still under credit scrutiny. A more comprehensive approach has been implemented throughout our customers’ supply chain, including their sourcing, manufacturing, marketing, and final distribution.
Our regulators and financial authorities have mandated a return to traditional risk management. For example, in factoring, we have returned to invoice verification, adequate notifications, reconciliation, and collection in a timely manner. In Latin America, we are confident that our pace of recovery will resume.
J-ME: Yes, sound risk management and increased investment in staff training are crucial in these challenging times exacerbated by the war in Ukraine, unpredictable demand patterns, supply chain disruptions, higher inflation, monetary policy tightening, interest rate hikes, and the phasing out of government support packages, among others. In this environment, clients are increasingly ‘motivated’ to assign ‘fresh air’ invoices and pre-invoice. Moreover, after two years of decline during the pandemic years, global insolvencies increased in 2022 and are predicted to rise further in 2023. A resetting of risk parameters is called for.
In Mauritius, there is a gap between the demand for credit insurance from suppliers (and factors) to the hospitality sector (with tourism now rebounding) and the shortage of cover on hotels, for whom credit risk appetite has yet to be restored.
FCI’s two-factor model for export receivables has become an increasingly important alternative to traditional credit insurance and helps strengthen the export factor’s KYCC exercise.
Credit risk analysis and management remain key. Being closer to clients, their debtors and understanding and managing the transaction risk well is equally important. AI and IT are gaining importance not only in risk management but also in measuring, managing and mitigating sustainability risk – remaining always vigilant about compliance and cybersecurity.
ZT: I foresee that financial institutions will take additional measures to prevent and control risks, including developing more stringent risk management systems, adopting more advanced technologies, and developing more dedicated risk managers.
The positive effects of new technologies on risk management are undoubted, but they are also imperfect and have a vulnerability to cybercrime and other systemic risks that require constant vigilance.
In recent years we have seen several causes of supply chain disruption, especially during the outbreak of the coronavirus. Consequently, in addition to credit and political risks, I think it is important to consider the negative impact of public health events, natural risks, and changes in the structure of the workforce on the continuous operation of the supply chain.
AB: Leaders in risk management annually formulate Credit Risk Strategies based on their definition of a Risk Appetite Framework adapted periodically to a changing environment. Recently, ESG risk factors mandated by EBA guidelines have also shaped Credit Risk Strategies.
Supply chain disruption assessment should include not only credit and political factors but also industry analysis, trends, and forecasts, macroeconomic forecasts in base and stressed scenarios (e.g., GDP, consumer, and business confidence indexes, consumption), and the impact of globalisation (realising that some industries and companies are more resilient to supply chain disruption than others). Ideally, these risks should drive forward-looking portfolio analysis, business origination, and underwriting.
TB: Thanks very much for your insightful comments, from which I gleaned the following:
(1) Although early in adoption, ESG is gradually having a beneficial impact;
(2) Digitisation, information technology, and traditional vigilance are becoming useful tools in the ongoing fight against fraud;
(3) the global trade outlook offers a mixed bag of factors. International trade agreements and diversification of procurement are positives for factoring and growth in reverse factoring is expected;
(4) in risk management, the panel reports the need for greater vigilance throughout clients’ supply chains, potentially aided by IT, as well as better internal education and greater use of FCI’s two-factor program. Although market conditions are challenging, the consensus view is optimistic.
(Photo: © Sadik Boujaida)
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