Receivables Discounting is a form of Receivables Purchase, flexibly applied, in which sellers of goods and services sell individual or multiple receivables (represented by outstanding invoices) to a finance provider at a discount.
- Receivables Purchase
- Receivables Finance
- Invoice Discounting
- Early Payment (of Receivables)
Discounted receivables range from a single receivable through to the majority of the receivables within the sales ledger of a seller. The funds available to the seller are based on the outstanding value of the invoices related to the relevant buyers.
Receivables Discounting is usually offered by finance providers to larger corporate clients selling to multiple buyers. The buyer coverage will depend on the number of buyers for which the finance provider is willing to take credit risk.
The finance provider offers finance based on a security margin applied to the open account receivables being assigned by the seller and as pre-agreed between the seller and the finance provider.
Typically, the finance provider will limit such offering to a client base, whose receivables comply with certain criteria, such as a minimum credit rating and will offer various typical features as follows:
- The financing can be provided on a ‘without recourse’ basis to the seller, although there are many situations where recourse or limited recourse is maintained. The act of discounting does not by itself connote whether a transaction is ‘with’ or ‘without’ recourse
- In general, if Receivable Discounting is executed without recourse to the seller, the expectation of the seller is that the receivable is removed from its balance sheet, subject to a confirmation of the relevant auditor
The financing transaction may be disclosed or undisclosed to the buyer (i.e. confidential)
- The finance provider may discount up to 100% of the receivables up front or apply a security margin or advance ratio to account for potential dilutions or cover for possible credit deterioration
- The finance provider may charge the discount in advance when paying out the discounted amount or in arrears within periods and terms pre-agreed with the seller
- Receivables Discounting may be provided on a one-off, seasonal or continuous programme basis
- The facility may be provided on an uncommitted or committed basis to the seller, the latter giving the seller a higher level of comfort in terms of access to liquidity within the buyer credit limits set by the finance provider. The likely offer of committed or uncommitted facilities may vary from one geographic market to another
- In the event that the transaction is disclosed to the buyer, the process of the collection of the receivables may be undertaken by either the seller (acting as agent for the finance provider which has purchased the receivable) or by the finance provider. In the event that the transaction is disclosed to the buyer, the buyer may be asked to acknowledge the sale of the receivables. The exact form of such acknowledgement will depend on the local jurisdiction, the size or structure of the transaction or the commercial preferences of the buyer and the finance provider
- A buyer may be asked to validate the existence of a receivable and indicate at a moment in time whether it is approved or accepted for payment
- The finance provider may act at its own risk or insure or share the credit risk with a third party (trade credit insurance or risk participations by other financial institutions), thus limiting its own risk exposure.
The parties to the financing are the seller and the finance provider. Whilst the buyer is not a party to the agreement, it is relied on for payment of the underlying receivables or invoices and may also be required to validate that specific invoices are genuine and in certain circumstances may confirm that invoices are approved for payment within a specified timeframe.
Contractual relationships and documentation
A Receivables Purchase Agreement (RPA) is executed between the seller and the finance provider. A certified copy of the invoice(s) or the invoice data set is made available to the finance provider. Under the agreement, the seller provides the finance provider with an assignment of rights to the receivables(s) being financed, according to the jurisdiction in question. Depending on the terms of the underlying Receivables Purchase Agreement, a notice of assignment may be provided to the buyer. Any additional required procedure according to the respective jurisdiction is suitably documented.
Generally speaking, Receivables Discounting is structured as a ‘true sale’ and the rights and title to the receivables are transferred to the finance provider by means of an assignment of rights (or transfer of title), or by filing or registering a security interest granting the same rights as an assignment, all executed according to the relevant jurisdictional requirements.
Risks and risk mitigation
- Default or insolvency of the buyer, mitigated by credit and risk assessment, monitoring and potentially credit insurance
- Existence of valid and eligible receivables being discounted, mitigated by a regime of sampling or individual verification
- Country or political risk, mitigated by due diligence and political risk insurance. Special circumstances relating to sovereign risk may apply to receivables due from governments or government agencies
- Risks arising from the removal of recourse to the seller in the event of non-recourse or limited recourse transactions, mitigated by the buyer’s ability to pay
- Receivables dilutions (e.g. credit notes, offsets against invoices due for payment), mitigated by the security margin and advance ratio
- Pre-existing security arrangements or bans on assignments, mitigated by waivers given by other secured parties or their removal or by taking additional security and completing the required perfection requirements
- Certain types of receivables, which could be said to be ‘non-fungible’ or not comparable with typical receivables, are often avoided, for example: where long warranties have been given, or where specific warranties or recourse arrangements have been provided by the seller, or for receivables arising in contracting businesses (e.g. construction), or situations involving stage payments; alternatively such receivables could be converted into ‘fungible units’ that meet the quality requirements of a Receivables Discounting transaction. In general, the finance provider will exclude prohibited and restrictive categories of goods. Restrictions may also be applied in the case of intercompany receivables
- KYC/AML to be handled during the on-boarding procedures and subsequently in periodic reviews
- Lack of legal authority, mitigated by legal due diligence on the respective jurisdiction and the involved contractual parties
- Set off and risks arising from counter-trading mitigated by regular verification for disclosed transactions that the balance outstanding with the finance provider matches that on the buyer’s records
- Risks arising in the event of insolvency such as ‘claw-back’, where a finance provider is aware of distress at the time of a receivable purchase, or in the case of co-mingling of funds in a general bank account. For the latter, there is mitigation through the use of a collection account in the name of the finance provider
- Fraud by the seller, for example by inflating the value of invoices or offering invoices without an underlying commercial transaction, mitigated by verification of the transaction and deploying adequate credit controls
- Double financing, mitigated by obtaining a security interest in the receivables, applying appropriate KYC procedures and perfecting the assignment of rights to the receivable, including notification to the buyer
- Fraud by collusion between seller and one or more of its buyers leading to diversion of funds from meeting maturing obligations, mitigated by monitoring the financial health and management integrity of the client through maintaining contact and receiving regular management information to look for signs of a deterioration of the business and suspicious circumstances, and also mitigated, where necessary, by direct collections on the part of the finance provider
- Fraud by collusion between the seller and an employee of the finance provider, mitigated by internal controls and segregation of duties
- General operational risks resulting from multiple operational requirements to perfect title to the receivables and undertake ongoing administration, mitigated by sound procedures, appropriate levels of automation and process controls
- Potential issues with the assignment of receivables due to various underlying governing laws in place and the resultant enforceability of the transaction, in both domestic and cross-border situations mitigated by legal due diligence.
All the above risks are also mitigated by a robust audit process regarding transactions, systems, and controls.
Transaction flow: illustrative only
Source: Global SCF Forum
The finance provider undertakes assessment of all aspects of the underlying transaction and agrees to provide financing to the seller. A credit facility on a committed or uncommitted basis is established for the seller, which may be further allocated to sub-components by buyer, geography and other agreed parameters, set out in the Receivables Purchase Agreement (RPA). If the transaction is structured without recourse, the credit limits would usually be marked against the buyer(s). Depending on how the transaction is structured, the credit limits may alternatively or additionally be marked against the seller, a guarantor or a portfolio of obligors.
The seller retains control of the sales ledger management and therefore must have established and adhere to credit control procedures that meet the finance provider’s requirements.
For individual transactions, the seller raises an invoice upon delivery of the goods or services rendered and sends a copy of the invoice or the invoice dataset to the finance provider.
After verification of the invoice copy or dataset, the finance provider makes a payment for the discounted value of the receivable (invoice) to the seller. The amount of such payment may be reduced according to the contractual details of the RPA.
At maturity, the buyer pays the proceeds of invoices due into a bank account in the name of the seller, but only the finance provider may withdraw available funds from that account, to meet maturing obligations, as the client has limited access rights to the account. Alternatively, the collection account can also be pledged to mitigate the transfer risk to the bank. However, it is also common for buyer payments to be made directly to the finance provider’s bank account, under an arrangement where the finance provider acts as the seller’s collection agent.
Sometimes sellers do not agree with the above mentioned process for collection of proceeds and funds continue to be paid directly into the seller’s bank account in the normal way. The seller then transfers the proceeds of collections to the finance provider under the terms of the RPA. This process for the collection of proceeds creates an additional element of risk for the finance provider.
If not deducted at the time of the initiation of the transaction, interest and other charges will be payable upon receipt of the proceeds from the buyer and any or the remaining, unfinanced portion of the invoice proceeds will be payable according to the terms of the RPA.
Operational procedures are appropriately modified in the event of individual receivables finance transactions or in the event of a breach of the RPA.
- Potentially allows the seller to provide extended credit terms to its buyer
- Working capital optimisation
- Growth in business on ‘open account’ terms
- Finance and liquidity availability with limited credit availability from traditional banking sources
- Potential for balance sheet management via ‘true sale’ of the receivables under the relevant legal structures
- Credit risk coverage in non-recourse Receivables Discounting as the finance provider will be responsible for normally 100% of any losses arising from the credit covered receivables if the buyer defaultsa
- Reduction of the concentration risk by distributing risk to a finance provider
- Better utilisation of the seller’s financial and operational resources if the sale of the receivable is disclosed and collection is handled by the finance provider
- Confidentiality of the source of finance from the buyer in the case of an un-disclosed contractual relationship between the seller and the finance provider
- Possible improved balance sheet management as the sale of receivables generates off balance sheet liquidity without creating additional leverage or use of credit facilities (as would be the case with a traditional loan facility).
For buyers, potentially extended payment terms and improved stability of its supply chain.
For finance providers, credit exposure with a lower risk profile due to the supply chain-related nature of the financed transaction.
Such financings are typically offered by one finance provider to a client although in the event of very large volumes, distribution techniques may be used, such as risk participations or syndications.
It should also be stated that a variation of Receivables Discounting involves the discount of negotiable instruments such as drafts, bills of exchange and promissory notes. This is akin to Forfaiting, but in this variation the transaction is less likely to be sold or traded in the forfaiting secondary market but rather provided as finance direct to the client.