Over the last 12 months we have seen a marked increase in interest in trade receivables financing in general and trade receivables securitisation in particular. This is a specialised area which brings with it unique challenges but also stable long term financing opportunities.
Trade receivables are commercial debts generated by the sale of goods and services between businesses. From a financier’s perspective, they are an attractive asset because: (i) they are self-liquidating; (ii) (typically) short-dated; (iii) often suitable for revolving financing and (iv) there is an enormous volume and variety of receivables to finance and a range of techniques to do so.
Trade receivables can be less volatile than consumer receivables because companies are hesitant to stop paying their suppliers (especially where alternatives are limited). While debtor performance is affected by the economic cycle, trade receivables themselves are unlikely to be affected by asset bubbles of the type which affect other securitisable assets. Historically trade receivables securitisations have performed well and in some transactions, the revolving period has continued for over a decade.
In an environment where many mid-market corporates are struggling to find reliable sources of cheap funding and the amount of credit available from banks has declined, there are opportunities for new players to enter this market. While securitisation is not appropriate for every company, it is an attractive form of financing for those with a sufficient volume and quality of receivables and can lend itself to syndication.
In its simplest form, a trade receivables securitisation consists of the sale of a company’s trade debts to a purchaser SPV. The SPV funds the purchase either by an ABCP conduit, loans and/or the issuance of term debt. As trade receivables are short dated and the size of the pool to be financed fluctuates with the fortunes of the seller, revolving financings (such as ABCP conduit financing) tend to be preferred.
A trade receivables securitisation can however require a great deal of structuring and ongoing administration. To justify the investment (by contrast with some other forms of trade receivables finance) a relatively large and consistent pool of receivables is required. For a securitisation to be viable, the contracts under which the trade receivables are generated must meet pre-defined eligibility criteria and, ideally, be relatively standardised. Further, the company must be able to track and report on the receivables on a frequent basis.
In our experience, there are several issues which can be challenging:
Suitability of the receivables
Financiers typically insist on a comprehensive review of the receivables that the SPV will acquire. This review tends to focus on: (i) the form of the contracts which generate the receivables; and (ii) the identity and location of the company’s debtors.
For a new entrant, the due diligence process can be onerous. In our experience, trade receivables tend to be originated under diverse terms to debtors which are often located in many different jurisdictions. A typical due diligence process will involve a review of the seller’s standard contracts together with samples of the actual contracts it has executed with key customers.
Issues we routinely encounter include contractual prohibitions on sale or transfer and/or confidentiality provisions which can make the sale of the receivables problematic in some jurisdictions. Even where a contract permits the sale of a receivable originated under it, the laws of the jurisdiction of the debtor may create obstacles to such sale. Finance providers therefore often also require a legal opinion confirming the transferability of the receivables in respect of each jurisdiction in which debtors are located.
Servicing and reporting
Securitisations rely on the seller continuing to effectively service and report on the performance of the receivables on a regular basis following the sale. The transaction documents will contain detailed provisions in relation to the origination, servicing and collection of receivables with which the seller will be expected to comply. As these tend to differ from the normal servicing and reporting practices of companies, it is essential that the seller is advised of these requirements early in the process and can demonstrate that it can meet them when considering whether securitisation is an appropriate financing option.
Collection account control arrangements
Ideally (at least from the financiers’ perspective), the seller’s customers would make payments with respect to any sold receivables directly into accounts held by the SPV. While in some cases this is achieved by novation of the accounts or notification of the debtors, it is more often the case that the debtors may continue to pay into the collection accounts of the seller. In this case financiers will usually require that the seller’s collection accounts are swept frequently to limit any losses which may occur on the insolvency of the seller. Security or trusts together with control agreements will also be required to ensure the SPV can control the collection accounts on the seller’s insolvency. In our experience negotiation of control agreements with third party account banks (which are understandably reluctant to depart from their standard terms) can make negotiation of account control agreements a lengthy process.
As companies often sell their products and services through subsidiaries incorporated in the jurisdictions in which they operate, trade receivables securitisations frequently involve significant cross-collateralisation (i.e. the transaction is collateralised by the receivables generated by more than one seller within a corporate group). In certain jurisdictions this could compromise the validity of the sale of the receivables to the SPV on the basis that the sale did not provide sufficient corporate benefit for a given seller (as it is effectively subsidising its sister affiliates). This risk is typically mitigated by clear corporate authorisations which confirm that the pooling of receivables benefits each affected seller by lowering its funding costs. In some jurisdictions however, guarantees whereby the holding company of the sellers guarantees the obligations of each seller are also required to reduce the risk that the sale of the receivables can be challenged.
Trade receivables securitisation and trade receivables financing in general present many business and legal challenges but are ultimately well established, practical financial products which are likely to develop further as new players seek investment opportunities in this area.