Igor Zaks, CFA - Co-founder and Chief Risk Officer of 40Seas - contributed this article to the World Factoring Yearbook 2024, which is available to purchase at the following link: https://bcrpub.com/world-factoring-yearbook-2024

‍

In my first corporate job (I moved there from banking), I got a great pitch from one of the major banks that started with an explanation of what a brilliant solution they had developed. After listening to the presentation, I made one comment: “ You forgot to ask me what my problem was.” When building a fintech, defining an ideal customer profile - and partnership strategies - is the first question we need to start with.

‍

Receivables finance occupies a unique niche at the intersection of four distinct areas, each of which has their ecosystem of players.

‍

1.  Supply chain management

Accounts receivables do not live in a vacuum. They are part of the order-to-cash cycle, which is itself part of supply chain management. Somebody needs to vet the buyer and supplier even before placing an order, that can include a variety of checks on both sides. Then, multiple things need to happen for the correct invoice to be issued, and it must be linked to various other events, such as logistics. There are multiple players dealing with supply chain management, third- and fourth-party logistics, etc.

‍

2.  Receivables management

This is a large area, and many providers focus only on it. E-invoicing, reconciliations, payments, FX, cash flow forecasting, and many other areas must be addressed to efficiently manage receivables. Similarly, there are multiple providers focusing on just this aspect, especially when they are delivering for larger players.

‍

3.  Risk mitigation

Accounts receivables introduce a unique mix of risks, combining credit risk, supplier performance risk, fraud risk, and others. Isolating and controlling such risks present a significant challenge and can be achieved through a combination of legal structure, process controls, and cutting-edge technologies. Some kinds of risk have multiple specialised providers, such as credit insurers.

‍

4.  Funding

Among other functions, receivables finance provides funding with benefits to either supplier or buyer (that depends on market power - whether the buyer has the ability to pass terms to the supplier or vice versa). Both buyers and suppliers have some alternatives if they want to achieve just the funding part. Banks and non-bank funders are providing various forms of funding, with associated availability (that is partly a function of the ability to analyse and mitigate risk, especially where cross-border transactions are involved) and administrative burden (structures like ABL can be very demanding on the borrower). In developing cooperation strategies, a platform needs to see what role it fills and what is the strategic fit with each of the ecosystem players.

‍

Suppliers

Fintech can do embedded solutions that become an integral part of the supplier management of their customers/partners. What this means in practice is that buyer/supplier cooperation happens on a platform, with or without added financing and risk mitigation. This is fundamentally different from the traditional factoring or trade finance paradigm, where there is a buyer/seller relationship, where the supplier originates the asset (receivable) and the financier purchases it afterwards. The whole origination process becomes a joint effort, not dictated by the risk and financing appetite of the provider. Who takes the risk and who provides funding become separate issues - the parameters for such mitigation and/or financing by the fintech are provided as part of the origination process, but the supplier can still use their own risk appetite, own funding or fintech to connect them to third party providers. This is not altering integration and the underlying process, and allows the supplier to benefit from the process, risk management and all other infrastructure (payments, FX, logistics integration, etc.) without being told what they can or cannot do regarding credit appetite (they can still have advice and analytical support in such decisions if the fintech cannot do this itself).

‍

Buyers

Traditionally, financiers are either completely buyer-focused (as in factoring) or supplier-focused (as in supply chain finance - SCF), putting a lot of effort into managing and integrating with their clients but very limited involvement with the other side. This has negative risk management implications but also provides a poor user experience for buyers in the case of seller-centric solutions. Similarly to what we described for the supplier, the buyer wants to have a comprehensive view of what is happening with their orders, invoices, payments, logistics, etc.

‍

They want to clearly understand their cash-flows and reduce the risk of disruptions that may be caused by, say, missing payments. They want to be able to allow such an efficient process to also work with their other suppliers. And they can even become a supplier client themselves, working with the same fintech in both capacities. This is why we see both buyers and suppliers as our key partners and design our platform to serve the needs of both parties.

‍

Risk mitigation – insurers

Part of the finance ecosystem geared to deal with risk is insurance, with multiple products designed to manage various risks. Part of what fintech can do is to isolate various types of risk and transform them into insurable risk. There is a large and specialised market for credit risk, with core players being credit insurance companies.

‍

While the industry has huge experience, risk-taking ability, expertise, and (depending on the market) access to private data, it is still often lagging in technology-enabled underwriting and also UX.  This opens two areas of potential cooperation. One is on underwriting, where fintech’s ability to use data and technology can allow significantly better underwriting outcomes and, as a result, the ability to manage portfolios with lower losses than relying on an insurer’s outcomes alone. The second is managing user experience. While the industry has moved a long way in making itself more user-friendly, its limited penetration (especially outside of Europe) is based on actual or perceived management complexity, difficulty to comply, and inability of the user to combine it efficiently within their overall process. This is a huge win-win for both insurers (that, through fintechs, can get access to a large supplier base that will not normally consider their product) and for fintechs themselves, which can efficiently use credit insurers as part of their solution design. Still, credit insurers are only part of the large cooperation areas - many other insurance products, such as the surety market dealing with supplier risk, and many other specialised products can offer mutually beneficial partnerships.

‍

Banks

Banks represent another huge area of potential cooperation. There are two core areas where banks serve the ecosystem. The first and most obvious one is funding. However, banks’ ability to fund is restricted by structure and risk appetite. While banks offer a variety of products, their ability to finance trade has severe restrictions. The risk appetite is normally local, so in cross-border transactions, it is mainly bank-on-bank risk, such as letters of credit (and even in the factoring industry, the two-factor model is still significant for cross-border transactions). Banks also normally have limited ability to take risks on smaller companies, particularly non-clients. This is why SCF becomes a big bank business (having risk on a large client with multiple suppliers). At the same time, the receivables-based financing is often contained in ABL structures (especially in North America), where receivables are just part of the borrowing base and are not viewed individually. The risk is only viewed through over-collateralisation and recourse to suppliers. Fintech has significantly better control of risk on both individual buyer risk and portfolio basis, allowing banks to fund the transaction in cooperation with fintech. The other area is complimentary business around the parts banks cannot finance themselves. For example, a bank has a buyer they are willing to finance - but the supplier may have many more buyers that the bank cannot, as they will not be their target customer base. Fintechs can do multiple kinds of cooperation, significantly improving customer satisfaction and retention for the bank.

‍

Logistics providers

As outlined above, receivables are just part of a much wider supply chain management process. One other part is logistics, i.e., the process of moving goods. Logistics companies have access to information and provide essential links between the buyer and supplier. Enhancing this link with the ability to finance the process, manage risks, and provide efficient receivable management provides a huge opportunity to all parties.

‍

Other fintechs

Modern technology, such as APIs, makes it very efficient for fintechs to cooperate. Nobody wants to reinvent the wheel, and many elements of the infrastructure are already perfected by relevant players. What it allows is to quickly build a structure where a fintech can focus on its core areas of competence and use other elements to do specific functions. This should be done with a huge focus on user experience - so one needs to have the ability to fill all the gaps to ensure smooth and efficient service to the customer.

‍

Conclusion

Technological, market, and ecosystem development present many unique opportunities for fintech to build efficient and mutually beneficial partnerships with corporate clients, financial institutions, and other fintechs. Mastering such cooperation holds the key to both individual fintech success and the overall success of the receivables/trade finance ecosystem.

‍