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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
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      • Italy
      • Spain
      • Holland
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      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
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      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
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      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
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      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
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      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
      • What are Export Credits and Country Risk Classifications?
      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
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Home Securitisation

Risk Mitigation for Trade Receivables Securitisation

John Goodden by John Goodden
January 4, 2023
in Securitisation
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Download file | Play in new window | Duration: 4:36 | Recorded on December 1, 2022

Among the various asset classes, trade receivables securities normally perform well even in trying economic times. One of the main reasons for this is that the trade receivables receive credit enhancement: they are separated from the seller and given reserves that result in higher credit ratings when used in securities. Thus, an unpaid invoice when it is securitised gains a higher credit rating than the company that issued the invoice. This post will look in detail at these credit enhancements.

Reserves

To understand why trade receivables become more attractive to investors once they are securitised, it is important to look at reserves. Credit loss reserves refers to money set outside to mitigate risks of non-payment or slow payment of the invoices that have been collateralised. Complex formulas are used to calculate reserve rates.

A dilution is a technical term that means that trade receivables are impaired not because of payment issues by the obligor (company who has to pay the invoice), but because of other issues such as product defects, erroneous billing and volume discounts. A dilution reserve is included into trade receivables securitisation to mitigate against the risk of dilution.

Another type of reserve is yield reserve. Unlike other assets, trade receivables are not interest earning. However, securities have interest paying liabilities. To allow for interest trade receivables are bought at a discounted price. The discount is to pay for yields and fees. The difference between the real value of the trade receivables and the purchase price is the yield reserve. When interest rates are low, this reserve is small comparative to credit loss and dilution reserves.

Concentration Risk

Another way that the process of securitisation of trade receivables reduces risk and enhances value is by looking at the concentration levels for obligors. A limit is set on the number of unpaid invoices that can be bundled into securities from any one debtor. This is determined by the credit ratings of the obligors involved.

Trade Credit Insurance

This term refers to insurance for trade receivables where there is a specific reason to fear that an obligor will default on its payment. Trade credit insurance is another strategy to enhance the value of trade receivables securities. Typically, trade credit insurance is used when there are high concentrations of certain obligors or where the transactions are carried out in countries deemed riskier than in developed countries.

Warranties

While sellers or issuers sell their trade receivables and are legally separated from the ensuing securities, they are still required to make legally binding warranties on their invoices. This is to provide protection against fraud, dilution and misrepresentation.

Monitoring

Finally, risk is mitigated by a robust regime for monitoring and reporting on the status of the trade receivables that have been deemed eligible for securitisation. The assets are relatively short-lived and as a consequence the composition of trade receivables used in securities is continually changing. The seller is tasked with tracking payments, providing details of new trade receivables, applying eligibility criteria, calculating reserves and concentration limits etc. Through careful monitoring and reporting the quality of the trade receivables securities can be maintained.

In Summary

It is not the case that the company holding unpaid invoices simply sell these invoices to another company specialising in trade receivables securitisation and have no further involvement. Although, they no longer legally own the receivables they are still contractually obliged to monitor and report on the composition and nature of receivables involved in the resulting securities.

Moreover, the securities are structured with a series of reserves to protect against a fall in market value. Warranties and trade credit insurance is also used to mitigate against various risks including non-payment, fraud and large currency fluctuations.  

Tags: concentration limitsdilutionreservesrisk mitigationTrade Credit Insurancetrade receivables securitisationwarrantiesyield reserve
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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
    • Europe
      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
    • North America
      • USA
      • Canada
    • Australasia
      • Australia
      • New Zealand
  • Hi-Tech
    • Digital Platform/IT/Software Providers
    • UK Fintech
    • Articles
      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
  • Legal
    • Law Firms
    • Articles
      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
  • Rates
  • Economy
    • Economic Indicators
    • Articles
      • The Collapse of the Russian Rouble: An Historical Analysis and Current Implications
      • The Current State of the UK Economy
      • Economic Forecast for the UK in 2023
      • Economic News for 2022
      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
    • Credit Insurers
    • Articles
      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
      • What are Export Credits and Country Risk Classifications?
      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
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    • Interview with Kyriba
    • Interview with Orbian
    • Interview with Crossflow
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