Trade receivables securitisation began in the USA in the 1980s. It is a system whereby a company can raise money by selling on a revolving basis a selection of its trade receivables to a Special Purpose Vehicle (SPV) which is legally separate and bankruptcy remote. The SPV issues collateralised notes that can be bought and sold. It is estimated that there are between 80 and 100 billion USD worth of such securities on the market at the moment.
Turning trade receivables into securities has become a popular financial tool for dealing with large invoice bundles, typically between 50 million USD and 1 billion USD. Securitisation is not limited to US dollars. The transactions represented by the trade receivables can be from multiple countries. Furthermore, the issuers or sellers can be unrated or below investment grade because the process of securitisation renders the bundled trade receivables investment grade.
The Appeal of Trade Receivables Securities
Since their inception securities have appealed to investors for the following reasons:
- Securities have performed well through the various stages of the economic cycle. There have been few cases of securities comprised of trade receivables having parts that default causing the markets to run away from these products.
- These securities are structured in such a way that they can be modified: the reserve levels can be adjusted monthly to mitigate risk. This facet of trade receivables securities provides protection to the assets.
- They perform well against other asset classes. Since these securities comprise of unpaid invoices, they provide returns after a few months.
- From an invoice financier’s point of view, securitisation of trade receivables represents a low-risk option to extend credit to companies with weak credit ratings. Moreover, separating the receivables from the seller makes the financial product more attractive to investors. Records indicate that securitisation has resulted in lower risk for the financier.
- From the point of view of banks and other regulated institutions, it is possible to reduce the capital requirements on their credit services due to the strength of the high credit ratings such securities are awarded.
Advantages of Trade Receivables Securitisation
Securities are classified as Asset Backed Commercial Paper (ABCP). The assets in this case are the unpaid invoices. An ABCP is further enhanced with a Letter of Credit (LC) from the sponsoring bank. This provides a double security net that has stood investors in good stead even through the Global Financial Crisis of 2008. Another strength of this type of security is the added layer of protection given by credit ratings. These are made by independent rating agencies that further scrutinise the securities for weaknesses.
As the composition of securities change as invoices come due for payment, rating agencies are obliged to check the portfolio of trade receivables and re-confirm their credit ratings. It is like having a car regularly serviced so that the vehicle remains road worthy for a long time.
As a result of these strengths, more than 20% of ABCPs are now using trade receivables as assets.
In the past banks would keep trade receivables securitisation at arms-length from their main balance sheets. Funding has been through bank-sponsored paper conduits instead. However, recently banks have been changing their attitudes to trade receivables securities, often bringing them onto to the balance sheet and applying their own fiscal discipline.
Capital Market Investors
In developed markets other funders are usually traditional capital market investors such as pension funds, insurance companies and asset management companies. In emerging markets there is a lack of ABCP conduits to release bank funding for trade receivables securities. As a result, these securities are funded by the capital markets. This is not necessarily a bad thing as this spreads risk in emerging markets, not placing all the burden on banks to provide trade financing.
The downside for emerging markets is that capital markets cannot offer the same level of sophistication. They do not accommodate variable funding amounts so the rewards of securities remain at a fixed amount during the revolving period of the security’s life. This inflexibility is detrimental to the seller. As a result, trade receivables securities in emerging markets generally have longer lifespans (up to 5 years) compared to trade receivables securities in developed markets that are renewed annually.
Since the 1980s creating securities using assets composed of unpaid invoices has been largely a success story. They are structured to appeal to the sellers of the trade receivables, the funders and the investors.
The benefits of the structure include providing flexible funding for the seller, low risk and high reward assets for investors, and commercial products for banks that can be carefully managed to mitigate risk and maximise profits.
Key components of trade receivables securitisation are: the unpaid invoices are legally separated from the seller; the securities are bankruptcy remote; the value of the securities are independently rated by credit rating agencies; and, the assets that back the securities come to fruition relatively quickly compared to other assets.
It is clear that while emerging markets are taking advantages of trade receivables securitisation, the facilities of the local banks to monitor and adjust the portfolio of assets are lacking. Already 20% of securities use trade receivables as assets, this figure will increase as developing countries enhance their banking systems.