2021-10-06 Deutsche_Bank_Guide_to_Receivables_Finance_3rd_edition.pdf

A Guide to Receivables Finance 3rd edition General Editor Geoffrey Wynne, Sullivan & Worcester UK LLP Tower 42, 25 Old Broad Street, London EC2N 1HQ Tel: +44 (0)20 7448 1000 [email protected] Editorial Director Clarissa Dann, Deutsche Bank AG, London [email protected] Design & Layout GTR D...

A Guide to Receivables Finance 3rd edition General Editor Geoffrey Wynne, Sullivan & Worcester UK LLP Tower 42, 25 Old Broad Street, London EC2N 1HQ Tel: +44 (0)20 7448 1000 [email protected] Editorial Director Clarissa Dann, Deutsche Bank AG, London [email protected] Design & Layout GTR Design, part of Global Trade Review (GTR) design.gtreview.com Assistant Editor Will Hulbert, Hulbert & Co. Ltd hulbertandco.com Printer Ashwyk.com The first and second editions of A Guide to Receivables Finance were published by ARK Group, a division of Wilmington plc Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and the International Trade & Forfaiting Association (ITFA). All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under terms of a licence issued by the Copyright Licencing Agency in respect of photocopying and/or reprographic reproduction. Application for permission for other use of copyright material, including permission to reproduce extracts, should be made in writing to the General Editor. Full acknowledgement of author, publisher, and source must be given. DISCLAIMER This publication is intended as a general guide only. The information and opinions it contains are not intended to provide legal advice. No liability is accepted by Deutsche Bank AG, Sullivan & Worcester UK LLP, ITFA or any contributor for any loss or damage which may result from reliance on it. Always consult a qualified lawyer about a specific legal problem. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved Contents 1 2 Preface 10 Meet our experts 12 About the Editor 12 About the Contributors 13 An introduction to receivables finance 18 1.1 What is receivables finance? 18 1.2 How receivables arise 19 1.3 Quality of the receivable 20 1.4 How to finance a receivable 20 1.5 Logistics affecting a receivable financing 21 1.6 Assisting the buyer 22 1.7 How receivables finance has evolved 23 1.8 Standard definitions 24 1.9 Trading receivables 25 1.10 The business case for receivables finance 26 Legal treatment of payment instruments 2.1 27 Overview of key legal considerations 27 2.1.1 Enforceability 27 2.1.2 Negotiability 28 2.2 ‘True sale’: Transferring outright or financing against collateral? 29 2.3 Independence from underlying trade transaction 30 2.4 Credit enhancement techniques 31 2.5 ‘True trade debt’ or bank debt 31 //3 4// A Guide to Receivables Finance, 3rd edition 2.6 Accounting treatment 32 2.7  egotiable instruments: N Promissory notes and bills of exchange 32 2.7.1 Characteristics 32 2.7.2 Electronic solutions 34 2.7.3 Transferability and tradability 34 2.8 Credit enhancement techniques 35 2.9 Contract receivables 36 2.9.1 Characteristics 36 2.9.2 Transferability 37 2.10 Supply chain finance 38 2.11 Non-notified transfers 39 2.12 Credit enhancement techniques 39 2.13  ocumentary letters of credit and deferred D payment undertakings 41 2.13.1 Characteristics 41 2.13.2 Transferability 41 2.13.3 Structured letters of credit 42 2.14 2.15 2.16 Bank payment obligations (BPOs) 42 2.14.1 Characteristics 42 2.14.2 Transferability 42 Bank loans and SWIFT loans 43 2.15.1 Characteristics 43 2.15.2 Transferability 43 Summary of key points 43 Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 3 Legal and regulatory issues 44 3.1 Basel regime and capital adequacy 44 3.1.1 Basel I and Basel II 44 3.1.2 Basel III and CRD IV 45 3.2 Effect of Brexit 49 3.3 Accounting treatment under IFRS9 50 3.4 Anti-money laundering and terrorist financing 51 3.5 Sanctions 52 3.5.1 Trade sanctions 53 3.5.2 Financial sanctions 53 3.6 4 Fraud 55 The role of credit insurance in receivables financing 56 4.1 Benefits of using credit insurance 56 4.2 Role of the broker 58 4.3 Sharing the benefit of credit insurance 59 4.3.1 59 4.4 Loss payee status General legal considerations 61 4.4.1 Indemnity principle 61 4.4.2 Insurable interest 62 4.5 Key terms of insurance policies 62 4.6 Claims under insurance policies 66 4.6.1 Key considerations 66 4.6.2 Claims process practicalities 67 4.6.3 Role of the broker and loss adjuster 68 4.6.4 Recoveries and subrogation 68 4.6.5  inancer’s ability to influence the handling F of the claims process 68 //5 6// A Guide to Receivables Finance, 3rd edition 4.7 4.8 5 6 Insurance and capital relief 69 4.7.1 Regulatory background 69 4.7.2 Key requirements applicable 70 4.7.3 Eligibility 72 Due diligence 73 Distribution techniques and issues 74 5.1 Drivers of distribution 74 5.2 Outright sales 76 5.3 Risk participation agreements 77 5.3.1 Master RPAs 77 5.3.2 Funded vs unfunded 78 5.3.3 BAFT – Market standard forms 79 5.4 New York vs English law 81 5.5 Updated forms of MPAs 82 Surety – how insurance companies can issue guarantees and risk participations 84 6.1 What is surety? 85 6.2 Benefits of surety 88 6.2.1 Different types of surety 89 6.2.2 Underwriting surety – Analysis of credit risk 91 6.3 6.4  egulatory background for insurance companies R underwriting surety 93 Surety for banks 93 6.4.1 Capital relief 94 6.4.2 Which bonds can be covered? 94 6.4.3 A win-win situation 94 6.4.4 Documentation 95 MRPA 95 The ITFA surety MRPA 96 6.5 Example of surety in action 97 Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 7A Trade receivables securitisations: Background to trade receivables securitisation 98 7A.1 Investible assets 98 7A.2 Issuers/sellers 99 7A.3 Investors/financers 100 7A.4 Banks 100 7A.4.1 ABCP conduits 101 7A.4.2 Balance sheet 101 7A.5 Capital markets investors 102 7A.6 Risk mitigation 103 7A.6.1 Reserves 103 7A.6.2 Loss 103 7A.6.3 Dilution 103 7A.6.4 Yield/fee 104 7A.6.5 Concentration risk 104 7A.6.6 Trade credit insurance 104 7A.6.7 Representations and warranties 105 7A.6.8 Monitoring and reporting 105 7A.7 Legal and regulatory 106 7A.7.1 Legal 106 7A.7.2 Accounting 106 7A.7.3 GAAP 106 7A.7.4 IFRS 107 7A.8 Features of a typical transaction 108 7A.9 Market outlook 108 //7 8// A Guide to Receivables Finance, 3rd edition 7B 8 Trade receivables securitisations: Trade finance synthetic securitisation 109 7B.1 Niche market 110 7B.2 Issuer benefits and investor appetite 111 7B.3 Forerunners 112 7B.4 Structural features and considerations 112 7B.5 An efficient hedging tool 113 Cross-border supply chain finance 114 8.1 Supply chain finance 114 8.2 Payables finance 116 8.2.1 Buyer centricity 116 8.2.2 Working capital optimisation 117 8.2.3 Securing supply chains 118 8.3 How does payables finance work? 119 8.4 How the mathematics works 122 8.4.1 Margin and cost of funds 122 8.4.2 Discounting methodologies 125 8.5 Onboarding 125 8.6 Service provider strength 127 8.7 Industry developments 128 Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 9 10 Forfaiting 129 9.1 Introduction 129 9.2 Definitions 130 9.3 What makes a payment instrument forfaitable? 132 9.4 Forfaiting and factoring 133 9.5 URF800 134 9.6 The meaning of ‘without recourse’ 135 9.7  he agreement between the seller of the claim T and the primary forfaiter 138 9.8 Documents relating to the payment claim and the underlying transaction 139 9.9  alculation of the purchase price and payment C without recourse 141 9.9.1 Straight discount 141 9.9.2 Simple discount to yield 142 9.9.3 Discount to yield compounded annually 142 9.9.4 Collection 143 9.10 Secondary market 143 9.11 Digitalisation and forfaiting 145 9.12 Not just a single product or technique 146 The involvement of fintech in receivables financing 147 10.1 Prudential regulatory drivers 148 10.2 The technology-based originate–and–distribute model 148 10.3 TFD Initiative delivers automated distribution practices 149 10.4 Wider reach 150 //9 10// A Guide to Receivables Finance, 3rd edition Preface There is no doubt that owing to Covid-19, the period from March 2020 to mid-2021 has been challenging for every sector and every business. The need for the digitalisation of trade has been moved along a decade in perhaps one tenth of the time. Across the receivables finance world we have seen remarkable resilience. Coupled with the seemingly unending uncertainties around Brexit the changes to our industry have been myriad, and they are not finished yet by any stretch of the imagination. As the editor of A Guide to Receivables Finance, it has been difficult to pick an appropriate time to finalise and publish the 3rd edition of this Guide, although, as contributors, we all knew it was long overdue. I am enormously grateful to a number of people who have been flexible and understanding with regards to drafting, revising, reviewing and editing copy on a moving timescale. I would like to thank several people for their contribution to getting this Guide finished and published in time for the ITFA LIVE 47th Annual Conference being held in October 2021. First, I would like to acknowledge the enormous support and contribution of the team at Deutsche Bank in making this guide happen. Without their input, both in terms of actual contributions as well as their invaluable editorial and logistical input, there is a chance we would not have got it over the line. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved Second, this Guide would not be as comprehensive as it is without the support and input of the International Trade and Forfaiting Association (ITFA). Many of the contributors are ITFA Board Members and I am grateful to all of them for giving their time to this initiative, to help make it happen. Third, and specifically, I would like to thank the chapter contributors: Christian Hausherr at Deutsche Bank, Sean Edwards at Sumitomo Mitsui Banking Corporation and ITFA, Paul Coles at HSBC Commercial Banking and ITFA, Silja Calac at Santander and ITFA, André Casterman at TradeTeq and ITFA, Adrian Katz at Finacity and Jonathan Lonsdale at Santander. Fourth, I would also like to thank my team at Sullivan & Worcester in London for their input, in particular managing associate Hannah Fearn, who has updated and provided a very detailed chapter on credit insurance and helped me with the chapter on the legal treatment of payment instruments. Should readers have any follow-up questions, I would encourage them to get in touch with the relevant author(s) directly. Clarissa Dann, Editorial Director for Marketing at Deutsche Bank, has also done an amazing job in pulling the book together and editing it. Clarissa has been such a positive influence as well as a tough taskmaster on timing! I am also grateful to Kris Ellis at GTR Design for his design expertise and for ensuring the book was published on schedule. And last, but by no means least I would also like to thank my Senior Administrator, Sue Cleary for keeping me in check and Will Hulbert, at Hulbert & Co, for his PR and marketing support. Geoffrey Wynne September 2021 //11 12// A Guide to Receivables Finance, 3rd edition Meet our experts About the Editor Geoffrey Wynne is head of the Trade & Export Finance Group and Sullivan’s London office. He has extensive experience in banking and finance, specifically corporate and international finance, trade, structured trade and commodity finance, electronic banking and digitising trade finance, structured finance, asset and project finance, syndicated lending, equipment leasing, workouts and financing restructuring, leveraged and management buy-outs and general commercial matters. Recognised as one of the leading trade finance lawyers globally, Geoff has advised many of the major trade finance banks around the world on trade and commodity transactions in virtually every emerging market including CIS, Far East, India, Africa and Latin America. He has worked on many structured trade transactions covering such diverse commodities as oil, nickel, steel, tobacco, cocoa and coffee. The team which Geoff leads has won numerous awards and recognition for its work in the Trade and Export Finance industry. In 2021 Sullivan was named ‘GTR Law Firm of the Year for Innovation’, recognising the role the firm played during the initial stages of the pandemic in 2020 helping to ensure the trade finance industry was able to move to a secure digital environment from a legal perspective. Geoffrey Wynne, Head of the Trade & Export Finance Group, Sullivan & Worcester UK LLP gwynne @sullivanlaw.com Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved //13 About the Contributors Hannah Fearn is a managing associate in the Trade & Export Finance Group in the London office of Sullivan & Worcester UK LLP. Her practice area covers trade finance and insurance, advising on a wide range of cross-border trade finance transactions in a variety of jurisdictions, with an emphasis on emerging markets. Hannah acts for leading banks in the market and her experience includes advising on syndicated and bilateral pre-export commodity financings, letter of credit Hannah Fearn, facilities, commodity repo structures, trade instruments and Managing Associate, receivables financings, including supply chain finance. Trade & Export Finance Regularly advising banks on risk sharing techniques, including the drafting of sub-participations and credit insurance policies, Hannah acted for BAFT on the 2018 update of its template Master Participation Agreement for Trade Transactions. She has extensive experience of advising on the eligibility of different credit risk mitigation techniques for capital relief purposes under Basel III. Group, Sullivan & Worcester UK LLP hfearn @sullivanlaw.com Hannah also advises clients on regulatory issues, including sanctions issues arising out of cross-border finance transactions. Jonathan Lonsdale is Head of Trade & Working Capital Solutions, Private Debt Mobilisation, Santander. Since April 2021 Jonathan has been globally responsible for the distribution of trade and working capital related risk at Santander. This includes underwriting, syndicating and distributing all asset classes across supply chain finance, documentary trade and structured trade. He has been involved in the trade finance and structured finance industry for over 15 years. Prior to his role at Santander, Jonathan was Head of Securitisation & Repackaging for Trade Finance assets at Deutsche Bank for seven years, and prior to that was part of structured credit and securitisation teams at UniCredit and Dresdner Kleinwort. Jonathan Lonsdale, Head of Trade & Working Capital Solutions, Private Debt Mobilisation, Santander Jonathan read Mathematics at Oxford University. jonathan.lonsdale@ santandercib.co.uk 14// A Guide to Receivables Finance, 3rd edition About the Contributors Silja Calac was born in Switzerland and studied in Paris, where she obtained a Maîtrise d’Ingénerie en Commerce International (Masters Degree in International Trade) at ILECI (Institute of International Economics and Commerce). She acquired her first taste of Forfaiting & Trade Finance when joining the secondary market distribution team of BDEI-Credit Lyonnais, Paris as a junior trader in 1996. Before taking over in Munich the responsibility as Global Head of UniCredit Group’s Center of Competence for Trade Risk Management, Forfaiting Financial Institutions and Secondary Market in 2007, Silja worked in Singapore where she assisted in the establishment of a new Forfaiting Department within Bayerische Hypo-und Vereinsbank. In January 2015, Silja joined Swiss Re as Senior Surety Underwriter with the Credit & Surety team, based in Frankfurt, where she had the responsibility to further expand Swiss Re’s Surety product offer for banks. Presently, Silja is heading the private debt mobilisation team for global transaction banking (GTB) for Banco Santander in Continental Europe. She started this position in 2020 which is located in Banco Santander’s Frankfurt branch. Silja Calac is a Board Member of ITFA, Head of the Insurance Committee and Treasurer. She chaired the German Regional Committee of ITFA from 2010 to 2012. Further, she was also a member of the ICC Consultative Commission for the Drafting of the Uniform Rules for Forfaiting (URF) and Chairperson of the ICC URF task force until 2014. Silja Calac, Head of Insurance Relations and Head of Treasury, Banco Santander silja.calac @gruposantander.com Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved Paul Coles is responsible for overseeing the development and deployment of end-to-end distribution functionality in the booking platforms supporting the HSBC Global Trade and Receivables Finance (GTRF) business. He has also been focused on creating greater consistency in the processes, documentation and investor management on a global basis, along with working with the regional teams on key multi-jurisdictional transactions. Prior to joining HSBC, Paul was the global coordinator and EMEA head for trade risk distribution at Bank of America Merrill Lynch. He has also worked in the trade credit distribution team at ABN AMRO, and subsequently at RBS as the trade asset management regional head for the NV business (part of the legacy ABN AMRO network). He started his career over 20 years ago at London Forfaiting Company (a specialist trade finance provider) where he held a variety of trade finance roles. Paul has a BSc in Management Studies from Royal Holloway, University of London and is a member of the Board of ITFA, where he currently chairs the Market Practice Committee. Paul Coles, Head of Global Transactional Distribution, HSBC paul.c.coles @hsbc.com Adrian Katz has been the President of Finacity Corporation since its inception in 2001. Finacity is focused on enhancing liquidity for trade receivables, with approximately USD100bn of funding facilitated by his company in the past 12 months. He has been involved in the assetbacked finance industry for 35 years, working in both the investment banking and specialty financing industry. As an investment banker, Adrian was a managing director at Smith Barney, responsible for all issuance of new assetbacked and mortgage-backed securities. Prior to Smith Barney, Adrian worked for Prudential Securities where he was a managing director and Co-Head of the Mortgage and Asset Capital Division. He was also the Chief Operating Officer, Chief Financial Officer, and Vice Chairman of AutoBond Acceptance Corporation, a consumer finance company. Adrian graduated from Princeton University with a BSE in electrical engineering and computer science. Adrian Katz, President, Finacity Corporation akatz @finacity.com //15 16// A Guide to Receivables Finance, 3rd edition About the Contributors Christian Hausherr is the European Product Head of Supply Chain Finance for Deutsche Bank’s Payables Finance solution, bringing to the role over 20 years of experience in banking, in-house consulting and product management for cash management and supply chain finance. Christian has spent his career within Deutsche Bank in various divisions and regions, mostly spanning across Europe and the Transaction Banking business. He holds a diploma in business administration from the University of Bayreuth and has worked in Germany, The Netherlands, Great Britain, Spain, the US, as well as in India and Uganda on Corporate Social Responsibility assignments in the financial and educational sector. Christian contributed to the Standard Definitions for Techniques of Supply Chain Finance and authored the open account section of the Wolfsberg Trade Finance Principles. Christian Hausherr, European Product Head of Supply Chain Finance, Deutsche Bank christian.hausherr @db.com He also acts as the chair of the Global Supply Chain Finance Forum (http://supplychainfinanceforum.org/) and as a technical advisor for the supply chain finance section of the ICC Trade Register. André Casterman is the founder of Casterman Advisory which advises fintechs and financial institutions on trade finance, capital markets and digital asset technologies. André spent 24 years at SWIFT, leading various innovations in the inter-bank payments, corporate treasury, and trade finance markets. During that time, he established an institutional partnership between SWIFT and the International Chamber of Commerce (ICC) and created the first digital trade settlement instrument embedding smart contract capabilities. André is a Board Member at ITFA and chairs the ITFA Fintech Committee with a focus on helping banks digitise trade finance and establish it as an investable asset class for institutional investors. André is a non-executive director at Enigio and Tradeteq. André Casterman, Founder, Casterman Advisory acasterman @c-advisory.eu Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved //17 Sean Edwards is an English lawyer, formerly with Clifford Chance, and is now Head of Legal at SMBC Bank International plc, part of the Sumitomo Mitsui Financial Group. He has a commercial role as Special Adviser to the Trade Finance Department of the bank and is a member of the bank’s Trade Innovation Unit. Sean is Chairman of the International Trade & Forfaiting Association (ITFA). He is one of the principal draftsmen of the Uniform Rules for Forfaiting (URF), a joint initiative of ITFA and ICC. The URF is the only set of international rules on any form of receivables finance to be recognised by UNCITRAL. Sean was also a member of the drafting group for the Standard Definitions for Techniques of Supply Chain Finance published by ITFA, ICC, FCI, BAFT and the EBA. He is a former member of the Executive Committee of the ICC Banking Commission and led a work-stream on the ICC Working Group on Digitalisation in Trade Finance. Sean is a member of the World Trade Organisation (WTO) Trade Finance Expert Group. He is a non-executive director of KomGo S.A. Sean has written articles on trade finance, particularly on different forms of receivables finance, for all the major trade finance magazines and is on the editorial board of Global Trade Review (GTR). He is a frequent presenter at trade finance conferences dealing with a range of subjects. Sean Edwards, Chairman, International Trade & Forfaiting Association (ITFA) and Head of Legal, SMBC Bank International plc sean_edwards@ gb.smbcgroup.com 18// A Guide to Receivables Finance, 3rd edition 1 An introduction to receivables finance By Geoffrey Wynne, Head of the Trade & Export Finance Group, Sullivan & Worcester UK LLP 1.1 What is receivables finance? This third edition of A Guide to Receivables Finance considers the current position in relation to receivables finance and seeks to update what has happened, and is happening, since the second edition. There have been many changes. One thing that has not changed is what receivables finance comprises: Any arrangement providing credit to a party, using an amount payable by one party to another for goods or services, should be included in the scope of receivables finance. The generation of receivables is a key factor in any trade finance arrangement. A party (the seller) sells something to another party (the buyer), and the payment by the buyer, until the time when it is paid, is a receivable. It is an asset which the seller has, and a liability which the buyer has. The speed with which the seller converts the receivable into cash is important for their business; faster conversion of receivables into cash reduces the amount of working capital the seller needs to run its business. The measurement of how long that takes is often called ‘days sale outstanding’ (DSO). The seller will often be looking for solutions that turn its receivables into cash more quickly. On the other hand, the buyer wants as much time as possible before they must pay the receivable. The more quickly it has to pay, the more working capital it needs for its business before it can utilise whatever it has bought. The longer the buyer has to pay, the better it is for the buyer. The measurement for the buyer is its ‘Days payable outstanding’ (DPO). See also Chapter 8: Cross-border supply chain finance. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved Given this apparent conflict, it is possible to see how each party might seek help to achieve a shorter DSO period, in the case of the seller, and a longer DPO period, in the case of the buyer. It is for these reasons that the parties seek solutions in the arena of receivables financing. 1.2 How receivables arise Receivables represent the culmination of most, if not all, trading arrangements where a product or service is sold, and which can result in some form of financing. It may well be the case that, in the time from producing a raw material to creating a finished product, there is more than one sale and purchase involved. The producer of raw materials sells them to a buyer. That buyer processes the raw material and sells the finished product to another buyer, and so on. Each of these sales and purchases would create a receivable, which could be the subject of a financing. In all these cases, either of, or both, the seller and buyer might see the need to obtain financial support for such a transaction. Equally, such a transaction provides an opportunity for a financer to offer an arrangement to one or other party to improve its DSO or DPO position, whichever is relevant. In addition, other parties have become more involved in arranging for this to happen and more parties have become interested in participating in such arrangements. All of these scenarios are considered below. //19 20// A Guide to Receivables Finance, 3rd edition 1.3 Quality of the receivable The quality of the receivable is a major determining factor as to what financing is available when it is produced in a trading arrangement. A financer might require, or offer, some sort of credit enhancement for that receivable. This might be by way of a guarantee of the payment obligation of the buyer, or by way of some other form of credit support like credit insurance or involving a surety. Another way of improving the quality of the receivable is by making it an irrevocable payment obligation. This can be in terms of the receivable itself, or because the receivable is replaced by something such as a separate irrevocable payment undertaking (IPU) or promissory note, which, by statute, constitutes an irrevocable obligation to make the payment. In order to achieve this, the buyer must give up its rights to stop payment if goods are faulty, although it may retain the right to claim against the seller. Similarly, the timing and likelihood of a payment will affect the value of the receivable from a financing point of view. A financer may well be prepared to finance a seller who needs time to produce the product being sold and then further time to transport it to the buyer. The financer will look at the time from production to the time the buyer is obliged to pay and calculate the cost of financing that receivable and its value at various times until payment is due. By contrast, a seller who produces an invoice which states payment is due in, say, 30 days has a more valuable receivable. 1.4 How to finance a receivable Once the quality of the receivable is ascertained, the question of how to finance it becomes simpler to answer. Where the receivable has not become an unconditional payment obligation, certain types of financing may not be available. For example, a financer may not want to purchase a receivable, or find a purchaser for that receivable, where the seller has to perform further actions to turn the receivable into an unconditional payment obligation. Whether the financer is taking any performance risk on the seller is a key element to consider in financing a receivable. Once a receivable becomes an unconditional obligation of the buyer, then the credit risk of the buyer is the main issue to consider. In many ways, this is a more quantifiable risk. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 1.5 Logistics affecting a receivable financing A financer taking performance risk on the seller will need to look at what needs to be done to make that receivable unconditional and the extent to which the financer can control that risk. For instance, if the product needs to be transported, then the whole issue of the logistics of the mode of transport and handling of title documents to the commodity while being transported must be considered. One example may be the transportation of goods by sea which results in the production of a bill of lading from the vessel concerned. If the financer has access to that document, it can present that document to the issuing bank, then that financer has control over changing the payment obligation of that issuing bank into an unconditional obligation. As will be seen in Chapter 2: Legal treatment of payment instruments, at this point, a payment obligation would arise even if that payment is deferred for a certain period pursuant to that letter of credit. In other words, it would be possible to finance a receivable once the relevant goods were on board a vessel. The issues regarding other forms of transportation might not be as clear. Goods transported by air would work in a similar way. Goods transported by truck or otherwise over land (e.g. rail) have more difficult logistical issues to resolve. In most of these cases, having payment made by way of a letter of credit, and control over presentation under that letter of credit, often helps improve the quality of the receivable where there is seller performance risk. In all these cases, it is assumed that the seller’s receivable can be financed by relying on the certainty of the payment obligation of the buyer in the case of an IPU or its bank in the case of a letter of credit. Turning to consider the value to the buyer of this arrangement means looking at the possibility of extended credit terms to the buyer. //21 22// A Guide to Receivables Finance, 3rd edition 1.6 Assisting the buyer Much of the above has looked at creating, for the seller, a means of converting its receivable into cash ahead of when the buyer might be prepared to pay. It is often possible to structure a receivables financing to give the buyer extended time to pay. This can be achieved where the financer is prepared to look at the quality of the credit standing of the buyer and to delay receipt of payment from the buyer beyond the period of credit that the seller might give. In these circumstances, the financer arranges for the seller to receive early payment and assumes the time delay from, and the credit risk of, the buyer. This Guide looks at some of the devices that can be used to achieve this. Generally speaking, this type of arrangement depends on the buyer accepting the certainty of its payment obligation, while delaying the date when it arises. There are issues to be considered in this delayed payment which means that the timing and structuring of the delayed payment could be crucial. Many involved in receivables financing want to ensure that the receivable remains trade debt. Also, parties including rating agencies have expressed concerns that extended payment terms to a buyer should turn trade debt into bank debt and be treated differently. These points are also considered in Chapter 2: Legal treatment of payment instruments. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 1.7 How receivables finance has evolved The chapter on forfaiting (Chapter 9) explores the historical context, the future of forfaiting and also considers factoring. A comparison of the two looks at the level of recourse to the seller of the receivable. In the case of forfaiting, the concept is to allow the sale of a receivable to be without recourse to the seller, but on the assumption that the seller has taken all steps to make sure the payment obligation is unconditional. At that point, the seller receives a discounted payment and no more, and the sale is without recourse to it. In the case of factoring, the seller receives a discounted amount, but may well receive more once payment from the buyer is received. On the other hand, if the buyer does not pay, there may be recourse to the seller for all or part of the unpaid amount. Variations between these products may result in different treatments, but essentially both are used where the receivable has come into existence resulting from a sale of goods or the provision of services. In each case, financers using these tools have sought to include other types of receivables within the product. Forfaiting talks of a payment claim as being the subject of a forfaiting transaction. That payment claim can arise not just from the sale of goods, but also out of a financial instrument, including a letter of credit or even a loan agreement. “Extending electronic data to encompass bills of lading and other shipping documents further increases the potential for speedier creation of receivables” Geoffrey Wynne, Head of the Trade & Export Finance Group, Sullivan & Worcester UK LLP //23 24// A Guide to Receivables Finance, 3rd edition Supply chain finance, as explained in Chapter 8: Cross-border supply chain finance, often uses an electronic platform to evidence the creation of a receivable. Depending on whether the programme is supplier-led (receivables) or buyer-led (payables) will determine the extent of the involvement of commercial parties. In all cases, the programme is designed to create a receivable which can be financed. It provides availability of credit to a seller/supplier and potentially extended payment terms to a buyer. A buyer might well use its programme to assist its suppliers in obtaining beneficial credit terms to support and enhance each supplier’s business. Third party arrangers and platform providers can use structuring to achieve good results for both parties. The use of electronic products has become more evident in recent times. Bank payment obligations (BPOs), which utilise matching electronic data to create an unconditional payment obligation of a bank, again increase the potential for receivables financing. The BPO (explained further below) has not proved as successful as many had hoped, due in some part to its inflexibility, but it has led to other electronic solutions including the Uniform Rules for Digital Trade Transactions (URDTT) which allow for a trade to be evidenced digitally including for its payment.1 Extending electronic data to encompass bills of lading and other shipping documents further increases the potential for speedier creation of receivables. This has been apparent in the use of electronic letters of credit. There have been many developments in the fintech arena considered in Chapter 10 with the law trying to catch up. English law changes are being led by the Law Commission. Other jurisdictions are seeking to embrace the UNCITRAL Model Law of Electronic Transferable Records (MLETR).2 1.8 Standard definitions Initiatives from a number of professional and industry associations involved in receivables financing and, in particular supply chain financings, has resulted in a publication entitled Standard Definitions for Techniques of Supply Chain Finance.3 This examines different types of receivable financing. It remains to be seen the extent to which these definitions are indeed utilised. See also Chapter 8: Cross-border supply chain finance. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 1.9 Trading receivables Once a receivable has been created, and it meets the requirement of being an unconditional payment obligation of a buyer, then there are ways for a financer to trade that receivable as part of a financing or refinancing of those receivables. Conceptually, the receivable needs to be in a form in which its holder can either continue to transfer it or can itself issue an obligation secured on that receivable. In the case of transferability, this can be achieved by making the receivable into a negotiable document such as a promissory note. That promise to pay can then be transferred by delivery, by endorsement or by a separate instrument of transfer. This is considered in Chapter 2: Legal treatment of payment instruments. Pending changes in English law regarding the transfer of an electronic promissory note, an electronic equivalent called an electronic Payment Undertaking (ePU) has been developed by ITFA and is considered in Chapter 2 and Chapter 10: The involvement of fintech in receivables financing. Where the receivable arises from a sale of goods, or from an invoice from that sale or the provision of services, it can still be acquired directly or indirectly by a financer. This is normally by assignment of that debt and notice to the paying party. Again, this is considered in Chapter 2. Instead of the financer acquiring the debt itself, it can establish a separate company (often specially formed for this purpose – a special purchase company or vehicle (SPV)) to acquire the receivable. The SPV pays for the receivables by issuing its own promise to pay, which is secured on the receivables. Its promises to pay are evidenced often by promissory notes, or other forms of note, which can be freely traded. This structure is termed a ‘securitisation’ and both parts of Chapter 7 covering trade receivables securitisation provide more detail on this. Financers often try to have other financers join in their financings by this and other means. These arrangements are also considered in Chapter 7. However, having non-bank financial investors acquire receivables is currently a major initiative. //25 26// A Guide to Receivables Finance, 3rd edition 1.10 The business case for receivables finance There are potentially advantages for all parties involved in the creation of receivables to enter into financing arrangements. From the seller’s point of view, it has the potential to monetise receivables at an early stage of their existence, and even before they exist in certain cases. Where the seller has availed itself of a financing in respect of an acceptable buyer it might be able to offer that buyer extended credit terms while building the discount it receives from delayed payment into its sale cost. For the buyer, the potential of extended credit terms may well be attractive. However, it may also lend its support to its seller by accepting a payment obligation that is unconditional. In all of these discussions, the financer may well see opportunities to arrange such financings. Financers should always be aware (especially when they are banks) of the regulatory capital cost of such financings and the opportunities to enhance their return by other means. In addition, there are other legal and regulatory issues to be considered in being involved in receivables financings. Some of these issues are considered in Chapter 3: Legal and regulatory issues. Providers of credit support may well see the advantages of becoming involved in supporting transactions for a fee to be charged for that credit support. The use of credit insurance is considered in Chapter 4 and surety in Chapter 6. Well-constructed programmes which create the receivables may well be products that investors would seek without actually bearing the cost of structuring them. In all these cases, there are reasons why instances of such financings will continue and, indeed, increase. There are risks that over-zealous arrangers of receivables financings may extend the usual definitions, such as supply chain financing, to other financings that are not in reality trade receivables, as they do not represent a receivable that currently exists but one that may be created in the future. Structures promulgated by Greensill Capital before its demise may well have fallen into that category.4 These serve as a warning to be aware of what is offered and not that receivables financing is risky. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 2 Legal treatment of payment instruments By Geoffrey Wynne, Head of the Trade & Export Finance Group and Hannah Fearn, Managing Associate, Trade & Export Finance Group, Sullivan & Worcester UK LLP There are many different payment methods used in the settlement of international trade transactions. As described in Chapter 1: An introduction to receivables finance, each method offers a different level of protection for the exporter (seller) and importer (buyer). Each payment method should create a receivable: a legally enforceable right to receive payment from another person, which the beneficiary of that receivable (usually the exporter) can sell or use as collateral for financing. The enforceability, transferability and tradability of a receivable depends on its legal nature. This will influence the forms of receivables financing available to the exporter (as beneficiary) for a receivable. 2.1 Overview of key legal considerations 2.1.1 Enforceability It is assumed for this purpose that the seller has done all that is required of it to create an enforceable payment obligation against the buyer. The buyer is then the debtor, owing the receivable, which is a payable in its books. As mentioned in Chapter 1, future payment obligations which have not yet been created are beyond the scope of this chapter. //27 28// A Guide to Receivables Finance, 3rd edition 2.1.2 Negotiability There are broadly two types of receivables: those which constitute negotiable instruments (such as bills of exchange and promissory notes) and those which do not (such as invoices). Put simply, the transfer of negotiable instruments is more straightforward than the transfer of non-negotiable instruments. This is because the transfer of a negotiable instrument can be effected by delivery (together with an endorsement, if applicable), without the requirement for additional transfer documentation. Negotiable instruments are, therefore, very suitable for receivables financing and for further trading on secondary markets. However, negotiability is a longstanding legal concept with its foundations in a paper-based world and the process for effecting the transfer of a negotiable instrument relies on the delivery of a physical instrument. In the ever-increasing world of fintech solutions, the legal limitations on the creation and transfer of electronic negotiable instruments under English law need to be, and are being, addressed. This is explored further below. The transfer of receivables that are non-negotiable under English law must occur by way of assignment. This requires the parties to enter into appropriate transfer documentation and (generally) requires notice to be served on the debtor. Depending on the terms of the agreement creating the receivable, transfer may be prohibited, or the prior consent of the debtor may be required before it can be sold. However, non-negotiable receivables are still frequently subject to receivables financings and financers have devised innovative ways to streamline the process of satisfying the legal steps involved. For example, buyer-led supply-chain finance programmes (now often referred to as payables finance) are often entirely managed using electronic platforms which allow for the buying and selling of large numbers of receivables at any one time. The nature of negotiable instruments, and the transferability of different types of receivables, are considered in further detail below. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 2.2 ‘True sale’: Transferring outright or financing against collateral? A key issue when considering the transfer of receivables is determining whether a receivable has been transferred outright by the beneficiary. If a receivable is transferred outright, the purchaser of that receivable is protected from claims against the original owner’s assets in the event of that party’s future insolvency. This is known as a ‘true sale’. If a true sale of the receivable cannot or does not occur, then the beneficiary of that receivable could instead borrow, or be treated as having borrowed, money that is secured against that receivable. In other words, the beneficiary is still the owner of the receivable. In that instance, the receivable is used as security for the debt and, in the case of the beneficiary’s insolvency, the financer ranks as a secured creditor (assuming it has taken valid security). When it comes to recovery, this position is less attractive to the financer than true ownership, as the secured creditor’s recovery in the insolvency may be subject to prior payment of mandatorily preferred creditors out of the insolvent beneficiary’s assets. In addition, the security will be unenforceable against a liquidator or administrator of the beneficiary if (where the beneficiary is a company in the UK) it was not duly registered with Companies House within 21 days of its creation. Other jurisdictions may have equivalent registration requirements or other requirements for the creation of a valid security interest. Registration of security might not have been carried out at all if the parties had intended for a true sale of the receivable to occur. If an intended true sale transaction is later re-characterised as a secured financing, the purported buyer of the receivable could be left in an unfavourable and unsecured position as a creditor of the beneficiary. The distinction between the true sale of receivables and financing secured by receivables is relevant in many jurisdictions besides England. A party who intends to purchase receivables owed by foreign entities should always seek local advice on transferability and true sale issues. //29 30// A Guide to Receivables Finance, 3rd edition “Arguably, ‘true trade debt’ is the debt arising from the sale and purchase of goods” Geoffrey Wynne, Head of the Trade & Export Finance Group, Sullivan & Worcester UK LLP 2.3 Independence from underlying trade transaction It is a key aspect of receivables financing that the purchaser of the receivable will want to be paid regardless of any future dispute between the parties to the underlying trade transaction. In a financing where the purchaser of the receivable has no recourse to the seller of that receivable, the purchaser will need to be satisfied that the obligation to pay is not subject to performance by the seller or any other condition. Some types of payment instrument are more independent than others. In other words, some payment instruments (such as bills of exchange, promissory notes, letters of credit and IPUs) create independent payment obligations which cannot be avoided solely by reason of a dispute between the underlying commercial parties. A financer can be more comfortable entering into a without-recourse financing arrangement in respect of these types of payment instrument. An amount due under an invoice forms part of an underlying contractual agreement between commercial parties. Payment can therefore be subject to any defences the debtor has under that contract. A financer of the receivables can attempt to protect its position in these circumstances. For example, the financer could only buy the receivables once performance of the contract has occurred (and the debtor has expressly accepted this). Alternatively, the financer could buy the receivables on a ‘with-recourse’ basis, where it can require the seller to repurchase the receivable if the debtor has not paid as a result of the seller’s failure to perform. The alternative is for the debtor to accept that its payment obligation is unconditional, or to give or arrange for the issue of an independent payment obligation, such as an IPU or a promissory note, or arrange for a letter of credit from a bank. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved 2.4 Credit enhancement techniques As part of a financing package, a financer may require the seller of the receivable to provide certain credit enhancements. These often have the effect of replacing the risk of non-payment by the debtor with bank risk or transferring the risk to a party with a better credit rating. For example, a financer might ask for an independent and irrevocable payment guarantee from the debtor’s bank or another corporate in its group. There are many other types of credit support which might be relevant in a financing. For example, corporate guarantees, security, export credit agency (ECA) coverage, or credit insurance or surety. 2.5 ‘True trade debt’ or bank debt There is debate about the nature of trade and even ‘true trade debt’ and its treatment on the insolvency of the debtor. Arguably, ‘true trade debt’ is the debt arising from the sale and purchase of goods.5 The genesis of this debate is the view that trade finance debt should be given more favourable treatment in the case of a debtor’s insolvency or restructuring. There is no general precedent for this, although specific examples do exist where short-term debt (which is often trade-related) or other trade-related debt has been given priority in restructurings (for example, the 2009 restructurings of JSC BTA Bank and JSC Alliance Bank, both in Kazakhstan). The beneficiary of a receivable that looks like ‘trade debt’ should not rely on that debt automatically getting better treatment in an insolvency. In addition, recent examples of how payment terms of the debtor can be amended and extended as part of a financing arrangement have given rise to the debate as to whether an amount owed by a debtor to a financer is still trade debt or should be classified as bank debt. Examples of these arguments can be found in the financial problems of companies including Abengoa and Carillion. Rating agencies, looking at how these receivables were created and financed, argued that the balance sheet of these companies (and others) should have reflected the obligations not as trade payables but as bank debt.6 Those involved in structuring these types of arrangements should bear these issues in mind. //31 32// A Guide to Receivables Finance, 3rd edition 2.6 Accounting treatment There are issues to be considered in relation to the transfer of receivables from an accounting point of view. Effectively removing a receivable from the creditor’s balance sheet is often a key driver in entering into receivables financing arrangements. The legal treatment for a seller of a transfer of receivables (i.e. has a true sale of the receivable occurred?) is not always the same as the accountancy treatment. For example, the legal analysis will focus on whether the arrangement would be construed by the Courts as being a legal transfer of the asset or whether it would be recharacterised as a financing, including considering how the transactions might be challenged on legal grounds in an insolvency situation. To achieve offbalance-sheet treatment of a receivable, the requirements of IFRS9 or equivalent accounting principles must be considered. 2.7 Negotiable instruments: Promissory notes and bills of exchange 2.7.1 Characteristics The Bills of Exchange Act 1882 (the Act) sets out the requirements that an instrument must meet in order to constitute a bill of exchange or promissory note under English law. Section 3(1) of the Act defines a bill of exchange as: “an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person, or to bearer”. Section 83(1) of the Act defines a promissory note as: “an unconditional promise in writing made by one person to another signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to, or to the order of, a specified person or to bearer”. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved In the context of a trade transaction, a bill of exchange is an order by the exporter to the importer to pay a certain amount (i.e. the purchase price) either on demand, or on a fixed future date. Similarly, a promissory note is a written promise by the importer to pay the exporter a certain amount (i.e. the purchase price) either on demand, or on a fixed future date. A key characteristic of bills of exchange and promissory notes is that they each create an unconditional and independent payment obligation of the debtor in favour of the beneficiary. This payment obligation is independent of the underlying trade transaction. A final consideration to bear in mind is that physical possession of the instrument is central to its legal nature. Transferring possession of the instrument can transfer the rights and obligations it represents, and presentation of the instrument is required to enforce the right to receive payment under it. However, English law only recognises possession of tangible assets and not electronic documents and so, for the time being at least under English law, bills of exchange and promissory notes do not exist electronically. //33 34// A Guide to Receivables Finance, 3rd edition 2.7.2 Electronic solutions These legal restrictions have held back the development of electronic solutions for the transfer of negotiable instruments. The Law Commission is actively considering this issue and in April 2021 published a consultation paper with recommendations for legal reform to allow for the legal recognition of electronic trade documents including bills of exchange and promissory notes, and to provide that electronic trade documents will have the same legal effects as their paper counterparts.7 Among the issues considered in the proposals is the question of exclusive control, being the principle of ensuring that only one person can “possess” the electronic instrument at any one time. Another key property of an electronic negotiable instrument is that, once that instrument is transferred, the transferor must have fully relinquished control of it and the transferee must have gained sole control. It is anticipated that parties can exploit distributed ledger technology to achieve this, where the creation of an electronic instrument is represented by a unique token which can be transferred between parties subject to a validation process to check the nature of the transfer (i.e. that both parties have consented to it) and the integrity of the instrument (i.e. that it has not been altered since its creation). The consultation paper was accompanied by a draft Bill to embody the proposed reforms, and it is hoped that this might become an Act of Parliament in 2022 or soon after, so that the industry can start to reap the benefits of switching to electronic processes. 2.7.3 Transferability and tradability A bill of exchange or promissory note that satisfies the characteristics of the Act will constitute a negotiable instrument under English law. A negotiable instrument expressed to be payable to the bearer can be transferred to a third party by delivery alone. If the instrument is payable to a specified person, it can be transferred by delivery together with an endorsement. As discussed above, transfer of possession currently requires delivery of a physical instrument. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved The holder of the instrument may transfer it without recourse. This is likely to be the case in a forfaiting transaction. However, it is common practice for the parties to enter into a separate forfaiting agreement under which the seller of the instrument gives certain representations in respect of the instrument, allowing recourse to the seller in the case that any of those representations turn out to be untrue. The transferee will obtain direct rights against the debtor for payment in accordance with the terms of the instrument. Bills of exchange and promissory notes are easier to trade than other types of payment instrument and buyers of these instruments, such as forfaiters, can sell them on secondary markets. Given the English law issues with regards to electronic bills of exchange and promissory notes, an electronic payment undertaking (ePU) has been suggested by ITFA and is discussed in Chapter 10. It is designed to have the equivalent rights as its paper equivalent, although such rights are created by a contractual framework, rather than under common law. 2.8 Credit enhancement techniques The most common type of credit enhancement technique in the context of bills of exchange and promissory notes is the debtor’s bank giving a transferable and irrevocable bank guarantee for the amount of the instrument. This can also be achieved by adding an ‘aval’ to the bill or note, although the concept of an aval is not expressly recognised under English law. Many financers will require such a guarantee, or aval, to be in place before agreeing to discount a bill or note. //35 36// A Guide to Receivables Finance, 3rd edition 2.9 Contract receivables 2.9.1 Characteristics An exporter selling commodities under an export contract will generate receivables due from its importer. The amounts due from the importer might be set out in the contract itself (in which case the creditor will have a claim for payment against the debtor under the contract), or the exporter might deliver invoices to the importer representing payments due for each delivery (in which case the creditor can sue for payment of the invoice). In comparison with negotiable instruments, the right to payment from the debtor is not necessarily independent of the underlying trade transaction. For example, payment might be conditional on performance of the underlying transaction, and, in case of a dispute, the debtor might be able to withhold payment and resolution of a dispute may result in the issuance of a credit note from the creditor (representing an agreed reduction to the contract price), which the debtor will set-off against the amount due under the invoice. There are no specific legal requirements as to the form of a contract for payment, or for invoices, beyond the basic English law requirements for formation of a contract. As such, it is possible (and indeed common practice) for contracts to be entered into and invoices to be issued electronically. Copyright© 2021 Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA. All rights reserved Physical delivery of the contract or invoice representing the receivable is not required to effect transfer or to enforce payment. This, together with the ability to create receivables electronically, offers a high degree of flexibility to potential financers. 2.9.2 Transferability Under English law, receivables of this nature are transferred by way of assignment. There is a distinction between a