Desert dialogues: Pulse check on receivables finance

Estimated reading time: 7 minutes

Africa has been a gateway for trade for centuries, yet the development of modern financial instruments like receivables finance has lagged. Receivables finance is not just a financial instrument. It’s a lifeline for businesses, especially in the ever-evolving landscape of African trade. 

Institutions and development banks are key players in this landscape, serving as catalysts for innovation and regulatory frameworks and providing essential financial support mechanisms like guarantees and credit facilities. 

Their involvement legitimises the practice of receivables finance and paves the way for sustainable trade ecosystems across Africa.

To dive deeper into what these institutions are doing and what more they can do in the future, Trade Finance Global spoke with Mr. Ahmed Attout, Ag. Director, Financial Sector Development, African Development Bank Group (AfDB); Mrs. Kanayo Awani, Executive Vice President, Afreximbank; Eng. Hani Salem Sonbol, CEO, International Islamic Trade Finance Corporation (ITFC); and Mr. Peter Mulroy, Secretary General, FCI

Receivables finance: back to basics

Receivables have evolved significantly from clay tablet engravings in Mesopotamian times to the invoicing norms of today. Over the centuries, receivables finance has seen many iterations, including the emergence of factoring.

As a financial tool, factoring has gone through various stages of evolution. It started with industrial factoring, where trading companies would buy products and offer financing. In the 1920s, a US Supreme Court ruling marked the birth of modern factoring by allowing the separation of trading and financing functions. 

Today, factoring has continued to evolve, with over 70% of factoring transactions being done on a non-recourse basis. This approach provides protection against debtor bankruptcy or default and allows for off-balance sheet treatment for publicly traded companies. 

Additionally, it aligns with Basel capital regulations, reducing capital risk for banks.

Recent developments, such as the introduction of Islamic factoring and the emergence of receivables exchanges, have expanded the scope of receivables finance, reflecting the dynamic nature of the financial industry.

Despite Africa’s historical significance as a gateway for trade, receivables finance development in the region has lagged, with various factors like economic diversity, informal trade, and regulatory variability contributing.

Africa’s economic landscape is diverse, with some countries, like Morocco, Egypt, and South Africa, having well-developed financial services systems and trade finance instruments. In contrast, others are less developed, leading to disparities in the availability of receivables finance products.

This variability also extends to the regulations and legal frameworks in place across the continent. 

Mrs. Awani said, “If we take a step back, you can see many differences in regulations for safe factoring. Some countries are regulated by the central bank, while some want factoring to be offered by commercial banks, for instance.”

These differences in regulatory environments create challenges for uniform receivables finance practices across the continent.

This may be one reason why a significant portion of trade in Africa is conducted informally. While informal trade may help traders avoid some of the regulatory burdens, it also limits data collection and ultimately hinders more widespread adoption of potentially long-term financing instruments such as receivables finance.

Continuing the status quo will further harm the continent’s small businesses, which often rely on receivables financing but face challenges in accessing it. 

To address these challenges and promote receivables finance in Africa, efforts have been made to create an enabling regulatory and legal environment. 

Legal framework for receivables

The Model Law for Factoring by UNIDROIT is a significant development in the world of receivables finance. 

This global model law aims to create a standardised legal framework for factoring that can be adopted by countries worldwide, including from a Shariah financing perspective.

The Model Law for Factoring seeks to establish clear rights and responsibilities for parties involved in factoring transactions while safeguarding their interests. 

Eng. Sonbol said, “The adoption of the model law for factoring aligns very well with the Islamic Sharia because it aims to establish very clear rights and responsibilities of individuals.”

The Sharia principles emphasise fairness, transparency, and ethical conduct in financial transactions. Additionally, Islamic finance principles emphasise the protection of property rights and the equitable treatment of parties. 

The model law includes provisions related to the assignment of receivables and the protection of third-party rights, which can help safeguard the rights of parties involved in factoring transactions.

Under Islamic law, receivables finance assets can be recognised and utilised provided they comply with Shariah principles. 

Introducing the model law can provide regulatory support for developing Shariah-compliant factoring practices and can serve as a practical reference point for countries looking to create or enhance their legal frameworks for Islamic factoring.

In addition to the legal frameworks, another vital contributing factor is development banks.

Development banks and their role in trade finance

Development banks are crucial in supporting trade flows and ensuring economic resilience. The African Development Bank (AfDB) is no different, playing a key role in supporting initiatives like the African Continental Free Trade Area (AfCFTA) to simplify regulations, reduce bureaucracy, and enhance trade within Africa.

Mr. Attout said, “We see trade as essential to economic growth and building resilience. That is why we leverage all our instruments and upstream and downstream capabilities to support the sector, as demonstrated by different types of operations that we have been doing.”

In 2009, the AfDB launched the Trade Finance Initiative, which became a fully-fledged trade finance program in 2013. This program has supported numerous projects across African countries, facilitating approximately $8.7 billion in trade flows. 

However, despite these efforts, a persistent trade financing gap of $80 billion exists.

Smaller businesses are particularly affected by this trade finance gap, primarily due to information asymmetry and the lack of credit infrastructure. 

To address this, the AfDB and partners, such as the Islamic Development Bank (IsDB) through the International Islamic Trade Finance Corporation (ITFC) and Afreximbank, have been developing innovative solutions like factoring, which is an alternative trade finance instrument that can serve underserved client groups.

While development banks are actively working to support trade flows and build resilience, there are still challenges to overcome. The development of innovative digital platforms may have a role in addressing these issues.

Digital platforms, marketplaces, and trade finance

Digital innovations are driving significant changes in the world of trade, particularly in the realm of receivables finance. 

Mr. Mulroy said, “It’s been an incredible journey in my 25 years in factoring. We’ve gone from an organisation where nearly everything was done manually to now everything is automated. We’re seeing now what I call evolution 2.0.”

One key trend is the development of receivables exchanges. These exchanges create a marketplace where sellers can offer their receivables, and buyers – which include banks, hedge funds, and other capital providers – can bid on them. 

These platforms reduce the risk of fraud and dilution events associated with manual processes. One notable example is TReDS – the ‘Trade Receivables Discounting System’ – in India, which has grown to nearly $10 billion, focusing on domestic receivables and targeting SMEs. 

E-invoicing is another pivotal innovation that simplifies trade by digitising invoices, significantly reducing paperwork and bureaucracy. Chile serves as an example, where 99% of the economy now relies on e-invoices, resulting in profound changes in the factoring industry. Other countries are following suit, and this trend is poised to expand globally.

Artificial intelligence (AI) is playing a crucial role in fraud prevention. Unlike traditional methods that analyse past events, AI assesses the potential for fraudulent activities in the future. This forward-looking approach is a game-changer, although it is still in its early stages.

One significant development is the Afreximbank Trade Link, a supply chain marketplace pilot in Nigeria that stimulates growth in receivables finance. The Pan African Payment and Settlement System (PAPSS)  is another example of a potential solution that enables trade in local currencies, reducing foreign exchange costs.

These digital innovations are revolutionising the trade and receivables finance landscape, offering efficiency, transparency, and security. Afreximbank is at the forefront of many of these innovations, driving their adoption to empower African trade and commerce. 

The future of trade is becoming increasingly digital, and these innovations are set to shape it for years to come.