What is commingling risk?
This is a risk for an investor who finances a portfolio of trade receivables. Commingling risk is a catch-all term for the risk that the buyer pays but the investor does not receive the money. The cash that the buyer paid gets lost or absorbed in transit. It is a big issue in the financing of trade receivables.
- The buyer pays the supplier and the supplier does not hand over the money.
- Cash is paid as required into the right bank account but there is a failure to identify the payment and it cannot be allocated to the trade receivable.
- Cash is paid as required but it is commingled (meaning combined with) other cash balances on a bank account and then some other creditor steps in and takes the cash for himself.
The main risk in most receivable financing is this last risk. It arises when the arranger or originator of the financing goes bust having many creditors. In the ensuing fight over the assets of the insolvent arranger or originator, other creditors manage to take the cash.
Is it a big risk?
For trade receivables, we can say that “50% of the risk in a trade receivable financing is the risk that the buyer does not pay … and 50% of the risk is that the buyer does pay but the payment does not reach the investor”.
It is a big risk for two reasons:
- Trade receivables turn into cash quickly. So there can be big cash balances arising quite quickly – and buyers can continue to make payments for some time even after some problem has arisen.
- Whilst investors will take ownership or security over a receivable, once the receivable is paid the secured asset disappears and is replaced with cash which is in some bank account somewhere. At this point, unless something is done, the investor is unsecured. The receivable asset has gone – replaced by a cash asset. But where is the cash and what attachment does the investor have to it?
This is commingling risk.
How can we mitigate commingling risk?
Commingling risk can be mitigated by:
- Asking buyers to pay towards the investor and not towards the original supplier.
- Sending an assignment notice to the buyer stating that the receivable belongs to the investor. This means that buyer cannot meet his obligation by paying the supplier any more.
- Setting up bank accounts that are under the control of the investor and directing buyers to pay those accounts.
Is this really necessary?
Yes it is – otherwise the risk that investors take when they finance becomes diluted by the credit risk of all the parties involved in the trade which can become material points of failure in the structure:
- the supplier
- the servicer of the portfolio who manages the receivables and collects the cash
- even the bank that provides the bank accounts
What does PrimaDollar do about commingling risk?
PrimaDollar has a diversified portfolio of trade receivables supported by structures and procedures to mitigate these risks. In particular, we have a segregated collection account structure which provides a full mitigation of the commingling risks that are described in this note. Our collection account technology is not public domain, but provides our investors and lenders with superior protections against losses from commingling risks compared to regular structures. We generate securities that investors can rely upon.
How can I find out more?
With a global network and global coverage, talk to us.