What is a trade receivable?
Trade generally involves the creation of trade receivables. These arise where the exporter ships, but the buyer pays later – a “ship now, pay later” trade. The obligation of the buyer to pay later is a receivable – a “trade receivable” – which is really a fancy name for an outstanding invoice.
Trade receivables are usually short dated, with typical credit periods of 30, 60, 90, 120 days.
Why is there interest in trade receivables?
Trade receivables are receiving a lot of attention.
- Many banks are reducing the volume of trade finance they provide for regulatory, compliance and political reasons.
- Fintechs are targeting this market. An alternative asset class is increasingly being promoted to investors.
- Many players in the trade ecosystem are looking to add finance to their core activity (freight, shipping, marketplaces, technology platforms).
What risks should investors think about?
Here are the main risks involved in financing trade receivables:
- Credit risk: This can be both buyer side and supplier side. On the buyer side, it is the risk that the buyer does not or will not pay the sum due. On the supplier side, it is if the supplier cannot make up a shortfall in payment from the buyer due to claim arising from a failure to perform (performance risk – see below).
- Commingling risk: This is the risk that the buyer does pay, but the cash does not reach the investor (it gets lost in transit).
- Performance risk: The risk that the buyer raises a dispute and so dilutes (reduces) his obligation to pay and so rightfully pays less than expected.
- Fraud risk: The risk that the receivable does not actually exist or is not as represented.
How big are these risks?
The extent of these risks will depend upon the way in which the trade receivables are being generated and the parties who are involved. The rest of this guide focusses on some of the major questions.
Buyer credit: weak or strong?
- Buyers that are large and prime quality credits tend to have well-established supply chains and professional teams involved in sourcing and making payments consistently and without issue. The credit risk is low – but then also the other risks tend to be much lower as well.
- Weaker buyers can take shortcuts and they may simply have less experience with their supply chains which can be under strong price pressure. They may also dispute or delay payments. As a result, performance and credit risks can be disproportionately higher than at first glance.
Confidential versus disclosed?
- If the buyer does not know that the receivable is being financed, he may legitimately pay the supplier. There is double jeopardy as there is both buyer and supplier credit risk.
- Confidential trades also bring with them significantly higher fraud risk. If the buyer is not confirming the order, then there is only the supplier’s word that the trade is real.
- If the buyer is not sent an assignment notice, the buyer may also legally reduce his payment if the supplier owes him money elsewhere, a process called set off.
Frequency of shipment / history of the supply chain
- Supply chains with infrequent shipments tend to have higher performance risks
- Supply chains with little history, or first time shipments, tend to have higher performance and fraud risks
- 50% of the risk in a trade receivable is the risk that the buyer does not pay; 50% is the risk js that the buyer does pay but the payment does not reach the investor. This is called commingling risk and it is usually mitigated by using controlled bank accounts and by notifying buyers.
- If all the receivables come from only one supplier or a small number of suppliers, then one failure can have a big effect on a portfolio. A supplier insolvency can lead to an increase in disputes and delayed payments.
How does PrimaDollar manage risks?
PrimaDollar has a diversified portfolio of trade receivables supported by structures and procedures to mitigate these risks. We generate securities that investors can rely upon. See here our discussion on the risks in trade finance: here.
How can I find out more?
With a global network and global coverage, talk to us.