Pawel Turek, counsel at DLA Piper, outlines how trade receivables securitisation is an innovative form of alternative financing compared to factoring

In most cases when economic entities need financing, they use traditional methods of obtaining funds. They take out loans, borrowings or issue bonds. But companies that issue invoices and have a very large number of contractors can also consider factoring.

Factoring allows for the sale of receivables before the maturity date and in exchange for an agreed discount to immediately obtain funds without waiting for the invoices to be paid on time. There are, of course, different types of factoring, including full, non-full, advance and so on. However, regardless of its form, it may not always be able to meet all the expectations of the company.

If the company operates in a market with a very dynamic upward trend or is rapidly increasing its portfolio level, it may need a relatively high level of financing. In such a situation, economic entities may consider choosing securitisation of trade receivables (trade receivables securitisation (TRS)) - especially in these demanding times, where diversification of financing sources seems to be necessary.

TRS is a well-recognised method of financing - particularly in the US and Western Europe, but increasingly developing in other parts of Europe - that allows companies to develop much faster than other traditional forms of financing, due to the fact that the analysis of the subject of financing and addressing the risks associated with it are approached in a completely different way. To better understand its mechanism, it is worth comparing it to factoring, whose subject is also trade receivables. Securitisation does not replace factoring, but it provides different possibilities.

The securitisation scheme
In the most simplified securitisation model, three entities are involved in the transaction. The company that sells the receivables (the originator), the SPV that acquires these receivables and issues bonds to raise funds to purchase them, and the investor who purchases these securities.

Compared to factoring, a purpose-made company is involved in the scheme. This is necessary due to the segregation of receivables from the originator. In this situation, the financing entity has the comfort that in a negative scenario – for example, the originator’s bankruptcy - the bankruptcy estate will not include the securitised receivables.

Five differences between securitisation and factoring
First and foremost, the main difference between securitisation and factoring is that through securitisation, illiquid assets (receivables) are converted into liquid assets (securities). Such securities can be purchased by banks, but also by private or public investors. Consequently, the seller has access to capital markets, along with all the benefits associated with it.

Second, in securitisation analysis, the quality and granularity (concentration) of the portfolio is more important than the seller itself. Disclosure to investors can be based on aggregate and average portfolio data; no disclosure of receivables on individual debtors is required, providing the debtor does not exceed a concentration ratio of usually 2%.

Credit risk for the investor is mitigated by applying a discount based on a multiple of actual losses. This multiple is called overcollateralisation. So, on a portfolio of €50m with a 5% loss rate, a multiple of 2x would create an overcollateralisation of 10% or €5m: on the collateral of €50m, €45m is advanced and €5m is overcollateralisation.

Third, in securitisation, for financial institutions, indicators related to portfolio quality are more important than financial indicators directly related to the seller, such as debt/EBITDA. As a result, securitisation may also be available to smaller entities if the analysis of the portfolio and its prospects is positively evaluated.

Fourth, as a rule, securitisation does not interfere with the status of the seller and it does not impose obligations prohibiting further borrowing or prohibiting the sale of assets, other than those that are the subject of securitisation (unless the documentation of other borrowing facilities prohibits the sale or assignment of trade receivables).

Finally, securitisation is a form of financing that is more flexible and adaptable to the specific needs of the portfolio than factoring. For instance, the amount of financing derives from the quality, historical data and prospects of the portfolio, rather than the data of the originator itself, and therefore it may be much larger and more favourable financing than if it were granted in the form of factoring directly to the originator, as long as the collections on the receivables can be effectively separated from the originator’s estate.

What receivables?
It is standard that the parties to the transaction agree on the eligibility criteria for receivables that are to be the subject of the sale in the sales agreement. These criteria determine the receivables that will be the subject of the sale at the time of the transaction and which will be able to be sold later during the transaction, where the SPV will be obliged to purchase them – providing they comply with the financing limit agreed by the parties and other eligibility criteria, like concentration ratios, are met.

Receivables should be generated in the entity’s normal course of business, as a result of the sale of goods or services by the entity. Receivables must be saleable and confirmed by invoices.

There are no strict requirements for payment terms, but in most cases the term should be in line with normal business practices in the jurisdiction. The portfolio should not comprise overdue receivables.

Receivables should not be disputed, but they may be subject to dilution, such as being associated with discounts. Depending on how the risk of diluting the invoice amount has been assessed, investors may expect the creation of a special reserve addressing this risk.

For which entities?
Securitisation of trade receivables is aimed at any entity generating trade receivables. Examples of transactions carried out in recent years include securitisation of receivables of telecom providers, as well as shipping, logistics, chemical, metal and fuel industry companies.

In summary, on the one hand, securitisation is a more complex transaction than factoring and requires significantly more operational effort from the seller. It also requires more engagement and the dedication of more human resources and time. However, on the other hand, it offers opportunities for development that are not possible using traditional financing methods.