An introduction to factoring and factors chain international

SINHVIENNGANHANG.COM

An Introduction to
Factoring and
Factors Chain
International

Copyright © Factors Chain International, Amsterdam


SINHVIENNGANHANG.COM

Acknowledgements
This manual has been created by members of the FCI Education Committee. In that process
the Committee used the available FCI documentation and information supplied by members
of FCI.
FCI would like to express their gratitude to all individuals involved in its preparation, writing
and editing.

Notice of Copyright ©
This document is made available to the members of Factors Chain International (FCI) for
their reference and evaluation.
The Dispute Prevention and Handling Manual is a major asset of FCI containing valuable
information. FCI has exclusive ownership and rights to it.
This document or its contents must not be used, disclosed or otherwise made available to any
party outside the members of FCI without the prior written consent of FCI.
FCI reserves all rights to proceed legally against any one member in breach of the contents of
this notice.
Originally issued: October 2001
Latest Revision: July 20062003

SINHVIENNGANHANG.COM

Table of Contents

Chapter One .............................................................................. 1
An Overview of Factoring .................................................................... 1
What Is This Chapter About? ............................................................................. 1
A Brief Historical Background ............................................................................ 2
Definition of Factoring ........................................................................................ 4
Assignment of Accounts Receivable .................................................................. 5
United Nations Commission on International Trade Law (“UNCITRAL”)............ 7
The Four Main Functions of Factoring ............................................................... 8
Cost Components of Factoring ........................................................................ 12
Some Varieties of Factoring............................................................................. 13
An Overview of Credit Insurance ..................................................................... 16
Comparison of Export Credit Insurance and FCI Export Factoring .................. 19

Chapter Two .............................................................................. 1
Factors Chain International .................................................................1
What is this chapter about? ............................................................................... 1
A Brief Historical Background to the Formation of FCI ...................................... 2
The Constitution of FCI ...................................................................................... 4
The FCI Private Forum ...................................................................................... 9
Summary ......................................................................................................... 13


Chapter One – An Overview of Factoring

July

20062004

Chapter One
An Overview of Factoring

What Is This Chapter About?
The purpose of this chapter is to give you a general understanding of
factoring.
Historical background

We shall look briefly at the historical background of factoring and see
how it has developed into the range of services which factors can offer
today.

Definition of factoring

We shall then define factoring and analyse that definition in more
detail.

Assignment

We define assignment and consider its importance in the context of
factoring.

UNCITRAL

A United Nations Commission was set up to draft a convention for the
regulation of assignments in international trade. We study briefly its
conclusions.

The various
components of
factoring

You will learn about the various components, which are used to build
the basic factoring product.

The pricing of
factoring

We shall examine the pricing structure and look at some of the
considerations, which will affect the price that we charge our sellers.

Product development

We shall see how we can use different combinations of the factoring
components to create products, which may better suit the needs of our
sellers.

Credit insurance

Finally we shall take a look at credit insurance which can be a
competitor and a friend of factoring. We end this section with a
comparison of credit insurance and international factoring.

Page 1 - 1


Chapter One – An Overview of Factoring

July
20062004

A Brief Historical Background
The origins

The concept of factoring is not new. Its origins have been traced back
to ancient Rome where rich manufacturers and merchants used a
mercantile agent or factor to administer the sales of their merchandise.
Records show that the use of these factor agents grew throughout the
Middle Ages.
During the period of colonisation by European countries from the
sixteenth century onwards exporters of consumer goods from the
mother countries sought the help of these mercantile agents or factors to
promote their trade.
This was especially important in the United States. Their rapidly
expanding population in the 19th century added significantly to the
demand for European merchandise, particularly textiles, which were
used in making clothes, bedding and furnishings. In those times
without air transport, telephones and faxes the exporters knew little
about the market and the customers. They also needed to maintain
stocks in the country to provide prompt delivery.
The services of these factors usually included the following :


taking physical possession of the goods on consignment;



storing them;



finding buyers and delivering the goods to them;



collecting payment from the buyers;

The factor’s remuneration for these services was a commission on the
value of the goods sold and was deducted from the payments made to
the principal.
Many factors flourished and in time were able to help the exporters
with finance by making loans against the goods sent to them on
consignment. The security for these loans was the factor’s longstanding right to reimburse himself from the sale of the goods. This
right was later ratified by statute in several states by the adoption of the
Factors’ Acts, which gave the factor a right of lien on his principal’s
goods. This right entitled the factor to hold on to goods in his
possession until the loan was repaid.
The development of
modern factoring
- in the United States

In the latter part of the 19th century the role of the American factor
changed radically. The improvement in communication and transport
systems meant that an exporter no longer needed to send goods on
consignment. The products could be sold by a local sales agent using
Page 1 - 2

Chapter One – An Overview of Factoring

July
20062004

samples and dispatched direct to the buyer.
The exporters, therefore, no longer needed the factor’s warehousing,
marketing and distribution services but many wanted to retain the
factor’s financial services.
The legal basis of these financial services had been the sale of the
actual goods by the factor and his right to recover his financing from
the proceeds. In the changed situation this could no longer happen and
the factor had to rely on the exporter’s assignment to him of the
accounts receivable arising from the direct sales of the goods to the
buyers.
The basis of the factoring of accounts receivable was created by the
factors’ recognition of the changing needs of their clients.
- and in Europe

The method of raising money by assigning accounts receivable had
been used in European countries for centuries. The assignments were
evidenced simply by copies of the relevant invoices and were not
notified to the buyers. This practice grew significantly in the 1950’s
particularly in London. It was attractive to companies in need of
additional finance because of its simplicity of operation and
confidentiality. The discounters wrongly believed that they had the
same protection as discounters of bills of exchange.
Many invoice discounters, however, suffered severe financial losses
when some of their important sellers became insolvent. They then
discovered deductions from the receivables by the buyers for

counterclaims or set-offs from which they had no protection and of
which they had had no prior warning.
This experience together with the introduction of the American
“model” in the early 1960’s encouraged the method of taking over the
A/R on a whole turnover basis. It was sometimes with and sometimes
without recourse to the seller but always with notification to the buyers.
The financier also managed the collection of payments from the buyers.
In other words it was factoring in the modern sense of the word.

- and in Asia-Pacific

In South East and East Asia the main instrument of ensuring payment
and raising finance from trading, at least up to the beginning of the
1980’s, was the Letter of Credit. But as in the American development,
the modern revolution in communication and travel methods has
created situations where the Letter of Credit is no longer appropriate.
The increasing demands of competition have also meant that the buyers
are not so willing to commit their funds before they are able to inspect
and use the products ordered. This is particularly true when Asian
Pacific exporters are trying to increase their trade with European and
American buyers. Thus the early impetus in the development of
factoring in this region was in cross border factoring but the FCI
Page 1 - 3


Chapter One – An Overview of Factoring

July
20062004

statistics of World Factoring Volumes show that domestic factoring is
also growing rapidly.
- and in the rest of the
world

StartingThe development of factoring began in South Africa in the early
1970’s, factoring has developed in many other countries particularly in
the last ten years. Factoring companies or factoring departments of
banks can be found now in most parts of the world and almost all of
these are members of FCI.. Other than in Morocco where it started in
the 1990’s it has yet to be used in other African countries. The 1990’s
also saw the development of factoring in several countries in Latin
America and its introduction in two countries, Israel and Oman, in the
Middle East

Definition of Factoring
To find one definition that will cover the various forms of factoring
arrangements that occur in one country is a difficult task. To find one
which will apply internationally is almost impossible. Each country has
its own particular language, customs, financial and business needs and
law. Each factoring company has different names for certain types of
factoring and often different types of factoring under the same name.
UNIDROIT

The definition used by
the UNIDROIT
convention

At a diplomatic conference in Ottawa in May 1988 the International
Institute for the Unification of Private Law in Rome (commonly known

as UNIDROIT) presented ".....uniform rules to provide a legal
framework that will facilitate international factoring....". The full text
of their definition contained in Article 1.2 and 1.3 is as follows (see
also Legal circular 0.5 in the Legal Manual):“1.2.

For the purposes of this Convention, ”factoring contract” means
a contract concluded between one party (the supplier) and
another party (the factor) pursuant to which:

(a) the supplier may or will assign to the factor receivables arising
from contracts of sale of goods made between the supplier and
its customers (debtors) other than those for the sale of goods
bought for their personal, family or household use:
(b) the factor is to perform at least two of the following functions:





finance for the seller, including loans and advance
payments;
maintenance of accounts (ledger keeping) relating to the
A/R;
collection of receivables;
protection against default in payment by the buyers;

(c) notice of the assignment of the receivables is to be given in
Page 1 - 4

Chapter One – An Overview of Factoring

July
20062004

writing to the debtors.
1.3.

Different terminology

In this Convention references to “goods" and "sale of goods"
shall include services and the supply of services.”

Note that the Convention talks about “suppliers”, “debtors” and
“receivables”, whereas FCI has standardised on the words “sellers”,
“buyers” and “accounts receivable”.
The Convention refers to the “assignment” of the accounts receivable
and we should spend a little time studying this concept before looking
in detail at the four functions mentioned in the Convention.

Assignment of Accounts Receivable
What Is an
assignment?

An assignment is an agreement by a creditor (or assignor) to transfer his
rights to an A/R to a third party (the assignee - in our case, a factor) and
the assignee’s agreement to accept those rights without necessarily the
consent of the buyer. (Per F R Salinger in Factoring Law and
Practice).
This means in factoring that the agreement is the Factoring Agreement

(or Contract) and the seller agrees to sell his rights to the A/R to the
factor. The purchase price is the value of the A/R transferred less the
factor’s charges and any deductions (such as, cash settlement discounts)
made by the buyer. The factor becomes the owner of the A/R. Usually,
but not always, the buyers are notified of this transfer of ownership.
(See below)
The procedures for perfecting an assignment, so that it will be fully
enforceable at law against all parties, vary greatly from country to
country.
As this is such a fundamental issue in factoring, you should research
the requirements of your country’s legal system.

Why have an
assignment?

Factoring in its simplest form is the financing of the seller without
providing any other service and is in effect no different from lending
money against the security of the A/R. As such, no ownership of the
A/R is really necessary. Indeed in some countries even when he is
providing other factoring services, a factor does not obtain ownership
of the A/R or at least not at the beginning. The reason for this is
usually to avoid some complex legal procedure or the payment of some
form of tax. An assignment of an A/R will be taken in these situations
only when the factor needs to enforce his rights to the A/R by taking
legal action.

Page 1 - 5


Chapter One – An Overview of Factoring

July
20062004

In most cases, however, the factor does take an assignment of each A/R
at the moment that it is created. This procedure is administratively
cheaper and more practical and the factor can more easily and quickly
enforce his rights to collect payment from the buyer, using, if
necessary, legal proceedings to do so.
Notifying the buyer of
the assignment

One common requirement in domestic and international factoring is
that the buyer is informed or (to use the technical term) notified by the
seller that all present or future A/R will be assigned to the factor.
This notification of the assignment is important for two main reasons:1. To prevent the buyer from making payment to the seller and
obtaining a valid discharge. Upon receipt of the notice of assignment
the buyer must treat the factor as his creditor as far as the assigned
A/R is concerned. If the buyer ignores the notice and pays the seller,
the factor may legally compel the buyer to pay a second time. You
should be aware that commercially this might not be so simple. If an
important buyer is involved, this experience may cause him to put
pressure on his other suppliers not to factor their A/R;
2. To stop the buyer from using any claims or defences which he may
have from other contracts. An example of this is where the buyer is
owed money for goods that he has supplied to the seller and wishes
to offset his debt against the one owed by the seller. This would
clearly reduce the value of the factor’s security.
The procedure for giving notice normally consists of two steps:

Introductory letter

This is sent to all the buyers at the start of the factoring agreement by
the factor but in the name of the seller. It will advise buyers that all
their accounts payable arising from their purchases from the seller have
been and will be assigned to the factor until further notice. This subject
is examined in more detail in Chapter 5 of the Communication Manual
together with an example of the text of a letter.
You should make yourself familiar with the text of your company’s
introductory letter.

Notice of assignment
on the invoice

This is usually printed on the invoice by the computer at the time of
raising the invoice. Labels printed with the text of the notice of
assignment (sometimes known as “stickers”) can be used but care must
be taken to avoid omitting them by mistake.
In some countries the notice of assignment is a legal requirement and
without it the assignment is not valid in respect of the buyer. In all
countries it is a necessary administrative procedure to assist in the
collection of the A/R. See also Chapter 6 of the Communication
Manual for an example of a notice of assignment.

Page 1 - 6


Chapter One – An Overview of Factoring

July

20062004

It is important to note that the notice of assignment to the buyers under
Article 1.2 (c) of the UNIDROIT Convention is not optional and
therefore, the convention is not applicable to any type of nonnotification international factoring.

United Nations Commission on International
Trade Law (“UNCITRAL”)
The role of UNCITRAL

You can see from the previous section that the legally enforceable
assignment of an A/R is a key issue in factoring. In domestic factoring
as long as the factor understands and follows the requirements of his
own country’s legal system, there should not be a problem. The
assignor (the seller), the assignee (the factor) and the buyer are all
subject to that system
In international factoring this is, of course, not the case. Throughout
the world there are a number of different legal systems and the
requirements for a valid assignment may differ to the extent that it may
be unenforceable against the buyer or challenged by the assignor’s
(seller’s) creditors.
In 1995 UNCITRAL set up a working group whose task it was to
produce a convention with rules to regulate the assignment of A/R in
international trade. The principal aim of the convention is to increase
the availability of credit and reduce its cost. This can be achieved only
if it can reduce the risks and administrative problems for those such as
factors who provide that credit.
Naturally this is an important issue for the members of FCI and since
1997 FCI has been represented by a very experienced observer who is
able to speak for the interests of the factoring industry as a whole.

Draft Convention

In 1999 the draft convention was produced and the following is a
summary of the most important rules that relate to factoring:


The effectiveness of bulk assignments and the assignment of future
A/R



The effectiveness of an assignment in spite of a prohibition against
it in the contract between seller and buyer. This may be subject to
an exclusion for government contracts.



Notification to the buyer.



Discharge of the buyer by payment (before and after notification of
the assignment and after multiple assignments).



The buyer’s defences and rights as regard set-off and changes to the
Page 1 - 7

Chapter One – An Overview of Factoring

July
20062004

original contract.


The priority of the assignee (1) against another assignee and (2)
against the assignor’s creditors and in the insolvency of the
assignor.

The draft also includes provisions by which a subsequent assignment
(as, for example, from EF to IF) is treated in the same way as the
original assignment (from seller to EF). The only difference is that the
notice of assignment to the subsequent assignee (the IF) will be deemed
to include notice of the original assignment.
Relationship with the
UNIDROIT
Convention

The UNIDROIT convention on factoring suffers from two major
disadvantages:
1. It applies only to factoring and not to invoice discounting (non
notification factoring);
2. It does not deal with the priorities among competing assignees and
the validity of an assignment in the insolvency of the seller.
The other rules in the draft convention as they affect factors are likely
to be similar to those in UNIDROIT and so FCI members will benefit if

the UNCITRAL convention overtakes UNIDROIT.

When will the
Convention become
operative?

The short answer to this question is when each nation state has ratified
the convention. Before that, however, the Working Party’s draft has to
be confirmed by the Commission and accepted by the General
Assembly of the United Nations. Then the ratification process state by
state can start and that will not happen quickly!

The Four Main Functions of Factoring
As we have seen from the definition of factoring in the UNIDROIT
Convention there are four main functions or services provided by
factoring.
Finance

One of the key elements in the need for additional working capital is
the growth in the A/R. In the factoring contract the factor agrees to pay
the seller a substantial proportion (commonly 80%) of the value of the
qualifying* A/R as soon as they come into existence. The seller will
receive the balance when the factor has collected from the buyer.
The seller no longer has to wait until the end of the credit period (and
often much longer) to receive his money. A substantial part of his A/R
becomes active working capital which, if he uses it properly, will
contribute significantly to the growth in the seller’s company.

Page 1 - 8

Chapter One – An Overview of Factoring

July
20062004

 What is meant by “qualifying A/R” will depend on the type of
factoring used: for full service factoring it will be the credit covered
A/R and for recourse factoring it will be the A/R that meet certain
control criteria.

Page 1 - 9


Chapter One – An Overview of Factoring

Advantages

July
20062004

The main advantages of factoring finance may be summarised as
follows:


Injection of working capital to finance expansion



More finance available than from conventional bank borrowing: it is

geared specifically to the A/R and therefore to the growth in the
seller’s sales.
 more turnover = more A/R = more finance



Suppliers can be paid promptly and so the seller can doubly benefit
from reducing costs by taking advantage of prompt payment
discounts and improving his credit standing with suppliers.



No loss of equity - the seller should not need to seek additional
capital from outside shareholders and thereby lose some control of
the company.



No formal funding limit - the funding automatically keeps pace with
growth.

A/R Ledger
Administration

The factor takes the seller’s buyer accounts onto his books and updates
these accounts with all transactions - invoices, credit notes, payments
etc. Where appropriate, the factor sends statements to the buyers
showing what should be paid to the factor and how this amount is made
up. The seller receives regular report on the status of the ledger and so
is able to keep fully informed about the performance of his buyers.

Advantages



Savings in personnel costs: this is most applicable to those companies
which are growing strongly. The increased volumes would mean
more staff and the factoring services can help to keep this to a
minimum.



Reduction in administrative overheads such as postage, telephone, fax
stationery etc.



Savings in management time.

Collection of
the A/R

One of the problems with the open account payment is that there is no
automatic means of initiating payment from a buyer as one would find
with an accepted Bill of Exchange, for example. The factor’s
administration system, therefore, is designed to prompt the buyers for
payment systematically by letter and to give the collection staff the
necessary information to seek payment from the buyer by telephone
when necessary.
In cases of serious delay legal action will have to be taken. If the A/R

is credit covered, the cost of this legal action will usually be borne by
the factor. However this is not always the case and you should study
Page 1 - 10


Chapter One – An Overview of Factoring

July
20062004

the Legal Manual for a more detailed explanation of the criteria which
determine who must pay the legal costs.
Advantages

Credit Cover



The seller will be able to focus on the key tasks of production and
sales rather than spending time on getting paid for what has happened.



The seller will be able to "hide" behind the factor when problems over
payment arise. It is often difficult to be both debt collector and
salesman.



Better collection management means faster payments which in turn

means lower financing costs.



The seller can use the factor’s high quality collection staff. It is
unlikely that he has employees of a similar standard in his own
company.

If the buyer defaults in his payment, the factor will pay the seller
normally 100% of the credit covered A/R when:


the buyer is insolvent (as defined in the contract); or



the A/R is (are) 90 days past the due date on the invoice. This
period may vary in a domestic contract - some factors do not have a
guarantee period in their contracts but simply pay if and when the
buyer becomes insolvent, as defined in the factoring contract.

You must check in your company’s contract for the precise definition of
“insolvent”.
Non-recourse

This arrangement is often referred to as “without recourse” or “nonrecourse” - in other words, the factor cannot seek payment from the
seller if the buyer is unable to pay but must suffer the loss himself. The
opposite of this is, of course, “with recourse” where no credit cover is
provided and the seller must bear any bad debt losses himself.

Credit covered A/R

A credit covered A/R is one which falls within the current line cover
agreed by the factor for that buyer and which is not subject to dispute.
The granting of a line cover does not restrict the seller from trading
above that line but the excess will be at his risk.
Not all buyers may be credit covered for 100% of the A/R. As soon as
the seller starts to negotiate with a prospective buyer, he should apply
for a line cover. The credit department will then carry out their
assessment of the buyer risk. Their decision may be to grant the line
requested in full or in the light of the information received to approve a
lesser amount or even to refuse cover altogether.

Advantages



Certainty of payment at least 90 days past due date for undisputed and
credit covered A/R.



Elimination of losses through bad debts.

Page 1 - 11


Chapter One – An Overview of Factoring


July
20062004

Expert evaluation of buyer credit standing.

Cost Components of Factoring
Having studied the four functions described above, you will realise that
factoring can be divided into two elements: financing and service (sales
ledger administration, collection, credit cover and credit assessment).
When we consider the pricing of factoring it is convenient to break it
down into these two elements.
Finance
Charge

This is also known as “interest charge”. This charge is normally
calculated on a day-to-day basis at a rate per cent per annum on the
amount of finance provided. The actual rate will be a margin over the
cost of funds to the factor. The cost of the funds at any given time will
depend on the political/economic situation in the country. The margin
is a matter decided by the factor’s business policy.

Factoring
Commission

This covers the service element and is generally charged as a flat rate
per cent of the total gross factored turnover (that is, disregarding credit
notes). Some factors charge a flat rate plus a fixed amount per
invoice/credit note, for example: 0.85% plus EUR 10 per invoice/credit
note. This is more common in international factoring when the import
factor cannot be certain of the workload.

Some factors will include a minimum charge or even a fixed amount
per month to guard against the possibility that the factored turnover is
less than an acceptable minimum.

Costing systems

There are a number of costing systems in use for calculating the exact
price of the factoring commission and generally these will take into
account the following:


Workload - the number of invoices, credit notes and buyers



Volume (sales turnover) - generally the greater the volume, the
more attractive the business and the lower the percentage rate. But
if there are many buyers and many small value invoices, this could
make the price too high and the business unattractive both to factor
and seller. Conversely the volume must be adequate. Most factors
set a minimum volume below which it would be unprofitable to do
business.



Buyer Credit Risk - the credit department will assess the portfolio
of buyers and set a price (a percentage of turnover) which will cover
the expected credit losses plus a margin for administration costs.
This assessment is based on the industry sector, the strength of the
buyers and their spread. If the factor uses credit insurance (see

Page 1 - 12


Chapter One – An Overview of Factoring

July
20062004

below) then the premium charged for this cover will be built into
the commission.


Profit Margin - the need for this should be self-evident!

Some Varieties of Factoring
The following are the more common varieties of factoring in use at this
time. You will find more varieties of international factoring covered in
detail in Chapter 12 of the Communication Manual.
Full Service

What you have been studying so far in the course is what is known as
“Full Service” factoring or as it is sometimes called "standard" or
"old-line" factoring. As the title suggests, it is made up of all the
factoring services - finance, sales ledger administration, collection,
credit risk cover - and the arrangement is fully notified to the buyers.
The factor takes over the A/R ledger of a seller and the seller in effect
has only one debtor - the factor. Although in principle this is a nonrecourse service, in practice, certain A/R will be " with recourse" to the
seller. The factor only carries the credit risk for approved accounts that
are not disputed. Depending on the agreement with the seller the factor
keeps any non credit covered and disputed A/R on his books on a

"collection only" basis or if collection is not possible, re-assigns such
items to the seller.
From the factor’s point of view the full factoring service is demanding
in terms of the administrative resources and know-how that it requires
but it does give him good control over risk.

Who can benefit?

This comprehensive form of factoring is best suited to small to medium
sized companies which are growing quickly and which need not only
additional finance but also the administrative support and protection. It
is also particularly appropriate for larger companies moving into new
export markets.

International
Factoring

This is usually based on the full service model. We shall be
concentrating our studies on this service as practised within FCI later in
the course.

Recourse
Factoring

In essence this type is the same as full service without the credit risk
cover. A number of factors do not offer full service factoring at all and
recourse factoring is the main part of their business. Despite this, in
certain countries recourse factoring is regarded as the lending of money
against the security of A/R (Account Receivable financing) – though in
other countries it is still treated as the purchase of the A/R

Page 1 - 13


Chapter One – An Overview of Factoring

July
20062004

notwithstanding the recourse element.
It is important to remember that credit assessment of the buyers is still
carried out by the factor even though he is not taking the buyer credit
risk. “Credit limits" on buyers in recourse factoring are concerned with
the level of advance payments that can be made to the seller. Such
levels will primarily be based on the total value of the A/R’s at any one
time. It may be, however, that the A/R on a particular buyer exceed
what the factor considers to be a prudent level of credit - the “credit
limit”. In that case the maximum value of the A/R for that buyer which
the factor includes in his calculation of the advance payments is the
credit limit.
In his contract with the factor the seller in effect "guarantees" that the
buyers will pay and at the request of the factor agrees to re-purchase the
A/R from the factor if a buyer does not make payment in full after an
agreed period beyond the due date.
The difference in cost to a seller between recourse and non-recourse
factoring is usually not great. Pure risk is only a part of the credit
service costing. The administration costs and the profit element will be
present in both types. Certainly the difference will nearly always be
less than the cost of a credit insurance policy.
Maturity

Factoring

This form is sometimes known as collection factoring, though neither
"maturity" nor "collection" fully describes this variety. It can best be
seen as the full service without finance. Because finance is not offered
the security requirements of the factor are quite different. The risk lies
only in the credit cover provided on the underlying buyers. There is no
seller risk. For the same reason there is no finance charge and the
factor takes his remuneration only from the commission fee.
The factor pays the seller for the A/R in one of two ways:
1. After an agreed period from invoice date, for example 60 days. This
is known as the "maturity period". The benefit of this method is that
the seller knows exactly when he will be paid and so can plan his
cash flow accordingly; or
2. On receipt of payment from each buyer or on the insolvency of the
buyer provided that the buyer is credit covered. This is known as the
"pay when paid" method.

Who can benefit?

To benefit from this service the seller will have adequate sources of
finance elsewhere and is looking to the factor to strengthen a weak
administration or maybe reduce overheads and provide protection.

Nonnotification
factoring

This is sometimes referred to as “invoice discounting”, "confidential
factoring" and “undisclosed factoring”. In essence it is purely finance.
The A/R are still assigned to the factor but the buyers are not notified of

the assignment. The seller collects the accounts receivable and pays the
Page 1 - 14


Chapter One – An Overview of Factoring

July
20062004

money either direct into the factor's own bank account or into an
account which is in the seller’s name but is controlled by the factor.
Usually all the A/R are subject to full recourse but some factors will
offer non-recourse to the right type of seller.
Product pricing

Although there is no service provided, it is usual for the factor to charge
a small factoring commission in addition to the finance charge. This
commission is more in the nature of a commitment fee because the
factor is obliged to provide finance on demand based on the total A/R.
It will also cover the advice the factor may give to the seller concerning
credit control and administration and to cover the costs of periodic
visits by the factor to the seller to inspect the sales ledger and his
business in general.

Who can benefit?

For the seller who does not need the service elements of factoring and
is only interested in raising additional working capital non-notification
factoring provides a very flexible way of achieving that. From the
factor’s point of view it is administratively cheap to run but requires

great skill and know-how in the management of risk.

Seller selection

In the first instance selection of the right sort of seller is critical: apart
from satisfying the normal factoring criteria the seller should be
financially sound and have a strong A/R administration. This last point
is particularly important, as the seller will in effect be managing the
factor’s prime security. The factor must then audit the seller at regular
intervals to check that the financial status and administrative standards
are being maintained.

MATRIX OF THE SERVICES PROVIDED BY EACH VARIETY OF FACTORING
A/R Ledger
Administration

Collection

Credit Cover

Finance

Buyer Notified

Full Service

*

*

*

*

*

International

*

*

*

*

*

Recourse

*

*

*

*

Maturity

*

*

Nonnotification

*
*
(in some cases)

Page 1 - 15

*
*


Chapter One – An Overview of Factoring

July
20062004

An Overview of Credit Insurance
Background

Credit insurance in many ways is a similar service to the credit cover
provided by factoring. It can, therefore, be a competitor but it can also
be an ally of factoring. Sellers can take out credit insurance instead of
the credit cover provided by factoring and sign a recourse factoring
contract. They can choose credit insurance plus bank financing and so
refuse factoring. A factoring company can have a credit insurance

policy in order to provide the full non-recourse factoring service rather
than underwriting and taking the risks itself. This last aspect of credit
insurance is covered in the Buyer Risk Control Manual.

What is credit
insurance?

A credit insurance policy (contract) provides protection for the insured
(the seller) against the non-payment of debts due to the insolvency of
insured buyers. Cover is normally extended to include the protracted
default of insured buyers – normally six months after due date of the
invoice.
Insolvency covers a wide range of situations and its definition is
normally the same as we use in our factoring contracts.
A key difference with factoring is that the insurer does not have direct
contact with the buyers or daily access to the state of the A/R ledger.
The insurer, therefore, must rely on what the seller tells him. For this
reason, as we shall see later, the disclosure of all relevant information
by the insured is of paramount importance when it comes to settling
claims.
For exports the policy can be extended to cover:

The cost (premium)



Political or transfer delay.



The buyer’s refusal to accept the goods.



Import/export licences have been cancelled.



Insolvency of the buyer prior to the date of shipment.

The basic premium for the policy is based on a rate percent of the
insured’s sales volume. The premium is normally set for one year and
reflects market pressures and bad debt experience. Premiums also
differ from country to country in export policies.
The insured has to pay an additional premium for the extensions to the
policy listed above. In addition the insured pays a fee for every new or
changed buyer credit limit.

The insured’s
obligations

As we have mentioned earlier, the insured must provide the insurer with
all relevant information. If such information is withheld it could
invalidate a claim or indeed the whole policy. Examples of such
Page 1 - 16


Chapter One – An Overview of Factoring

July

20062004

information are:
1. During the initial negotiations for the policy the bad debt history of
the insured and any payment problems over the past three years.
2. Any previous payment problems with the particular buyer for whom
a credit limit is requested.
3. The insured must report to the insurer any situation where a buyer
payment is 60 days or more overdue.
4. He must be able to demonstrate effective collection procedures;
5. He has stopped shipment of the goods as soon as he becomes aware
of payment problems.
Insurers will review the collection activity when they believe that there
is a potential problem and if necessary, specify what action must be
taken. They may also involve their own networks of collection agents
and lawyers not only to protect their risk but also as a service to the
insured if he should need it.
Claims

Claims can be made either upon formal evidence of insolvency such as
bankruptcy or 6 months after invoice due date.
In processing the claim the insurer will demand confirmation of the
following:


There is a valid debt. To prove this the insured must show that the
buyer exists and ordered the goods, that they were delivered, that
there was no dispute and that the debt was unpaid.



The insured has carried out satisfactory collection procedures.



The insured has notified the insurer of all sales falling within the
scope of the policy.



The insured has paid the premium promptly.



The insured has complied with all the other policy terms.

The extent to which the insurer will scrutinise the insured’s compliance
with these requirements normally depends on the size of the claim or
the number of claims. A large claim or frequent claims can expect to
be met with very careful scrutiny!
You should note that the burden is always on the insured to prove his
case and the whole process can take several months to complete.
Once the insurer has agreed the claim, the insured will receive up to
80% or 90% of the bad debt provided that it all falls within the agreed
buyer credit limit. This may then be subject to a deductible or “first
loss” which is taken off the value of the claim.
Limit of total annual
liability

In addition the policy may contain a condition which will limit the

Page 1 - 17


Chapter One – An Overview of Factoring

July
20062004

insurer’s total liability in any one year to a certain amount. If this
amount has been reached, then the insurer will not pay further claims
that year which would otherwise be valid.
Example

The agreed value of the bad debt is EUR 15,000. The cover provided is
90% subject to a deductible of EUR 1,000. The credit limit is EUR
10,000. The annual limit of liability is EUR 100,000
Credit limit

= EUR 10,000

90%

= EUR 9,000

Less deductible = EUR 1,000
Amount paid

= EUR 8,000

If the insurance company had already paid claims of EUR 96,000 in
respect of that year, then the insured would receive only EUR 4,000 of
the above claim
Catastrophe cover
policy

This type of policy is designed for a seller who is capable of absorbing
a number of bad debts but wishes to protect himself from incurring
losses over an acceptable level in any one year. A large deductible is
agreed at the start and the insurance cover will only come into play
when that deductible has been reached. Of course the higher the
deductible, the lower the premium.

Discretionary credit
limits

In certain cases the insurer will permit the seller to make the credit
assessment and set the credit limit. The maximum size of the limits and
the credit criteria that the seller must meet are clearly set out in the
policy. Failure to comply with these criteria will invalidate the limit
and any claim on the corresponding buyer will not be paid.

Advantages

1. It is a “one service” product and so can be attractive to those sellers
who perceive credit cover as their major or only problem.
2. Credit insurers generally can offer a wide geographical coverage.
3. Usually their response to credit limit requests is fast.
4. The pure cost of the premiums can be lower than the cost of
factoring credit cover.

Disadvantages

1. The risk of non-compliance with the policy conditions. This can be
a considerable burden on the seller’s administration.
2. It is the seller’s responsibility to prove that he has a valid claim.
3. Claims can take weeks and sometimes months to be paid.
4. Cover is restricted to between 80% and 90% of agreed credit limits.

Page 1 - 18


Chapter One – An Overview of Factoring

July
20062004

Comparison of Export Credit Insurance and FCI
Export Factoring
Feature

Credit Insurance

Factoring

Assignment of Accounts Receivable

No

Yes

Often

No

180 days

180 days

No - between 80% &
90%

Yes

Line Cover per Buyer

Yes

Yes

Credit Assessment Fee

Often

No

Deductible

Often

No

Limit of Annual Total Liability

Often

No

Payment under Guarantee

180 days

90 days

Formal claims procedure

Yes

No

Political Risk

Optional

Yes

Insolvency of buyer prior to
shipment

Optional

No

Debt collection service

Optional

Yes

No

Yes

Whole Turnover
Maximum Payment Terms
100% cover of approved receivables

Accounts Receivable financing

STATISTICS OF FCI FACTORING VOLUMES
We recommend that you study these to get an appreciation of the business involved for
different types of factoring product and a comparison of the FCI member volumes with all
factoring companies. You can see these on the FCI Private Forum, File Library Section,
Service Quality. The figures are available from 1993 onwards.

Page 1 - 19


Chapter two – Factors Chain International

July
20062004

Chapter Two
Factors Chain International

What is this chapter about?
Before we study the technical details of international factoring we
should first get to know the organisation that makes it possible, Factors
Chain International or FCI.
Historical background
of FCI

We shall look briefly at the historical background of FCI and learn why
and how it was started.

The constitution of
FCI

We shall then study FCI’s legal constitution, its objectives,
administrative structure and the qualifications for full and associate
membership.

The FCI Private
Forum

Finally we explain what the FCI Private Forum is, where to find it and
describe its various features.

Page 2 - 1

Chapter two – Factors Chain International

July
20062004

A Brief Historical Background to the Formation of
FCI
The first factoring
company in Europe

The first factoring company founded in Europe was International
Factors Ltd. in London in 1961. The founder-shareholders were a
London Merchant Bank, a London Confirming House and, most
important of all, the First National Bank of Boston (FNBB), which was
already running a large and successful factoring operation in the USA.
FNBB decided that the trade between the USA and the United Kingdom
offered a good chance to develop international factoring. Although they
chose local partners, they still had to invest a considerable amount of
management time at the early stages of the company’s development.
Little was known locally about this new financial tool and so FNBB’s
know-how was needed to get the business started.
FNBB also found partners in other Western European countries to start
joint venture companies nearly always with the name: International
Factors. The idea was that these companies would factor the trade
between their countries as well as their own country's trade with the
USA.
There was also another important USA factoring company entering the
European market in the early 1960's: Walter E. Heller & Company of

Chicago. They approached the development in a different way. Their
objective in setting up companies in various countries with local bank
partners was to develop domestic factoring in each country rather than
international business.
The International Factors Group was set up as a closed network: in
other words, their international business would only be conducted with
sister companies in the various countries. This would ensure that a
seller who had exports to several countries could receive, through the
EF, identical paperwork from each IF.

The origins of FCI

By the mid 1960’s there were several factoring companies in most West
European countries and they needed correspondents to handle their
growing volume of international business.
FCI traces its origins to a co-operation agreement in 1964 between two
companies, Shield Factors of London and Svensk Factoring of
Stockholm. Shield Factors became part of Griffin Credit Services (now
HSBC Invoice Finance (UK) Ltd) and Svensk Factoring is now known
as Handelsbanken Finans. Svensk Factoring was already working
closely with companies in other Nordic countries, now known as DnB
Page 2 - 2


Chapter two – Factors Chain International

July
20062004

Factoring A.S. of Norway, NCM Forenede Factors A/S of Denmark and

Nordea Finance Finland Ltd., and so was used to working a “two factor”
system.
It was these fiveThese companies which met in Baden-Baden, Germany
met , to decide how this group of "independent" factors should operate.
At a further meeting in 1968 in Stockholm they decided to form FCI
with a permanent Secretariat in Amsterdam.
The first official Council meeting was held in June 1969 in
Scheveningen, Holland, and 29 member companies attended. The first
constitution was adopted and it stated, among other things, that FCI
would be open to all factoring companies that were able to meet certain
basic criteria except to those which were already members of a "closed
network".
An open chain

The arguments that led to the decision to make FCI an “open chain”
rather than a “closed chain” have remained valid to this day.


With several members in each country an open chain will become
more efficient because competition between each member will
demand that the best levels of service are maintained.



Market forces and competition are considered to be more powerful
instruments than common shareholding when it comes to providing
sellers with the best service.

Nevertheless FCI's members realised that great efforts would be needed
if the open chain were to grow into a closely collaborating network. The

competition stressed that a closed chain with common shareholders
would give a better service and provide uniformity in its reporting.
Existing FCI members were anxious to help new members in other
countries. In so doing, they would be able to offer a better country
coverage to their sellers.
The transfer of know-how from the more experienced to the less
experienced members has been and still is one of the strong forces
binding FCI's open network. Seminars and round table conferences are
organised to assist in this transfer of technical knowledge and
experience. In addition FCI has created a legal framework and standard
operating procedures for international factoring to be used by all its
members.

Page 2 - 3