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81184EQD Riskfactor Fight Fraud Article 900X330 2 3

Navigating Risk in Uncertain Times

21 November 2022

By Christopher Hart, European Business Director, Equiniti Riskfactor

When the history books are written, the entry for 2022 will be an interesting read. The difficult Covid years may be recorded as a prelude to what came after.

Christopher Hart Christopher Hart European Business Director, Equiniti Riskfactor

With a need to repay Covid induced debt, and general inflation returning to levels not seen in the UK since the late 1970s and early 1980s, the outlook for business is tricky at best. Throw into the mix Russia's invasion of Ukraine, the consequences of which are likely to last for decades, and we are potentially at the beginning of a redrawing of the commercial landscape with consequences we can only imagine.

German Chancellor Olaf Scholz has used the word 'Zeitenwende' to describe what he sees as a pivotal moment in the history of Europe and its people. English translations do not capture the weight and importance at the heart of the word Zeitenwende. No one knows where we go from here, but it will undoubtedly be a very different world from the immediate past. The road ahead will be lined with much uncertainty and will present both opportunity and danger.

It has been a difficult time for many, dealing with the health consequences of the pandemic and the impact of lockdown, ranging from reduced income to isolation and mental health issues. Governments worldwide have sought to shield many from the worst effects with handouts of cash, cheap loans and, from a commercial standpoint, measures to protect struggling businesses from creditor action, at least for a period.

Government support schemes and suspension of creditor action greatly helped thousands of companies that would otherwise have been in serious trouble. The State essentially took on the role of working capital funder for businesses, many of which would previously have utilised a receivables financing product.

All that stops this year.

With opportunity comes risk

Businesses need to organise their working capital financing in a way that they have not seen for over two years whilst paying back emergency loans taken out during the pandemic. This environment presents a significant opportunity for funders across the market. However, with more opportunity comes more risk. There will be more risk in the financing system in general, and receivables finance will be no exception. Indeed they may be the first part of the finance sector to see its tangible effects as companies struggle for cash in the short term.

A challenging world

The Russian invasion of Ukraine is also likely to significantly impact trade patterns, terms of payment, and therefore working capital requirements. The effects will be both short and long term. In the short to medium term, businesses will need to abide by an ever-increasing list of sanctions against Russian companies, individuals and their connections. They may lose customers or suppliers or both, which may impact trading just as activity was on the increase.

In the longer term, whole supply chains may need to be reconstructed to avoid contact with sanctioned states and entities, taking up significant management time and focus. And this will not be confined to just a few large organisations. As western democracies pursue reducing energy dependence on Russia, the ripples are likely to spread out across whole economies and last for an extended period.

The threat from a belligerent Russia may seem like a throwback to an era lost in the mists of time. Inflation was rising before the tanks started to roll and was forecast to hit levels not seen in many years. Increasing energy costs, in particular, will affect the whole economy as transport costs rise significantly, again, something we were already beginning to see before the outbreak of war.

Since the global financial crisis struck more than a decade ago, we have lived in a reasonably benign monetary environment with low inflation and extremely low interest rates. People and businesses are just not used to seeing this type of shock. After that crisis, we saw stagnant living standards, with almost no growth in real wages. Many people will be unsure how to react to this new environment. Some of them are going to make bad decisions.

And still lurking in the background, partially hidden by Covid and Ukraine, is Brexit. Further disruption to the UK's trade flow is expected as more comprehensive import checks are finally introduced.

So, Covid, Ukraine, Inflation and Brexit. This year is shaping up to be a challenging year for the economy and will absorb management time and resource.

From a receivables finance standpoint, what does this all mean?

Historically, volatile times and difficult circumstances produce many opportunities, and there is no real reason to think that this time will be any different. Considering all of the factors weighing on the global economy, it is likely that the next few months will see a tightening of credit criteria across the board. Such a course is likely to see secured lending become a growing feature of the funding markets.

Growth and risk

From a corporate perspective, a general increase in working capital requirement at a time of tightening credit criteria is likely to lead to many borrowers either returning to a receivables finance or ABL product or using one for the first time. So, a time of great opportunity beckons for the market.

The counterbalance to more opportunity is, of course, more risk. And more risk will require more resources to react to it and manage it properly. With the removal of government support schemes, increasing the demands on cash and management time there is a real risk that we will see a significant increase in businesses in difficulty and a heightened risk of fraud.

Lenders will need to fully understand their new prospective clients' performance and remain close to their existing clients' trends, ensuring they are proactive in reacting to changes in client behaviour, both positive and negative.

These proactive conversations will help to support the growth and recovery of businesses’ working capital needs.

These developments will involve the use of some key metrics.

Examples of metrics to monitor for change against historical benchmark trends include:

  • Sales movement – percentage levels
  • Debt turn trends - potential impact of clients' own debtors stretching payment terms
  • Cash desperation – how quickly is the client drawing down available funds after invoice submission.
  • Dilution/erosions – potential pre-invoicing and fresh-air concerns.

The pandemic accelerated digitisation in receivables finance and this will only continue across new prospective clients and existing clients. Technology remains key to servicing clients, gaining a competitive edge and protecting a lender's security.

Technology

The good news is that now, more than ever, we have the technological means to manage risk from end to end.

Lenders can use technology to analyse far more extensive and diverse amounts of data to gain a 360-degree view of the portfolio so that the right people can make better-informed decisions.

Certainly, from a portfolio monitoring perspective, products like Riskfactor come into their own at times like these. Evaluating real-time performance, driven by dynamic daily transactional activity and supplemented with data available via API integrations (such as sales/purchase ledgers extracted directly from prospect/clients accounting software, credit bureau data and KYC data).

Technology can, on a daily basis, greatly assist in highlighting situations which are deteriorating and which might need further attention, allowing lenders to focus their time and relevant resources on potential issues within their portfolios.

Receivables finance has always benefitted in times of economic difficulty, so does all this mean that 2022 will be a bumper year for the industry? It does seem highly likely that this year will see a significant increase in the use of receivables finance and ABL products but, for the industry, much will depend on the nature of growth and how it is managed. If there is a significant increase in demand for receivables finance and ABL products, it will need to be resourced appropriately for both people and systems. As an industry, we currently have access to more tools than ever before to ensure that growth is controlled and managed effectively. These tools support lenders in growing their business safely and securely and will allow receivables funders and ABL lenders to take a positive role in helping the economy to grow in a post-pandemic world.

Maybe, we should wait for the history books!

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