Evaluation of factoring rule of Bangladesh Bank
Bangladesh Bank (BB) issued a circular on June 25, 2020 allowing factoring in Bangladesh. The Government of Bangladesh has not yet ratified the UNIDROIT Convention on International Factoring (Ottawa, 28 May 1988). Factoring is a trade finance product. The rule of factoring issued by BB mostly focuses on recovery of export proceeds but not full factoring services such as export trade finance. It does not have details of other issue of probable disputes and dispute resolution methods. Furthermore, the circular is silent about single factor or two factors methods.
The traditional bank finance relies on security of mortgage, but the factoring does not require such mortgage of fixed assets and others. A trend has recently started of accepting receivables as collateral, but mostly as supplementary securities. This trend has left many of the SMEs struggling to get funding in the absence of hard collateral and has created a strong basis for development of factoring in the market.
Factoring as per circular has some probable challenges. As per Gazette Notification issued under Section 12 of Foreign Exchange Regulation Act (FERA), 1947, export proceeds must be repatriated within four months of shipment. Factoring is a kind of short-term loan up to 180 days. The Foreign Exchange Regulation should be amended in order to get optimum benefit of this financial product.
The scope of factoring reflects in the definition of the UNIDROIT Convention. It states that the factoring is traditionally associated with functions beyond pure financing to include collection of receivables, debtor management, and protection against default by debtors.
The guideline of international factoring prepared by technical committee and adapted by BB in the rule referred that, -- in factoring, 'invoice' is the only document that gives right to the debt. Section 6 of the circular mentioned that Authorized Dealers (Ads) might allow 'transport documents' to be issued in accordance with underlying arrangements among the parties. It is conflicting with the guideline of technical committee of BB. The circular is silent about single factor or double factors methods although the guideline of BB stated that the assignment of the invoice gives the right to the import factor to recover the money from the importer, which in turn enables import factor to provide the guarantee to the export factor on behalf of the importer. This guarantee is what enables export factor to advance funds to the exporter at the post shipment stage. It may be presumed that BB will allow single and double factors to provide the services. The rule recognises the designated institutions which are international factoring companies/foreign banks/foreign financial institutions/trade financiers/insurance entities, but historically the insurance companies are not in this finance trade anywhere in the global market and their law does not permit such trade.
Factoring service has many risks in its operation. Commercial risk represents the risk of disputes between the assignor and debtor. The others are performance risk of the exporter and credit and payment risk of the import factor. The other generic risks include defective/false/fake invoices, direct payment by the importer to exporter in spite of assignment of receivables and not to routing all invoices of exporter through the factor. Fraud risk represents the risk of factoring "fresh air" invoices or pro-forma invoices, which are not based on an actual delivery.
There may be documentary risk represents the risk that the receivables or the assignment may not be properly prepared and hence in the event of enforcement procedure the factor may have collecting difficulty. There are many operational risks which represent the risk of human operational error and can be mitigated through minimisation of manual work with the implementation of high end software for managing the factoring transactions, and by applying the four-eye principle. Most importantly, the relevant market risks of volatile foreign exchange and the interest rate risk.
To face those risks and smooth functioning of factoring, several global institutions have been established which support, promote and facilitate factoring activities: Factor Chain International (FCI) and International Factors Group (IFG) and others. The scope of their activities includes receivables financing, such as promoting best practices on developing markets, training staff in specific skills, as well as participating in the synchronisation of the global legal practices and improvement in the business environment. EU Federation for the Factoring and Commercial Finance Industry (EUF), is the representative body in the EU, acting as a platform between the factoring and commercial finance industry and key legislative decision makers across Europe.
In order to mitigate the risk of the service, the FCI issued (a) the General Rules for International Factoring (GRIF), (b) the edifactoring.com Rules, and (c) the Rules of Arbitration. These rules constitute the basic framework governing co-operation between members and these rules define the rights and obligations of the parties to transactions under the two-factor system. However, the United Nations Convention on the Assignment of Receivables (UNIDROIT) and the UNCITRAL Legislative Guide on Secured Transactions are two important instruments for better factoring services. All those apply to international factoring, and govern the legal principles related to the effectiveness of assignments, the rights and obligations of the factor, the assignee and the assignor, and the subsequent assignments.
Bangladesh should consider ratifying UNIDROIT Convention to facilitate the factoring services.Bangladesh may consider having a law on factoring services. BB should clarify the issues related to general rule of factoring, effective communication with edifactoring and arbitration in order to resolve the disputed and smooth transaction of factoring in domestic and international trade.
THE WRITER IS A LEGAL ECONOMIST.