Cash & Liquidity ManagementCash ManagementAccounts PayableOpen Standards for Payables and Receivables

Open Standards for Payables and Receivables

In recent years, corporates and banks have worked on the creation of a number of open standards that are expected to reduce the costs of connecting their systems and passing data electronically. Major efforts have been made by multiple standard organisations to work under two interlinked umbrellas, ISO 20022 and UN/CEFACT. The suite of ISO 20022 messaging standards now includes widely accepted designs for the processing of payments. There is global support for these standards, from the EU to the US to the Far East, helped by the tireless efforts of SWIFT and major cash management banks to ensure locally developed EDI-based standards are upgraded to the XML-based ISO 20022 design. Work is underway to incorporate other standards under ISO 20022, such as standards for derivative trading and the billing of bank services. A group of major banks is working on detailed implementation guidelines to avoid banks and their customers deviating from best practices.

Regarding message standardisation of corporate-to-corporate and corporate-to-government financial supply chains, there is a similar trend of collaboration between multiple standards organisations. UN/CEFACT is the most logical candidate to be the umbrella for such standards. Banks, public administrations and a few corporations are collaborating to ensure that the existing EDI-based invoicing standards are upgraded in line with the many requirements assembled around solutions for e-invoicing. This process is accelerated by the work of the EU Expert Group on e-Invoicing, which aims to deliver before the end of 2009 a comprehensive electronic e-invoicing framework that includes message standards. This framework also covers specific designs for interoperation between multiple e-invoicing service providers and recommendations to remove legal bottlenecks for e-invoicing in the EU.

The roll-out of such designs depends on whether service providers offer services that work with these message standards. The ease of implementation, however, does not only depend on good data models being provided by the message standards. It also requires ease of connecting systems and secondly an easy manner to ensure that the information passed from A to B can be trusted and acted upon.

To facilitate the connection of systems and to route data in a manner that each sending and receiving system can understand, an advanced but simple to implement open standard transport protocol has been developed by investment banks and a number of technology providers. This protocol, called AMQP, is now reaching maturity with the active support of players such as Microsoft, RedHat, Intel and Cisco.

Acting upon any information received depends on whether it can be trusted that the sender of the information is who he says he is and has the authorisation to send electronic information and electronic instructions. One needs low-cost and pervasive solutions to authenticate the origin of messages in order for the receiver to trust the origin of the sender and act upon it. Multiple projects are working on exactly this topic, often subsidised by the EU Commission and national governments. It goes too far for this article to explain the progress in detail, but suffices to say that low-cost and qualitative solutions are already being rolled out in multiple EU member states, making it much easier and more affordable for users to obtain digital identities and use these cross-border.

Improving Access to Financing More Important than Improving Payment Services

It is nice that open standards are becoming mature and solutions that support these are more widespread. But the key is whether a company is interested to start with implementing new solutions that make use of such open standards.

In an article earlier this year, I described how corporate users of payment services in 2009 can start to benefit from pro-actively engaging with their banks in 2009, using the implementation of the Payment Services Directive (PSD) as a trigger. Corporates do not need to invent any wheels to do so. There is widespread knowledge of how ISO 20022 standards can be deployed. But maybe more importantly, corporates can simply start with using an Australian list of user requirements for payment services in their discussion with banks. This list can be found in the previous article, 2009 – A Good Year for Users of Bank Services.

But even though the SEPA Credit Transfer (SCT) scheme is ready to roll out on a wide scale from the point of view of the banks, the uptake thus far has been limited. Corporates can indeed now benefit from the changing payment services landscape and ensure their requirements for such services are met by their banks when implementing SEPA. But in an age of scarce access to financing, the implementation of improved and/or lower cost payment solutions is likely not highest on the agenda for the corporate treasurer, let alone his company’s senior management. The improvement of collections from customers, managing payment terms adequately and enabling easy access for suppliers and buyers to financing, is likely to be higher on the priority list.

The current economic climate has resulted in a significant reduction in access to financing for businesses throughout the world. In particular small and medium sized businesses (SMEs) are affected, given the fact that these firms often lack access to long term financing instruments and often lack the means to counteract a deterioration of payment terms by their larger suppliers and buyers. Small firms further lack bargaining power to negotiate credit lines and affordable levels of interest rates with their banks. Unlike large firms, small businesses tend to be mono-banked, having less flexibility to shop between banks to obtain better services or to obtain access to financing at attractive interest rates.

Another Approach Needed to Improve Access to Credit

Banks have responded to the credit crisis by rapidly increasing interest-rate margins and tightening the provision of credit. Revenues from trade finance have gone up considerably. While the amount of transactions have reduced somewhat, margins have often doubled or even quadrupled. Governments have tried to respond by taking initiatives to guarantee loans to small firms, such as the UK government’s ‘Small Firms Loan Guarantee’ scheme. These schemes are not always successful. Sometimes this is due to government charges levied for such guarantees. Sometimes this is due to operational complexities for banks administering the scheme and/or for companies to obtain the funding.

The lesson learnt is that financing solutions cannot be forced upon banks and their customers by governments unless a number of key requirements are met. The other lesson is that where banks, as a result of their increased margins, do not have a commercial incentive to improve their services, their customers should take a more pro-active role. The first step – as with payment services – is to identify key requirements for financing schemes. The second step is for a number of corporates and solution providers to structure solutions with their banks that meet these requirements and provide a win-win for buyers, sellers, service providers and banks at the same time. And it should be no surprise that open standards can provide the designs as well as the required ease of implementation to make such schemes successful.

Requirements for a Successful Financing Scheme

One could identify the following key requirements for a successful financing scheme:

  1. Easy access to multi-bank financing for small and large businesses where required without a need to change banks or bank accounts.
  2. Financing the exact amount of cash required by a company on a daily basis, not much more or less.
  3. Technical and operational solutions that are easy to roll out to hundreds of thousands of small businesses within 6-12 months.
  4. Minimal credit risk and related capital requirements for banks when providing financing through the scheme.
  5. Rapid and low-cost provision of relevant information to financiers, buyers and sellers, enhancing efficiency of payables and receivables management plus providing the necessary transparency of information at the same time.
  6. Competition between solution providers that ensure market requirements are met and multiple, efficient solutions are offered to the market.

These requirements are to be met by solutions that are efficient and have a wide reach, which means they need to be interoperable and hence based on open standards.

A Successful SME Financing Scheme: Operational in Peru and Rolled Out Elsewhere

There are examples of schemes that meet these requirements and are effective. The World Bank has successfully piloted a receivables financing scheme in Peru that is currently rolled out with the help of major companies in Peru to hundreds of thousands of very small companies. The World Bank is actively pursuing the creation of a similar scheme in Colombia, Turkey, Vietnam and the Ukraine. The same model is currently implemented in the People’s Republic of China with the active support of the Guangdong regional government and the Guangdong chamber of commerce.

The scheme operates on the basis that many small companies have commercial relationships with large suppliers. These large suppliers tend to know their small buyers and their operations better than most banks. This is because there is generally is a long-term commercial relationship between suppliers and their buyers, within which suppliers can often assess the quality of business operations of their buyers. More than bank relationship managers, suppliers are in regular contact with their buyers, visiting them frequently. Suppliers need their buyers to prosper, and buyers often need the products or services of their major suppliers to be in business. This observation is supported by the extensive analysis by the World Bank in Peru of the collection by corporates of four million invoices and the performance on loans by over 100 Peruvian financial institutions. The study showed that the probability of default on the bank loans was between 4% and 8% (dependent on the size of the borrower) and the probability of default for corporates on their collection of invoices was just over 1%.

So, by explicitly facilitating suppliers and buyers to manage the payment terms between them in a flexible manner, banks could finance their corporate customers and benefit from a significantly lower probability of default. They would use the invoices of the suppliers as their collateral. The result is that the first loss would be for the collecting corporate (the supplier). The second loss would be for the bank, with a risk that (1) collecting suppliers do not pay off their bank, (2) that at the same time the suppliers’ buyers do not pay the supplier (3) AND that these suppliers do not pay the bank when it takes over control over the invoice collection. The bank further has the option to finance only a percentage of the face value of the invoices, and could further benefit from a government guarantee, as is the case in Peru and China. In total, these schemes would reduce the risk of the banks in lending to their corporate customers, while keeping margins at attractive levels and benefiting from efficiencies of scale of portfolio-based financing programmes.

It may be no surprise that introduction of the scheme resulted in very significant reduction of interest charges for very small merchants in Peru and was actively supported by large Peruvian companies, the Peruvian government and a local bank.

Efficient and Rapid Access to Financing by Applying Open Standard-based Solutions

Such programmes as described above have been rated AA risk or higher, even when the buyers are many SMEs. Key from an operational perspective is (1) that the bank can obtain daily information about the operational payment behaviour of the debtors, (2) that the so-called dilution risk of receivables is removed by introducing dispute management of invoices before their payment and (3) that the bank has a contractual ability to transfer the ownership of invoices from the collecting supplier to the bank at the moment the payment behaviour of debtors deteriorates or suppliers lose their creditworthiness. The latter requires the rapid analysis of real-time information about collection and payment behaviour.

In particular, the rapid information about disputes benefits the corporates involved beyond improved access to financing. Such disputes often relate to faults in the delivered products, wrong deliveries or incorrect prices. Dispute information enables suppliers to make timely adjustments in their deliveries and to significantly reduce costs. The buyers in the meantime have control over what they pay their suppliers and a reduced administrative burden. At the same time, both buyers and suppliers have full visibility on outstanding invoices and payment behaviour, facilitating their credit control and cash management.

The provision of timely dispute information can only be done efficiently when it is being automated and the data can be understood by many. Good financing programs are only successful longer-term when involving multiple banks and many buyers and sellers. All these buyers and sellers may use their own accounting systems and payment services. The solution providers facilitating the programs should operate with other service providers to gain critical mass more quickly. So a quick and efficient roll-out will depend on the willingness of all these players to implement on the basis of open standards.

This brings us back to the value of using open standards, in this case in particular standards for e-invoicing that include dispute management in their design. As the Peruvian example demonstrates, solutions are available nowadays, not only for better payment services, but also for improved access to low cost financing and solutions that provide greater efficiencies in the financial supply chain. For corporates that wish to benefit, it takes them to (1) identify their requirements, (2) seek the relevant service providers (3) apply valuable open standards designs as much as possible and then (4) implement attractive solutions efficiently and rapidly.

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