Asset based finance is coming of age

Article Written by: Kevin Day, CEO, HPD Software

First appeared on: AltFi

HPD Software’s CEO Kevin Day explains why SME funding requirements increasingly are being met by fintech lenders owing to the scarcity of traditional bank loans and business overdrafts.

Industrial plant machinery – (Photo by Crystal Kwok on Unsplash)

Industrial plant machinery – (Photo by Crystal Kwok on Unsplash)

Is asset based finance coming of age?

Asset-based finance is entering a new era of significant growth and market acceptance. The business world has not always embraced this method of funding and it has sometimes been seen as a route only to be considered if other options were unavailable. However, asset-based finance is now expanding globally with businesses in both developed and developing countries showing a greater appreciation of its value. Although the pace of growth varies from continent to continent, with more established geographies such as the US and developed Europe growing more slowly, there is strong demand in emerging economies in Central and Eastern Europe, Africa, and Asia-Pacific for this highly flexible financing option.

The drivers are varied. Traditional lenders operating within tighter banking covenants have been restricting SME lending globally, not just in the UK. Emerging economies in Central and Eastern Europe, Africa and in Asia-Pacific are experiencing strong growth, driving demand from businesses for easily accessible and highly flexible cash-flow and working capital funding.

The commercial environment is marching forwards to increasing digitisation, cloud computing and Software as a Service models (SaaS). This means even small businesses are much more likely to have robust accounting processes and are more easily funded using asset-based finance. The opportunity for banks and other lenders to enter the asset based finance market are enhanced by technology solutions which are available on a SaaS basis, helping banks to provide a cost efficient and sophisticated asset-based finance and invoice financing service to their business customers.

Europe ahead of the US?

North America is widely perceived as the home of invoice finance. Though growth is moderating the absolute numbers are still vast. A recent study commissioned by the Commercial Finance Association estimated the volume for factoring in 2018 to be $101bn managed by around 900 factoring companies. The same report estimates asset-based lending to be $465bn. However, it seems as if Europe leads the world in terms of factoring volume, and in the most recent FCI figures, puts the total advances in Europe to €242bn. The combined asset-based lending and factoring business in the US is still more than double the European volume, however, so this all depends on what is being measured.

The five largest economies in Europe – UK, France, Germany, Italy and Spain – account for around two thirds of factoring volumes across the continent. These mature Western European economies are all showing an upward trend driven by SMEs adopting asset based finance (ABF), typically full service factoring or confidential invoice discounting, as their working capital finance solution. The trend is also supported by the strategic emphasis placed by the commercial banking sector on factoring – banks control approximately 90 per cent of Europe’s factoring volumes.

How does the UK's sterling volatility affect volumes?

With more than a 20 per cent market share, the UK is the largest factoring market in Europe. However, the sterling’s recent high volatility has meant that in the last 18 months, as a percentage of European volumes, the UK’s market share has fallen slightly, and now France has almost caught up and is poised to overtake the UK market.

The combined turnover of British businesses using ABF, both invoice factoring and asset based lending, is now more than £300bn. To put this in perspective, in the second half of 2018 there were 40,333 users of ABF, the majority of them SMEs – the area of the UK economy that continues to grow. Given that SMEs account for 33 per cent of UK GDP, we expect demand will continue, despite the relative maturity of ABF in the UK. The sheer volume of companies at the smaller end of the market, which need funding to grow, and the banks’ continued reluctance to lend to young growth businesses will fuel this demand. It should be noted thought that although volumes have increased, actual client numbers have fallen over recent years, which may indicate smaller SMEs are be funded by alternative FinTech lenders, such as a peer to-peer or crowdfunding.

Central and Eastern Europe is a rapidly accelerating market for ABF

Looking east at emerging European economies, countries in the CEE region are also driving growth in this sector. According to the Polish Factors Association, its ABF market, primarily invoice factoring, is growing by 18 per cent year on year, equating to 8,000 businesses adopting this source of financing. Other sources report this number to be 15,000 businesses.
The importance of ABF to the Polish economy is demonstrated by the fact that companies in the Polish Factors Association collectively had turnover of over PLN 117bn (€27 bn) in 2018. For less established economies, growth is at an even faster pace. Hungary’s factoring market enjoyed a formidable 58 per cent expansion in 2018, while Romania’s invoice factoring market enjoyed a more modest but nonetheless impressive growth of 14 per cent. Africa and the Middle East sees remarkable uplift.

Africa and the Middle East sees remarkable uplift

Africa has seen remarkable uplift in the growth of ABF in recent years, culminating in a nearly 50 per cent increase in invoice factoring between in the last three years, with indicators pointing to continued growth across the continent over the longer term. Growth of invoice financing across Africa has been mixed, with market leader South Africa accounting for nearly 79 per cent of the total market, seeing a 5 per cent uplift in recent years. At the northern end of the continent, the Moroccan factoring market enjoyed growth of 25 per cent, however this was offset by a more measured performance in Egypt, Tunisia and Mauritius.

There has been significant investment to help the factoring industry expand across Africa, which has targeted SMEs, and this is helping to support economic growth. Afreximbank, the Pan-African Multilateral Financial institution, is playing a leading role in building the necessary infrastructure, and recently pledged $950,000 to help grow the industry and support SME development.

In North and sub-Saharan African countries, a number of major international banks including Societe Generale and BNP Paribas have partnered with regional banks to roll out invoice factoring in local markets, which has proved to be a facilitator of investment in economies that are increasingly seeking to access the world market.

What is the impact of increasingly sophisticated tech?

Globally, SME funding requirements, driven in part by the scarcity of traditional bank loans and business overdrafts, has led to high levels of innovation and a rapid pace of expansion in fintech solutions to meet demand. In particular, ABF management software functionality and transaction streamlining has been transformed in recent years, with new capabilities developing year on year. A good use case is the ability to synchronise the bank’s platform with the accounting system of the client, thus collateral values increasing as clients generate invoices in their day-to-day business, reducing the wait time for funding, and accelerating business growth. Lending platforms automate and streamline data capture, offering real time risk management, and provide insights, analytics and extensive reporting. As technology progresses further, it is rapidly disseminating across borders and geographies, becoming more accessible in markets that were previously lagging behind by such developments.

What is the future of asset-based finance?

For many businesses across the world, ABF in its various forms is a growing and critically important financing tool. In highly developed countries it provides smaller, entrepreneurial businesses with the additional support they need for growth and innovation – the lifeblood of a sophisticated market economy. For developing markets without an advanced banking infrastructure, but with young businesses yearning to tap into the global economy, the flexibility offered by ABF is being increasingly recognised and adopted. Given ABF’s rising popularity in both developing and developed markets, it is likely only to increase in importance as a significant funding tool for companies and a key facilitator of business expansion globally. ABF is still a peripheral financial solution in comparison to more traditional bank lending, but it is gaining momentum globally and having an increasingly positive impact upon economies. Active promotion and support will continue to edge this method of delivering working capital into the mainstream and into the consciousness of entrepreneurial businesses wishing to unlock their potential.