Factoring Under Scrutiny: Global Regulatory Trends and Challenges

Written by: Andrew Coon, CEO of CapFlow Funding Group

Factoring, a financial transaction where businesses sell their accounts receivable to a third party at a discount, plays a crucial role in providing liquidity and supporting business operations. However, the regulatory environment for factoring is complex and varies widely across different jurisdictions. Unlike many other financial services, there is no uniform set of specialized regulatory standards for factoring that is universally accepted. This article explores the specific disclosure regulations in the factoring industry across key regions around the world.

Overview of the Factoring Industry

Factoring is a vital component of the financial ecosystem, enabling businesses to manage their cash flow effectively by allowing for the sale of invoices early in the sales cycle to blunt the impact of customers buying on net-30, 60, or 90 day terms. The industry has seen significant growth, driven by the demand for alternative financing solutions. Key players include banks, non-bank financial institutions (NBFIs), and specialized finance companies known as “factors.”

Disclosure Regulations in the United States

In the United States, the regulation of factoring is primarily a state-level concern, leading to a diverse regulatory landscape. Below, we delve into the specific disclosure requirements in several U.S. states.

California: In California, factoring companies must adhere to stringent licensing requirements and disclosure standards under the California Financing Law (CFL)and must be licensed under the California Department of Financial Protection and Innovation (DFPI), which oversees these regulations. Key disclosure requirements include:

• Transparent Fee Structures: Factoring companies must clearly disclose all fees associated with the factoring transaction, including discount rates, service fees, APR, and any additional charges.

• Contract Terms: Detailed terms of the factoring agreement, including the duration, recourse provisions, and the rights and obligations of both parties, must be provided to the client.

• Annual Reporting: Factoring companies are required to submit annual reports detailing their financial condition and the volume of transactions handled.

New York: New York’s regulatory framework for factoring is governed by the New York State Department of Financial Services (DFS). While New York does not have a specific statute for factoring or a licensing requirement, general financial service laws apply, requiring:

• Disclosure of Financial Terms: Factoring agreements must include comprehensive information about the financial terms, such as advance rates, discount rates, and payment schedules.

• Client Notification: Clients must be notified of any changes in the terms of the factoring agreement or additional fees that may apply.

• Compliance with UCC: Factoring transactions must comply with the Uniform Commercial Code (UCC) provisions related to secured transactions, ensuring transparency and fairness.

Additional States in the United States:

Utah: SB183, also known as the Commercial Financing Registration and Disclosure Act (CFRDA), applies to various commercial financing providers, including those who offer merchant cash advances, in amounts of $1 million or less. The law requires providers conducting more than five commercial financing transactions in Utah per year to apply for a commercial financial license, register with the Utah Department of Financial Institutions, and maintain this registration annually, with certain exemptions for specific types of transactions and entities.

Florida: The Florida Commercial Financing Disclosure Law (FCFDL) applies to commercial closed- and open-end loans and accounts receivable purchase transactions of $500,000 or less, effective for transactions on or after January 1, 2024. The law mandates that providers conducting more than five qualifying transactions per calendar year must disclose essential terms of financing, including total funds provided, dollar cost of financing, and payment schedule, though they are not required to register with the state or revise disclosures post-transaction.

Virginia: Also known as House Bill 1027, Virginia’s commercial disclosure law focuses on regulating sales-based financing, specifically merchant cash advances under $500,000. Providers must register with the Virginia State Corporation Commission, ensure up-front disclosures about financing terms, and follow specific dispute-resolution procedures. Introduced by Delegate Kathy Tran, the bill passed both the House and Senate and was signed into law by Governor Glenn Youngkin, mandating that MCA providers disclose nine specific terms at the time of offering, without requiring APR disclosure, and abide by regulations on arbitration and dispute resolution.

Disclosure Regulations in the European Union

The approach to regulating factoring within the European Union varies by country, reflecting differing legal traditions and financial systems. Here, we highlight the specific requirements in Germany and France.

Germany: In Germany, factoring is regulated under the Banking Act (Kreditwesengesetz - KWG), overseen by the Federal Financial Supervisory Authority (BaFin). Factoring companies must meet specific disclosure requirements, including:

• License Requirement: Factoring companies must obtain a license from BaFin, which involves demonstrating adequate capital resources and a sound business model.

• Transparency Obligations: Detailed disclosure of the terms of the factoring agreement, including fees, interest rates, and the calculation method for the purchase price of receivables.

• Periodic Reporting: Factoring companies are required to submit regular reports to BaFin, providing information on their financial status, risk management practices, and transaction volumes.

France: In France, factoring is regulated under the Monetary and Financial Code, with oversight by the Autorité de Contrôle Prudentiel et de Résolution (ACPR). Key disclosure requirements include:

• Clear Contract Terms: Factoring agreements must explicitly outline the terms and conditions, including the scope of services, fees, and the process for handling disputes.

• Financial Transparency: Factoring companies must disclose their financial health and operational status through periodic reports submitted to the ACPR.

• Consumer Protection: Strong emphasis on protecting the interests of clients by ensuring clear communication and fair treatment in all factoring transactions.

Additional Countries:

United Kingdom: In the UK, factoring is regulated by the Financial Conduct Authority (FCA) under the Financial Services and Markets Act 2000. Factoring companies must comply with FCA regulations, including disclosure requirements and conduct of business rules.

Canada: In Canada, factoring regulations vary by province. For example, in Ontario, factoring companies are subject to the Consumer Protection Act, which mandates disclosure of terms and conditions in factoring agreements.

Australia: In Australia, factoring is regulated by the Australian Securities and Investments Commission (ASIC) under the Corporations Act 2001. Factoring companies must adhere to ASIC regulations, including disclosure requirements and licensing obligations.

Impact of Disclosure Regulations on the Factoring Industry

The specific regulatory frameworks in different regions impact the factoring industry by promoting transparency and protecting client interests. By mandating detailed disclosures, these regulations help ensure that businesses using factoring services are well-informed and safeguarded against unfair practices. Clear regulatory standards enhance market stability by fostering trust and confidence among stakeholders. However, navigating the diverse regulatory landscape can pose compliance challenges for factoring companies, requiring significant resources and expertise.

Recent Developments and Trends

There is an increasing demand for a comprehensive regulatory regime for factoring. This demand is driven by the need for financial stability and the protection of market integrity. Recent developments include the introduction of specialized factoring laws in several jurisdictions, which aim to provide clear guidelines and regulatory requirements for factoring companies.

For instance, some countries are implementing new laws that establish specific licensing regimes for NBFIs engaging exclusively in factoring activities. These laws typically include provisions for prudential regulatory standards and conduct of business rules tailored to the unique aspects of factoring. The adoption of such laws reflects a broader trend towards recognizing the importance of factoring in the financial system and the need for dedicated regulatory frameworks.

Best Practices for Compliance

To stay compliant, factoring companies should adopt the following best practices:

Governance Framework: Establishing a clear governance framework is essential for effective regulatory oversight. This involves allocating supervisory functions and regulatory powers to designated authorities responsible for overseeing factoring activities. Coordination between existing authorities, such as financial regulators and supervisory bodies, ensures consistent enforcement of licensing and regulatory requirements. A well-defined governance framework promotes transparency and accountability in the factoring industry.

Entry Requirements: Factoring companies must meet specific entry requirements to obtain licenses and operate legally. These requirements typically include demonstrating a sound corporate structure, adequate ownership, and sufficient capital adequacy. By ensuring that companies meet these standards, regulators can mitigate risks and promote the stability of the factoring market. Additionally, clear entry requirements provide a benchmark for the regulatory authority to take supervisory actions, such as license suspension or withdrawal, if necessary.

Regulatory Regimes: Implementing simplified prudential regulatory standards and core conduct of business rules is crucial for the effective regulation of factoring companies. These standards should be tailored to the unique characteristics of factoring, considering the specific risks and operational aspects of the industry. Simplified prudential standards help ensure that factoring companies are financially sound and capable of managing risks, while conduct of business rules promote fair and transparent practices.

Staying abreast of evolving regulations is crucial for businesses operating in the factoring industry, whether their operations are confined to the US or extend internationally. As the factoring industry expands, the ongoing development of comprehensive disclosure regulations becomes increasingly vital to safeguard stakeholders and cultivate a resilient financial ecosystem.

About Andrew Coon

Andrew Coon has over thirty years of experience in the financial services industry. Mr. Coon co-founded CapFlow Funding Group (“CapFlow”) in 2009 and CFG Merchant Solutions (“CFGMS”) in 2015. Throughout his career, Mr. Coon has gained a reputation as a seasoned leader, having worked for major financial institutions such as Morgan Stanley, Merrill Lynch, Standard and Poor’s and Salomon Smith Barney. Mr. Coon currently serves as the CEO of CapFlow which provides factoring and working capital solutions to small and medium-sized businesses throughout the US. His commitment to providing innovative solutions to his clients has earned him a reputation as a thought leader in the commercial finance industry. Mr. Coon holds a BA in International Relations and Economics from Brown University, and an MBA in Finance from Washington University.

The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.