Supply chain finance ABS helpful in financing SMEs in China

Large-scale enterprises and assets have long been dominant in the asset securitization product market, leaving little space for participation by small and medium-sized enterprises (SMEs). However, in recent years, with such groundbreaking products as the Vanke Group’s supply chain finance ABS breaking the mold, supply chain ABS has become a new means of financing for small and medium-sized suppliers tied to large real estate enterprises. Since the beginning of 2018, with the successive approvals of a batch of ABS that serve the new economy, of which the Ping’an-BYD Supply Chain Finance Asset-Backed Plan handled by the author’s team is representative, this model has rapidly moved from the traditional real estate industry to covering the new economy, internet and other such sectors, becoming an important asset-backed securities product for enterprises.

Compared with traditional modes of financing, supply chain finance ABS, relying on the core enterprise, is helpful in opening new modes of financing for upstream enterprises, can effectively reduce the reliance on traditional bank credit, and accelerate the recovery of funds, thus having great significance for revitalizing the accounts receivable assets of SMEs and resolving their financing difficulties.

Reverse factoring is an effective channel for aggregating supply chain payables. The core enterprise’s supply chain payables (i.e., the supplier’s receivables) serve as the underlying cash source for supply chain finance asset securitization. The reverse factoring model achieves the aggregation of claims by transferring the supplier’s accounts receivable from the subsidiaries of the core enterprise to the factor. In this model, the factor considers the creditworthiness of the core enterprise rather than that of the supplier. Through confirming the accounts payable and the transfer matters, the core enterprise, as the debtor, provides a certain degree of credit enhancement for the factoring financing, allowing a small or medium-sized supplier to recover accounts receivable early for relatively minimal funding costs while also permitting the core enterprise to realize effective management of its suppliers, accounts payable terms and cash flow.

Under this structure, the addition of the core enterprise’s creditworthiness will usually take one of two forms: (1) debt accession: the core enterprise, as co-debtor, bears a joint and several obligation to discharge the accounts receivable in the pool, but such debt accession by the core enterprise does not exempt the subsidiaries from the payment obligation bearable by them based on the underlying transactions and they do not withdrawn from the original claim-debt relationship; or (2) provision of security: if a subsidiary fails to perform its payment obligation, the core enterprise bears the security liability. Additionally, with respect to the debtor repayment risk brought about by a drop in the entity credit rating of the core enterprise, a prepayment arrangement is usually provided for in the plan.

UNDERLYING ASSETS EXAMINATION

The general criteria of genuineness, lawfulness, free and clear title, encumbrance free and lawful and valid transfer should likewise be complied with for the underlying assets in the core enterprise reverse factoring asset securitization. Additionally, in light of the features of this model, the due diligence should focus on the following aspects:

Lawfulness and validity of the dual claim transfer notices. Pursuant to Article 80 of the Contract Law, “when a creditor is to transfer a claim, he shall notify the debtor thereof. If he fails to do so, the transfer shall not enter into effect as for the debtor”. Accordingly, when transferring the accounts receivable claims from the supplier to the original beneficiaries and the further sale of such claims from the original beneficiaries to the plan, separate notices shall be given to the subsidiaries of the core enterprise. Additionally, the original beneficiaries and/or the plan manager shall secure an acknowledgement of receipt or letter of confirmation signed by the debtor so as to confirm that the debtors are aware of the transfer of the accounts receivable claims.

Registration of the two transfers of the accounts receivable. Article 33 of the Measures for the Registration of Pledges of Accounts Receivable specifies that, “the registration of a transfer of accounts receivable for financing purposes by a rights holder through the registration disclosure system shall be carried out with reference hereto”. Additionally, an adjudication guideline issued by the Court of the Shenzhen Qianhai Cooperation Zone in December 2016 reads “a factor shall log on to the Uniform Movable Asset Financing Registration Platform of the Credit Reference Center of the People’s Bank of China to do a search on the title to accounts receivable. Failure to conduct such search does not constitute good faith.”

Based on the foregoing, we would argue that although the transfer of accounts receivable does not fall within the scope of those things for which laws and regulations require registration, based on the credibility effect of the disclosure of the registrations of transfers and the higher duty of care incumbent on factors as professional firms, a factor should carry out a one by one search and registration of the underlying assets at the time of the first claim transfer, provide to the plan manager and the intermediary firms the exclusive search results and registration table from the registration system and, at the time of the transfer of the claims to the plan, assist the plan manager in completing the registration of the second transfer.

Examination penetrating to the lowest level underlying transactions and comprehensive investigation of the major debtors or guarantors. The genuineness and lawfulness of factoring claims are subject to the genuineness and lawfulness of the underlying transactions. Accordingly, with respect to the lawful securing and transfer to the plan by the factor of the accounts receivable claims, an examination penetrating to the lowest level underlying transactions that gave rise to the claims should additionally be conducted. Confirmation that the creditors have performed their obligations under the contracts, that the payment conditions specified in the contracts have been satisfied and that there are no defence grounds or instances of set off in respect of the debtors’ performance of their payment obligations should be effected by examining the contracts and orders for the underlying transactions, and the documents and other relevant information evidencing that the creditors have performed their obligations under the contracts for the underlying transactions. The business position and financial position of the major debtors or guarantors should also be comprehensively investigated so as to ensure that they have the corresponding capacity to repay.

Zhou Tao is a salary partner at Grandway Law Offices in Shenzhen. He can be contacted on +86 755 2399 3388 or by email at zhoutao@grandwaylaw.com

He Qian is an associate at Grandway Law Offices in Shenzhen. He can be contacted on +86 755 2399 3388 or by email at heqian@grandwaylaw.com