Factors beyond regulatory control

Ask any player, in any section of the economy, from the utility companies to the big insurance houses, whether they’d prefer regulation imposed from outside, or self regulation, and it’s obvious which they’d choose.

Industries like self regulation because they fear external regulation will interfere with their activities. This, however, is the whole point of having external regulators. The idea is always to impose a certain shape on the market because, the assumption is, without regulation, the market will operate “unfairly”.

So it will surprise some to discover that the highly-regulated financial services sector has an heroic anomaly in its midst – an unregulated service that allows anyone at all to set out their stall for business, despite the fact that the sums involved can be as high as £160m.

We refer, of course, to invoice discounting and factoring, long the most profitable of all financial services outside venture capital. Returns have run as high as 25% on monies advanced, which is a nice margin for money lending in anyone’s eyes.

Admittedly, competitive pressure has been slowly driving margins down over the past few years, and this pressure is likely to increase as more new players enter this lucrative market. Factors, of course, would argue this is a sign the market is doing its job and that it should be left to do said job unaided by meddling regulations imposed from outside.

Yet the fact remains that the unregulated status of factoring firms is a glaring anomaly. Do they need regulating? “Absolutely not,” says Robin Clarke, CEO of the Factors and Discounters Association (FDA). “Our take is that all our members’ clients are covered by a legal agreement between themselves and the member, and that the normal law of contracts governs matters. There is no driver for regulation here as there has been in other parts of the financial services sector.”

But he admits that external regulation is a possibility. “My guess is that it would happen if part of the industry was involved in something that was considered sufficiently unprofessional, and which obviously called out for regulation,” he says.

Clarke argues that such a mishap has not happened and is not likely to.

At the end of March 2002 there were 30,000 UK companies using services provided by FDA members, and the FDA has received no complaints it could not resolve itself. With no public hue and cry, there is no need for Government intervention.

Clarke adds that, in any case, external regulators are usually appointed to police the areas of interface between businesses and the general public, not to get involved in business-to-business transactions.

This is an interesting, but dubious argument. The US Securities and Exchange Commission’s (SEC’s) interest in audit firms, for example, is not particularly prompted by concern for Joe Public as investor. It wants company books to be “true and fair”, and recent debacles demonstrate why this is important.

Factors operate lower down the pecking order, but the size of the sales books they are willing to take on is growing. As Tony Cox, vice-chairman of the FDA notes, while books of £3m to £10m are standard, his members are now providing services for larger corporates.

“We are seeing lines of credit up to £100m being advanced by our large members,” he says. Indeed, FDA members recently syndicated a £160m book.

Cox and Clarke argue that factoring is regulated by default, since the vast majority of operations are owned by large banks, which are themselves the subject of regulation. Tim Corbett, marketing director at GMAC, the banking arm of General Motors, says: “In this industry, the parent stands for the subsidiary and the subsidiary cannot afford to act like a rogue and still carry the bank’s brand above the door.”

True, of course, but the argument can be reversed just as easily. Since the parents are regulated anyway, why not extend regulation to the subsidiary?

The plain fact is that, as things stand, if a factor went belly up, the industry, despite the doubtless sterling efforts of its trade body, provides no safety net for clients. There are no bonded monies put aside, no liquidity levels that have to be maintained.

What the FDA does have, as Clarke explains, is an agreement that members have to sign up to. This says that, if they raise money by giving a charge over the books they have “bought” from their customers, they have to get the lender to sign a letter which says that, if there are funds collected in from the ultimate debtors of the clients, those funds will be used to cover only the debts owed by that client.

This is the cutting edge of the FDA’s self regulation. “Every member has to give us a signed assurance on joining the FDA to this effect, and they have to renew it every time they raise money in this way,” he says.

As for risk, Corbett argues that clients of factoring companies should choose their factor as they would any other supplier, on the grounds of size, substance and track record. If you use LloydsTSB, Royal Bank or GMAC the risks are miniscule.

So does the FDA have a code of practice? “Of course,” says Clarke. May we see it? “No, it’s on our members-only website. Not for public viewing.” It’s fun, self regulation.