Financial Services and Markets Bill

Lord Leong Excerpts

Committee stage
Tuesday 21st March 2023 Grand Committee

Moved by

[Lord Leong]

241E: After Clause 71, insert the following new Clause—
“Regulation of factoring companies
(1) Within one year of the passing of this Act, the Secretary of State must by regulations make provision for factoring companies to be regulated by the FCA.(2) Regulations under this section are subject to the affirmative procedure.”Member’s explanatory statement
This new clause would bring factoring companies, those which provide, arrange or facilitate invoice discounting or factoring, into FCA regulation.

[Lord Leong (Lab)]

My Lords, I rise to speak to Amendment 241E in my name. Start-up and scale-up businesses, especially small and medium-sized business, occasionally face the issue of managing their cashflow, especially when expanding. Traditional funding through banks has diminished since the 2008 financial crisis and often, in looking for a more flexible, less onerous solution, businesses look to factoring or invoice-discounting companies. I used many factoring companies when I started my businesses and when we ran into a bit of a cashflow situation.

The model for this is straightforward: the factoring or discounting company pays the client typically 80% to 90% of the value of invoices they have raised for goods or services supplied and then either assumes responsibility for the debt itself or bills the client for the amount given, plus a percentage fee, when the invoice is settled by the customer. This enables the client company to operate and expand with limited capital. It effectively does not have to wait for the normal 30, 45 or, in some cases, 60 to 90 days settlement period, which is typical for larger companies and many public sector organisations. This model is typically used in sectors with long payment cycles that require the purchase of goods or raw materials to create products and in international transactions.

However, there has been considerable growth in this sector in recent years due to the uncertainties and disruptions caused by the pandemic, Brexit and the war in Ukraine. Like any well-run financial services, when times are good, such arrangements are mutually beneficial, but if the financial crisis of 2008 has taught us anything—and I hope it has—it is that the money ultimately must come from somewhere, and problems with financial instruments often become apparent only when things go wrong.

Factoring as a concept has existed for a very long time, but its use has grown rapidly in recent years. UK Finance, the collective voice for the banking and finance industry, maintains an independent standards framework setting out and enforcing standards for its members that clients can expect from providers of invoice finance or asset-based lending. However, companies do not have to become members to operate in this sector. This is why I have tabled Amendment 241E as a probing amendment. There are concerns that factoring and invoice discounting risk becoming a scandal for small businesses equivalent to the payday loans rip-off for consumers. Unscrupulous companies can obfuscate fees, and interest rate charges of 2% to 4% for a period of 45 to 60 days seem low but equate to 18% to 24% per annum, which is a relatively expensive way to finance a business in the medium to long term.

Many companies offer their service “with recourse”, which asserts the lender’s right to be paid their fee even if the customer defaults on their invoice. This means that small companies could become liable for fees and interest charges on invoices that they have never been paid if, for example, their customer goes bankrupt. This is a rising concern, as there has been a sharp rise in insolvencies in the past 18 months and we are approaching levels not seen since the 7,000 insolvencies per quarter at the peak of the 2008 financial crisis, with almost 5,995 declarations of insolvency in the quarter ending January this year.

Dependency on the factoring model can develop; debts which have been purchased by a factoring company cannot be counted in the company’s balance sheet when applying for other financial products such as a bank loan. There is a danger that a company may find it difficult to move on to cheaper and long-term finance. There are a lot of companies operating in this space and, while many are entirely credible and reputable, we must recognise that, without FCA regulation, small businesses particularly are at risk of being exploited or taking on excessive fees or risks in their eagerness to survive and grow.

Of course, we cannot mitigate against all risks. As the very well-known fellow book publisher and former Member of this House observed, “Events, dear boy, events.” We know from recent history that clear, strong and effective regulation, such as that which can be provided and enforced by the FCA, can prevent excess and exploitation, and help us build a stronger economy in turn, with the passion, flexibility and innovation of SMEs at its heart. I beg to move.

--- Later in debate ---

[Lord Harlech (Con)]

My Lords, I thank the noble Lord, Lord Leong, and others noble Lords for their contributions on this amendment headed “Regulation of factoring companies”.

As noble Lords know, invoice factoring is a type of invoice finance where suppliers effectively sell their invoices at a discount to a finance provider in exchange for an advance. This means that suppliers can receive payments sooner, helping them to manage cash flow. Invoice factoring is an important product for British businesses, helping them to grow sustainably when they might otherwise struggle to do so. It is a relatively standardised product designed to help businesses manage their cash flow and support growth.

Businesses benefit from a diverse finance market made up of high street banks, smaller banks and a range of non-banks to ensure that they can continue to access suitable finance. This is particularly important to ensure that UK SMEs are accessing finance to support their goals and contribute to the UK’s growth agenda. We have discussed the approach to regulating small businesses in an earlier debate but, as noble Lords know, invoice factoring is not considered credit, because it is an advance on invoices already generated; therefore, any small businesses using these products do not benefit from protections such as those under the Consumer Credit Act, which apply to the smallest businesses taking out loans.

However, invoice factoring is generally used by larger SMEs that would not benefit from protections under the Consumer Credit Act in any case. UK Finance estimates that its members advanced invoice finance and asset-based lending facilities to just 35,000 firms in 2022, representing less than 1% of all UK businesses; in comparison, according to the SME Finance Monitor, 36% of SMEs—nearly 2 million of them—were using external finance in 2022.

However, the Government believe that businesses using invoice finance are well protected in other ways. The banking and finance industry has recognised that businesses should be able to use invoice factoring with confidence, so has taken steps to ensure that businesses have adequate protections. UK Finance members, representing between 90% and 95% of invoice factoring by volume, are subject to a standards framework and code, which set the standards that firms should meet when supplying invoice factoring facilities. They include an independent complaints process focusing on the requirements of those smaller businesses using invoice factoring, which might otherwise be reluctant to raise concerns about their treatment. For invoice factoring among larger firms, these businesses will have the financial and legal resource available to take action through the courts.

Bringing invoice factoring into regulation would likely increase costs for businesses. This would negatively impact the ability of these businesses to manage their cash flow in a flexible, cost-effective way at a time when it is important that they have the confidence to invest and expand. There is a fine balance between the costs and benefits when bringing activities into the regulatory perimeter. It requires careful consideration to ensure that there is an appropriate balance between several factors, including ensuring that consumer protection is in place and that businesses are allowed to innovate.

Overall, the Government believe that the current approach—enforcing standards through industry bodies and voluntary codes while facilitating innovation and competition—is more likely than new regulation to drive positive outcomes for businesses that rely on invoice factoring. I therefore ask the noble Lord, Lord Leong, to withdraw his amendment.

[Lord Leong (Lab)]

I thank all noble Lords who have kindly supported this amendment. Access to finance is vital to start-ups and small companies; it is one way in which they can easily get money without any security. The number of small companies that have to resort to factoring invoice discounting is on the rise because banks are becoming more and more demanding as far as security is concerned. As I said in my speech earlier, my amendment is a probing one. I want to take this opportunity to ask the Minister this: can we do some more work to see how many companies access this form of finance and how many companies go bust because they cannot afford to pay some of the rates that are being asked by these companies?

On that basis, I beg leave to withdraw my amendment.

Amendment 241E withdrawn.