FACTORING IN BRAZIL

- AABHAS KSHETARPAL, ROLL NO.: 856, V SEMESTER, B.B.A. LL.B. (HONS.), NATIONAL LAW UNIVERSITY, JODHPUR

FINANCING ACTIVITY IN BRAZIL – IN TERMS OF NUMBER OF

COMPANIES

Finance Companies Leasing Companies Factoring Companies0.00

100.00

200.00

300.00

400.00

500.00

600.00

700.00

800.00

Finance Companies;

39.00

Leasing Companies;

71.00

Factoring Companies;

717.00

FINANCING ACTIVITY IN BRAZIL – IN TERMS OF NUMBER OF TOTAL

LOANS (BILLIONS)Finance Companies

Leasing CompaniesFactoring Companies

0.00

20.00

40.00

Finance Companies;

4.60

Leasing Companies;

11.60

Factoring Companies;

27.40

EVOLUTION AND DEVELOPMENT

Factoring, known in Brazil as ‘fomento mercantil,’ is a service activity that includes ongoing advisory work on credit, risk, accounting, inventory, and working capital management, in tandem with the irrevocable purchase of credit rights, in the form of receivables that arise from the sale of goods or services with a typical maturity of 30 to 60 days.

There are an estimated 717 known factoring companies in Brazil, which provide services to more than 65,000 small and medium enterprises.

Eighty percent of these enterprises belong to the industrial sector, with a monthly turnover of around US$1 billion.

Brazilian enterprises obtained about US$10 billion (R$27 billion) as creditor rights resulting from mercantile sales, representing 6 percent of all domestic sources of financing.

This figure constitutes an impressive increase of around 50 percent over 1998 (US$7 billion, R$19 billion).

Brazil’s factoring companies are located mainly in the Southeast (51 percent), South (21 percent), and Northeast (17 percent), with more than 250 in the state of São Paulo alone.

SECTORS ACCOUNTING FOR FACTORING ACTIVITY IN BRAZIL

Metallurgic Industries;

22.00%

Services; 15.00%

Printing Industry; 14.00%

Sugar-Alco-hol Indus-

tries; 3.00%

Other In-dustries; 15.00%

Commerce; 6.00%

Chemical Industries;

1.00%

Textile Indus-tries; 2.00%

Trans-portation; 34.00%

PRICING INTEREST RATES AND THE PURCHASE FACTOR

The cost of a factoring operation has two components: a fee for the provision of services and

the price, or the ‘purchase factor,’ for the purchase of receivables.

The fee for the provision of services is fixed ad valorem.

The purchase factor is the price paid for the sale of a credit right.

Factoring companies use as a base the ‘factor ANFAC’ (Associação Nacional das Sociedades de Fomento Mercantil; Brazilian Factoring Association) to quote the price of factoring services in Brazil.

The factor is published daily and varies with the money market or certificado de depósito bancário (bank certificate of deposit; CDB).

The components of the factor ANFAC include the opportunity costs of resources, assessed in terms of the CDB rate, operational costs, taxes, and expected profits.

The purchase factor varies with industry conditions and the creditworthiness of the customer.

AN ILLUSTRATION The purchase factor was more than twice the interbank lending rate in

February 2003, at 4.4 percent per month (67.7 percent per year equivalent), compared to the prevailing CDB interest rate of 1.83 percent (25.7 percent per year equivalent).

As expected, this was also higher than the prevailing average bank discount rate for commercial invoices, which was 58.5 percent per year at the same time.

Factoring companies point out, however, that this rate is effective and final, while banks’ effective interest rates are higher, as other bank charges are added to the rate, such as a credit issuance fee, a price for receivables, overheads, retention of a percentage of the loan’s value, product sales, and so forth.

However, many of the factor’s clients may not be able to obtain lower rates through bank discounts or any other formal financing.

FACTORING VERSUS BANK SERVICES — CONTRAST AND

COMPLEMENTARITYFinancial Intermediation

Factoring

Credit operations No credit operations, but purchaseof credit rights (receivables)

Obtains funds from the public to invest in credit operations by means of financial intermediation.

Only operates with resources not collected from the public; no financial intermediation.

Remuneration consists of interest rates for the use of capital during a period of time.

Remuneration does not have an interest rate or discount rate but the payment of a price for the sale of services and the purchase of credit rights.

Financial Intermediation

Factoring

Needs authorization from the Central Bank (Law No. 4595/64) to operate.

Is not a financial intermediary; a commercial activity that only operates with legal persons; does not require authorization from the Central Bank.

Operates with legal persons and individuals.

Only operates with legal persons or professionals that are considered to be legal economic entities.

Profits are generated by means of a spread between financing and credit interest rates.

Price includes all cost items (market interest rate, operational costs, taxes) and the expected profit and risks.

Factoring normally uses the negative credit information systems of the two principal private credit bureaus of Brazil, SCI (Segurança ao Crédito e Informações; Credit and Information Security) and SERASA. Factoring companies are both users and producers of information.

As a result of these differences, factoring has several benefits over funding from bank loans

First, funding can be obtained more rapidly. Second, for the provider of credit, the exposure is

limited to the amount of invoices issued to the seller, and the creditworthiness of the seller is less important.

Third, this allows for companies in legal difficulty to borrow from factors, because factoring depends on the creditworthiness of the seller’s customers.

On the contrary, banks do not have an incentive to lend to firms in financial distress, as this could imply a higher risk classification of the loan and would mean higher capital requirements.

Under the prevailing bankruptcy law, unlike factors, banks have not been permitted to operate with companies in receivership.

Fourth, it is clear that factoring will have considerably higher implied rates of interest than bank loans, but this can be explained largely by the composite nature of services provided, the need for much closer client scrutiny and knowledge, and the limited sources of finance available to the factor, who must rely largely on internal resources.

REGULATION Challenges to the legitimacy of factoring are

compounded by suspected illicit activities of some firms, which have been known in particular to offer services outside their legal scope.

For example, deposit taking or loan provision. One of the main objectives of ANFAC, the factoring

company trade association, is to delimit factoring from other activities, sometimes illegal, of financial intermediation, without the required approval of the Central Bank, or grant loans at usurious interest rates under the name of ‘factoring.’

ANFAC has agreed on a model of factoring contract (contrato de fomento mercantil) to be used by its associates, has issued a Code of Ethics (Código de Ética e Auto-Regulação), has approved a set of General Rules for Factoring Operations (Regulamento Geral das Operações de Fomento Mercantil)

In 1999, reached a Technical Cooperation Agreement (Acordo de Cooperação Técnica) with the Economic Law Secretariat of the Ministry of Justice (Secretaria de Direito Econômico do Ministério da Justiça).

The agreement has three basic objectives: (1) to recognize and preserve factoring as a means

of supporting productive activities, (2) to protect affiliated companies by means of a

‘qualification and quality’ certification, and (3) to establish a system of technical cooperation

with the Federal public administration to prevent the emergence of illegal activities under the guise of factoring. ANFAC has been petitioning strongly for a specific factoring law to help eliminate illegitimate activities and protect its members.

TAX REGIME First, factoring companies, unlike banks, do not pay interest, as

there are restrictions against their access to funds from third parties in the market. Thus, they cannot deduct from their income any interest expense, and taxes affect them more heavily. This tax burden is passed to clients as the additional costs of factoring services.

Second, as they undertake commercial transactions to purchase receivables, the tax note, invoice, and duplicata (credit right) associated with such sales must be issued.

The commercial transaction is subject to the Imposto de Circulação de Mercadorias. Law No. 5474/68 (Article 20) allows service providers to issue invoices and commericial invoices representative of their rights.

Next, the service provider is subject to a tax on services, the Imposto sobre Serviços (Tax on Services; ISS), which is locally collected with a tax rate varying from 0.7 percent to 5 percent, depending on location.

Sometimes, factoring companies are asked to collect the ISS on overall revenue (service provision plus revenues from purchase of receivables). An additional charge, the COFINS (Contribution for the Financing of Social Security) tax, does not take into account the dual nature of factoring activities, and the tax base includes both the revenues for service provision and the revenue for receivables purchase.

Third, factors are taxed in the same way as banks in terms of financial transaction taxes.

Another indirect tax, the Imposto sobre Operações Financeiras (Tax on Financial Operations; IOF) on financial transactions, which was established by Law No. 9532/97 for credit operations of financial intermediaries, includes factoring companies in its scope (Article 58), although factoring companies are not financial intermediaries.

Moreover, factors complain that they should be exempted from the IOF tax.

On the other hand, credit transfers (cessão de créditos) between financial intermediaries or between financial intermediaries and leasing companies are not subject to the IOF (Decree 2219/97, Article 8, VII), and factors do not benefit from this. These appear to be contrary to principles of equality of tax treatment.

INTERNATIONAL FACTORING

International factoring in Brazil is undeveloped, especially relative to the large size of the domestic factoring sector.

The most significant obstacle to the development of international factoring is that factoring companies in Brazil are not allowed to hold foreign-currency accounts.

Thus, they are not able to make advances to the exporter in the currency of their invoices, which introduces exchange rate risk. It would thus be difficult to serve the export community without involving commercial banks.

If conditions for permitting international factoring could be eased, export companies could reduce their risks. Italy and the United Kingdom have extensively used factoring to involve SMEs in export activity.

In Latin America, countries such as Mexico have also begun to engage in international factoring.

In contrast, in Brazil, exports are carried out by big companies with more access to financial services from conventional financial intermediaries.

TURNOVER FROM FACTORING IN THE AMERICAS AND THE WORLD

Argentina

Brazil

Chile

Mexico

United States

Rest of the World

0.00100000.00

200000.00300000.00

400000.00500000.00

Argentina; 1715.00

Brazil; 12012.00

Chile; 2650.00

Mexico; 5030.00

United States;

120000.00

Rest of the World;

497323.00

THANK YOU. ANY QUESTIONS?