Can tighter oversight rein in risks in Singapore's booming invoice finance market?

The industry’s unregulated nature renders investors vulnerable as revealed by a massive S$6.9m fraud case.

Investors are treading more cautiously after an unravelling $6.9m sham at a Singapore crowdfunding site laid bare the vulnerabilities and risks associated with an industry promising quick returns to growth-hungry SMEs. 

The move comes as a local news report revealed that invoice financier Capital Springboard sold around 60 fake invoices worth $6.9m to investors from Vangard Project Management (VPM), an SME specialising in interior design.

Cautionary tale
As the lion city throws open its doors to SMEs with the hopes of driving innovation and attracting international talent, a number of financing methods have similarly cropped up to meet the various capital needs of growing businesses. Obtaining financing has been cited as the fourth greatest growth challenge hounding startups, ceding only the top spots to chronic manpower problems and limited market size, according to a report from NUS Enterprise.

From venture capital and angel investing to traditional business loans to various incubator and accelerator programmes, invoice financing has emerged as another viable funding method for cash-strapped SMEs.

Also read: 1 in 5 fintech firms believe Singapore doesn't attract enough venture capital

Invoice financing enables businesses to secure cash by leveraging against the value of payments they are owed from their customers for an agreed return to investors, providing them with instantly available capital to pursue further growth opportunities. Investors assume the cost of between 70 to 90% of a business’ total invoices which works best for short period of time ranging from two weeks to a year.

Higher flexibility, easier access to funding and speedier funds provision as opposed to traditional banking loans are invoice financing’s greatest strengths, Dimitri Kouchnirenko, founder and CEO of online multi-currency invoice exchange platform Incomlend told Singapore Business Review.  

“Businesses with tight cash flows due to large receivables or long credit terms from customers usually utilise this product. Historic or existing cash balances do not matter as much as repayments are secured via payment on invoice,” added Pawel Kuznicki, CEO of peer-to-peer and invoice financing platform Capital Match.

Whereas it would take months for a traditional lender to review a facility limit, invoice financing can disburse funds often within 24 hours and borrowers often have little to no collateral to provide, Kouchnirenko added.

“A rising rate environment also makes it difficult for SME’s to acquire funding through traditional methods such as the banks and the scrupulous vetting procedures generally expose fundamental flaws in the SME’s structure,” explained Oriano Lizza, a sales trader at CMC Markets.

Also read: 4 in 5 SMEs fail financing assessments

This means that the method arguably carries less risk of default for lenders than short-term financing as the borrower has already delivered to its customers amidst reasonable expectations of being repaid.

However, the method is not entirely without risk as the unraveling fraud with Capital Springboard revealed, especially as VPM’s invoices with CS were non-notified in nature. An invoice financing of this type means that the SME did not inform its customers of its working relationship with platforms like Capital Springboard including the fact that it was tapping the financier for its funding needs. 

This method of invoice finance inherently raises the risk premium, noted Kouchnirenko, as the lender is left with little option to verify the authenticity of the invoice as it is not able to confirm it directly with the buyer. 

“Most often this could lead to the lender being exposed to fraud. Due to its highly risky nature, not only does it increase the probability of fraud but it also raises the risk premium hence the cost of financing for the borrower,” the Incomlend founder pointed out.

Capital Match’s Kuznicki similarly suggested that, whilst non-notified invoice financing is more troublesome in terms of verification, the platform is able to verify invoices as well as provide supporting documents including certified delivery orders and progress claims with the buyer to guarantee that the financing is backed by a legitimate invoice where the work has already been completed, although this is not necessarily practiced by all lenders in the market. 

Regulation and risk management
The recent fraud that took place calls attention to the relatively unregulated nature of the industry that has allowed fraudsters to slip to the cracks and take advantage of a legitimate funding method that has provide the necessary financing fuel for countless businesses in the past.

Although demand from SMEs for invoice financing has not dampened significantly, investors are proceeding with more caution amidst calls for greater oversight to prevent similar lapses in the future.

“It could be argued that a Monetary Authority of Singapore regulated company would not have got[ten] this far or even set up in the first place,” explained Lizza. “The market is somewhat regulated but not completely so this leaves it open to exploitation and abuse.”

With this case as the catalyst, MAS could possibly proceed to reduce the number of new market entrants or intensify its regulatory reach and set more stringent risk management standards to set a precedent for similar cases in the future.

Although the number of approved funding applications may diminish in the short term as a result of intensified regulatory scrutiny, the industry is poised to benefit in the long run from common basic standards and practices in place to ensure the stability and transparency of the funding process, Kouchnirenko added.

Crowdfunding platforms are similarly doing their part by ramping up their risk management capabilities. Carrying out regular background checks on borrowers, scrutinising new applicants and creating a shared database of blacklisted borrowers between platforms and traditional lenders can also do wonders to avoid multiple finance for the same receivable title, he added.

“Different lending platforms are communicating, albeit unofficially, to ensure errant SME owners are blacklisted by the various credit teams,” said Kuznicki.

For Kouchnirenko, the case is not only a timely reminder of the pitfalls of investing but also an opportunity to improve funding methods for SMEs.

“We think that the industry will be called upon coming together to improve collaboration, risk management measures and common standards. This event is an opportunity for everybody to re-think and improve the industry’s working practices and we are confident this will happen."