Accounts Receivable Put Options protect accounts receivable if a customer files bankruptcy. The market has been around for over a decade and is used to support sales to high risk customers or customers after credit insurance has been cancelled. Basically, it provides an option to keep selling on open terms, when you normally would not.
The contracts are provided by a bank or hedge fund. They are available to protect customers that are publicly traded or with publicly traded debt (bonds).
A Receivable Put removes limitations from risk solutions provided by the Trade Credit Insurance market and limitations within Capital Markets.
While Trade Credit Insurance provides protection for receivables, it comes with many contingencies. The market is locked into traditional agreements. In addition, insurance is very conservative when protecting receivables of a single customer and require a deductible (10%+). Often companies experience credit insurance cancellations and a common complaint is that credit insurers only want the good risk and not the customers that concern you.
Limitations of Capital Markets
On the other end of the spectrum is Capital Markets including Credit Default Swaps, Short Selling, and outside investors. While these tools can be effective, most companies lack the appetite, expertise, or capital to utilize effectively. It is almost impossible to match the hedge to the receivable balance, always leaving some form of risk. In addition, they require Mark to Market accounting which is challenging for many companies to manage.
Given a gap between market demand and the solutions available, the Receivable Put Option was developed to provide a solution to protect receivables on high risk customers.
Receivable Put Option Key Features
The Receivable Put Option Market
- Several large banks are active in the market.
- Banks are financially strong and provide contracts on their company paper.
- Many companies prefer to work with banks for comfort.
- What banks provide in financial strength, they sometimes lack in flexibility. They are restricted by internal controls and regulation.
Hedge Fund Providers
- Hedge Funds are often privately held, so lack the financial transparency. However, they can hold some of the strongest balance sheets available.
- What hedge funds lack in a standardized process and financial transparency, they gain in flexibility with structuring deals and have strong contracts. They are not as restricted by internal controls.
Nearly all Receivable Put providers will ultimately hedge the risk of their contract. Hedging occurs in the background and is typically silent. We like to stress the importance of the hedging process as it ultimately drives the underlying cost you pay and availability of a Receivable Put. The single greatest factor to determine availability of a Receivable Put is an active Credit Default Swap market on your customer.
Primary Hedging Methods:
- Credit Default Swaps (CDS) – assuming there is a liquid market available
- Shorting Bonds – the provider makes money as the bond price goes down
- Investors – sourcing a 3rd party investor to take on the risk.
- None / Own Balance Sheet – if they are really comfortable with the risk.
Cost is based on a number of factors and ultimately will be different for nearly every situation. Please refer to our pricing guide or our article on Receivable Put Cost for more details.
Swift is the only consultant specifically focusing on Receivable Put contracts. Many companies learn about Receivable Put through an insurance broker. This approach typically offers little value, beyond getting a price. Insurance brokers typically lack the financial market knowledge and their compliance departments restrict them from providing any valuable advice or consultancy on an Receivable Put.
Swift is fully dedicated to the RPO market and dedicated to guiding you through the entire process.
A Receivable Put Option simply would pay your receivables outstanding when the customer files for bankruptcy. The contract typically has a limit to the maximum amount to be paid. So it would be the lesser of the outstanding receivables or the contract limit.
Yes, you can. Depending on the your bank relationships, capital, and knowledge – there is a market you can use to hedge the risk. The primary challenge with this approach comes down to three main obstacles:
BASIS RISK: Basis Risk means that the payout of your hedge does not match the amount of your exposure. Also, often times the legal entity that you buy CDS on may not match your customer.
EXPERIENCE: Purchasing Credit Default Swaps or Shorting the Bond Market are not simple trades to be executed by any treasury manager. There could be challenges with locking the trade in, counterparty risk, challenges with execution, and accounting requirements to constantly mark the asset to market value.
CAPITAL: With a derivatives instrument or complex bond trade, comes margin and collateral.
Absolutely not. There are very material differences that need to be understood and may be negotiated.
As part of our transparency, we disclose that we are paid a nominal portion of the contract price, only upon execution. We never get paid unless we find a solution that works for you. In addition, by letting us help you access the entire market of providers our results will deliver a substantially lower cost and better product.