Money to Survive, Money to Thrive

April 18, 2021

By Roger Atwood

  • Businesses in Peru were hit hard by the pandemic, especially SMEs.
  • By bundling their accounts receivable to investors, known as “factoring,” small businesses have been able to attain much-needed financing.
  • Through the Joint Capital Markets Program (J-CAP), the World Bank and IFC are helping such financial innovations take root in Peru.

The COVID-19 pandemic hit Peru with ferocity. The economy faced one of the biggest pandemic slowdowns in the world—significantly worse than the country’s 1989-90 economic collapse. Lima’s bustling markets were shuttered, tourism evaporated, and for a time the country had the highest COVID-19 fatality rate in the world.

Businesses in Peru were hit hard, especially small and medium-sized enterprises (SMEs) who already struggled to get financing from banks. The pandemic caused SME revenue sources to evaporate. Freddy Rojas, whose company, Inversiones Rojas SAC, sells rice, sugar and other foodstuffs on contract, wasn’t sure how he was going to keep his five employees on the payroll, with lending rates typically between 18 to 20 percent.

Prior to the pandemic, World Bank and IFC experts joined forces under the Joint Capital Markets Program (J-CAP) to find innovative solutions to provide SMEs in Peru with alternative avenues to financing through local capital markets. They also supported the Peruvian government in the implementation of a new factoring law that was introduced in 2015. Known as the “Regulation of Factoring, Discounts, and Factoring Companies,” the law allows small businesses to sell their accounts receivable at a discount to a third party in order to free up working capital and meet immediate cash needs, a process known as factoring.

Through J-CAP, IFC started supporting a local fund manager, Compass Group SAFI, in the expansion of its SME factoring fund. The fund provides critical working capital to Peru’s SMEs at affordable interest rates, allowing these businesses to better manage their business cycles and overcome problems, such as short-term demand contractions or supply and payment delays.

Once the pandemic hit, the J-CAP and Compass program morphed into an emergency plan to inject survival capital into companies whose revenue sources suddenly evaporated. The SME receivables fund would operate alongside the government’s own aid package, but, like such plans in many countries, had proved inadequate to the scale of the crisis.

"The loans that have allowed me to survive this crisis were on the basis of monthly invoices. I was able to turn them into capital."

Through this program, Freddy Rojas received the equivalent of nearly $90,000 through factoring, at interest rates averaging about 3.5 percent, “which for Peru is extremely low,” he said. Factoring invoices helped Rojas keep his five employees on the payroll. “The loans that have allowed me to survive this crisis were on the basis of monthly invoices. I was able to turn them into capital,” said Rojas.

Last September, IFC invested $21 million into the fund managed by Compass, known as Fondo de Inversión Adelanto de Efectivo, or Cash Advance Investment Fund. The fund provides crucially needed working capital to Peruvian SMEs at interest rates well below prevailing commercial rates. Borrowers can also get advice on investments through an IFC technical support program.

So far about 1,900 businesses have gained access to working capital through the fund, according to Jorge Díaz Echeverría, general manager of Compass Group SAFI in Lima. These businesses receive money through factoring, in which they sell their accounts receivable to the creditor, which can then collect on the invoices or sell them to another party. The original clients—which are typically too small to get conventional bank loans—get a quick infusion of cash and are spared the labor and time consuming process of collecting on outstanding invoices, which so far have had an average value of about $3,300, according to Díaz.

“The point was to give some liquidity to SMEs at affordable prices. It wasn’t designed for the pandemic, but it has functioned very well to get businesses through the pandemic. It’s as if the pandemic were testing the fund to show the clear need for it,” said Díaz.

IFC’s investment into the factoring fund would not have been possible if Peru’s financial markets had not been maturing and improving steadily over the last decade. Compass has been offering factoring capital in Chile and elsewhere in South America since about 2004. Once Peru’s capital-market regulations were brought in line with those in Chile, Compass was in a good position to offer the high-volume, low-denomination payouts associated with that system on a much larger scale in Peru than previously possible.

“The change in the regulatory framework was important because it gave legal status to invoices, and therefore much more value,” said Díaz.

As an outgrowth of these and other changes, Peru’s capital markets have been growing steadily in volume and complexity. The Lima Stock Exchange’s total market capitalization reached $143 billion in November 2019, up from about $98 billion five years earlier. In 2014, the exchange merged with financial services company Cavali to expand its range of instruments and broaden its appeal to global investors. One of the improvements implemented by Cavali was a system for trading digitized invoices known as Factrack, which allowed for the expansion of factoring.

“Peru has developed the market infrastructure that can support this kind of instrument,” said Ana Fiorella Carvajal, a finance expert at the World Bank who has been involved in the J-CAP program. For IFC to join Peru’s factoring market, she explained, “certain preconditions had to be met—well-developed capital markets, a base of sophisticated investors, the appropriate tax and regulatory frameworks. Those things exist now.”

“All the ingredients are present in Peru, including the presence of an intermediary,” said Ivy Figueroa, the IFC Senior Investment Officer who has worked together with Compass on the investment. Compass, a regional leader in factoring, “aggregates those thousands of receivables, allowing institutional investors to participate, including pension funds which are sitting on very large cash amounts and looking for diverse investable assets,” she said. The resulting financial instrument “acts as a bridge, or an aggregator, between SMEs and institutional investors, since SMEs would not normally have access to pension funds and pension funds would not normally be interested in this kind of small, short-term product.”

Once the pandemic is past, J-CAP’s venture into Peruvian factoring will continue to mark a new approach to its longstanding commitment to building up SMEs as engines of employment and equitable growth in the emerging and developing economies.

Published in April 2021