In Brazil, an innovative regulatory environment is set to create new markets for receivables. So what does this mean for fintech?
By Leonardo Lanna
Note: This piece was originally published in Tech Crunch on August 17, 2021. You can read the original post here.
Something strange is afoot in Brazil, and it promises great changes for how merchants get paid. It’s a story about one regulator — the Brazilian Central Bank — and how it has taken center stage in creating a framework that will have far-reaching effects across merchants and the fintechs that serve them in this fast-growing Latin American nation.
But first, a history lesson: In Brazil, unlike in the rest of the world, when a credit card is used for payment, the merchant does not receive the funds owed to them all at once. Instead, nearly 50% of card sales are completed in monthly installments, leaving the sellers to manage a difficult cash flow process that is unparalleled elsewhere. The most common solution for merchants is that they end up selling the remaining receivable at a discount — taking less than they are owed — in order to get their funding sooner. And we’re not talking about a small-volume market: some R$ 2 trillion (Brazilian Reais) in card transactions were processed in 2020.
Here’s what this looks like in practice: Let’s say Maria purchases a few articles of clothing from retailer Clothing Incorporated. When paying via her credit card at checkout, Maria can choose to pay in two to twelve installments. Maria decides to pay the balance of R$620 over six installments.
While Maria is happy with the products in hand, Clothing Incorporated is without the full payment — and for small merchants in particular, the difficulties associated with limited working capital can be acute. Clothing Incorporated can either wait the full six months to be paid, receiving payments from their merchant acquirer each month until they are paid in full, or they can choose to dramatically discount the amount they are owed and not have to wait the six months. Let’s say Clothing Incorporated merchant acquirer is ExMarko — instead of receiving R$620 over six months (net of any merchant discount rates), they could receive R$520 within days after the purchase, with ExMarko pocketing the rest when it comes in. This comes at a steep cost of doing business to the merchant, with an implied annualized interest rate that sometimes can reach ~50% — for a risk-free operation, since the acquirer is only liquidating earlier its own obligation to pay the merchant.
Receivables financing has been prohibitively expensive in Brazil for one primary reason: until earlier this summer, sellers could only discount their receivables in a relationship with a single receivables buyer (or acquirer), as in the above example — there was no competitive marketplace for them to use to get the best discount for the receivables they were selling. This relationship historically put the seller at a distinct disadvantage; they needed capital, the buyer set the terms (sometimes 50% or more), and that was that. But not anymore.
All of this changed in early June with the Brazilian Central Bank’s move to create so-called “Registration Entities.” Today receivables acquirers now must register all of a merchant’s receivables into a Registration Entity, which enables any interested receivables buyer/acquirer to make an offer for those receivables, forcing buyers to become more competitive in their discount offers.
This means that Clothing Incorporated can sell their receivables to anyone who would like to purchase them, which is expected to drastically improve rates for merchants.
If you think, “well, that’s a cost of doing business if you have to sell your receivables to get cash now,” that’s true. But the inefficiencies created by such high rates are undeniable, and undoubtedly were part of the driving force pushing this new regulation into being. As in the example above, many acquirers were effectively charging 50% (or more!) interest rates for an earlier payment that is essentially risk-free for them. Of course one should consider the cost of funds that the acquirer must incur to be able to settle this payment before the due date, but this cost is nowhere near the rates the merchants would find in the market.
This compelling new regulatory framework brings new opportunities for many players willing to participate in the financial revenues involved in receivables discounting operations. Think about it: The existence of Registration Entities can ultimately provide for other financial operations, serving as verification of receivables collateral for other merchant loans, or even proof of quality customers. It’s a gateway to other financial services.
The dominance of acquirers such as Rede, Stone, Cielo, SafraPay, and PagSeguro, as well as CIP (a consolidated financial infrastructure player that has become a Registration Entity) has now been invaded by new players such as Cloudwalk, receivables marketplaces such as Spike, and new Registration Entities such as CERC and B3, as well as many others in the Brazilian Central Bank’s approval process. Indeed, these are exciting times for fintechs in Brazil.
B3 is arguably Brazil’s most important market infrastructure and Latin America’s largest stock exchange. Fernando Bianchini, products associate director at B3, says, “The market recognizes our solid know-how as a financial assets and securities trade repository, and we are now broadening our portfolio to provide a new infrastructure for credit card receivables. We are aiming for greater transparency, security, and development in this segment, which among other things should translate into reduced spreads on transactions using receivables as collateral.” Bianchini also notes that the exchange is uniquely attuned to the specific business model requirements of individual clients, and is taking that into account in building its customized solution.
“We see the new regulation as a win for business owners, who have historically been hamstrung by a system that provided few options to the merchants selling their receivables,” says Jonathan Whittle, a venture capitalist who is co-founder and Managing Partner at global fintech VC firm Quona Capital, which invests heavily in Latin America. “The old system dramatically slowed growth for both merchants and the Brazilian economy as a whole.”
It’s a win that applies to pretty much everyone except the traditional receivables acquirers. It opens the door to a plethora of opportunities and new business models, from payments to credit. Removing transactional friction, providing transparency, and bringing the hard costs of discounting receivables down to a fraction of what it’s traditionally cost merchants should be a boon to the economy overall.
“We’re beginning to see innovation taking place with credit card receivables registration at its core in the fintech startup world,” adds Whittle. “Everything from facilitating low-cost B2B payments to collateralized working capital loans is up for grabs; it’s an exciting time in Brazil.”
It’s rare to think of regulation as truly driving innovation, but in this case, it’s happening. The market is changing at a fast pace, becoming much more competitive, and ultimately, it’s a move that will dramatically improve merchants’ funding costs while helping to boost the Brazilian economic recovery. And that’s the kind of regulation that we can all applaud.
Leonardo Lanna is head of payment products at Monkey Exchange, a Brazilian marketplace startup that enables sellers to offer receivables from sales in a single platform to many buyers at once, receiving the best price with low effort. Before joining Monkey, Lanna worked for more than a decade in the financial industry structuring financial products. Lanna now brings his expertise in credit card receivables to the Monkey team, which has introduced its own new credit card receivables platform, called Spike.