Regulation on Criteria and Method of Risk Management for Factoring Companies

UNOFFICIAL CONSOLIDATED TEXT
REGULATION ON CRITERIA AND METHOD OF RISK MANAGEMENT FOR FACTORING COMPANIES (Narodne novine No. 86/18 and 142/22) The Regulation on Amendments to the Regulation on Criteria and Method of Risk Management for Factoring Companies (NN No. 142/22) entered into force and applies from January 1, 2023.

INTRODUCTORY PROVISIONS
Article 1.
(1) This Regulation further specifies the criteria and method of risk management for factoring companies as defined in Article 64 of the Act.
(2) The provisions of this Regulation apply mutatis mutandis to branches of factoring companies from other European Union Member States as well as branches of factoring companies from third countries.
(3) The penalty provisions of the Act apply mutatis mutandis to the conduct of factoring companies and responsible persons within factoring companies regarding the application of the provisions of this Regulation.

Terms and Definitions
Article 2.
The terms used in this Regulation have the following meanings:

1. HANFA is the Croatian Financial Services Supervisory Agency.

2. Act means the Factoring Act ("Narodne novine" No. 94/14, 41/16).

3. Customer means a business entity that is the debtor of the subject matter of factoring, i.e., the bill debtor in a factoring transaction under Article 12 of the Act.

4. Supplier means a business entity that is the creditor of the subject matter of factoring, i.e., the bill creditor in a factoring transaction under Article 12 of the Act.

5. Credit risk is the risk of loss due to the failure of the recipient of factoring to fulfill monetary obligations to the factoring company.

6. Concentration risk is the risk arising from any individual, direct or indirect, exposure to one person or a group of related persons, or a set of exposures linked by common risk factors such as the same economic sector, geographical area, or similar activities, which could lead to losses that might jeopardize the continuation of the factoring company's business.

7. Market risk represents the potential effects that external influences have on the value of assets and liabilities of the factoring company, caused by movements in financial markets. Market risks are currency risk, interest rate risk, and liquidity market risk.

8. Currency risk is the risk of change in the value of a financial instrument due to changes in foreign exchange rates.

9. Interest rate risk is the risk of change in the value of a financial instrument due to changes in market interest rates.

10. Liquidity market risk is the risk of inability to liquidate assets at an acceptable price and within a suitable timeframe.

11. Operational risk is the risk of loss due to inappropriate or incorrectly executed business processes, procedures, and failures relating to human resources or systems within the factoring company, or due to external influences or events.

12. Liquidity risk is the risk of loss arising from the current or expected inability of the factoring company to meet its monetary obligations as they fall due.

13. Financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity (in accordance with the provisions of International Financial Reporting Standards).

14. Total exposure includes exposure from factoring transactions, exposure from factoring transactions involving bill purchase, exposure from supplier factoring transactions, claims for interest, fees, and commissions from factoring transactions, exposure from other activities related to factoring transactions, exposure from deposits made, investments in securities and business shares, and other exposures carrying credit risk.

15. Exposure from factoring transactions is the total claim from the customer (due and undue) for the nominal amount of the monetary claim.

16. Exposure from factoring transactions involving bill purchase is the total claim from the customer (due and undue) for the nominal amount of the bill claim.

17. Exposure from supplier factoring transactions is the total claim from the customer (due and undue) for the amount paid to the supplier.

18. Other exposures carrying credit risk are granted (long-term and short-term) loans, other (long-term and short-term) claims, other (long-term and short-term) financial assets, investments in derivative financial instruments, and similar items.

19. Exposure to an individual person/group of related persons is the exposure from point 14 of this Article viewed per individual person/group of related persons. To this exposure is added the potential exposure to the same person/group of related persons that appears as a supplier in factoring transactions with recourse and factoring transactions involving bill purchase with recourse. If in a specific factoring transaction with recourse and a factoring transaction involving bill purchase with recourse the supplier and customer are part of the same group of related persons, only the exposure to the customer is included in the exposure. Potential exposure to the supplier is taken as claims from the supplier for the paid advance.

20. Group of related persons are two or more persons linked in accordance with the provisions of Articles 25, 26, 27, and 28 of the Act.

21. Exposure to the State is exposure to the central government, social security funds, public non-financial enterprises, and units of local government and self-government (local state), all in accordance with the sectoral classification of institutional units according to the European System of National and Regional Accounts.

22. Capital of the factoring company is the capital from Article 23 of the Act.

RISK MANAGEMENT SYSTEM
Article 3.
The factoring company is obliged to establish a comprehensive and effective risk management system in accordance with the type, scope, and complexity of its business, which must include at least:
– risk management strategies, policies, procedures, and measures, – risk measurement techniques, – monitoring and reporting on risks, – division of responsibilities regarding risk management.

Strategies, Policies, and Internal Acts for Risk Management
Article 4.
(1) The factoring company is obliged to adopt strategies, policies, and other internal acts for risk management.
(2) The risk management strategy from paragraph 1 of this Article is one or more written documents that minimally include the objectives and basic principles of taking on and managing risks and the factoring company's risk appetite. (3) The policies and internal acts from paragraph 1 of this Article for risk management constitute one or more documents that minimally include the following:
– determination of acceptable levels of risk for specific risks, – clear lines of authority and responsibility for risk management within the factoring company, – methodology for determining and measuring or assessing risks to which the factoring company is or could be exposed, – internal limits and controls and other procedures for managing and monitoring risks, including the establishment of appropriate limits, – procedures and measures in case of deviation from the application of adopted policies and procedures, – procedures and measures in case of crisis situations. (4) The strategies, policies, and internal acts from paragraph 1 of this Article must be in written form, clearly defined and documented, and available to all employees of the factoring company involved in the process of taking on and managing risks.

Determination, Measurement, and Management of Risks
Article 5.
(1) The factoring company is obliged to continuously identify risks to which it is or could be exposed in its business and analyze the causes of exposure to risks.
(2) The factoring company is obliged to regularly measure or assess the risks it has identified in its business.
(3) The factoring company is obliged to measure or assess risks based on appropriate quantitative and/or qualitative methods of risk measurement or assessment that will enable the detection of changes in the risk profile of the factoring company, including the emergence of new risks. (4) The factoring company is obliged to clearly determine criteria for decision-making and procedures for managing risks, taking into account the existing and desired risk profile and risk appetite. (5) The factoring company is obliged to appropriately document the method of risk management, including the reasons for accepting, reducing, avoiding, or transferring risk.

Monitoring and Reporting on Risks
Article 6.
(1) The factoring company is obliged to establish a system for regular monitoring and reporting on risk exposure and the risk profile of the factoring company.
(2) The factoring company is obliged to establish a risk monitoring and reporting system in such a way as to provide all relevant levels of management with timely, accurate, and sufficiently detailed information necessary for making business decisions or for the safe and stable operation of the factoring company. (3) The factoring company is obliged to appropriately monitor risks from business processes that it has outsourced to other persons.

Division of Responsibilities Regarding Risk Management
Article 7.

(1) The Supervisory Board of the factoring company is competent to give consent to the management of the factoring company on the organization of the risk management system.
(2) The Management of the factoring company is responsible for:
– establishing clear and consistent internal relations regarding responsibility for taking on and managing risks, including the demarcation of authority and responsibility between the Supervisory Board, the Management of the factoring company, and the leadership of the factoring company, – ensuring an appropriate number of employees with professional knowledge and experience in the system of managing all significant risks, – approving and periodically (at least once a year) checking and aligning strategies and policies for taking on and managing risks, – establishing general awareness of risks at all levels of the factoring company, the attitude and behavior of employees towards risk and risk management, taking into account the acceptable level of risk for the factoring company. (3) The Management of the factoring company participates in the risk management process and is obliged to actively engage in the management of all significant risks. (4) All employees of the factoring company participate in the implementation of the risk management system.

MANAGEMENT OF INDIVIDUAL RISKS
Article 8.
(1) The factoring company is obliged to adopt and implement appropriate management policies and procedures for at least the following risks:
– credit risk (including concentration risk),
– market risk (including currency risk, interest rate risk, and liquidity market risk), – liquidity risk, – operational risk.
(2) The factoring company is obliged to adopt and implement appropriate management policies and procedures for all other types of risks to which it is or could be exposed in its business.

CREDIT RISK
Management of Credit Risk
Article 9.
(1) The factoring company is obliged to make decisions on approving factoring transactions based on appropriate and clearly defined criteria and is obliged to define procedures for decision-making on approval, changes, renewal of factoring agreements, and refinancing of factoring transactions. (2) Before concluding a contract that is the basis for the emergence of credit risk exposure, the factoring company assesses the creditworthiness of the customer, and in the case of recourse factoring, the supplier, as well as the authenticity and collectability of the subject matter of factoring, and the quality, value, and marketability of the instruments securing the claims. (3) The factoring company is obliged to monitor the business of the customer and supplier and the quality, value, and marketability of the instruments securing the claims throughout the duration of the legal relationship representing credit risk exposure. (4) The factoring company is obliged to establish an appropriate and effective system for managing and continuously monitoring the portfolio and individual exposures carrying credit risk and ensure its implementation, which includes:
– management of the portfolio and individual exposures carrying credit risk, – recognition and management of problematic factoring claims, – implementation of valuation adjustments and value corrections for balance sheet and, if applicable, off-balance sheet items. (5) The factoring company is obliged to ensure that the diversification of portfolios carrying credit risk is in line with the strategy and target markets of the factoring company. (6) The factoring company is obliged to establish an internal methodology that enables the assessment of credit risk exposure to individual customers or, in the case of recourse factoring, suppliers, and credit risk at the portfolio level.

Credit Process
Article 10.
The factoring company is obliged to establish and organize the credit process in an adequate manner, which includes at least:
– the process of approving factoring transactions, in which the factoring company is obliged to assess the creditworthiness of the customer and, in the case of recourse factoring, the supplier, as well as the authenticity and collectability of the subject matter of factoring, and the quality, value, and marketability of the instruments securing the claims, – the process of monitoring claims, in which the creditworthiness of the customer and, in the case of recourse factoring, the supplier and groups of related persons with them, as well as the authenticity and collectability of the subject matter of factoring, quality, value, and marketability of the instruments securing the claims, and regularity in fulfilling obligations to the factoring company, are assessed throughout the duration of the exposure,

– analysis of the credit portfolio, which implies continuous analysis of the structure and quality of the entire credit portfolio and includes analysis of the concentration risk contained in the portfolio and assessment of future trends in the structure and quality of the credit portfolio, – handling of problematic claims, which implies defining criteria for increased levels of riskiness according to which a specific factoring transaction will be considered problematic, and handling of problematic claims that should be subject to special monitoring due to their increased level of riskiness.

Concentration Risk
Article 11.
(1) The factoring company is obliged to adopt appropriate rules for identifying and measuring concentration risk, which minimally include:
– identifying and measuring concentration relating to individual persons and groups of related persons, – identifying and measuring concentration relating to a set of exposures linked by common risk factors such as the same economic sector, geographical area, similar activities, and – identifying and measuring concentration relating to the entire portfolio of the factoring company. (2) The factoring company is obliged to adopt appropriate methodologies for monitoring and reducing concentration risk, which minimally include:
– active management of credit portfolio diversification, – determination of concentration limits.

Limitation of Exposure to Individual Persons and Groups of Related Persons
Article 12.
(1) The factoring company is obliged to adopt and, when concluding transactions that expose it to credit risk, apply at least the following exposure limitations so that the maximum exposure to an individual person/group of related persons must not exceed 25% of the total exposure of the factoring company. (2) Exceptionally, the factoring company may determine exposure limitations different from those in paragraph 1 of this Article by its own internal acts:
– for exposures to the State,
– if its total exposure is less than 66,000,000.00 euros, whereby the maximum exposure to an individual person/group of related persons must not exceed 50% of the total exposure of the factoring company, – if its capital amounts to more than 20% of assets, whereby the maximum exposure to an individual person/group of related persons must not exceed 50% of the total exposure of the factoring company. (3) The factoring company is obliged to regularly monitor and analyze exposure to ensure that exposure to an individual person/group of related persons is in line with the limitations from paragraph 1 of this Article or in line with limitations determined in its own internal acts.

MARKET RISK
Article 13.
(1) The factoring company is obliged to adopt appropriate rules for identifying, measuring, and managing all market risks to which it is exposed in its business, particularly in the part of:
– currency risk,
– interest rate risk,
– liquidity market risk.
(2) The factoring company is obliged to adopt appropriate rules for identifying and measuring currency risk, which minimally include:
– identifying and measuring mismatches of assets and liabilities by sources in specific currencies, including contracts with currency clauses, – identifying and measuring mismatches of cash flows in foreign currencies, including contracts with currency clauses. (3) The factoring company is obliged to adopt appropriate rules for identifying and measuring interest rate risk, which minimally include:
– identifying and measuring changes in assets and liabilities or the financial position of the company with regard to changes in interest rates, – identifying and measuring changes in the company's cash flow with regard to changes in interest rates. (4) The factoring company is obliged to adopt appropriate rules for identifying and measuring liquidity market risk, which minimally include:
– identifying and measuring changes in the financial position of the company with regard to the possibility of selling assets at market price and within an acceptable timeframe,

– identifying and measuring changes in cash flow with regard to the possibility of selling assets at market price and within an acceptable timeframe.
(5) The factoring company should determine an adequate strategy and measures for managing and limiting exposure to individual market risks.

LIQUIDITY RISK
Article 14.
(1) The factoring company is obliged to appropriately identify, measure, and manage liquidity risk, which includes the risk of difficulties that the factoring company may encounter in securing funds for meeting obligations related to financial instruments and securing funds for achieving the strategy and business objectives of the factoring company. (2) The factoring company is obliged to adopt appropriate rules for identifying and measuring liquidity risk, which include the identification and measurement of expected and potential cash inflows and outflows, maturity matching of assets and liabilities, and source analysis. (3) The factoring company should determine an adequate strategy and measures for managing and limiting exposure to liquidity risk.

OPERATIONAL RISK
Article 15.
(1) The factoring company is obliged to determine principles for determining and classifying operational risk events or sources of operational risk for the purposes of managing operational risk.
(2) The factoring company is obliged, within the framework of managing operational risk, to particularly cover business changes, including activities, processes, and systems, operational risk arising in project management and outsourced activities, and significant risks in existing activities, processes, and systems. (3) The factoring company is obliged, within the framework of determining and measuring or assessing operational risk, to take into account all relevant internal and external factors and to cover operational risk or events that have resulted in losses as well as operational risk to which the factoring company is exposed but has not resulted in losses. (4) The factoring company is obliged to measure or assess exposure to identified operational risk, taking into account the possibility or frequency of realization of the risk as well as the potential effect on the factoring company. (5) The factoring company is obliged, for the purpose of appropriate management of operational risk, in accordance with the Act, regulations adopted on the basis of that Act, and other regulations, to particularly ensure:
– appropriate management of fraud risk,
– appropriate management of information systems and information system risk, – appropriate management of risks related to outsourced activities, – appropriate management of compliance risk and legal risk, – appropriate management of business continuity, – establishment of an appropriate system for preventing money laundering and terrorist financing.

FINAL AND TRANSITIONAL PROVISIONS
Article 16.
(1) This Regulation enters into force on the eighth day from the date of publication in "Narodne novine".
(2) The factoring company is obliged to adopt internal acts, including strategies and policies prescribed by this Regulation, within 90 days from the entry into force of this Regulation.
(3) The factoring company is obliged to compile a Report on Large Exposures (VI) as of the date of entry into force of this Regulation in the manner prescribed by the regulation that prescribes financial and additional reports and the chart of accounts for factoring companies. (4) If on the date of entry into force of this Regulation the exposures of the factoring company exceed the limitations prescribed by Article 12, paragraph 1 of this Regulation, the factoring company is obliged to adopt a Plan of Measures and deadlines by which exposures will be aligned with the limitations from Article 12, paragraph 1 of this Regulation. (5) The factoring company is obliged to submit the Report on Large Exposures (VI) from paragraph 3 of this Article to HANFA within 30 days, and the Plan of Measures from paragraph 4 of this Article within 90 days from the entry into force of this Regulation.