The provision of working capital against receivables is one of the world’s most enduringly popular financial services. As a workaday form of commercial funding, with private, tailored arrangements and low default rates, supply chain finance (SCF) has tended to operate well below the radar – until the collapse of Greensill Capital made it front-page news.
The recent failure of the Anglo-Australian SCF provider, which had been advised by the former prime minister, David Cameron, has raised questions about whether this form of finance is truly beneficial to everyone involved.
What is supply chain finance?
In its widest sense, SCF is a range of solutions that provide working capital to aid the cash flows of companies that are both buying and selling. So says Lionel Taylor, co-founder and managing director of the Trade Advisory Network, a provider of SCF consultancy and training services.
And it’s big business. The International Chamber of Commerce (ICC) reports that SCF is responsible for most market growth in trade finance. Nearly two-thirds (64%) of global banks offer such services.
But the ICC also notes that this market is beset by a lack of common understanding about what it deems “appropriate practice” in SCF. There is no definitive guidance on accounting treatments and reporting requirements either, which can lead to “boundary-pushing practices or even outright abuses”.
Greensill advanced funds against what it called “future receivables”, but the firm imploded because those receivables did not exist.
The big, bad buyer
The Greensill affair puts the spotlight on how small players in the supply chain are treated by their bigger customers. Any business will typically need to finance its purchases and other overheads before it has been paid by its customers. That is not a problem for large companies with investment-grade liquidity lines from big banks, but a stuttering cash flow can hit SMEs hard. They may find it difficult to borrow to cover their outgoings while they await payment, or have access only to high-cost credit.
“This cash flow gap can become more challenging as these businesses grow. It’s not uncommon for a banker to hear that a company that had purported to be doing well has overtraded and run out of cash,” Taylor says.
SMEs inevitably get the rough end of the deal, as slow payments are an ingrained problem, observes the national chair of the Federation of Small Businesses (FSB), Mike Cherry.
“Our members long for a world where SCF doesn’t exist,” he says. “Rather than forcing firms to borrow against invoices or sell them on for a cut of their value, we should focus on achieving a culture change, with the aim of finally putting our poor-payment crisis to bed.”
The FSB is working with the Small Business Commissioner, a public body established by the Department for Business, Energy and Industrial Strategy in 2017, to have 30 days set as the new maximum payment period in the UK.
Are big companies deliberately wringing out their suppliers? Taylor says that they would rather pay later whenever possible to preserve their working capital. But the existence of SCF does not necessarily mean that their suppliers will suffer as a result.
“As an example, a small company could get its cash after five days at a rate that reflects the credit rating of a large investment-grade company rather than their own,” he says.
What’s going on
To make this possible, banks will set up a payables finance programme for large buyers. Each programme requires much analysis of different areas of the buyer’s organisation, all of which are keen to ensure that any programme does not harm the relationships the buyer has with its suppliers, says Taylor, who adds: “It takes months to set up the right arrangement.”
One reason why the process is complex is that there are few rules governing it. The ICC wants to see a co-ordinated effort to decide on the right approach. This, it says, should involve stakeholders such as credit rating agencies, accounting firms and institutes, regulators, trade bodies, finance providers and companies of all sizes.
Even with a set of clear rules to follow, SCF wouldn’t become a simple process. For instance, banks are required to ensure that funds aren’t used for activities such as money-laundering, but this becomes more difficult if they’re dealing with SMEs on the other side of the world.
And small firms can be happy to join an SCF programme even if they find some aspects of it uncomfortable. For one thing, it makes them an integral part of the buyer’s production process – something that a big company with a just-in-time supply chain will work hard to protect. Fundamentally, it will try to pay its suppliers on time even when liquidity is tight.
Transparency and sustainability
The supportive relationship that a good SCF programme offers small firms should also enhance initiatives to improve sustainability.
The FSB wants corporate audit committees to be granted full oversight of their firms’ payment practices. This is partly so that boards adopting an environmental, social and governance agenda would have a way to ensure accountability when it comes to nurturing the supply chain.
Greater accountability is required to focus minds. But getting sustainability right depends on having all the right data to hand.
“One lesson from Greensill is that it’s incumbent on funders to do their homework and understand what they are financing,” Taylor says.
That has always been a long, costly process. But, as the internet of things enables the real-time collection of supply-chain data, SCF providers should find it far easier to track performance in many areas.
This could support the nurturing relationships the FSB wants to see. The German Banking Industry Committee, for instance, recently noted that tokenised commercial bank money could allow the use of automated ‘smart contracts’. These could trigger an immediate payment when, say, a shipment has been sent. On-the-ground data could also take liquidity right up the supply chain to the smallest firms that SCF currently doesn’t reach.
What is clear is that SCF is unlikely to go away. Smaller firms will always face the threat of liquidity gaps. Done right, SCF can benefit everyone in the chain and support sustainability. The latest technological advances promise to make all this possible.