Liz Salecka examines the supply chain finance model of the future.
While many banks have traditionally relied on a three-corner approach to the rollout of global supply chain finance programmes, increased attention is now being focused on four-corner models, which engage the supplier’s bank, as well the supplier, buyer and the buyer’s bank.
Already, this is being seen as an important move towards not only alleviating supplier onboarding and know your customer (KYC) issues in overseas markets, but one which will help to spearhead the growth and development of the supply chain finance market.
“When an industry wants to reach a level of maturity and grow, the four-corner model is a must,” says Andre Casterman, global head corporate and supply chain markets at Swift. He believes that that the four-corner model has already proved its worth in industries such as e-invoicing and mobile communications where it has enabled service providers to expand their geographical reach. “Working together can help competitive providers of a service to grow their businesses.”
At Bank of America Merrill Lynch (BofAML), Chris Bozek, global head of trade and supply chain finance products, explains that while the deployment of three-corner models is expected to grow in line with demand for supply chain finance, the four-corner model will be appropriate in select circumstances.
“There needs to be a compelling reason to take a four-corner model approach. A global bank needs to look at the gaps that exist and consider whether using the supplier’s bank will help it to deliver a programme more quickly and more cost-effectively because this approach does add more complexity,” he says.
Lloyds Bank, meanwhile, is a firm supporter of the four-corner approach, attributing this primarily to the way it can help ease the supplier onboarding process.
“We always consider the four-corner model because when it comes to rolling out large, international supply chain finance programmes it is our belief that not one bank, including the global banks, can offer an optimal global solution,” says Rene Chinnery, head of supply chain finance at Lloyds, who identifies the optimal solution as one in which a single, well-known bank in a particular market takes on responsibility for onboarding large numbers of local suppliers. “You cannot onboard large numbers of suppliers in a market where your name is not that well known – even if you have a presence in that market.”
He adds that this makes the four-corner model particularly suitable for emerging markets. “In Africa, it is often the case that large numbers of suppliers have never heard of, nor understand, supplier financing and this means that they are suspicious of getting involved,” he says, explaining that if this type of financing option is presented to these businesses by their own banks, or a well-known local bank, such concerns can be eliminated.
First contact
Adoption of the four-corner model is also expected to improve the provision of pre-shipment finance to suppliers, which is often seen as risky by many global players.
While suppliers may often want access to pre-shipment finance, this requires the bank to do an assessment of the performance risk presented by the supplier.
“This is not something that large buyers’ banks can do as they do not have relationship managers in overseas markets,” says Casterman. “However, once a buyer’s bank engages with a supplier’s bank, it can make buyer-side commitments to that bank, enabling the latter to extend its financing proposition to the supplier. In this scenario, the performance risk involved is managed by the supplier’s bank.”
He adds that in many cases suppliers are mid-caps or SMEs and want to work with their local banks, maximise on these relationships and take advantage of their proximity. “They do not want to become clients of four or five different large global banks selected by their large corporate buyers.”
The four-corner model also brings benefits in other areas. There may, for example, be legal, regulatory or tax issues that impede a global bank’s ability to make early payments to suppliers in certain countries, and in this case, the supplier’s bank can step in to effect those payments.
While supplier onboarding adds costs, compliance risk has also now become a greater priority for banks, and in a three-corner model, banks currently need to perform KYC on the suppliers they are onboarding. “By partnering with a local bank, a global can leverage on that bank’s documentation, its skills in supplier onboarding and the KYC processes it has in place,” says BofAML’s Bozek.
This is also acknowledged by Deutsche Bank, which relies primarily on its own network when rolling out global supply chain finance programmes, but recognises the logic in working with local banks.
Rick Striano, global head of trade finance project management, global transaction banking at Deutsche Bank believes that a “partner bank” approach will become more important in future given the growing size of programmes and the amount of capital required.
“Additional reasons for partnering with other banks can be the strength of a particular bank in a certain region and their knowledge and relationships in the counterparty region or client segment. This may streamline the effort of KYC requirement sor onboarding topics,” he says.
The final frontier
However, the engagement of suppliers’ banks in supply chain finance programmes also brings its challenges. Their involvement adds greater complexity and necessitates good communication and co-ordination between more parties.
The lead bank must also enter a risk and reward sharing agreement that does not impede the overall economics of the transaction with each supplier’s bank.
“The first thing that two banks have to be clear about is what type of service will be provided by the bank engaged, and the reward it can anticipate,” confirms Chinnery, pointing out that Lloyds typically allows suppliers’ banks to share in programmes by means of participation or syndication so that they can also generate returns from the provision of some of the financing.
Bozek, however, notes that there is more likely to be a fee related to the additional services provided by suppliers’ banks.
“There may also be an opportunity for risk sharing, although this is more applicable to receivables financing,” he says. Here, he explains that as in a supply chain finance programme the risk is structured on the buyer, and the global bank will be comfortable with that risk. A local bank in another market may not have that same level of comfort.
Meanwhile, Striano believes that the inclusion of suppliers’ banks in a programme can bring technical challenges in areas such as technical integration, as well as business and commercial issues, such as the standardisation of agreements to ensure consistency.
“Finally, there is the open variable of client experience and satisfaction, which is particularly complex because there is always a risk of something going wrong somewhere in the chain, which you may not control, but which can have a material impact on the client,” he says.
However, one of the biggest hurdles to engaging suppliers’ banks in supply chain finance programmes relates to the number of local institutions that those suppliers bank with.
“If there are 10 different suppliers in a market, the global bank may need to build relationships with 10 different counterparty banks,” says Bozek.
Lloyds’ Chinnery confirms: “Where there are thousands of suppliers in a market that bank with a large number of different banks, the four-corner model can become too complicated, and most banks find this type of scenario unmanageable. The best way to handle it is by using a partner bank that is well-known in the country to do all the onboarding.”
The next generation
While the four-corner model approach to supply chain finance typically refers to the engagement of suppliers’ banks, global banks rolling out programmes in new markets have another route open to them: to use their own regular partner banks, based in those countries which can provide the local market expertise required.
Bozek notes that the second option is attractive because it provides a global bank with a manageable number of counterparty banks to work with in different markets.
Meanwhile, Deutsche Bank, which leverages on its own global footprint to provide supply chain finance services across multiple markets, also acknowledges a role for correspondent banking partners.
“In the context of certain supply chain finance solutions like confirmed payables, for example, we can service the majority of our client needs through our own network,” says Sharyn Trainor, global head, financial supply chain product management, who believes that this approach enables the bank to deliver a consistent and uniform service and process. “For products like the bank payment obligation (BPO) or import or export letter of credit, the correspondent banking network creates an excellent pool of capable, qualified and trusted partners. Finding the right balance between competition and collaboration will be a success factor in future supply chain finance propositions for banks and corporates,” she says.
Other banks want to develop their own partnerships with strong local counterparties in certain markets. “At Lloyds, we do want to see our business develop in this way, and are looking to build relationships with local banks in target countries that offer supplier financing themselves, understand it well and can onboard suppliers,” says Chinnery.
Nevertheless, cost factors may inhibit the scale of the correspondent banking models that global banks pursue.
“It is likely that many global banks will look to rationalise the number of correspondent banks they work with at country level to reduce compliance costs and the maintenance costs of these relationships. However, this does not mean that there will be a reduction in business flows – just a decrease in the number of these relationships,” says Casterman. “However, suppliers in overseas markets can always switch to a correspondent bank that is actively involved in the provision of supply chain finance – or move part of their business to that bank to benefit from its fast-mover approach.”
Four-corner models and the BPO
While four-corner models have a place in the rollout of global supply chain finance programmes, they are also integral to BPO transactions geared at enabling the provision of early finance to suppliers.
“The BPO can play a prominent role in the viability of four-corner supply chain finance programmes by helping to standardise the rules of engagement between the buyer’s bank and the supplier’s bank,” says Bozek at BofAML, explaining that it may remove the need to negotiate bilateral agreements with suppliers’ banks, which can take a lot of time.
There are strong suggestions that greater use of the BPO to facilitate the provision of supplier financing via their own local banks could reduce the need for supply chain finance programmes, which call for the intensive job of supplier onboarding. Instead, large buyers may opt to instruct their banks to issue guarantees in favour of their suppliers. However, this is still open to debate, and is likely to depend on a number of factors such as the size of the suppliers, the size of their local banks and both parties’ readiness for BPO transactions.
“The BPO provides an important opportunity but it is only one part of the many solutions available in the supply chain finance offering,” says Chinnery.
A BPO transaction is unlikely to make much sense when multiple, smaller suppliers in a particular market need early access to finance. “It is more appropriate where a single large supplier to a major buyer needs access to finance,” he adds.
However, Casterman believes that as the BPO secures widespread market acceptance, it will be used more frequently to enable the provision of early finance to smaller companies.
“Small suppliers can also benefit from BPO transactions, but we do need to increase their awareness of it,” he says, noting that a few SMEs in Asia have already taken advantage of BPOs – and by using traditional paper-based processes – to secure faster payment. “There is also still a way to go with improving BPO awareness among the counterparty banks that these smaller suppliers use, but in some countries, such as Thailand, local banks have taken major steps forward.”
He points out that global banks too will realise benefits from BPO transactions. “I do not see downsides with this type of financing for banks representing large buyers because instead of charging suppliers for their services, as is the case in supply chain finance programmes, they receive fees from the suppliers’ banks.
The total cost is also lower as there are no supplier onboarding or KYC costs.”
