A new European Union directive that places a cap on the length of payment terms for EU-based buyers and suppliers looks set to generate demand for supply chain finance. Liz Salecka reports.
A new EU directive geared at combating lengthy payment practices and boosting the cashflows of European SME suppliers comes into effect in March, bringing with it expectations that more organisations will turn to supply chain finance.
Already, many banks across the region are witnessing growing demand for supplier financing solutions from both public sector bodies and corporates keen to maintain their existing payment terms but ensure that their suppliers are paid on time.
“Generally, it is the large corporate buyers that can make the biggest impact in terms of the amount of cash released to SMEs, but this will trickle down to the mid-sized sector too. In many cases, steps have already been taken in this direction, and there has been a noticeable effect,” says Adnan Ghani, head of transaction services origination, UK at RBS.
“Supply chain finance is a tested way of getting cash to SMEs who benefit from their relationship with big buyers, but it does not, in any way, impede or add to the costs faced by larger buyers.”
The extent of the EU late payments directive’s impact on the payment terms practised by corporates and public sector bodies in individual European member states – and the timing of any measures they take to meet its requirements – is expected to vary.
In the first instance, there are major national differences in the existing payment terms and practices that prevail across the EU. While payment terms already tend to be within 30 days in some parts of central Europe, longer terms are more typical in southern European countries, such as Italy and Spain. In Italy, for example, payment terms can stretch for up to 180 days for suppliers to public sector bodies.
“In countries such as Germany and Austria, many organisations already make payments within 30 days so for them the directive does not bring any significant changes,” says Markus Wohlgeschaffen, head of global trade finance and services at UniCredit.
There are also concerns that meeting the directive’s requirements may not be given the same level of priority by organisations in some EU countries.
“This directive has largely been taken into cognisance by corporates across the EU. However the level of importance attached to it, and also preparedness for implementation, is extremely varied,” says Raj Subramaniam, product strategy and marketing, Global CASHplus at Fundtech. “Many corporates are yet to approach this internally as a focused project, whereby additional working capital needs to be made available for payment within the 30 or 60 day period.”
Wohlgeschaffen adds: “Some countries may understand what the directive is saying, but this is not the first time in history that a directive of this kind has been introduced and, on the whole, meeting its requirements will prove cumbersome.”
In Italy, where the SME sector is large and made up of relatively small SMEs, a strong dependence on public sector body contracts already makes it difficult for these suppliers to dictate payment terms. This may constrain their ability – and will – to take action against large buyers should they, on a case-by-case basis, fail to meet the directive’s requirements once it is fully implemented.
“If you are an SME with contractual arrangements to supply a public sector entity, it is clear who the stronger party is,” explains Wohlgeschaffen. “If you have a top client, which may be your main or only client, and they generate a lot of revenue for you, taking any type of action can prove very tricky.”
There are also historic issues that have contributed to lengthy payment terms in some countries. Many SME suppliers in countries such as Italy, for example, do not stipulate payment terms in their invoices and this underpins the practice of delaying payments.
“In some countries, there are no maturity dates on the invoices sent to public sector bodies. This means that when an SME issues an invoice, it is paid when the public sector body concerned decides to pay it,” says Wohlgeschaffen, pointing out that supply chain finance is beneficial here because it introduces a maturity date.
However, the late payments directive has been welcomed by some national governments, which see it as an important means of speeding up and securing cashflows for SMEs in a more difficult financial climate.
The UK government is publicly very supportive of its requirements.
“The UK government has been quite active and public in its efforts to get cash to the SME sector so that the real economy can grow,” explains Ghani, pointing out that large corporate UK buyers are already being actively encouraged to make faster payments to SMEs. “When the UK government looked at the availability of cash to SMEs, it found that about £160bn was tied up in late payments.
“In our experience, a lot of UK companies are now open to dialogue about the situation. It may not have been at the top of their agenda, but they are now engaging in this.”
Ghani points out that the UK government generally pays its own suppliers very quickly, and that at a national level this can be within a week of receiving an invoice. However, in the current economic environment, supply chain finance can prove very beneficial to these public sector bodies too.
“We have already seen a greater interest from UK government bodies in solutions like supply chain finance – which was not really there before,” he says.
Large corporates to lead
There is a general consensus, however, that large EU-based corporates that already have a strong awareness of the implications of lengthy payment terms will take the lead in implementing supply chain finance solutions to ensure suppliers are paid on time.
“This stems back to the financial crisis of 2008/09 when corporates themselves realised the importance of ensuring steady cashflows – both for themselves and their own suppliers,” says Wohlgeschaffen. “Corporates today are also less vertically organised and more horizontally organised and as a result they rely on key relationships with suppliers in different countries. They have to take due care that there is no disruption in their supply chains and secure the cashflows of strategically important suppliers. This makes the need for supply chain finance indisputable.”
Fundtech’s Subramaniam also believes that many EU corporates are now exploring the use of supply chain finance, but notes that many larger organisations already have spare cash available in investments.
“On a case-by-case basis corporates will look at utilising supply chain finance if they need liquidity, or else deploy their idle cash instead, which is earning relatively low yields, to meet payment terms,” he says.
“This is an opportunity for financial institutions to highlight the benefits of supply chain finance in meeting corporate liquidity needs at minimal cost. The directive will help in giving supply chain finance an initial boost, but continued usage and sustained growth will depend on the ability of financial institutions to offer the service to corporates who are in need of liquidity at interest rates that are cost-effective.”
Banks shift focus
While the late payments directive will help drive take-up of supply chain finance across Europe, it is only one of a number of factors that is expected to facilitate future growth.
“Although Basel III stretches out to 2019, banks need to be prepared for it – and one of its biggest implications is a reduction in their provision of pure working capital loans to businesses. Banks are now focusing more on their transaction banking businesses – and the provision of supply chain finance is a key element of that,” explains Wohlgeschaffen at UniCredit. “The bank payment obligation (BPO), once it receives authentication from the ICC Banking Commission, will also boost the use of supply chain finance techniques.”
Banks’ ability and willingness to offer supply chain finance also remains positive.
Ghani at RBS points out that the amount of supply chain finance that RBS has provided so far in comparison to other facilities is still relatively low. “As long as trade finance is a core product to a bank, the provision of supply chain finance represents an interesting and exciting opportunity,” he says, noting: “Supply chain finance is also more attractive to offer because it is lower risk than other types of facilities and funding.”
This is also emphasised by Wohlgeschaffen, who points out that the provision of supply chain finance represents a change in banks’ lending strategies – as opposed to an add-on facility.
“There is a clear evolution in transaction banking finance as opposed to the provision of working capital facilities,” he says.
“If a bank is providing a credit facility to a supplier, this will depend on its credit capacity for that supplier, which will be based on the supplier’s rating – and this is unlikely to be as strong as that of the buyer.”
Here he explains that although the amount of credit offered by a bank to an SME in a supplier financing programme does not change, the risk involved does, and a bank can hence (leaving all other aspects unchanged) not only provide the supply chain finance facility required, but take on more risk and make more finance available.
“If a bank can improve the quality of its business then it can provide more liquidity than before. Supply chain finance is not an add-on product – what it provides for a bank is a way of shifting the risk involved from the supplier to the buyer and a way to improve the quality of its portfolio.”
However, that is not to say that banks will always ‘go it alone’ when offering supply chain finance.
“Looking forward, as banks grow, their supply chain finance portfolios and the size of facilities grow. Partnerships will become more prominent,” says Ghani, pointing out that RBS already actively enters partnerships with other banks to deliver such solutions.
“Many corporate clients are also encouraging banks to join forces to diversify funding risk, guard against putting their eggs in one basket and to enhance their bank relationships.”