Liz Salecka examines some of the key messages and recommendations stemming from a new market guide, which aims to drive the economic growth and development of the supply chain finance market.
Earlier this year, the European Banking Association (EBA) published a market guide to supply chain finance in a move to iron out inconsistencies in definitions and promote wider awareness of this type of financing.
The document, which examines the risks inherent in supply chain finance, the regulatory environment and the important role of both collaboration and automation, is expected to play a role in standardising and spearheading the development of supply chain finance.
One of the key findings of the guide’s market analysis, which drew on the experiences of more than 25 bankers from banks operating in Europe, is that working capital management is now an urgent issue for suppliers, which have seen their liquidity squeezed by longer payment terms and more limited access to credit.
Supply chain finance practices, initially focused on cross-border east to west trade, have helped to address this issue, and are now more widely used at domestic and regional level to secure business continuity.
Receivables financing, which includes factoring, invoice discounting and receivables finance, is still the largest segment with an estimated 60 to 70% market share, followed by payables financing (25%) and inventory or pre-shipment finance (10%).
Despite this, supply chain finance is still seen as a niche activity that engages larger buyers and suppliers. SMEs seeking new sources of finance and liquidity have yet to fully benefit.
“In producing the market guide, we wanted to establish a common framework which banks can use to raise awareness of supply chain finance,” explains Eugenio Cavenaghi, director of trade and working capital at Barclays, who is a senior member of the EBA supply chain working group (SCWG), set up in 2011 to conduct the market study. “Banks can now use the guide to push supply chain finance to the wider marketplace, andthis should result in it being seen as less of a niche product, more established, and accessible to more players.”
The market guide examines the risks banks face when offering supply chain finance and proposes measures to manage them.
It argues that to fully understand ‘real’ risks, banks must break supply chains into individual phases, such as building the product, loading onto the ship, shipment and delivery, and then establish a risk profile for each phase.
A similar approach is also called for in relation to performance risk, which reduces as events in the physical supply chain are accomplished.
“One of the biggest issues banks face is that they cannot see into the physical supply the way corporates and their suppliers can,” explains Cavenaghi. “Supply chain finance calls for the extraction of flows of information from the physical supply chain and its provision as evidence to banks so that they can eliminate question marks over performance risk. This can then be modelled into banks’ assessment of the risk involved.”
He explains that the greatest performance risk faced by banks offering supply chain finance is that the buyer will not pay up, but that if a bank is provided with evidence of a buyer having approved invoices for example, then it can factor this into its assessment of performance risk.
“In general, the more transparent a supply chain is and the better the flow of information, the more confidence a bank will have in providing financing,” he says.
He adds that greater transparency could also have implications for the capital allocation requirements prescribed under Basel III because it will refine the way that banks model the risk involved in supply chain finance.
The market guide also discusses the role of transaction controls in monitoring transaction cycles and the location of goods, as well as the use of collateral as security to mitigate risks. Where security is available – in the form of receivables, for example – it recommends that banks take advantage of this. However, they should not rely on a security interest alone to mitigate risk, and always maintain transaction controls.
Another area of topical debate covered in the market guide is banking regulation. Here, it acknowledges banks’ concerns about the impact of Basel III and its European equivalent – the capital requirements directive IV – on both their provision of trade and supply chain finance, and the amount of finance made available to enable growth in world trade.
Although regulators have already made some concessions, further proposals are being discussed at national level in relation to the capital, leverage and liquidity requirements for trade finance including: a one-year maturity floor waiver to reflect the short-term and self-liquidating nature of trade assets;adjustment of the credit conversion factor for trade finance instruments – this would influence the amount of capital held against risk assets;separate asset value correlations for trade finance;accounting for the lower risk behaviour of trade finance under the liquidity coverage ratio.
The market guide encourages banks and corporates to make representations to regulators – and use the document to make their case. “It is a tool that both banks and corporates can use when making representations to regulatory bodies – and they can also use it to show them that the industry is fully agreed on concepts relevant to supply chain finance,” says Cavenaghi.
Not surprisingly, the market guide identifies automation and the use of a range of IT-based business tools as key enablers of supply chain finance.
The growing movement towards the e-transmission of business documents over B2B networks means that supply chain finance offerings can now be substantially automated, and take advantage of faster cycle times in relation to invoice, payment and other approvals, which trigger the provision of financing.
It also identifies e-invoicing as an important “gamechanger”, pointing out that its use alongside supply chain finance could dematerialise, and more fully automate, supply chain finance processes, ease supplier onboarding, and enable earlier invoice approval, thereby accelerating the provision of finance.
However, there are still many questions over the relevance of e-invoicing, which has yet to achieve critical mass and is offered by multiple service providers in a market which has witnessed limited standardisation.
“We have not seen much yet in the way of international standards for e-invoicing. Some countries do have e-invoicing networks at a domestic level, but there are few large established networks,” says Cavenaghi. “However, today, there is a movement towards roaming agreements between e-invoicing network operators in different countries across Europe, where there is recognition that large companies working across borders do not want to enter a contract with a different provider in every country.”
Cavenaghi believes that banks do need to play an active role in e-invoicing so that payments can be generated from e-invoices.
“However, the provision of e-invoicing services is likely to be better suited to technical solution providers. A few banks have invested in their own e-invoicing solutions, but this is not their core business and it may be better for them to partner with technology solution providers,” he concludes.
Collaboration and competition
The market guide also recognises a growing need for greater collaboration among financial institutions and other stakeholders in the provision of supply chain finance, which, to date, has taken place in a competitive marketplace. So far, industry co-operation has been limited to syndications and asset distribution.
Greater co-operation between banks on a bilateral basis can help to achieve: better geographic coverage – banks can complete transactions and understand risks in markets where they do not have a presence;four-corner models – these can help banks to serve both ends of a transaction, in areas such as payments, supplier onboarding, risk sharing and distribution.
“Collaboration is very important because corporates have been faster in their efforts to globalise than banks,” says Cavenaghi, pointing out many multinational corporations now have an established presence in more countries than banks. “At the moment there is not one bank in this world that can implement and manage a truly global supply chain finance programme.”
The market guide also identifies scope for bilateral collaboration with:third-party providers of outsourced technology and business processes; B2B networks and SCF-enabling platforms, which offer tools, technology and other value-added services.
It also calls for greater collaboration on a collective basis to ensure that the market develops to the benefit of all players in areas such as governance, regulation, standards and infrastructure development.
Aside from making recommendations for the future, and participating in actions geared at supporting the development of the supply chain finance market, the SCWG is now working on extensions and additional research, including quantification of the benefits for corporates.
One of the strongest messages presented in the EBA’s market guide is the need for greater clarity and convergence in the definitions, language and terms associated with supply chain finance – including supply chain finance itself.
It points out that a number of bodies have devised terminologies and built glossaries for supply chain finance, most notably the US-based Bankers’ Association for Finance and Trade-International Financial Services Association (Baft-IFSA), and it proposes taking these forward as the basis for further collaborative work among stakeholders.
“We first looked at the Baft-IFSA definitions to see if we could use them as a base, and decided that we needed to adjust them to provide more granular descriptions and also take on a more European feel,” explains Cavenaghi. “The definitions published in the market guide have now been sent back to Baft-IFSA for their feedback. We expect total co-operation and believe that this will help drive awareness, and use of, common standardised definitions for supply chain finance across the globe.”