Historically, supply chain resilience has always been a priority for businesses of any size. However, climate change and the consequent drive towards sustainability in supply chains has added further urgency and potential cost. Amit Agarwal, MD and group head of open account trade products and trade risk distribution, Global Transaction Services at DBS Bank, highlights some innovative ways of addressing this challenge efficiently and economically.

 

Supply chain finance and resilience are intrinsically interlinked and as a result are a common point of discussion among banks, corporate treasuries and procurement teams. Procurement teams look to create solutions and embed technology that will assist in minimising any supply chain disruption. This in turn requires capital or transactional expenditure, for which they look to corporate treasury, with banking partners stepping in to provide support as required.

To date, most emphasis and focus has been on providing cost-effective working capital financing to support suppliers and thereby maximise supply chain resilience. However, this is changing due to the impact of climate change and sustainability requirements on resilience, which is driving a need for additional forms of financing – plus banking partners capable of the innovation to deliver them.

Meeting sustainability demands: the rise of mezzanine/transition finance

One example of these additional financing needs relates to new sustainability requirements that large corporates are increasingly demanding of their suppliers. For suppliers to comply with these sustainability requirements, they will need to make capital investments or regular expenses to obtain third-party certifications. Such increased cash outlay can be supported by mezzanine or transition finance provided via a trilateral arrangement across supplier, corporate customer (the anchor client) and bank. This is an important extension to traditional working capital finance, but uses the same basic model of leveraging the credit differential between the supplier and customer (in an established or ‘sticky’ trading relationship) to provide discounted funding at more competitive rates than the supplier could access on the basis of their own balance sheet.

The holistic resilience benefits of combining this new mezzanine/transition finance with conventional working capital supply chain finance are considerable. However, delivering this combination requires thorough technology integration, but very few banks have picked up on this point and so are still unable to offer integrated production solutions. While there are some opportunities currently available for micro-SME suppliers via various trade platforms, these are very small-scale niche solutions that are insufficient for the supply chains of large corporates.

There is therefore still a pressing need for mezzanine/transition finance in situations where mid-sized corporate suppliers need to satisfy the sustainability requirements of large corporate customers. In Asia (excluding Greater China), this need is compounded as local currency interest rates are higher than those for US dollar (for example, the Indian rupee or Malaysian ringgit). In these situations, midmarket corporate suppliers can gain a significant arbitrage benefit on their costs for mezzanine/transition finance along with working capital finance for amounts of up to approximately US$2mn equivalent per supplier (as per DBS supply chain programmes). The bank has already piloted mezzanine/transition financing schemes of this type with several suppliers in the apparel and textile industry.

Addressing supply chain bottlenecks: structured inventory financing and risk-specific financing

In addition to mezzanine/transition finance, another key element in building supply chain resilience is the ability to address major inventory bottlenecks, as well as satisfy more specific risk management requirements. The aftermath of the pandemic and the start of the war in Ukraine saw a logjam in goods available for manufacture. In order to minimise the risk of a recurrence of this issue and to ensure the smooth transition of manufacturing along the supply chain, there has been a growing trend towards holding higher inventory buffers.

Depending upon the relative size of participants, two distinct market practices usually apply. Larger suppliers are typically reluctant to hold additional stock on behalf of a smaller buyer, which is where innovative inventory financing comes into play for the buyer. However, if the supplier is smaller than the buyer, they may be willing to hold the goods on the buyer’s behalf for future inventory usage, but they will factor the cost of this into their pricing.

There is also the situation where climate-related risk directly affects a key supplier: for instance, where a primary manufacturing site is now in a floodplain when it wasn’t previously. This might cause a key buyer to demand some form of additional contingency manufacturing capability elsewhere. Alternatively, it may be that the supplier will simply not be able to service the buyer’s future demand without additional capital expenditure on manufacturing capacity. In fact, this is becoming an increasingly common issue for original equipment manufacturers (OEMs) across multiple industries as climate-related disasters become more commonplace. In both cases, this is a situation where a suitable banking partner can leverage a large buyer’s credit rating differential to support its suppliers’ enhanced inventory levels at attractive lending rates.

Speeding up financing: timelines and technology

Collectively, these changes drive a need for greater speed and efficiency in the financing process. For a bank with a highly structured methodology for delivering working capital financing, supplier onboarding can take as little as perhaps 15 minutes, with live transactions potentially happening within 24 hours. While mezzanine and transition financing are not as transaction intensive as traditional working capital finance, they obviously still require due diligence and regular disbursements. Under certain circumstances, this process can be streamlined. For instance, if the anchor client flags candidate suppliers as A-grade and they also satisfy certain sustainability criteria, then a combined checklist for both transition and working capital finance may be applicable, rather than an independent credit analysis of the supplier. So from time to market and ease of process perspectives, the turnaround time and experience can be significantly superior to most banks’ traditional silo-bound alternatives.

However, other factors will also influence the timeline. Account opening and document execution can vary widely due to local jurisdiction, such as whether a physical in-branch wet signature is required, as opposed to online digital completion. Another factor here for both working capital and mezzanine/transition financing is the availability of technology resources at the anchor client for integration. While the technical processes involved may be quite straightforward, the need for sufficient testing, when only limited resources are accessible, can slow things appreciably.

There are few obvious trends here, with the situation typically being corporate-specific, rather than always relating to company size or industry. However, in terms of acceptance of technology types, there are some very clear distinctions.

For example, anchor clients based in China are typically comfortable dealing with using APIs for bank connectivity, whereas elsewhere the preference remains very much for host to host.

Looking ahead: sorting practical application from hype

The situation mentioned earlier regarding attitudes to API and host-to-host connectivity is a reflection of a wider reality in supply chain finance. While various future technologies and concepts may attract extensive column inches and excitement, the reality for global trade is whether or not there is an immediate practical application; in many cases, there either isn’t yet or only in a highly localised manner. For example, deep-tier financing has seen a lot of enthusiastic commentary over several years, but apart from China (which has it in place), it hasn’t gained much traction elsewhere. A combination of limited industry knowledge and in some cases also local regulation have proved durable obstacles. Blockchain presents a similar picture: there has been plenty of discussion, but apart from tackling duplicate financing or ecosystems with multiple participants, as yet limited practical application.

However, there are some technologies with potentially widespread application.

A case in point is generative AI, which has various possible use cases and has also prompted some major tech companies to incorporate it into their ERP systems. As yet, much of the focus has been on using it to improve the quality of physical inventory processes, such as warehouse management. However, by leveraging process improvements and transparency, it also potentially has a role to play in areas such as inventory finance. As we move forward, strategic integration of practical technologies will be the catalyst for unlocking new opportunities and shaping the future of supply chain finance.

All in all, the need for supply chain financing is broadening and increasingly reflects industry changes around demands for digitalisation and sustainability coupled with swift implementation. DBS has already embarked upon this journey with a growing number of clients who are benefiting from technology-led advantages over other banking alternatives.