Previously only accessible to large, investment-grade businesses, supply chain finance is now a reality for the mid-market, offering growth and partnership opportunities for international trade and investment, writes Neil Ross, Regional Manager EMEA Trade Credit at AIG.
With global supply chains extending further and deeper than ever before, businesses around the world are faced with new opportunities to increase their participation in the world economy. Supplier firms have the opportunity to expand their footprints into new markets, driving growth and creating jobs in their local economies. Meanwhile, large buyers have access to a wider choice of goods and services, alongside more competitive pricing. The opportunities for collaboration, growth and expansion are greater than ever before.
But financing this expansion has been a challenge in recent years, with banks often reluctant to lend due to concerns over risk and regulations – not to mention the recent restrictions placed on them through Basel III. This has made it difficult, if not impossible, for many businesses to capitalise on global trade opportunities.
Compounding the problem is the fact that suppliers don’t always receive payments in a timely fashion.
A YouGov poll commissioned by AIG and PrimeRevenue found that over three quarters (77%) of UK companies have been asked to accept longer payment terms, with 28% saying the issue has increased in the past year.
Yet, the longer it takes for a supplier to receive payment, the more risk the supplier bears and the harder it is to fund operations. A lack of cashflow is the death knell to any global trading relationship, with neither buyer nor supplier prepared to take the risk.
Supply chain finance comes of age
Supply chain finance offers an innovative solution, enabling buyers to optimise their payment terms, while offering suppliers early payment – freeing up valuable working capital for both parties. While the concept isn’t new, it has previously only been available to large investment-grade businesses, with funders (usually banks) unprepared to risk their investment on businesses with a lower credit rating. This has put smaller mid-market players – and their network of suppliers – at an immediate disadvantage.
But this is now changing, with an innovative online and credit insurance-backed solution – Supply Chain Finance from PrimeRevenue and AIG – reaching a much wider span of businesses. Designed for firms with revenues from around £100mn, the solution promises to ease global trade by providing a ready source of funding across the supply chain, increasing efficiency, flexibility and minimising risk.
How does it work?
Supply Chain Finance from PrimeRevenue and AIG is the product of a partnership between a leading global insurer and the largest working capital finance platform in the world. The solution provides funds that enable suppliers to take early payment less a small discount, while enabling buyers to standardise and potentially lengthen their payment terms. This means low-cost access to working capital on both sides of the transaction, via an intuitive, secure and reliable technology platform.
The solution is able to cater to mid-market, non-investment-grade companies, as the credit risk is insured by AIG’s market-leading trade credit insurance, removing the credit risk for funders.
The financing requirement is organised by PrimeRevenue Capital Management, offering investment opportunities to banks and non-bank entities looking
for stable returns.
Building sustainable global supply chains
Supply Chain Finance from PrimeRevenue and AIG has the potential to revolutionise global supply chains, contributing to a more streamlined, lower-risk and more collaborative approach at all levels.
Highly complex supply chains have always been prone to using capital inefficiently, with each level of the chain sourcing funds independently and with costs, fees and charges mounting at each stage. In fact, studies have shown that funding required can be two to four times the end user sales price of the product, because of overlapping financing needs of successive parties in the supply chain, according to HSBC’s Guide to Cash, Supply Chain and Treasury Managementin Asia Pacific 2012.
Supply chain finance solves this problem through ensuring that suppliers can be paid more promptly, reducing the need for expensive bank funding or overdraft extensions, thereby reducing the costs for all involved. This, in turn, reduces risk along the chain, ensuring suppliers are able to fulfil orders and meet targets, while decreasing the likelihood that they will get into financial difficulty or go out of business in the future.
This approach can also contribute to delivering a more collaborative supply chain, enabling buyers and suppliers to work more closely together in areas such as demand and logistics planning, to maximise effectiveness. This is the holy grail for global supply chains, maximising efficiency, quality and customer service. In a competitive marketplace, the ability to support and work together with your key suppliers is invaluable.
Introducing supply chain finance can also help buyers to streamline administration around payment terms, avoiding the need to negotiate these on a case-by-case basis and improving consistency and transparency across suppliers. This makes managing early payment discounts much simpler, as these no longer need to be handled and processed individually – freeing finance teams to focus on more strategic priorities.
Low risk, high yield for funders
It isn’t just supply chains themselves that can benefit from this new way of working. By offering working capital finance to the mid-market, Supply Chain Finance from PrimeRevenue and AIG also offers a new opportunity to funders looking to maximise return on their investments.
The market for supply chain finance is very large and growing. A 2015 report from BCR Publishing estimated a growth rate of 30% per year, plus a total worth of €43bn (US$46.5bn) for funds currently in use. This is growth that can no longer adequately be served by commercial banks with new regulations, balance sheet constraints, limited funding capacity, and less availability of overall credit, making it hard for them to meet corporates’ ever-growing requirements.
Not least of these concerns is Basel III, the reform measures designed to improve risk management and resilience in the banking sector. By forcing banks to retain a certain level of capital on their balance sheets, the measures are restricting lending – and the pressure is likely to get worse. New rules due to come into force in 2019 mean the capital retained will be on average 40% higher than current levels – according to recent reports from The Basel Committee on Banking Supervision – potentially restricting lending even further.
These developments open the way for non-bank lenders to enter the working capital finance market and with new solutions, such as Supply Chain Finance from PrimeRevenue and AIG, the opportunities look more attractive than ever.
Understanding return relative to risk is essential to all investments. With most supply chain finance products historically aimed at investment grade buyers, any concern over credit risk is resolved and mitigated by the financial strength and payment obligation of the buyer. As a result, default rates on account receivables have been very sustainable – between 2005 and 2010, only 0.03% of trade finance transactions defaulted worldwide1.
The transparency provided by specialised platforms further reduces default risks. For example, funders using the PrimeRevenue platform have experienced zero default across all its supply chain finance programmes, with US$120bn-worth of invoices processed. With Supply Chain Finance from PrimeRevenue and AIG, the higher credit risk of funding mid-market, non-investment-grade businesses is fully mitigated through AIG’s Basel III-compliant trade credit insurance – this gives further assurance to potential funders.
In terms of the yields, with interest rates on most short and long-term investments currently at almost zero, the difference with working capital finance can be staggering. A Wall Street Journal (April 16, 2013) article highlighted that Procter & Gamble’s supply chain finance programme is financed at 1.3% over base rate, compared to just 0.1% for a comparable commercial paper. This combined with virtually zero default, makes it a win-win for investors.
An opportunity for brokers
A final group who are set to benefit from the rise in supply chain finance are trade credit insurance brokers. While highly skilled and knowledgeable in advising clients on insurance, feedback from AIG’s broker community has highlighted an increasing client expectation for broader financial advice and a more lateral understanding of their business needs. Supply Chain Finance from Prime Revenue and AIG is therefore welcome, giving them a vehicle through which to broach these conversations and help their clients in a different way.
Working capital is the fuel that drives global supply chains, enabling investment in growth and expansion for the future. But for a long time, there was a disconnect: mid-market companies and their suppliers needed funding, while non-bank funders wanted a low-risk, high-yield investment opportunity in a market and system monopolised by the larger institutions. Now there’s another way: enabling businesses to power innovation and growth, while giving funders another route to investment.
It really is a win-win-win.
About Supply Chain Finance from PrimeRevenue and AIG
Supply Chain Finance from PrimeRevenue and AIG provides funds that enable suppliers to take early payment less a small discount, while enabling buyers to standardise and potentially lengthen their payment terms. This provides low-cost access to working capital on both sides of the transaction.
Until now, supply chain finance platforms have been limited to supporting the largest, investment grade businesses. Supply Chain Finance from PrimeRevenue and AIG is able to cater to the thousands of mid-market, non-investment grade companies, by providing financing with the credit risk insured by AIG’s market-leading trade credit insurance.