The supply chain finance market is pushing ahead with efforts to restore the product’s reputation in light of the Carillion collapse last year, writes Rebecca Spong.


The collapse of UK construction firm Carillion in early 2018 saw supply chain finance (SCF) dragged into the headlines as concerns grew that failing companies were able to misuse these financing programmes to prop up balance sheets and potentially treat suppliers unfairly.

Industry bodies and rating agencies became increasingly worried that SCF schemes could allow troubled companies to hide their worsening financial situation and extend payment terms well beyond industry standards.

While many working in the industry are quick to point out the benefit SCF brings to both buyers and suppliers, there are those that are worried that the reputation of SCF could be under threat.

“The concept is great – the issue for me is that there are cases where it gets exploited,” Philip King, chief executive of the Chartered Institute of Credit Management (CICM) tells GTR. CICM is a UK-headquartered industry body that regularly works with the government to improve poor corporate payment practices.

“SCF ranges from brilliant and really good to abusive. For me, if businesses are doing it as a way of supporting their supply chain and making it more sustainable, that’s really helpful and laudable. If they are using it as a way of extending payment terms, that – in my view – can’t be right,” he continues.

King says it is an “abuse” of the system to extend payment terms so far out from the industry standard and then make the supplier pay for the “privilege” of being paid within the original terms – or earlier – via a reverse factoring programme.

This is something Carillion stands accused of doing, which has contributed to the wider confusion surrounding the benefits and pitfalls of supply chain finance.


Carillion’s demise

Carillion set up its early payment scheme in 2013 in an effort to give suppliers the option – for a fee – to receive early payment on invoices. The company was also a signatory to the UK government-backed Prompt Payment Code under which corporates pledged to pay suppliers within 60 days. The code is administered by the CICM and was set up in 2008.

In the wake of Carillion’s collapse, it emerged that the company was far from a timely payer, with hundreds of small suppliers left stranded with unpaid bills. According to industry bodies such as the Federation of Small Businesses (FSB), some suppliers reported they had to wait up to 120 days for full payment.

The stretched payment terms were reportedly brought in around the same time as the early payment scheme, leading to arguments that the reverse factoring programme was just a way for the company to detract from the fact it was extending its terms to non-standard lengths to prop up its balance sheet.

While the demise of Carillion was the combination of many factors, rating agencies were among the first to voice concerns that the use of SCF had helped mask the severity of the company’s financial woes.

Moody’s Investor Services said in March last year that the company’s reverse factoring programme had enabled it “to delay the outflow of cash to many of its suppliers”.

Carillion had not made the extent of its liability to the banks clear on its balance sheet, the agency said in a report. The company’s liabilities to banks related to overdrafts and loans stood at £148mn on its 2016 balance sheet, whereas there was in fact a possible further £498mn owed to banks under the reverse factoring scheme, Moody’s said.

Fellow rating agencies Standard & Poor’s and Fitch issued similar reports calling for more transparency in the recording of SCF programmes on balance sheets, questioning whether they should be potentially categorised as debt.

Carillion was not the first company – and is unlikely to be the last – to face questions about its SCF programme following financial difficulty or insolvency.

A few years prior, in 2015, rating agencies raised concerns about the Spanish energy group Abengoa, which faced financial problems and ultimately a restructuring of its debt. It had also been running a large reverse factoring scheme, which agencies said had “debt-like” features.

With insolvencies on the rise – a report in February from credit insurer Atradius points to an expected 2% growth in bankruptcies in Western Europe in 2019 – the need to learn from Carillion and ensure SCF programmes are used in a more sustainable and transparent way is becoming more urgent.


Industry response

There are already signs the SCF industry and wider business community is taking steps to minimise the damaging repercussions of the Carillion scandal.

Omar Al-Ali, partner at law firm Reed Smith tells GTR the industry will likely consider the introduction of restrictions on the ability of large buyers to push out their suppliers’ payment terms to non-standard lengths.

In the UK, the FSB is at the forefront of lobbying efforts to improve payment practices and ensure that more publicly-listed corporates sign a strengthened Prompt Payment Code.

In light of the rating agencies’ concerns, the market will also be pushing for greater accounting transparency, says Al-Ali. “Companies’ accounts may have to make it clearer that SCF or other receivables purchase arrangements exist so that it is clearer to creditors that debt-like obligations exist that may not be being treated as debt,” he explains.

Trade finance industry body, the International Trade and Forfaiting Association (ITFA), has had discussions with rating agencies in an effort to persuade them not to view all trade payables as debt, and has developed guidelines entitled Payables Finance: What can we learn from the Abengoa and Carillion experiences? for the industry to help banks and other finance providers assess whether SCF programmes are being misused.

The guidelines, released last October, outline various warning signs or “red flags” banks should keep an eye out for, such as the extension of payment terms far beyond industry norms and the relative large size of programmes compared to the size of other liabilities owed to banks.

ITFA wants to ensure that the Carillion incident remains an anomaly, avoiding a situation where a negative light is cast on all programmes and they become subject to blanket accounting treatment and categorised as debt.

“ITFA believes it is important to provide an impartial guide to SCF facilities in light of recent events, and in particular around how multiple organisations – from the financing banks to the client’s auditors and the rating agencies – should consider programmes on their individual merits rather than taking a ‘one size fits all’ approach,” says Paul Coles, chair of ITFA’s market practice committee.

Sean Edwards, ITFA chair, adds that as SCF providers look to offer their product to more mid-market corporates, it is even more important to ensure it is being used correctly.

“Some very difficult but far from insurmountable questions around accounting for SCF have been asked in the light of Abengoa and Carillion. Banks and multilaterals are now very seriously looking at pushing down payables finance to smaller buyers so it’s crucial to understand that this technique is perfectly legitimate and workable if the right balance is found. Our paper shows a route to that,” he says.


Ethical SCF and reputational risks

The Carillion collapse has led to some lenders questioning the extent of their obligation to suppliers if a buyer enters financial difficulties, a London-based lawyer, who wishes to remain unnamed, tells GTR.

“Because you’ve got a mechanised automated system, it all happens online on a platform. When an insolvency happens and you want to stop the process, you are not always clear where the process has stopped. If a discounted rate has been quoted already, is the bank committed to discounting and must it take the hit on the invoice? Or is the bank in a position to say ‘we haven’t agreed that yet’,” she says, recounting similar queries posed by her clients.

In such situations, lenders will need to make a call on whether it’s worth the reputational hit they could face in the mainstream media if they were to pull the plug on a SCF programme leaving small companies stranded, or to go ahead and take the financial loss of paying invoices.

It is vital to get to grips with why a buyer wants to use SCF in the first place to minimise reputational risk, says Eric Balish, head of corporate trade sales, UK & Ireland, at Bank ABC.

“When analysing any request to participate in a customer’s supply chain programme it is important to understand their motivation and objectives. A key consideration is whether the term or term extension being contemplated is in line with industry and market standards,” he says. “This is not just a matter of potential supplier impact and ensuing reputational issues for both buyer and possibly the banks supporting the proposal. It may be that the term is viewed as excessive and may well be indicative of more fundamental trading issues where there is poor or inadequate cash generation from their trading activities.”

The notion of being fair to all parties involved is even more relevant in today’s environment, Balish says. “The essence of a good SCF programme is where both the cohort of suppliers and the buyer operating the facility believe the arrangement is equitable and that the advantages promoted at inception of the original proposition are realised,” he explains.

This move to ensuring SCF is ‘fair’ is demonstrated by buyers becoming less focused on only using SCF to improve their days payable outstanding (DPO) measure, Balish says. “Whilst the DPO metric remains important, the requirement to nurture the supply base has become ever more important. The connections between provenance, ethics, quality and consistency of delivery from supply chain partners are essential to business and corporate reputations.”


Educating the market

The long-term reputation of SCF will rely on better education among banks, suppliers, buyers and the general public, says CICM’s King.

“The problem is that some commentators are saying SCF is inherently bad and it should be stopped. But when it is used properly it is a powerful tool. They [the suppliers] could pay a lower interest rate which is better than paying for an overdraft with the bank. There is a real lack of understanding about what it is and how it works,” he says. “We just need to get clarity out there. The banks can play a role in that. We need to call out the bad schemes but avoid tarring any SCF programme with the same brush. That’s a challenge.”

While credit rating agencies have recognised the efforts made by banks to ensure buyer-clients are more transparent, they argue there is still more to be done. In a statement given to GTR, Moody’s says: “We are in regular contact with banks and corporates and explain our analytical views. Banks (especially arrangers of the programmes) have indicated that they encourage their clients to disclose the programmes, and we generally see a trend of improving disclosure by corporates. Nevertheless, some corporates still provide very little information about their programmes. High and increasing trade payables are the main red flag, and we encourage corporates to explain the underlying reasons for this.”

Al-Ali says he is “not convinced” that the SCF industry will substantially change – or if it even needs to. “Buyers will continue to set up reverse factoring programmes and suppliers will continue to make use of them without any change,” he says, noting there may be some shifts in the accounting practices.

“We should not lose sight of the fact that unless things go wrong, these programmes do not just benefit the buyer; they also benefit the suppliers, as they allow suppliers to be paid almost immediately – at a small discount – rather than having to wait; as even without a SCF programme in place, large buyers would almost invariably insist on deferred payment terms,” he says.

Despite the controversy around SCF, Balish reports that client appetite remains “undiminished”. “We see this as a growth area alongside intelligent use of receivables financing,” he says.

For the market to continue to flourish, it is increasingly evident that the industry must engage in a wider educational process to ensure the benefits of SCF as sustainable means of managing working capital are fully understood.