The supply chain finance industry is approaching a crossroads. Though widely touted as a way of freeing up cash for corporates and their suppliers alike, the practice faces growing pressure from authorities over accusations of misuse and lax disclosure rules. Coupled with better data sharing and analytics, some SCF providers say it is time for the product to change, writes John Basquill.
“I think the days of supply chain finance, as it stands today, are very much numbered,” says Lex Greensill, the Australian entrepreneur who founded London-based supply chain finance (SCF) provider Greensill in 2011.
“It will be replaced with a newer model that is based on big data, and I think that tectonic shift is going to impact all players in the market,” he tells GTR in an exclusive interview. “We’re just at the very earliest stages of that.”
SCF programmes vary widely, but typically involve a bank or other intermediary paying suppliers’ invoices early, at a discount. In reverse factoring arrangements, that provider can also allow the buyer – often a large corporate with a strong credit rating – to extend their payment terms by weeks or even months.
When they work well, these programmes can benefit all parties. The buyer can hold onto its cash for longer, freeing up working capital, while the supplier receives funds much more quickly than through traditional invoicing. For the financial intermediary there is ample opportunity to collect commission, fees and interest payments, as well as data.
However, critics say that is not always the case in reality. In Australia, the ombudsman for small businesses has accused large corporates of pressuring suppliers to join SCF programmes and claimed financial intermediaries are using artificial intelligence (AI) to extract excessive returns from smaller firms. In the US and elsewhere, calls are growing for buyers to disclose their use of SCF in company filings after concerns it can be used as a way to obscure their true financial position.
Industry representatives insist incidents like those are rare. The Global Supply Chain Finance Forum, a group representing five influential trade associations, said in a February discussion paper that “such cases … are not representative of how payables finance programmes are used by the majority of buyers and sellers in mutually supportive supply chains”.
But with the SCF sector facing the possibility of new disclosure rules, restrictions on payment terms and even investigations on competition grounds, suggestions that the product itself needs to evolve are growing louder.
Payment terms and supplier “bullying”
The Australian Small Business and Family Enterprise Ombudsman (ASBFEO), an independent authority that protects the interests of the country’s 2 million SMEs and micro-enterprises, published a controversial position paper in February 2020 that argued the government may have “little choice but to regulate” the use of SCF.
Many suppliers leapt to the defence of such programmes. A paper published by Greensill in March included testimonies from two of its supplier customers; one said access to 10-day payment terms “saves our cashflow and our sanity”, while the other said it can offer better payment terms than its competitors due to its “consistent and predictable” revenue streams.
But ASBFEO said it had uncovered “unacceptable” cases of buyers arbitrarily delaying payment to suppliers – increasing terms from 30 to 45, 60 or even 90 days – before offering a discounted payment on their original terms.
The report had an immediate impact. Two large Australian companies – metals and mining firm Rio Tinto and telecoms giant Telstra – each announced within days that they would restrict payment terms to 20 days, for invoices of up to A$10mn and A$2mn respectively.
However, industry representatives dispute whether there is a direct link between supplier bullying and SCF itself.
Supply chain finance is designed to benefit both parties. The supplier has the option to receive payment early while the buyer is providing low-cost liquidity to strengthen their supply chain. “Whether the supplier elects to use the early payment option doesn’t benefit the buyer directly,” Bob Glotfelty, vice-president for growth at non-bank SCF provider Taulia, tells GTR.
“When you do see tension and pressure, it’s usually around payment terms rather than supply chain finance. Suppliers being paid late if they choose not to use the early payment option is not something we see.”
Perhaps unsurprisingly, governmental efforts in Australia have so far focused on payment terms. Draft legislation tabled in early 2020 would require businesses whose annual turnover is over A$100mn to disclose details of the shortest and longest payment terms they offer their suppliers on a publicly accessible online portal, with the added transparency intended to incentivise better practice.
If passed in its current form, the bill would also require corporates to reveal whether they offer any form of SCF, though it stopped short of backing the ombudsman’s calls for an outright ban on payment terms over 30 days.
A statutory cap of that nature would likely prove divisive among providers of SCF. Sean Edwards, chairman of the International Trade and Forfaiting Association (ITFA), welcomes efforts to increase transparency but says a hard 30-day limit would likely restrict financiers to “plain vanilla” offerings.
Lex Greensill, however, is more supportive. “Our position is that SMEs should have payment terms of 30 days or less,” he says. “We’re very happy to provide supply chain finance to companies in Australia that adhere to that practice.”
Asked whether the company would refuse business from corporates that do not adhere to that principle, he adds: “We’re not doing business with companies that are not content with that, and we consider it to be best practice on a global basis.”
Steven van der Hooft, founder and chief executive of Capital Chains – a Netherlands-based consultancy firm that works with corporates, financial institutions and fintech platforms on their SCF arrangements – takes a more radical view.
He suggests firms should look at the wider picture and consider adjusting the kind of SCF product they offer in the first place.
“If payment terms were restricted to 30 days the room for early payment initiatives would be smaller, but I think the majority of the supply chain finance providers are already looking at different products that would work around the same lines,” van der Hooft tells GTR.
He gives the example of inventory, purchase order or in-transit finance, where the supplier may have to part with cash long before the final goods are provided and payables are due.
“What I’m hoping is that supply chain finance will shift from almost entirely payables finance to much earlier in the supply chain. That’s where you add more value,” van der Hooft says. “If you are a small supplier and you run a small production facility, you do care about when you get paid but you care even more about how you make your own payments before you deliver the goods.”
Artificial intelligence and big data
Improvements in data collection and analytics are also driving change within the SCF industry.
For the ASBFEO, that is a cause for concern. Its report says some finance providers “are using artificial intelligence (AI) and algorithms to target small businesses by dynamically setting SCF fees to extract the greatest possible return from small businesses, including those that are already in distress”.
Van der Hooft outlines one way that could work in practice. “A solution provider could have so many data points on a supplier that they could advise the buyer on what rates to offer early payment at,” he says.
“They could say a supplier with certain characteristics located in a certain jurisdiction may have a cost of funds of 11%, and so advise the buyer to charge 10%. That way they could extract maximum value from suppliers because they could marginally undercut their cost of funding.”
The Australian ombudsman suggested the issue could be taken up by federal competition regulators, as it could indicate an abuse of larger firms’ market position. However, it is not yet clear which providers of SCF are the subject of its allegations.
Taulia, which uses AI as part of its product offering, has been quick to distance itself from the claims. Glotfelty says its platform does not pull in small businesses’ financial status, but uses data to find situations where early payment could prove beneficial to a supplier, explaining: “If a 30-day invoice isn’t approved until day 28, let’s say, there’s essentially no opportunity for early payment. We use AI to identify situations like this so we know not to contact the supplier.”
The ombudsman does not say which firms it believes have been misusing AI, and a spokesperson tells GTR it is “still looking at just how widespread the issue is”. Of the other companies consulted by the ombudsman, a spokesperson for Fifo Capital says the company does not use artificial intelligence in any part of its business, while representatives from Apricity Finance and C2FO did not respond when contacted by GTR.
In Greensill’s case, the company says it uses data analytics to assess credit risk rather than “to gouge suppliers”. Its founder and chief executive explains that the supplier data it collects allows it to make credit decisions in real time. “We don’t share our own information with the buyer,” he adds. “It’s a one-way street.”
Greensill goes further, adding that the ability to collect and analyse such data shows the extent to which the industry “needs to evolve”. “The future is to use the enormous volumes of data we have about historical activity to underwrite and deliver the same solution, but without requiring the irrevocable obligation of the buyer of the goods and services to pay,” he says.
“In other words, a data-driven supply chain finance product: that is the future, and one that represents an even bigger opportunity than the current market.”
The ‘accounting loophole’
A separate pressure facing the SCF industry is the prospect of new financial disclosure rules for corporates that use reverse factoring programmes. Ratings agencies started the push for reforms, initially suggesting firms that delay payment to suppliers through the use of a financial intermediary should have to disclose those arrangements as bank-like debt in their company filings.
A Fitch Ratings report in 2018 said reverse factoring contributed to the high-profile collapse of UK construction giant Carillion. Calling the arrangement an “accounting loophole”, it found Carillion owed an estimated £400-500mn to financial institutions, but classified much of that as “other payables” and disclosed debt of just £219mn.
Similarly, Moody’s has argued that the “debt-like features” of reverse factoring programmes used by Spanish technology firm Abengoa contributed to its bankruptcy in late 2015, and that the rapid withdrawal of supply chain finance arrangements at Spanish supermarket chain Distribuidora Internacional de Alimentacion “contributed materially to the company’s liquidity crisis” during 2018.
The US Securities and Exchange Commission (SEC) has taken up the issue, recommending in late 2019 that accounting standards-setting bodies consider producing fresh guidance on how to disclose reverse factoring programmes.
Proposals to list such arrangements as bank-like debt have won the support of Lex Greensill, who says: “It’s my view that a dollar of debt that is owed to a supplier should be considered the same as a dollar of debt that’s owed to a bank or a bond holder. Ratings agencies have maintained a distinction between accounts payable and borrowings, but it seems to me that there is no merit in maintaining that distinction because those liabilities are equivalent.”
However, that view is not necessarily shared across the broader industry. ITFA’s Edwards says those cases are best viewed as “rotten apples” and should not result in drastic action by authorities; treating trade debt in the same way as bank debt may make banks “less willing or less able to provide supply chain finance and all the benefits might disappear”, he warns.
Geoff Brady, head of global trade and supply chain at Bank of America, says greater transparency is generally favoured by banks. “But if SCF is reclassified as debt rather than payables, the change could negatively impact SCF’s economic value and in doing so also impact the ecosystem of suppliers,” he tells GTR.
“It’s important to remember that we’re considering not just the large corporate or the multinational corporation, but the whole community, the whole ecosystem of suppliers. Nobody wants to put them at risk by pulling away this valuable type of financing.”
Moody’s has since softened its tone, stating in September 2019 that there is in fact “a strong case” for requiring corporates to disclose SCF programmes only as a potential risk to liquidity rather than as bank-like debt.
But that carries risks too, according to Capital Chains’ van der Hooft. He says: “One reason buyers don’t want to disclose supply chain finance programmes is if they offer it extensively it could have a tremendous impact on their leverage ratios.
“Currently accounts payable are excluded from that ratio, but the moment that’s reclassified – even if it’s in notes – your ratios could be readjusted. Your leverage becomes bigger, your ratios deteriorate and you might end up violating loan agreements you have with banks.
“That’s the nature of the beast.”