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Companies that use supply chain finance (SCF) products are set to be hit with stricter disclosure requirements, as an influential US-standards setting body works to “enhance transparency” in the sector.

The Financial Accounting Standards Board (FASB) unveiled the plans in a proposed accounting standards update in December, a little over a year after the independent body – which sets financial reporting requirements for public and private companies – said it would examine the issue.

Under the draft update, which is still open to review until March, buyer companies would be required to disclose their use of supply chain financing.

The structure of SCF programmes can vary, but they typically involve a financial intermediary paying suppliers’ invoices early – generally at a discount – while granting the buyer extended payment terms, maximising working capital. When initiated by the buyer, that model is also known as reverse factoring.

The tabled regulatory changes would see buyers be required to submit details such as the key terms of the programme and a so-called “roll forward” of their obligations – in other words, they would have to show the amount outstanding to an SCF provider at the beginning of the reporting period, the amounts settled and added during, and the outstanding gross figure at the end.

GTR understands the FASB is welcoming feedback on whether to make reporting a quarterly and annual process, or whether to only require companies to make a disclosure at the end of a quarter when there is a “significant event or transaction” related to a particular SCF programme.

The FASB argues this would arm investors with sufficient information to “understand the programme’s nature, activity during the period, changes from period to period, and potential magnitude”.

Ratings agencies, regulators and the Big Four accounting firms have long criticised a total absence of disclosure requirements for SCF, which they say has allowed ailing businesses to conceal liquidity issues.

The demise of Abengoa in Spain and the collapse of UK company Carillion have both been cited as examples where companies were able to use SCF to hide serious financial distress – though industry bodies, such as the International Trade and Forfaiting Association (ITFA), have said that these cases are rare and not illustrative of wider industry practices.

The changes, if approved, would amend the generally accepted accounting principles (GAAP), a set of rules which the FASB is tasked with shaping – and which are largely used in the US.

In June, similar plans were tabled by the International Accountings Standards Board (IASB), the body tasked with governing a set of standards used mostly in Europe, South America, Middle Eastern and Sub-Saharan African countries, in addition to Australia, Canada and some Asia Pacific nations.

 

“Limited improvement”

While the FASB proposals are preliminary and subject to change, ratings agencies have already criticised the scope of the draft document.

A January report from Moody’s says FASB’s mooted changes would only provide “incremental improvements”.

“If the proposal is adopted, at least the financial statement users could identify which companies are using supplier finance programmes,” the report says.

But the ratings agency takes aim at the FASB for failing to require companies to provide original invoice information, limiting an investor’s ability to assess the impact of SCF use on payment terms.

They argue this poses potential problems for anyone trying to untangle whether a programme fits within a company’s normal operating working capital, or is being used as a financing facility.

“The whole risk with SCF is about using it as a financing mechanism,” David Gonzales, senior accounting analyst at Moody’s, tells GTR.

“Are you using these facilities to pay your working capital commitments beyond the date they would have otherwise been due? If you do that, you’re basically extending the working capital commitments into a borrowing – and those are the structures that we are concerned about,” he says.

For instance, if a company has an accounts payable due in 60 days, it could look to boost working capital up to 100 days through an SCF programme.

“[But] if something happens where the financing is no longer available, the company will have a hole in their working capital of 40 days, which they’ll have to otherwise fill with borrowing, cash or any other resources. If they can’t, it’s problematic,” Gonzales says.

He adds, from an ongoing operations perspective, this 40 day pick-up in working capital “makes it seem like they’re achieving operational efficiency in their operating cash flow, when actually they’re just inserting a financing element in order to improve their working capital”.

 

Right balance?

With the FASB and IASB having both now released their plans for overhauling SCF standards, there are diverging views over which body has struck the right balance.

Philip Robinson, senior credit officer at Moody’s, says the IASB’s plans would mean investors could compare the range of payment dates for invoices covered under an SCF programme with those outside the arrangement.

“What that’s giving you is an indication of how much longer the terms accepted by suppliers in the arrangement are,” Robinson says, who adds the IASB’s proposals would be “helpful”.

But trade finance industry figures have suggested the reverse.

“From the point of view of the industry… we’re pleased that the standards boards have realised that it’s not appropriate to try to recategorise or reclassify SCF assets as financial debt,” says Sean Edwards, chairman of ITFA.

“That was one of the big worries about this. The fact a bank is taking over debt… does not in of itself make it different from a trade debt, because that debt was originated from the supply of goods and services, which remains the case. It’s not giving money to expand recklessly.”

But Edwards, who says the FASB appear to have “got the balance right” with their changes, suggests the IASB plans would be overly prescriptive and require “a lot of involvement from banks”.