The role of credit insurance in trade and supply chain finance transactions has been thrust into the limelight in recent months. In several separate cases, creditors seeking to recoup lost funds after insolvencies, fraud allegations or other unforeseen issues, are encountering resistance when submitting claims to insurers.
In the insurance market, meanwhile, questions are being raised over whether the product is being used not as a risk mitigant, but as a risk substitute. GTR speaks to Baldev Bhinder, managing partner of Singapore-based law firm Blackstone & Gold, about how all parties involved in a transaction can ensure they are protected if problems arise.
GTR: Disputes over the validity of insurance cover are proving a major part of the fallout from Greensill’s collapse. What are the lessons to be learned from that case?
Bhinder: Greensill remains an outlier, but there are common themes from other cases we have worked on that highlight the need for transparency between invoice and investor. In particular, no matter how many layers of financing or securitising there are, there needs to be visibility of how that underlying asset – the invoice – is generated and monitored.
Supply chain finance remains a traditional and secure business because it involves highly rated obligors. If anything, the focus should turn on the credit management processes of the insured, or where a fintech is used as a gatekeeper of the invoices, on the competence of the gatekeeper in adhering to the portfolio requirements.
This is nowhere more pronounced than when it comes to claims. The issuer of the invoice, the lender and the investor are different entities, but it is the insured under the policy that has to demonstrate compliance with the policy and knowledge of the underlying transaction. This would invariably require visibility over the transaction.
Also, the receivables portfolio needs to be stress tested. What happens if insurance cover is not renewed or withdrawn? Why can’t the transactions stand without insurance? How can the invoice be authenticated?
GTR: What can be done to minimise the risk of an insurer withdrawing or cancelling cover?
Bhinder: Of course, if your entire business model is predicated on insurance cover, then it is imperative that non-cancellable policies, like those used by banks for capital relief, are in place. Where policies are cancellable, there is still a substantial notice period before winding down – it’s not the ‘rug pull’ that has been portrayed – but to expect insurance policies to stay in place in perpetuity strikes me as somewhat unrealistic.
GTR: Can credit insurance be relied upon as a tool in trade and supply chain finance?
Bhinder: In our work handling insurance claims and investigations, we notice a fair amount of misunderstanding as to how credit insurance works. The issue is not in the product, but in the conduct, where right from the outset a standard credit insurance policy is misconceived as something akin to a financial guarantee.
A standard policy is intended to operate as a risk mitigant and not a risk substitute. Fund managers need to ask themselves constantly why a transaction cannot stand without credit insurance, and that question should properly highlight whether there is an over-reliance on credit insurance and the attendant risks that brings. Too often, we see that the transaction due diligence is not robust enough and I suspect that has to do with this misconception that the risk has been transferred to the insurer.
Each layer of securitisation pushes the underlying receivable further away from scrutiny, so the initial gatekeeper of the financed invoice needs to have a robust system with visibility over the trade origination and structuring, as well as the physical flow of goods and the credit management procedures. A fair presentation of risk is the foundation of any insurance product, and in my view should also be the foundation of any trade structure – to the investor as much as to the insurer.
GTR: What are your thoughts on the relationship between insurance cover and future receivables?
Bhinder: The use of future receivables between companies that have an active trading relationship would baffle traditional supply chain professionals, who would view their business as a form of secured financing. I am not an underwriter but I think if a company has a track record of delivering goods to its buyers in a consistent manner, then perhaps future receivables could be insured but disclosure of the nature of the receivables needs to be put before underwriters.
Even so, future receivables are quite different from so-called prospective receivables, between companies that have not traded with each other in the past. That is nothing short of fiction.
GTR: In cases where credit insurance is in place, but structuring is poor, how are claims impacted?
Bhinder: While it is the funder, asset manager or investor that relies on the policy for its financial benefit, it is the insured who owes obligations to the insurer as to the underlying trade, compliance with credit and trading limits and mitigation steps. That is loosely described in the insurance market as acting as a prudent uninsured.
Over-reliance on insurance can take away important scrutiny over the types of trades being funded. When it comes to processing claims, the beneficiary of the policy not only needs to have control of the policy, in case the insured becomes insolvent, but also a detailed understanding of the trade. An invoice is just a piece of paper and by itself does not demonstrate compliance with the terms of the policy.
In some cases we have worked on, we have discovered that there was no real physical flow of goods or transfer of ownership between the parties, that a synthetic trade structure between related parties was created to obtain financing, or in other cases, that invoices were forged or fraudulent.
GTR: What do you think can and should be done differently?
Bhinder: Invoice financing is a volume business, so better technology needs to be deployed in the due diligence process. The prevalence of fictitious trading in our work suggests that unscrupulous traders are continually looking for ways to get easy financing. Trades, invoices and accounts can be easily manufactured between related parties to fulfil the requirements of invoice financing businesses, so a more critical eye needs to be cast on some businesses.
There is a trade finance gap and fintechs can serve a critical role, particularly in programmes like SME invoice financing that are historically labour-intensive. However, the promise of increasing invoice values should not overlook the basics of understanding the trade flow.