It’s safe to say that supply chain finance (SCF) is firmly part of any toolkit where working capital management is the focus. The solution has had a rapid rise in useage, but where does the future lie? Jay Dang looks at five emerging European trends that are set to alter the course of SCF forever.
1. Legislative support
Over the course of the last few months we have seen a flurry of new legislation in Europe, designed to combat the continuing practice of late payments by large corporate buyers.
In April, the UK government introduced rules which require the largest companies to report twice a year on their supplier payment practices, publically. The rules not only force disclosure of payment terms but also require companies to publish whether or not they have complied with the terms and if there is supplier financing involved. Research by YouGov and Crossflow Payments estimates that a staggering £266bn is trapped in late payments in the UK alone.
The Dutch government has gone a step further and adopted rules that will require buyers to make payments within 60 days to small and medium-sized suppliers. Past agreements with payment terms longer than 60 days will no longer be valid and will be converted into 30 days, after which the supplier can claim interest. It has also been mooted that the Scandinavian countries will follow suit and implement similar legislation.
Philip King, chief executive of the Chartered Institute of Credit Management (CICM), cautions the power this legislation can have, but says the point is to bring about a change in culture: “If businesses really want to delay payment then there are a myriad of opportunities to do that and get around the legislation. The UK legislation, especially, is about transparency and for businesses to act more responsibly.”
There are already notable examples, including that of Tesco, which has been criticised for the treatment of its suppliers, so much so that in 2012, the supermarket chain topped a Groceries Code Adjudicator list for supplier complaints. This negative publicity drove Tesco to pay its smallest suppliers – invoices of £100,000 or less – within 14 days and shaved five days off the industry standard for its larger suppliers.
2. The slow progress of ethical supply chains
Much has been written about prominent apparel companies including Levi Strauss and Co, PUMA and Nike, which have focused efforts to link corporate social responsibility (CSR) – including the ethical sourcing of materials, safe working conditions and providing a living wage to their workers – to pricing in their supply chain finance programmes. For instance, a supplier with a better CSR rating – pegged to the International Finance Corporation’s rating or built internally by the business – will achieve a better margin on the financing compared to a lower-rated supplier. Incorporating sustainability standards and incentivising suppliers to consider their practices make good business sense due to the reduction in supply chain risk. But the uptake of such sustainability-linked pricing programmes has been much slower than expected.
Farzin Mirmotahari, senior operations officer at the IFC believes that introducing sustainability requires very close co-ordination between sustainability, procurement, and finance teams, which is often time-consuming.
“[In my experience] the sustainability angle has been implemented where the sustainability teams are completely integrated in the sourcing and finance functions of the company,” he says.
“As such, the sustainability targets also become the objectives of the company as a whole and sourcing and finance participate actively in its implementation.”
Implementing SCF programmes in large enterprises would require further collaboration of many other stakeholders, including legal and compliance. But additional consideration of a sustainability team might not be at the forefront of a programme manager’s mind.
“Generally speaking, we are seeing more companies interested in sustainability-linked pricing in SCF programmes, but they are also cautious moving forward, and as such progress is gradual and will take more time,” says Mirmotahari.
“It is difficult to change a company’s supply chain and is not a task that can be done overnight. But more and more companies are putting sustainability front and centre and the influence of sustainability teams is becoming greater, especially if you consider 10 years ago when the scope of influence was significantly smaller.”
3. Central Europe – the manufacturing hub of Europe
European supply chains continue to dominate world trade, and according to Equant Analytics, 49% of pharmaceuticals, 42% of aerospace and 49% of shipping traded globally is conducted in the region. It is this dominance that has enabled Central European countries such as the Czech Republic, Poland and Romania to specialise in highly skilled manufacturing operations including for precision equipment, car parts and electronic equipment.
Rudolf Putz, head of the European Bank for Reconstruction and Development’s (EBRD) trade facilitation programme, believes this is because of a number of factors: “It’s mostly Western European producers who have moved some production into these countries. They benefit from lower labour costs, close proximity to Western European markets and the highly educated labour force.”
These factors have also drawn investment from companies in non-EU countries that wish to manufacture close to markets they want to sell in. In Asia, countries such as South Korea and Japan have located key production facilities to benefit from the same advantages.
Putz believes that the production of high-quality goods will remain in Central Europe but the region we will continue to look further eastward for the low-cost labour force that can provide high-volume, labour intensive production
Ukraine, Georgia and other former Soviet Union countries, as well as Central Asian countries, could all evolve into low-cost manufacturing hubs. This however, isn’t without its concerns: the political uncertainty in Ukraine, for example, has stalled investment.
The next five to 10 years should see further manufacturing sites blossom across other EU countries and those waiting to join the bloc. Serbia and Moldova, for example, will try to become more attractive to both EU and non-EU investment.
“It’s a natural development for foreign investors to look at countries close to the EU,” says Putz, but cautions that this growth might be hampered by the abilities of local banks to support trade finance.
“You need the support of local banks, you cannot rely on banks that are based abroad. Local banks should be able to facilitate factoring, receivables finance and supply chain finance services; but this will only come from demand. The more trade you have, the more demand there will be for trade financing.”
4. Delivery and sources of SCF
In Europe, bank proprietary platforms account for 48% of SCF platforms, according to the SFC Barometer published by PwC and the SFC Community in December 2016, which surveyed 62 corporates across Europe. Meanwhile, fintech platform suppliers such as Taulia hold a 12% share and 21% of corporates use platforms that they have developed in-house. The remaining 19% were not accounted for.
The growth in non-bank SCF poses the question of what role banks will have in the SCF world in the next 10 years. Recognising the need to keep on top of technological advancements, banks are investing in various trade platforms. Barclays, for one, is backing HaloTrade, an application to drive sustainable and transparent global supply chains, combining blockchain technology, mobile apps and supplier financing. HSBC too recently invested in Tradeshift, to provide supplier financing through a cloud-based supply chain management platform.
Another interesting dynamic to SCF has been a shift in investment source.
“In the past it was banks and other financial institutions that were financing companies and in the future it will be companies that are taking responsibility and control for financing their own supply chains,” says Matthew Stammers, vice-president of marketing at supply chain finance platform Taulia. “The reason they can do this is because they have the relationship and they have the data.”
The flexibility to self-fund a programme comes at a time when businesses have high levels of surplus cash, but where investment policies have restricted the use of riskier investment vehicles, and in an environment where margins continue to remain low. By self-funding a SCF programme, corporates can participate in a low-risk investment whilst making a good return. Additionally, by indirectly providing financing to the participating suppliers, corporates can maintain the surety of their supply chain.
In a recent example, AGCO, the agricultural equipment maker, chose to work with non-bank solution, PrimeRevenue, so that it could retain flexibility of funding sources, including the option to self-fund.
Chairman and founder of SCF Community, Michiel Steeman, says: “We see more and more hybrid models where companies are using their own cash [within their own SCF programme] as well as external cash and like the option
to switch between the two.”
5. The blockchain buzz
Blockchain is the anticipated foundation technology that some of these trends are being based on. From the transparency of payment practices, to monitoring the provenance of goods, blockchain can securely transmit data between all parties in a transaction, in real-time.
So what are the developers getting excited about? Rebecca Liao, vice-president of business development and strategy at Skuchain, details two areas. The first is pre-shipment finance. “Every lead buyer and supplier that we have spoken to believes this is more advantageous than the current SCF programmes,” she says.
Liao foresees a future where suppliers have the option to release funds at the point of manufacture, process, packaging or purchase (pre-shipment financing) or at the point of invoice (supply chain finance).
However, Stammers cautions that pre-shipment financing is currently expensive and difficult as it’s a very labour intensive, manual process: “The big game changer is the introduction of blockchain, which allows us to track documentation and ownership securely. Being able to do this enables us to quantify risk. With the risk quantified, we now have the opportunity to deploy accurately priced finance and scale the solutions to employ technology to deliver pre-shipment financing.”
Liao reiterates the risk element and anticipates that blockchain could help in a number of ways. She says: “There are three main ways in which blockchain facilitates pre-shipment financing. Firstly, smart contract governance, which makes the contract visible, auditable and changeable in a secure way. Secondly, transparency – for pre-shipment financing you need to hold title to the goods and understand the nature of the goods – this information can be produced and then stored on a secure blockchain. Lastly, accounting nuances – blockchain brings certainty.”
The second area where Liao believes the technology will add significant value is the provision of financing to tier two and tier three suppliers. Currently, the cost of financing for tier three suppliers could run into the tens of percent, whereas the large multinationals may only pay a few basis points. To ensure the continuation of the supply chain it is imperative that lower-tier suppliers have access to affordable funding, but with this comes the issue of commercial privacy.
Many tier one suppliers may not want to reveal to buyers the terms on which they do business with the tier two suppliers, including details of the cost of goods and the operating margins they work upon. Without some degree of information sharing, however, lower-tier suppliers will not be able to access the lower-cost financing. The security features of a permissioned blockchain ledger means that businesses could transact confidentially or allow selective information to be accessed.
“Blockchain allows the transaction to remain auditable and immutable while still allowing parties to keep sensitive information hidden,” says Liao.
“The real value of blockchain is achieved when you have multiple parties collaborating with one another – sharing information and making transactions quicker and more secure.”
A bright future?
A 2015 Moody’s report on the Spanish environment and energy group Abengoa SA caused concern for the SCF market when it raised the question of how reverse factoring (RF) programmes – a type of finance where a vendor (bank or non-bank finance provider) pre-pays the company’s invoices to its suppliers – are treated from a debt perspective.
Currently, trade payables are treated differently from traditional bank/financial debt, but the Moody’s report suggested that trade payables were the equivalent of bank/financial debt and so should be reclassified. This would have huge implications on the debt levels of a business which in turn impacts its credit-worthiness and, consequently, its credit ratings.
Such a move could have rendered the use of SCF programmes useless and put in peril the whole supply chain ecosystem as so many buyer-supplier relationships rely on this kind of financing.
In December 2016, after much wrangling by the industry bodies including the International Trade and Forfaiting Association (ITFA), Moody’s decided not to go ahead with a universal reclassification of RF-related debt, but instead said that each case must be looked at individually.
Whilst the SCF industry can breathe a sigh of relief, the question may come up again and it remains to be seen what will happen to supplier finance programmes in the future. For now, however, using finance in the right way to support and sustain a supply chain has lost none of its appeal.