Corporate TreasuryFinancial Supply ChainSupply Chain FinanceThe Growing Need for Supply Chain Finance

The Growing Need for Supply Chain Finance

Supply chains are certainly undergoing increased pressure. Over the last decade huge efforts have been made to improve the efficiency and effectiveness of supply chains, extending them into more distant and low cost geographies, using sophisticated analysis and planning routines to predict and meet future demand, as well as refining international logistics. In fact, it is often said that the physical supply chain has become just about as efficient as it can be. Yet the current global economic downturn is putting increasing pressure on those supply chains, especially in wholesale/retail, automotive, hi-tech, telecoms and specialist chemical sectors, to name a handful.

When customer demand falls, large companies at the end of the supply chain tend to look to their suppliers to share the burden of that downturn. However, now that the supply chain has been subject to such fine-tuning since the 1990s, supplier margins have been pared and payment terms so extended that virtually no room for manoeuvre is left.

One major study of supply chain management trends released late last year1 identified supplier failure amongst its top ten risks. The same organisation also estimated that risk associated with ‘volatility and supplier failure’ had increased 54% between mid-2007 and mid-2008. Yet many supply chains rely on a set of specialised suppliers who cannot be easily replaced, if at all. It is therefore in the interests of large firms to preserve the health of their supply chain, while at the same time maintaining pressure for economies and efficiencies.

The risk of supplier failure is highlighted in other economic statistics. In 2008, insolvency rates increased by some 24% in the UK, 11% across Europe and by a more modest 3% in Germany.2 Access to corporate credit in Germany has historically been easier in an economic downturn than in the UK and its densely banked economy still remains culturally committed to supporting industry and business through thick and thin, despite the removal of previous long-term state guarantees for bad debt. A troubled German automotive sector is under pressure from a downturn in the market, which in turn renders them a higher risk to lenders.3 Evidently, Germany fears that its insolvency rates may climb to match those of the rest of Europe in the course of this year.

Overall economic indicators tend to suggest that pressure is increasing for supplier firms. In October 2008, European countries established pledges and guarantees collectively worth some €2 trillion to prop up their banking systems.4 Yet too little commercial finance seems to have become available as a result. Creditreform projects that 35,000 German companies will face bankruptcy this year. A survey from Close Invoice Finance points to a huge contraction of SME credit availability this year.5

Other factors essential to the smooth running of the supply chain are also at risk. Credit insurers in Germany have both shortened capacity and raised rates – reportedly by some 25%.6 In Britain, legislators are scratching their heads over how to deal with the withdrawal of trade credit insurance for many businesses.7 In addition, late payment is freezing some €250bn of liquidity annually.8

The World of Supply Chain Finance

As a result of the current situation where pressure on supply chains is mounting because of the economic downturn, but where refinements to the physical supply chain no longer have a significant impact, interest has been mounting in supply chain finance techniques to ease the burden. Banks, in particular, who are keen to lend but are very reluctant to damage their risk profiles further, are exploring imaginative methods of extending credit secured against robust assets, such as invoice debt.

Although definitions of supply chain finance tend to vary, the Aberdeen Group defines it as: “A combination of trade financing provided by a financial institution, a third-party vendor, or a corporation itself, and a technology platform that unites trading partners and financial institutions electronically and provides the financing triggers based on the occurrence of one or several supply chain events.”

Supply chain finance is generally viewed as the province of a commercial bank’s lending arm. Relationship banks offer a working capital management facility for their large corporate clients (product or service buyers), while at the same time providing prompt payment facilities for their suppliers. This is essentially the same as a closed user group factoring arrangement, the main difference being that the facility is arranged with the buyer, who then introduces the service to its suppliers, to the benefit of both parties. In industries where efficiencies in the physical supply chain have been refined to the utmost level, attention has now moved to the financial supply chain. The result is abundant activity around financing solutions that allow buyers to ease payment terms while also ensuring that their suppliers’ cash flow is improved, thus reducing or avoiding instability in the supply chain.

The Research Findings

Demica first published a report on the supply chain finance market in early 2007, which showed that 73% of larger European corporates were looking to extend payment terms with their suppliers in order to conserve cash. In 2009, this proportion of larger corporates has fallen to 58% on average across the UK and Germany, the assumption being that the supply chain was already stretched as far as it could be in terms of payment periods.

This latest Demica research study into payment terms and financing techniques in the supply chain covered a balanced sample of more than 1,000 firms in the UK and Germany, rather than just larger corporations. The results were revealing, not just in terms of the wider corporate sample, but also the overall corroborative picture their responses painted.

In the UK, 63% of companies overall are trying to extend payment terms with their suppliers, compared with 48% in Germany. Moreover, the survey confirmed that many supply chains are stretched as taut as they can be without breaking. 88% of UK firms and 55% of German companies recognise that “some of our key suppliers will not be able to sustain further lengthening of payment terms.” This underscores the growing importance of supply chain finance programmes, which often use the security of invoice debt to provide a bridging facility that maintains or even reduces supplier payment periods, while at the same time helping to conserve the large buyer organisation’s cash.

Nevertheless, the pressure will not go away. The European Central Bank and the Bank of England have all reported no let-up in the tight credit terms from relationship banks.9 The losses – and consequent write-downs – suffered by major international banks as a result of the collapse of some sections of the credit derivative markets in 2007 have greatly contributed to this tightening of terms. So from a corporate perspective, supply chain finance has come under the spotlight as financial directors and bankers seek ways of raising finance to free up working capital using alternative techniques, in order to substitute for part of the squeeze on normal lines of credit.

Supply Chain Finance for Bankers

From the banking point of view, our first research report revealed high levels of interest amongst global banks in meeting the growing corporate demand for supply chain finance. It highlighted that they viewed supply chain finance as offering more attractive margins than traditional bank financing, as well as presenting a valuable opportunity to extend existing customer relationships. The last 12 months have seen these trends gain significant momentum. Euromoney reported supply chain finance as “one of the hottest topics in transaction banking…over the past few years” and states the demand for supply chain finance services is continuing to grow.10 Similarly, Global Trade Review reported that bankers are “continuing to lend to their clients through supply chain finance programmes and that the credit crunch has had little [negative] impact on that line of business”11 – and the credit crunch may well drive supply chain finance, substantiating the view that it will be an alternative source of funding for those corporates facing difficulties obtaining bank credit.

Demica’s latest research into supply chain finance trends show that some two-thirds of firms in the UK (61%) and two-fifths of companies in Germany (43%) are planning to “monetise receivables or payables in order to maximise the current scarcity of liquidity available to us and our suppliers.” Validating this finding, 49% of UK respondents and 41% of German respondents specifically confirmed that they were considering “factoring, securitisation, asset-based lending, supply chain finance and other non-traditional financing techniques.”

Most recently, a partnership has begun to emerge between the commercial lending arm of a bank and its securitisation colleagues.12 Commercial banking certainly retains, and will continue to manage, the overall relationship with clients, for whom it organises a whole range of credit facilities, treasury management, custodian and other services; including supply chain finance solutions as one element of this range. On the other hand, securitisation colleagues are beginning to find themselves enlisted to structure, manage and execute these supply chain finance solutions, as they are in effect “reverse securitisations”.

Supply chain finance is one area where a few pioneers have introduced an intermediation13 in the form of pooled supply chain finance receivables securitisation, issued to the markets as commercial paper through one of the bank’s existing, or specifically established, conduits.

Up to a few years ago, the idea of a pooled (multi-company) securitisation of trade receivables was not considered economic or practical. However, systems are now well-established to automate the collection of data from the buyer companies effectively to track the receivables and produce the relevant settlement reports. Furthermore, all this is possible across a multi-company, multi-currency, multi-jurisdiction environment and multiple time zones.14

Conclusion

Companies are now turning to financing techniques to improve their supply chain efficiency without damaging essential suppliers in the chain. Banks are becoming increasingly active in the supply chain finance portfolio, as this technique lifts the lid on lending without taking on unacceptable risk. Invoice debt is seen to be a high quality security at the heart of many supply chain finance programmes. It also seems likely that as these two key European economies recover from recession, supply chain finance programmes will become the norm. 61% of British firms and 50% of German firms believe that “market conditions have brought procurement and finance strategies into closer alignment” in their organisations.

Finally, and perhaps even more fundamentally, 55% of German companies and 83% of UK firms are of the opinion that “banks’ relationships with their business customers have been irrevocably altered and restructured during the last 18 months.” It would appear that non-traditional financing techniques are becoming mainstream.

1 AMR Research, ‘Managing the Biggest Supply Chain Risk of All: Constant Change’, November 2008. See also Supply Chain Top 25, 2008.

2 Creditreform, Unternehmensinsolvenzen in Westeuropa, January 2009.

3 Financial Times, ‘European suppliers face acute financial difficulty’, 14 November 2008.

4 The Guardian, ‘European leaders won over by Brown’s triple-whammy bank rescue strategy‘, 13 October

2008.

5 Close Invoice Finance, ‘SME Survey’, February 2009.

6 Business Insurance, ‘German primary rates expected to decrease’, November 2008.

7 The Guardian, ‘Fears for high street over lack of credit insurance’, 20 November 2008.

8 Intrum Justitia, ‘European Payment Index’, 1 December 2008.

9 Central Bank, ‘Euro Area Bank Lending Survey’, January 2009;
Bank of England, ‘Credit Conditions Survey Q4 2007′, January 2009.

10 Euromoney, ‘Supply Chain Management:Towards Stronger Chains’, Laurence Neville, April 2008.

11 Global Trade Review, ‘Trade Services and The Supply Chain, Sibos Report‘,,Justin Pugsley, November/December 2007.

12 ABN AMRO, ‘Banking solutions for supply chain finance’, Andrew Betts, May 2007.

13 GSCF, ‘Hewlett Packard Europe sign Dollar ABS (Securitization) program’, 2004.

14 Citigroup,‘Optimising the Supply Chain’, May 2006.

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