Supply Chain Finance and Alternative Capital: What Lies Ahead?
A growing interest from European companies in supply chain finance (SCF) and alternative capital markets stems from the perceived opportunity for higher yields, as well as an untapped reservoir of financing opportunities.
Financing starts with the simple relationship between a buyer of a product or service and the supplier, thus creating the receivable which could be financed through a loan secured on it, or the sale of that receivable. Investors could come from a securitisation, a special purpose vehicle (SPV) issuer or a fund. Short-term receivables can be converted to long-term financing opportunities. Within the process there is increasing involvement of technology, such as e-invoicing and supply chain management (SCM) reporting.
SCF is a receivables finance transaction. It is led by the debtor, the buyer of the goods and services who wishes to manage their own supply chain, taking advantage of elements such as early payments discounts and rebates to extend credit terms while maintaining the supply;
asset–based lending (ABL)
is a secured loan arrangement, based on the receivables and the financing of these transactions through the capital markets or commercial paper conduits.
Robert Parson, a partner at Reed Smith who chaired the panel at the London seminar, suggested that since the 2008 global financial crisis the shrinking of banks’ balance sheets had put tremendous strain on the ability of the traditional providers to fund trade finance. This provided an opportunity for others to step up in response and has led to change in the market and the way the supply chain could be financed
Michael Bickers, managing director of BCR Publishing, expects to see more change within the receivables finance industry by 2020 than has taken place in the past 30 to 40 years. Drivers for expansion and development are twofold: firstly, the post-crisis environment has pushed receivables into the limelight. Prior to the crisis, receivables took a back seat but have since been revealed as an overlooked asset class. An asset class which is short term, self- liquidating and stable. Secondly, the focus by large corporates on working capital management has also helped to gain attention.
Squeezed Suppliers
In many cases, the financing relationship between large corporates and their smaller suppliers remains fraught. It’s clear that the actions of customers can still have a material effect on suppliers, causing hardship. Occasionally, it’s possible to have a glimpse of what can take place. Documents filed in an American court revealed that one US supplier, which filed for bankruptcy, had complained to its customer, Apple, about the excessively long payment terms, merely to be told to
“put on its big boy’s pants and sign up.”
In that context, what can be done in terms of generating finance is important.
Less dramatically, a UK government consultation paper reported that over the period April 2013 to March 2014, no fewer than 48% of small and medium-sized enterprises (SMEs) applying for loans of £25,000 or more were turned down on the grounds of affordability. Such a statistic reveals the huge financing gap that exists. The government consultation, which looked for ways around technical barriers to spur growth in the market, proposed the
nullification of prohibition clauses on the assignment of invoices.
The second major driver is improvements in technology, where already the impact is discernible. The next few years will see much less reliance on paper, in part from the increase of e-invoicing, which will speed up the flow of transaction processing for receivables financing. Bickers describes it as “a perfect storm”.
While SCF has generated much attention since the global crisis, Bickers said that there was still much confusion over its terms. This does not help the development of the market, which might best be described as reverse factoring. Its basis is a buyer-centric model, where finance is provided to the suppliers of large corporates priced on their major customer’s credit rating. After the talk has come some action, with several banks putting much resource into SCF. Those investing in SCF include HSBC, JP Morgan, Lloyds, Standard Chartered, Citi and RBS. However, these players are throwing resources at SCF they have not seen a lot in terms of result so far.
Bickers estimates that globally, around €43bn of funds were in use as of a few months ago. Annual growth appears to be around 30%. There are also signs of trade receivables securitisation taking off, as interest in secondary markets grows and large organisations look to invest.
Victims and Joint Ventures
As the market develops there will, inevitably, be a degree of consolidation – as happened in the factoring industry. Joint ventures between emerging players and larger corporates may happen in this alternative finance space, but many of those emerging players are unknown – making others cautious in dealing with them. Nonetheless, these relationships are beginning to happen. Examples include a partnership announced last June to support thousands of UK businesses between Santander and UK lending platform Funding Circle (which has since
tapped US investors
).
Despite their problems and a shrinking footprint, big banks still have a lot to offer though. Their capital base can withstand losses that would put newer and smaller players out of business. However, they could team up with a smaller player to gain the focus required to achieve at this level.
Bickers said that regulation has been biting at the heel of the factoring industry for decades. More regulation will come in, but not immediately; when it does it will cause a shakeup and consolidation.
Technology is helping to disrupt the established market, although one could argue that the banking sector did an effective-enough job of disrupting its own supply chain, without any great help from by P2P disruptive technology.
Oliver Gabbay, chief operating officer (COO) at online trade receivables platform. Aztec Exchange, noted that technology should allow anyone who is part of the supply chain to receive funding, regardless of where they are in the world. Technology also allows efficient pricing across the spectrum across all risks. It helps to move away from a binary approach to pricing of risk through approval of a particular corporate debtor.
Technology developed in an opportunistic way when banks stepped back from the market, but now they are moving back in and embracing those technology changes. There are still some areas where technology could help. For instance, the possibility of an electronic version of a bill of exchange is an exciting development.
Damian Crowe, chief executive officer (CEO) of early payments finance start-up Obillex, said the market is huge but fragmented and there are as many different models as there are suppliers. Technology is helping to break down the barriers to entry. The non-bank channel raises the possibility of a viable asset class, which opens up the market to investors.
The UK is a hot spot, with organisations starting to identify where they want to collaborate and where they want to compete. At the same time, there will be a gradual compression of margins. Perhaps given the size of the market, it is inevitable that standards will be introduced. With the market demanding a move towards efficiency, eventually the high-cost players could be forced out and there may be a move towards greater specialisation, building on core strengths.
Gabbay said that technology is now being designed for all of the players in the supply chain. In the past, too often technology was developed to suit one party but not all. Inevitably, talk over the next few years will be of cloud-based systems. These systems must work with mobile devices – so trade suppliers can easily upload their invoices – and deal with many languages. It should be as simple as operating an ATM; stick the invoices in and get out the cash.
From the bank and/or funder’s perceptive, they need to keep a tight control on information and have the ability to track. Much of what is required is there but it is in different technology formats. The ideal is greater efficiency and equivalence of access of funding across the globe. Gabbay drew a comparison with the US mortgage market, where beside the funders there is a whole system of service and originators.
A report in 2010 by the Association of Corporate Treasurers (ACT) for the Bank of England (BoE) on SCF highlighted issues with the technology with individual large corporates wedded to particular enterprise solutions, which just add to complexity for their smaller suppliers wrestling with these separate systems.
Missing Standards
The industry needs reliability and it needs a platform. SME-to-SME trading activity in the UK runs to £1.2 trillion annually, which represents a massive diversification of risk. The systems are not yet in place to gain access to all those trade credits. “We don’t want to do business with individual SMEs,” said Crowe. “Instead, the idea is to set up a market revolutionising access to the working capital smaller businesses need on the same terms as the big corporations.
“This revolution is not only for the British economy, but the global economy providing capital for those little guys that are the drivers of innovation, growth and employment. If that were to happen that would transform economic prospects. The key is interoperable technology solutions which allow small organisations to be included. Until the technology has matured we are not going to see the market achieving its potential. A lack of standards is probably the key growth constraint.”
Sarah Gannon, director of business development at working capital solutions provider Demica, noted that the company has to deal with 275 enterprise resource planning (ERP) and accounting systems on behalf of its clients. “Some of the major corporations in the world have up to 50 different internal systems which just do not talk to each other,” she added. “It is unbelievable and it is such a problem, but one we are well versed in dealing with.”
Beyond technology there are other questions, especially for investors contemplating becoming involved in this sector. Gannon said that although yields are attractive at the smaller end of the market it remains risky. According to Stephen Ceurvorst, managing partner at Lord Capital, the industry is in danger of underestimating that risk.
“While we have been talking about the importance of SME financing and getting capital down to that level, the truth is investors will take a bloodbath in the SME space as they always have,” he warned. “It is not a stable credit environment to invest in although technology will make it more attractive for us to invest. We are looking at the SME place and it is going to be an unexpectedly tumultuous ride. Standardisation isn’t going to help with know your customer [KYC] processes.”
Investors understand larger corporate receivable pools or factoring that is securitised through conduits. They are less sure about the same pools or securitisation of smaller businesses. Ultimately, in that area it would be premature to imagine that the huge credit risk involved is about to be eliminated.