The potential market is vast, but is the concept sound?
The potential market is vast, but is the concept sound?

Is supply chain financing a safe bet?

Will Green is news editor of Supply Management
27 August 2021

The demise of Greensill Capital highlighted the risks involved with complex payment agreements. Though it paid the ultimate price, was the company on to something?

You could be forgiven for thinking Lex Greensill shares more than a first name with Superman’s arch-nemesis Lex Luthor, particularly after the damning media coverage of his downfall. According to the UK government’s Business, Energy and Industrial Strategy Committee, Greensill has “refused multiple requests” to appear before its inquiry into the future of the steel industry.

Some very high-profile names have been dragged through the mud as the committee has sought to understand the links between company Greensill Capital and Liberty Steel – whose parent, Gupta Family Group, was among its largest borrowers. But beyond the man, the committee is also keen to investigate supply chain finance (SCF) and determine whether it is a true ally of business.

So is SCF the new bogeyman of the corporate world, to be avoided at all costs? One notable member of the procurement profession was said to have dismissed SCF with the words: “Just pay your suppliers on time.” But can we really leave it at that?

Origins of supply chain financing

SCF is essentially suppliers lending money on the strength of invoices a buyer has pledged to pay. The supplier either receives favourable credit terms – based on the credit-worthiness of the buyer – or agrees on a discount to get paid sooner. According to McKinsey, SCF may be “one of the earliest commercial-payments activities” – and one that has enabled the flow of goods throughout history.

The value of assets covered by SCF globally is currently $7.3tn, said McKinsey in its 2020 Global Payments Report, but the market is untapped and “nearly 80% of eligible assets do not benefit from better working-capital financing, and the remaining one-fifth of assets are often inefficiently financed”.

If SCF encompassed every invoice and receipt issued, it would be $17tn globally. “The idea of SCF is it’s a mutually beneficial offering,” says Anna Jones, a consultant in SCF operating in the APAC region. Jones says it’s about working capital – suppliers want to be paid as soon as possible and buyers want to pay as late as possible.

“The bank isn’t trying to do anything evil. They’re saying to suppliers, ‘You can get paid early, this is how much we’re going to charge you and ideally it’s less than what you’re being charged by your bank [for credit]’. I think the problems happen when a buyer says, ‘Either opt in or you have to bear the brunt of increased payment terms.’”

Supplier pressure

In Australia, SCF has a reputation for exactly that. Kate Carnell, former Australian small business and family enterprise ombudsman, launched an inquiry amid concerns companies were extending payment terms to small firms in exchange for SCF. “One of the worst forms of supplier bullying is the example of an SME being told, ‘Deal with our SCF provider or wait for your funds,’” said Carnell’s final report.

Carnell called for legislation mandating payment to small firms within 30 days: “The experience of both the UK and many European nations shows voluntary codes of conduct requiring improved payment times to small business suppliers do not work.”

Demand for SCF has surged during the pandemic “as cash-strapped companies seek liquidity”, according to S&P Global. Worldwide revenues from SCF grew in the first quarter of 2020 by 3-4% “despite global trade disruption”, driven mainly by Europe and the US. Revenues reached $50-$75bn in 2019, reported the International Chamber of Commerce.

S&P warned of a “sleeping risk” caused by poor financial disclosures obscuring a company’s underlying health. It said some companies had extended payment terms to 364 days using SCF, effectively opening a credit line with the bank providing the SCF, which is reported as “trade payables” rather than debt.

Colin Cram, chief executive at consultancy Marc1, says the system “relies on the companies that are due to pay the invoices being able to pay them, that is, remaining solvent. It also relies on purchasing the invoices at a sufficient discount to mitigate the risk of very late or non-payment. Typically, the discount used to be 20%.”

Is SCF all bad?

Greensill Capital had a “very aggressive target” to sign up companies to its SCF programme, says Jones, and “where Greensill came into trouble was it had a few losses”. In effect, companies were unable to pay the invoices Greensill had lent against.

There are similarities between the dubious mortgage-backed assets that contributed to the 2008 global financial crisis and Greensill’s collapse, notably, in how the latter purchased “future receivables” from suppliers and bundled them into securitised assets protected by insurance. When insurers pulled the plug on Greensill, the house of cards collapsed.

“Greensill ran a high-risk business,” says Cram. “It relied on spotting winners, effective due diligence, accurate forecasting and rising commodity prices.” However, Cram believes Greensill got one thing right. “The Greensill case has exposed some serious issues and one procurement gem of an opportunity for the NHS,” he says.

Greensill launched a now-defunct app called Earnd for NHS staff, which enabled them to be paid more quickly. Cram believes this should be resurrected because it could reduce the NHS’s £480m annual spend on agency staff.

“One potential benefit of the scheme is that agency staff often get paid more quickly than staff employed by the NHS, therefore they prefer to work as agency staff. Greensill’s scheme would provide an incentive for agency staff to join the NHS workforce – with a potential saving to the NHS of up to £480m annually.”

Tesco is using SCF to incentivise sustainability among suppliers, saying that, from September, suppliers signing up to the voluntary programme will have their annual greenhouse gas emissions data verified independently and used to set SCF financing rates by Santander.

“In this critical year for climate action, we’re delighted to be able to offer thousands of suppliers access to market-leading supply chain finance linked to sustainability. This programme not only provides suppliers with a real incentive to set science-based emissions reduction targets, it will help embed sustainability goals throughout our supply chain and support the UK in realising its climate change targets,” said Tesco chief product officer, Ashwin Prasad.

For Jones there is still a place for SCF, as long as it isn’t abused, particularly because small suppliers have difficulties securing finance. She says it can be integrated into purchase-to-pay systems so providers have visibility over key elements, such as purchase orders, inventory and sales.

“Lots of other fintechs are doing what Greensill did,” she says. “There’s a huge proportion of players in the industry offering it because there’s great demand.”

However, Jones advised buyers against extending payment terms unreasonably as part of an SCF scheme.

“A supplier has to be profitable and have net-positive working capital,” she says. “If they don’t have enough working capital, they can go bankrupt. If you’re starting to make your suppliers go into administration or be a bit stressed, it doesn’t take long before suppliers start making a lot of complaints.”

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