Supply chain finance – mainstream or pipe dream?
It seems that financial headlines in the press these days are dominated by the plight of falling commodity values and the negative effect on commodity producers and trading houses.
The outlook for commodities and the so-called China recovery remains uncertain – we are told this is the new world and corporates and industry participants need to wrap their minds around this as returning to the heady days of China producing more cement during a three-year period (2011 to 2013) than the United States during the entire 20th century*is not going to happen. The mainstream view is that industry can now expect a slow recovery with incremental growth rather than the high trajectory previously seen.
The trade finance industry is now at an inflexion point as corporate credit rating pressures, resulting in downgrades and failures in some quarters, has led to traditional lending becoming more selective. In the previous paradigm, higher commodity prices meant that corporates were awash with cash and keen bankers were willing to rent their balance sheets on very liberal conditions at all-time pricing lows.
Corporates with high production costs and blasé balance sheet management may not survive, as nervous bankers are now reducing, and in some cases even withdrawing, credit lines as quickly as they provided them.
The warning signs are here, but how corporates and finance providers respond will have broader implications to edgy commodity supply chains that are facing their own challenges.
As history shows during times of financial turmoil and uncertainty flight to quality kicks in and trade finance often comes to the fore in providing low risk financing that creates confidence across the banks’ credit committees to ensure the provision of liquidity to corporates continues. I can recall during the GFC a high level of conservatism returned to corporates’ risk considerations and as a result previously unanswered telephone calls by some corporates quickly changed their disposition and deeper engagement was seen.
Nowadays, we are seeing a renewed interest by corporate treasurers, of commodity producing and mining services companies, as they turn to the trade finance industry to solve their liquidity and risk challenges.
The time is now ripe for trade finance to step into the breach to provide mainstream finance to corporates and their supply chain counterparts.
Successful trade financiers adopt the mindset that someone across a supply chain needs financing and the solution lies in the identification of the strength or so called anchor within the supply chain - does the solution lie within the corporate’s purchasing activity, selling activity or the underlying commodity they are trading in?
Supply chain finance, otherwise known as reverse invoice discounting and buyer led financing are early payment programs structured for corporates to reconcile the competing needs of a buyer wanting to delay payments to their suppliers for as long as possible and for sellers to receive cash as soon as possible.
Trade finance banks purchase suppliers’ receivables at a cost that reflects the credit quality of the corporate buyer and transaction costs of the bank, and at the receivable maturity date the corporate buyer repays the bank, a simple concept indeed.
The proposition is now made even easier as technology has largely solved the manual processes often in play when talking about trade finance.
The proliferation of tech companies developing innovative platforms has seen trade finance banks adopt a range of engagement models from bilateral arrangements to white labelling partnerships to outright acquisition of the platform provider.
Overlay this with the altruistic mantra of “a financially healthy supply chain is a sustainable supply chain”, the stars appear to be finally aligned for this form of financing to progress to mainstream financing rather than an interesting topic at an industry conference.
Whilst the level of interest from commodity producers in supply chain finance has increased and banks’ pipelines are starting to build key questions remain:
- Will corporates embrace the new paradigm?
- Has the trade finance industry done enough to make the value compelling enough for corporates to change?
- Will the regulatory environment, impacting on both cost and ease of use, stifle its renewed interest?
- Can corporates get their business units strategically aligned?
These are complex problems to solve and the answers are multidimensional.
If credit constraints prevail, the supply chain finance solution may soon be one of the preferred ways banks lend to corporates to meet their short term financing needs. Typically an uncommitted and short term financing arrangement allows banks to quickly respond to further deterioration in credit quality of the corporate and economic environment.
Compelling corporates to change is one of the main challenges for trade finance banks to influence the demand of supply chain financing. Because of the complexities of delivering the multi-dimensional benefits, sometimes the value proposition gets clouded in where the true value lies – is it working capital benefit, is it lower cost of goods sold through early payment discounts, is it supplier support or balance sheet driven?
Crisp, clear positioning will aid the proposition to influence a favourable outcome for the trade finance bank, corporate and their suppliers.
Regulation has certainly added to the degree of challenge when implementing these solutions. With an ever increasing need for banks and corporates to adhere to KYC and KYCC requirements, supplier on-boarding remains a critical success factor as to whether these programs are successful or not. Failure to on-board suppliers on these programs will result in the benefits of the solution not being delivered to all the parties involved.
Collaborative business models may hold the key to this problem as banks join forces through alliance partnerships with correspondent banks and platform providers to satisfy both internal and external compliance requirements.
Supply chain financing in many ways is a zero sum game, a corporate buying entity who increases its payment terms benefits by cash flow optimisation and releasing working capital to enhance its balance sheet position, however this comes at the expense of their suppliers who need to wait for longer terms to receive their cash. The negative impact is softened through cost effective financing provided by the trade finance bank. Despite this, corporates are often conflicted between financial objectives from the treasurer and the supplier relationship managed by powerful procurement teams who may see this threaten the strategic supplier relationships. Additionally, once payment terms have been extended, the motivation of the corporate to on-board suppliers may be diminished as their working capital objectives have been realised.
As supply chain finance can be a major project for a corporate and for the organisation to be strategically aligned the more successful global programs have been mandated at the CEO or CFO levels and investment provided to support the implementation whilst at the same time resolving the finance versus supplier relationship complication.
In summary, whilst the trade finance industry adjusts to the challenges presented by a gentleman known to many as CARL (Compliance, AML, Regulation and Liquidity), the industry is at an inflexion point to increase its relevance in solving financing problems for credit constrained and cash strapped corporates and their suppliers.
As credit markets, on the back of stressed commodity prices, are becoming more conservative, the time is right for supply chain financing to be positioned as mainstream financing rather than the specialised focus previously seen.
For this to occur, the value proposition needs to be sharpened up and corporates placing this on the strategic agenda to ensure successful execution internally.
If successful, this form of financing will foster the necessary confidence across corporates, financiers and strategic trading counterparties.
By Gerry Gannon, Director, Trade Finance, Westpac Institutional Bank
*Statistic from GTR conference, Sydney 2016, key note speaker Andrew Charlton