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, i.e. product or service buyers (buyers), while at the same time providing prompt payment facilities for their suppliers (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. | | Phillip Kerle |
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.
Most recently, however, a partnership has begun to emerge between the commercial lending arm of a bank and its securitisation colleagues, according to Andrew Betts of ABN Amro in Banking solutions for supply chain finance, May 2007. Commercial banking certainly has, and will continue to manage the overall relationship with clients for whom it organises a whole range of credit facilities, treasury management, custodian services, and other services; including supply chain financing 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’.
Changing environment
With Basel II just over the horizon (which may change elements of the process), there is a steadily increasing interest from US and international banks in finding additional methods of intermediating between borrowers and the capital markets. At present (although rules may change over time), current accounting regulations allow securitised assets to remain off balance sheet for banks running a conduit. While the underlying risks having been in part passed to the capital markets (bar liquidity facilities and backstop guarantees), the bank’s usage of regulatory capital is reduced when compared to traditional balance sheet lending.
Supply chain finance is one area where a few pioneers have introduced just such an intermediation (GSCF, Hewlett Packard Europe sign Dollar ABS [Securitization] programme, 2004), in the form of pooled payables securitisation, issued to the markets as commercial paper through one of the bank’s existing, or specifically established, conduits.
A number of buyer organisations can be gathered together by the bank, then a pool of invoice debt can be created which is sufficient for a payables securitisation programme. This has been the case so far with a number of US and Nordic banks. The aggregated debt allows the bank to securitise a diversified pool of buyer obligations. In these circumstances, banks have found it advantageous to reduce their capital exposure by securitising the debt effectively out to the capital markets. The price for the buyer community (corporate buyers of goods and services) may remain the same or less, but the bank has found that it can set-aside less capital in the process. The element of economy pass-through that the bank decides to make in this structure is at its own discretion.
A financing strategy is therefore emerging in supply chain finance backed by the trade payables of a diverse set of buyers. Here, the credit quality of the large corporate buyer is virtually identical to the quality of the outstanding debt being issued into the markets (before any credit enhancements), and will affect the credit quality and price of the paper so issued. This should provide the smaller suppliers with positive financing arbitrage, allowing them to effectively divorce their borrowing rate from their own credit rating (if they have one) and obtain cheaper financing based on the buyer’s cost of funds.
This much highlights the advantage for the supply chain. What about the buyer community? Well, by clubbing together under the aegis of a multi-buyer payables securitisation, they collectively benefit from the efficiencies of reduced bank regulatory capital, which may translate into even more efficient pricing. Certainly, banks will find this strategy more appealing when compared to traditional balance sheet lending.
Securitisation in the supply chain has been much discussed, but – until recently – little executed, according to Citigroup, EVA: The Economic Profit Equation (1998). Up to a few years ago, the idea of a pooled (multi-company) securitisation of trade payables was not considered economic or practical. However, systems are now well established to effectively automate the collection of data from the buyer companies, track the payables and produce the relevant settlement reports. Furthermore, all this is possible across a multi-company, multi-currency, multi-jurisdiction and multiple time zones (Citigroup, Optimising the Supply Chain, May 2006).
What, then, is the situation from the demand side – namely the corporate buyer community? According to recent research by Demica, 73 per cent of large European companies are still trying to extend payment terms offered by their suppliers. They evidently feel the need to improve cash flow and release working capital, which are essential elements for corporate expansion and to support wider economic growth.
This is creating a situation where the pressing corporate need to extend payment terms leads to an unproductive ‘tug-of-war’ – one where tension is building between large European corporations as buyers, and smaller corporations worldwide as their suppliers. If the payment terms of a deal are extended, the buyer improves its cash flow, but the supplier’s cash flow suffers, moving them into a more vulnerable position. Of course, if the supplier is essential to the buyer, then the extension of payment terms also, in effect, creates a potential threat to the buyer’s own business.
Demica’s research asked leading corporates to name the financing techniques for managing working capital that they believed would grow most strongly over the next two years.
Based on their own experience and balanced with a wider view of their industry, respondents noted that bespoke credit lines would grow the most, followed by supply chain financing.
Summary
In short, our research shows clear demand for innovative supply chain finance solutions from the corporate market. The emerging collaboration between international banks’ commercial banking arms and their securitisation colleagues is beginning to fulfil this demand with trade receivables backed solutions that provide highly economic credit facilities, off the bank’s balance sheet, that help free cash flow and thereby introduce greater stability in the supply chain. |
