SUPPLY CHAIN FINANCE OFFERS END-TO-ENDLESS OPPORTUNITIES FOR ENTERPRISING LENDERS
|By Brown, Anthony|
Supply Chain Finance (SCF) is much in vogue as the finance technique du jour.
But what does it mean?
Is it reverse factoring?
International trade finance?
Or all of the above?
A broad definition of supply chain finance is best - the financing of self-liquidating transactions linked, to successive stages of domestic and cross-border supply chains. In other words, SCF is the financing of inventory and receivables relating to the processing of materials that are bought by manufacturers to make finished products, that are then sold by exporters to importers, that are then sold by importers to distributors, who then sell them to end buyers.
Business is changing and the earlier (and more often) a lender can add value in extended supply chains, the likelier they will be to win new and maintain existing clients.
Here we explore how lenders can use non-traditional financial solutions at various stages of supply chains to competitively differentiate and to simultaneously maximize their value proposition to clients. The main trends driving new product development in global commerce are included in the sidebar Befriending the Trends on page 20.
In today's globalized economy, any discussion about supply chains inevitably encompasses more than domestic trade. And that's good since global trade has generally grown faster than global production (see chart 1 above). This opens up huge opportunities for factors and asset-based lenders.
A combination of several facts augurs well for the future of receivables and payables financing in the West: The use of open account terms is most prevalent in the US and EU; at
The competition is about to heat up between players vying for this space - banks, factors, insurance companies, pension funds, hedge funds, IT platforms and, of course, corporates themselves.
Digital is the New Black
Much of the focus of trade financiers today is on how to make the availability of receivables, payables and inventory financing as efficient, streamlined, transparent and inexpensive as possible. Drivers for this are the increasing rate of adoption of electronic invoices and purchase orders (15-20% p.a.) and the use of B2B and bank trade platforms to transmit them and aggregate data. Liquidity providers, risk takers and logisticians are participating in these platforms to provide finance, protect against non-payment and provide transparency into the physical supply chain at multiple stages. This facilitates the provision of financing and risk management appropriate to visible "events," such as issuance of orders; receipt of raw materials; shipment, arrival, warehousing and delivery of finished goods, disputes, and so on.
These developments represent a challenge to those invoice financiers whose processes rely on cumbersome verification of delivery, confirmation of payables and other forms of manual intervention. Moreover, lenders who focus solely on financing suppliers' receivables are increasingly likely to find the spread of debtor risk skewed against them as more of the larger and higher-rated customers are attracted to buyer-driven programs providing early funding of approved payables.
Best-in-Class Supply Chain Finance
Hardly any lenders offer a complete end-to-end trade finance proposition - especially to emerging middle-market companies. This can be attributed to a combination of risk aversion, lack of funding for foreign assets, absence of strategic leadership, paucity of IT budgets, and shortage of know-how.
But if one were to answer a trader's prayer, what would the holy grail of supply chain finance look like? Chart 2, exemplifying a typical international transaction, offers an array of solutions that might come close.
Most readers are likely already familiar with factoring and asset-based lending in their local markets. So below the focus is on some less well-known ingredients that can be tossed into the Supply Chain Finance mix to whet the appetite of prospective clients.
i. Work-in-Progress (WIP) Financing
Asian lenders are specialists in providing "Packing Credits", a form of WIP financing typically available against incoming purchase orders from creditworthy buyers or LCs. Loans typically finance up to 70% of the finished product value and are secured by personal guarantees and fixed assets. In addition, particular attention is paid to trading history (manufacturing capacity, timely delivery, product quality, disputes) and the manufacturing cycle during which funds are deployed and recovered. Field audits are common during production. As databases of historical factory performance deepen (digitization of transaction data is accelerating this), scorecards can be developed to give greater comfort to lenders.
In the U.S., lenders can tap the working capital programs of government agencies such as
2. Warehouse Financing
Quite typical in
3. Purchase Order Financing
PO Finance is a solution for companies long in orders, but short of a credit line to finance the sourcing of goods to fulfil them. Although expensive (20-40% p.a.), it is less costly than foregoing hard-won orders or giving up equity to attract capital.
PO lenders accept confirmed buyer purchase orders issued to their clients as collateral to provide LCs or payment undertakings to fund (typically, finished) goods to be shipped by suppliers. The key is to manage the inherent performance risks. Not only does extensive due diligence need to be undertaken in terms of prior trading experience, product expertise, factory credentials and so on, but PO lenders must "lend to the transaction" not the company. Backing orders need to be scrutinized for authenticity, product quality attributes inspected, logistics monitored, and cash flows controlled according to transaction cycles. This is now greatly facilitated by global trade platforms that provide visibility into all transaction stages.
4. In-Transit Inventory Finance
Seasonality and the pressure on vendors by customers to hold back-up inventory for immediate replenishment has caused unsold inventory to be a key financing requirement of clients. Already somewhat risk averse to accommodate this domestically, lenders typically shun goods held by clients overseas or in transit "on the water."
Some enlightened lenders have differentiated themselves by offering such finance. They perfect their security interest in the goods by having bills of lading consigned to them, insuring them, and by entering into tri-party agreements between themselves, the client and the freight forwarder/customs broker. In extremis, these give the lender control over the goods and require instructions regarding the goods to be taken solely from the lender.
An alliance with freight forwarders and transportation companies is another approach ripe for development - not only for transaction information but also to act as the lender's "agent" to file local liens on overseas inventory held in their possession. And perhaps even to put "skin in the game" by funding goods transported.
5. International Factoring
Although the messaging platforms, operating rules and factor networks of the
A variety of open account receivables finance, forfaiting involves the discounting of negotiable instruments such as trade drafts (aka bills of exchange) and promissory notes. Why would a seller use these instruments in international trade versus simple open account terms? For several reasons:
First, the seller may want to offer the buyer long unsecured credit terms (that is, without needing an LC that can tie up the buyer's bank line).
Second, the seller prefers to control the release of goods shipped until the buyer provides an irrevocable, legally unconditional payment obligation. Such a "documentary collection" is typically handled by a bank, where the seller entrusts title documents to the bank with instructions only to release them once the buyer has executed the negotiable instrument.
Third, the seller needs 100% financing of the receivable (less financing costs) without recourse for buyer slow payment or insolvency or disputes. Since trade drafts are legal obligations of the buyer to pay the full amount on time and without deduction, forfaiters typically make higher advances than factors - provided they judge the buyer creditworthy.
Forfaiting was previously applicable mainly to the sale of capital equipment on multi-year credit terms supported by the buyer's bank guarantee. Today, the technique is more popular for shortterm open account deals. It would be even more popular if negotiable instruments were electronic!
7. Reverse Factoring
Also known as Approved Trade Payable Financing, unlike factoring, Reverse Factoring is buyer-driven. Creditworthy buyers are offered a facility enabling them to extending payment terms (say, from cash at Day 4, in the example below, to Day 90). Ordinarily, this might challenge an overseas supplier in terms of liquidity and risk, but Reverse Factoring provides optional early, non-recourse payment to the supplier at Day 4 against assignment of buyer-approved invoices. Funding costs, typically at a rate that reflects the buyer's credit rating, can be much lower than available to SMEs in developing countries. If structured correctly, the transaction remains a trade payable on the buyer's books and can be an additional source of off-balance sheet finance to the seller.
Today, Reverse Factoring is estimated to be a
So far, the mid-market, non-investment grade buyers and their overseas smaller suppliers are largely untapped for Reverse Factoring and this represents a major opportunity for lenders - especially those with a well developed buyer underwriting capacity. Pricing in this segment runs from 12-20% p.a. compared to substantially less than half for larger buyers.
Business Not As Usual
Competition is heating up. Whether from peer-to-peer lending, online receivables marketplaces, B2B supplier networks, or from traditional sources - business as usual won't be a viable option for long. The earlier (and more often) a lender can add value in extended supply chains, the likelier they will be to win new and maintain existing clients. In the process, by financing successive links in the supply chain, rather than increasing transaction risk they will have access to early warning signals that will reduce it. tsl
BEFRIEND THE TRENDS
The last decade has witnessed some key changes in the way business is done - by banks, traders and governments. These trends are key to identifying market opportunities and developing timely solutions.
Here's a sampling:
Trend: Increasing use of open account terms in global trade - now estimated at 85% of global trade
Befriend: Financing export receivables finance via 2-Factor platforms (
Trend: Dematerialization - According to Paystream, today about 80% of world trade is still paper-based (90% in the US). But companies are switching to einvoicing at 20% per year.
Befriend: Capturing digital data from POs and invoices to (a) streamline operations; (b) improve risk management; (c) provide funding relevant to the transaction stage in the supply chain.
Trend: The need to increase working capital is causing buyers to lengthen payment terms (DPO), shorten sales terms (DSO) and optimize inventory levels(DIH).
Befriend: Financing inventory while in transit to your clients' overseas points of sale; purchase order financing; early funding of trade payables; inventory purchase financing (where the lender purchases inventory from a supplier and sells it to the buyer when needed).
Trend: Middleman Disintermediation - International wholesalers and trading companies have been squeezed by end-buyers and manufacturers as they seek to trade directly
Befriend: Creating virtual trading companies that bundle accounting, legal, logistics, back office and financing services for overseas manufacturers on a variable cost, fee-per-service basis.
Trend: Bank capital regulations (Basel III) will reduce bank leverage and increase capital allocated to higher risk-weighted transactions. This will result in higher bank costs and lower appetite for international trade and small business lending
Befriend: Alternative funding via securitizations, hedge funds, wealth offices, pension funds and insurers to serve markets segments shunned by banks.
Trend: The rise of seller-and buyer-focused trade platforms that facilitate sourcing/selling of goods and services, buyer credit risk mitigation, e-receivables and payables funding/collection (
Befriend: Participation in platforms as a buyer credit risk taker, liquidity provider.
|Copyright:||(c) 2014 Commercial Finance Association|