Down but bouncing back: Supply chain finance roundtable

The era of historically low interest rates has come to an end in most major markets, at least for now. How did the rapid rise in the cost of debt impact supply chain finance (SCF)? In July, GTR assembled a group of senior industry professionals from financial institutions, platforms and investors, to pose this question. They also gave their views on the waxing and waning of sustainability-linked SCF programmes, the current appetite for SCF assets and whether deep-tier supply chain finance is the next big thing.

Roundtable participants:

• Alistair Baxter, executive director, Pemberton Asset Management
• Maurice Benisty, chief commercial officer, Demica
• Chris Cox, global head, trade and working capital solutions, Citi
• Thomas Dunn, chairman, Orbian
• Duncan Lodge, global head of supply chain finance and Emea head of trade finance, Bank of America
• Enrique Rico, global head of trade and working capital solutions, Santander
• Priyamvada Singh, global head of supply chain finance and co-head of global trade finance, Americas, SMBC
• Makiko Toyoda, global head, global trade finance program and global supply chain finance program, International Finance Corporation (IFC)

GTR: Many developed economies have had elevated interest rates for around two years now; what impact has that had on demand for SCF products? Conversely, with inflation falling fast, those rates may soon start to come down – what effects do you think that will have?

Cox: There’s no question that 2023 was softer than 2022. But I’m not convinced our volumes were significantly down; I think people were more conscious about discounting decisions and there is a lot of interest in new programmes. We certainly see pockets of the world where the prospect of higher rates is actually increasing appetite for supply chain finance programmes, where they perhaps haven’t been used heavily in the past. People are now looking at the contribution they can make in a situation where economies are facing – for the first time in a very long period of time – the prospect of higher interest rates, and how they support those smaller suppliers in their supply chain. We feel pretty confident about the long-term trend. The market has definitely been softer as interest rates, particularly in the western economies, have spiked. But there are higher levels of interest in the product generally.

Rico: We’ve seen a slight decrease in the utilisation of our programmes during the last year because of the increase in the interest rates, although probably total volumes have come up due to new programmes being closed. That’s the case across products – we’ve seen it especially in confirming or supply chain and to a lesser extent in receivables finance, and both due to lower discounts from suppliers, and shorter discount periods as well. We see the number of suppliers using confirming to raise liquidity being reduced and those that use it at quarter end doing it for shorter periods.

The overall utilisation of the programmes is lower but the amount of RFPs in the market is not going down, meaning that we still see the appetite of buyers in terms of confirming programmes and sellers in terms of receivable programmes. So there’s still demand, and as interest rates start coming down, I believe volumes are going to increase even higher to 2020/2021 levels, so we are definitely optimistic about the business.

Lodge: We’ve seen from our data that in 2023, discounting activity was reduced year-on-year, and large suppliers particularly have been more selective about how and when they discount. But anecdotally, we’re seeing some rebound. Working capital optimisation remains a key topic for clients, particularly in a high interest rate environment where they are looking to optimise cash and then use that cash to invest in their business, or maybe pay down debt and bring down their interest burden. Therefore supply chain finance remains an especially important device in the toolbox for clients. In fact, we’ve had a number of new RFPs, where the client has never used supply chain finance before. A high interest rate environment was actually one of the reasons they decided to look at this solution. Supply chain resiliency has also been a key consideration for clients as well.

Benisty: There has been a specific impact in countries that are exposed to the strengthening of the US dollar. In Southeast Asia and in Asia more broadly, we’ve witnessed a shift in funding from the dollar to local currency. That has impacted the take-up because these programmes were very competitive when they launched, but that’s changed. That’s more driven by exchange rates than interest rates, but it is interesting nonetheless. Another interesting change has been to do with sub-investment grade counterparties. We focus on corporates that have large, complex receivables portfolios, so typically companies with more than US$250mn turnover looking for portfolio solutions, whether through securitisations or large-scale receivables discounting programmes. The cost of debt going up due to higher interest rates has rendered these programmes more attractive because they are cheaper. From private equity sponsors that we cover, and their portfolio companies, we’ve seen a lift and we’ve done a lot more this year than in any other year in terms of new mandates. Some of that is Demica-specific, but a lot of it is down to being in an environment where high-yield debt is actually high yielding, and so the cost differential drives a different decision with the treasurer or even the private equity owner.

Toyoda: For smaller suppliers in emerging markets, sometimes they don’t have a choice and reverse factoring is the only way to access financing, so we see continuing demand from them. Similarly to Maurice, we see SCF platforms as a great opportunity for sub-investment grade buyers to access finance. IFC did a survey last year about SCF demand, and 42% of financial institutions said they need some support to strengthen their SCF offerings. There is an opportunity in the low-income countries we work in to introduce supplier financing.

Dunn: The biggest shock in 2022 was not so much that rates were going up, but the rapid pace of the increases. It came as a real shock to suppliers, especially because SCF business is priced on short-term interest rates – Sofr or equivalent – plus a spread basis. Every day that rates were rising, the cost to the suppliers was going up. Because of that, we’ve seen an unprecedented rise in demand for fixed-rate alternatives that allow suppliers to lock in the discount charge that they pay over the course of a procurement cycle – so they don’t agree a price and then find the cost has risen during the 120- or 140-day period of extended payment terms. I believe the reduced activity we’ve observed is not due to lower volumes, because while transaction flow is slow, it is growing. Instead, it’s primarily driven by changes in how working capital is managed by suppliers. This isn’t about buyers placing fewer invoices on platforms but rather about suppliers adjusting their discounting strategies. They’re still discounting the same number of invoices but for shorter durations. Instead of taking cash immediately, suppliers might now defer receiving payment until the end of the month or quarter when they actually need it. The average cost of a programme is around 6%, about two basis points per day — significantly higher than in 2021. Over 30 days, deferring that discounting decision could save 60 basis points, which, in the context of commoditised procurement, can meaningfully impact a supplier’s net margin.

Singh: There was an initial shock for suppliers when rates went up, but other factors, such as the continued disruption of supply chains due to geopolitical events, key trade route disruptions, port congestion and weather events have all contributed to lower SCF utilisation. While higher interest rates would have generally led to greater need from suppliers, we saw a much softer demand for SCF. Payables finance, which had previously been growing at rates much higher than receivables finance, has now reversed, with demand for receivables finance growing much stronger.

Baxter: Our focus is on growing mid and large-cap sub-investment grade companies, so I can talk to this segment in a little more detail than the wider market. Hawkish monetary policy has dominated the last couple of years, which has seen a change in the way companies finance themselves. In particular, for sub-investment grade names, the hot term loan B market has prompted CFOs to look into working capital finance more seriously and demand has remained present. Generally, this has been receivables programmes and not payables. We don’t anticipate any softening in demand as rates fall: any potential recovery in aggregate demand should ripple through the supply chain, so we believe working capital will remain essential to help companies capture growth opportunities. Generally, all central banks have been guiding a steady reduction in rates, so the impact of this will be more gradual than some forecast, or indeed hoped for, at the start of the year.

GTR: What do you see in terms of investor appetite for supply chain finance assets on the secondary market? How is the landscape for attracting funders to your platforms or programmes?

Baxter: SCF remains an interesting asset class to us due to its short-dated nature and is a simpler credit risk to understand than receivables. Around half of our strategy is deployed in payable programmes, and at the moment, we are seeing particularly good relative value in the US compared to Europe in the sub-investment grade space. We are also seeing a significant interest in funding working capital and trade finance assets. With a five-year track record of zero defaults and zero losses, institutional investors are starting to appreciate the attractive risk profile of the asset class.

Singh: Investor appetite in trade finance, including SCF, has always been high and we haven’t seen a slowdown. In fact, the problem is that demand for assets remains higher than the current supply. There is an issue around the economics of trade asset distribution, because of the uneven recovery of global trade and geopolitical tensions leading to redefining of supply chains, particularly in emerging markets. All these elements impact where and how trade assets, including SCF, are originated and booked. Some sectors, such as transport equipment, electric vehicles and the AI hardware space have shown strong growth. We are continuing to see a trend of strong investor demand for trade assets underpinned by sustainable goods and renewable energy projects. Hopefully that demand can continue to be met. Another aspect is that the pricing expectation from investors still hasn’t come down. They’re still expecting higher rates on supply chain finance, considering the higher interest rate environment. But you can’t always meet that expectation.

Rico: We see a divergence between the investment grade market and the sub-investment grade market. For the former, there is significant appetite given the reduced volume on the primary side, and pricing on the distribution side is coming down because of the higher demand versus supply. But appetite for sub-investment grade assets is still softer than investment grade, despite the presence of some funds that are active in that segment. When you look at our leveraged finance colleagues, for example, there’s a super liquid private market that we are still to develop in trade finance. There is good progress being made and we should keep moving forward.

Cox: We’re very optimistic about distribution; we think it’s very good for clients and our investing partners. Increasingly, SCF is becoming a platform business and the barriers to entry to do this well, and at scale, are getting higher. That benefits banks that have strong platforms with multi-partner opportunities. With rates higher and there being plenty of cash around from an investable asset perspective, we’re also seeing non-traditional investors come in on a cash-plus basis. We’re seeing what was traditionally a bank-led market broaden out into non-banks. There are also partners like the IFC and others with their own objectives. Citi is very comfortable working with the IFC to risk share, so we actually get funding into the places where both us and the IFC want to get funding to.

Lodge: Clients are also taking an interest in how the programmes are being funded. At an RFP stage, they might ask about liquidity, which parties will be involved and they may even request a specific investor to join a programme. Many investors are willing to sub-participate in programmes through our standard master participation agreements that we usually use in trade finance between participating banks, rather than through investors purchasing securities. As a result, we’ve seen trade finance expertise becoming an increasingly desirable skillset for non-bank investors, and they’ve started recruiting people who understand how to buy assets under these methodologies. But, given the softer market over the last 12 to 18 months, investors are keen to understand the projected programme utilisation dynamics before they join the programme. Because they need to obtain credit approvals and get their documentation negotiated and reviewed, they want to make sure that they’re coming into a programme where they’re going to receive a good supply of assets. They also want to work with banks that have strong experience in the SCF space and provide a very high level of service.

Toyoda: IFC’s agenda is to focus on emerging markets, especially high-risk countries, sub-investment grade buyers and SME suppliers. We are trying to show the SCF demand in the market and that multilateral development banks have a willingness to support those markets. IFC chairs the supply chain finance task force within the World Trade Organization’s Multilateral Development Banks (MDBs) Working Group, and during the World Bank/International Monetary Fund annual meetings in October, this task force would like to show that MDBs are committed to support banks to expand SCF markets in developing economies.

Benisty: Banks have demanded a supply chain platform that handles connectivity with customers, automates previously manual processes and drives growth in the origination of SCF assets. We are now getting additional demand for risk distribution tools, which will add automation to what is still a very manual distribution market.

GTR: Deep-tier supply chain finance is much-discussed as an innovative financing method in China. Do you see it taking off in other markets and on a cross-border basis?

Singh: The only domestic deep-tier SCF that has been done on any scale is in China, and that’s primarily been driven by the anchor buyers. The two biggest challenges in actually delivering deep-tier finance to scale and having any sort of impact are technology – having a scalable technology solution – and an enabling legal environment. What you’re eventually relying on is the irrevocable commitment of the offtaker, the eventual anchor buyer, and whether that is split or transferred. Those legal mechanisms need to be in place for any sort of international expansion of deep-tier finance to take place, and that doesn’t exist yet. Another major challenge is the due diligence that banks may have to do on the supply chain, due to regulatory requirements, such as recent corporate sustainability and due diligence regulations in the EU.

Supply chains are inherently very complex. In the case of a simple t-shirt, you have to think about where the cotton was grown, where the cloth was woven, dyeing and sewing, where the zippers and buttons were produced – which involves multi-tier supply chains and potentially suppliers in various countries. To achieve any kind of scale, there’s got to be much more development seen and adoption of these technology tools, legal enabling environment and due diligence standards.

Toyoda: I agree, we are hesitant to enter markets without SCF laws and regulations. IFC is currently working with FCI to map SCF laws globally. It will also be a call for action for governments, especially those in emerging markets, to strengthen their laws to help promote deep-tier financing in their countries.

Dunn: What we’ve found is that outside China, it is far more effective and efficient for suppliers to just start their own programmes for their own suppliers. They’re likely going to be smaller, but it’s much more straightforward than trying to engineer something for which, frankly, the technology and legal constructs are still significantly lacking. We’ve seen remarkable success in that because people understand how it works.

GTR: There have been mixed reports about the success of sustainability-linked supply chain finance. What level of demand are you seeing for it?

Rico: We have been believers in sustainability-linked supply chain finance since its inception, having closed some of the largest transactions in the market. There is demand, and it is growing, but it is slower than we expected. Under new EU carbon accounting rules [which come into effect in 2025], many companies will have to start measuring their scope 3 emissions, which include the emissions from their supply chains. Sustainability-linked SCF allows companies to incentivise suppliers to reduce their emissions or penalise them if they go up, and sustainability-linked supply chain finance is a very important tool for scope 3 emissions management.

Cox: I agree, I think regulators could help us both in the form of capital relief but also by helping us understand the standards a bit better. On sustainability, we see a diverse range of appetites from different clients: some are very focused on scope 3 emissions, others have more of an interest in net zero, human rights or social development. If you cover 1,000 different clients and they all have different sustainability objectives, it can be quite hard to administer.

Benisty: In our benchmarking survey last year, 43% of the 180-190 respondents said they had participated in a sustainability-linked SCF programme. That went up to 62% this year, which is a significant and encouraging jump. When we asked what would drive more penetration of these programmes, the ability to provide more favourable rates based on ESG scoring was the most popular response. However, only 22% said they had used an ESG rating service to score a transaction, so you can see there’s still a long way to go. We also found big differences in the way banks are putting limits, or not putting limits, on non-ESG-friendly sectors. Some banks are actively reducing limits for sectors like oil and gas, whereas others, notably in North America, are increasing them and they don’t have the same level of sensitivity. But generally speaking, we got more positive results on sustainable SCF than perhaps I was expecting. I thought it would take a bit longer to get the usage levels up.

Singh: When sustainability-linked SCF was the shiny new tool for sustainability initiatives, companies saw that this could do something about improving the carbon footprint of their supply chain and also publicise such programmes. But the real question is how much impact is it actually having in improving compliance standards when the financing incentive is for an approved invoice at the end of their supply chain? Now, companies are looking at other ways to amplify the effort for greater compliance in their supply chains. We see some companies issuing a sustainable bond and deploying those proceeds into greening their supply chain, by supporting the implementation of supply chain transparency tools for raw material sourcing and labour standards, which could have a much bigger impact in holistically improving sustainable supply chains.

Baxter: Specifically for supply chain finance, we are watching carefully the new European Corporate Sustainability Directive, which is entering into force this month. It creates mandatory human rights and environmental due diligence requirements for corporates with turnover over €450mn, which is right in our core clientele. Over time, this should give more transparency to the sustainability claims of financial products and make ESG-conscious institutional investors more confident.

GTR: The SCF disclosure rules for companies which use GAAP are fairly bedded in now, and the IFRS standards kicked in at the beginning of this year. What impact have they had on the product?

Lodge: There has been a limited impact across firms operating under both IFRS and GAAP rules. As I mentioned, we are seeing a high volume of SCF RFPs, including programmes being deployed for the first time, so it doesn’t seem to be reducing demand for the product. Clients are explicitly seeking specific data in order to make the disclosures, which we’ve been developing for them.

Dunn: Overall, it’s probably been a positive change. It’s provided a level playing field for people and provided a degree of certainty. Sometimes it was a little burr under the saddle for people’s decision-making because they were unsure what the new rules actually were. But now there are some very well-promulgated guidelines. In a couple of cases, programmes were disclosed for the first time and there was commentary that they seemed out of proportion to the size of the company. Following that criticism, you’ve seen some companies, including a handful of large US firms, significantly scaling back their use of supply chain finance arrangements.

That’s probably also healthy, to the extent that they may have had something that was looking a little bit too much like financial engineering, and less like supply chain financing.

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