Supply chain finance: A performance review
Orbian chairman Thomas Dunn conducts a comprehensive performance review of the supply chain finance industry, evaluating its strengths, areas for improvement and the critical factors that shape its future.
As has been oft remarked, tools for securing finance across cycles of production, supply and sales processes have been operating since the BCE eras of Phoenician and Sumerian traders.
Supply chain finance (SCF) in its modern guise, as a technology-enabled mechanism for suppliers to secure lowest cost finance against confirmed future obligations of their largest customers, may, however, be most conveniently traced back to 1999. This was the year of incorporation of a joint venture between respective technology and finance giants, SAP and Citibank. Subject to countless developments, iterations and improvements, this company’s core technology and methodologies have underpinned the majority of global SCF programmes today.
As we approach Orbian’s 25th birthday, we might consider the current scorecard for SCF, the industry and its participants, by adopting the model of a performance review: three strengths and three areas for improvement.
1: Widespread adoption
It has been clear for many years that SCF has been growing considerably faster than either global trade or domestic GDP. Particularly since the global financial crisis of 2007-08, it was estimated that SCF activities were growing at five to 10 times the growth rates of trade and OECD GDP. The introduction of new audit reporting requirements in 2023 has provided further evidence of what previously relied more heavily on anecdotalism. SCF is now a multi-hundred-billion-dollar activity, widely adopted by corporations across all types of industries and geographies. It is seen as a core tool of both treasury liquidity management and procurement effectiveness. Rare now is the Fortune 500 company engaged in manufacturing or retail that does not afford (at least some) of its suppliers access to the advantages of an SCF programme.
2: Good in a crisis
Over this period, the global economy has been wracked by numerous crises and disruptions. Among the more notable: the global financial crisis of 2007-08, the Eurozone crisis in 2010-11, the Covid pandemic of 2020-22, and the continuing Russian invasion of Ukraine in 2022-23. To this list of geopolitical and economic shocks may be added the SCF industry’s localised crisis in the 2021 collapse of Greensill Capital. In every case, the SCF industry performed with strength, resilience and often notable agility.
The core principles underpinning SCF programmes, of buyer confirmations to pay followed by timely and non-disputed due payments, ensured that finance continued to flow to participating suppliers. Financing costs may, on occasion, have fluctuated, but rarely by more than fractions of a percent, and the incidences of funding actually being curtailed have been reassuringly low.
3: Continuous improvement
Whilst remaining true to the underlying technologies and contractual principles, the SCF industry has seen a continuous array of product innovations and new service deliveries. These have included mechanisms for buyers to expand the range of suppliers eligible for inclusion, whether by geography, size or industry type. They have included mechanisms for suppliers to have better tools for managing the costs of SCF liquidity via highly innovative behaviourally based interest rate management instruments. They have included arrangements for an expanding range of financial organisations to participate as sources of liquidity even without any innate ability to originate SCF assets. This innovation has been driven by both incumbents and new entrants.
With the obvious exception of the unfortunate behaviour evidenced at Greensill Capital, and in sharp contrast to the shrill claims of radical change in other areas of finance (including blockchains and other crypto applications), innovations in SCF have been measured, and respectful of the foundations upon which they are built. There has not been a ‘wild west’ in SCF. Given its importance to global trade and manufacturing processes, that is to be applauded.
Areas for improvement
For too long, and for too many of its users, SCF has been kept under wraps, hidden in the attic and subject to minimal amounts of disclosure. It has been clear for many years that best practice has buyers provide disclosure in their accounts of SCF programme activities. Unfortunately, for other companies, there has been very little systematic reporting of the range of programmes and the extent to which they have used SCF programmes as tools for their working capital management. Perhaps two factors underpinned this reticence. Firstly, a desire not to draw attention to the programme in order that supplier engagement could be limited only to those suppliers selected and ‘specially invited’. Secondly, a desire to make improving working capital metrics appear as a result only of ‘procurement efficiency and discipline’.
New accounting guidelines adopted by FASB in 2022 have already yielded important new disclosures during the first quarterly reports of 2023. Multiple instances of US$1bn-plus programmes are now routinely disclosed. Similar changes at IAS should provide further material information. Together these will best allow both suppliers and providers of capital to understand the opportunities provided by major SCF activities.
2: Tools for ESG improvements
As has been well noted, supply chains typically account for 80%-plus of a company’s carbon footprint. A similar proportionality almost certainly applies to other metrics of the company’s social and governance profile. As such, there is massive scope for SCF to play a disproportionate role in the ESG agenda of global corporations. This opportunity is well understood and indeed has been a mainstay of conference presentations and panels for several years. Unfortunately, however, SCF has yet to develop a truly effective mechanism or product configuration that can meaningfully contribute. ‘Bonus/malus’ arrangements that see suppliers rewarded (or punished) for their ESG efforts tend to be insignificant, arbitrary and subject to profound challenges as to ‘who pays’. Such SCF programme arrangements may have served a purpose in highlighting the challenges and opportunities of ESG, but the priority now needs to shift to the delivery of substantial funding to support supply chain transitions. Such substantial funding will not be measured as a few basis points up or down in early payment discount charges.
3: Crowded participation
As remarked earlier, the last 25 years have seen the SCF industry develop in a generally measured and self-resilient fashion. No wild west. At the same time, however, the barriers to new entrants announcing themselves as participants in SCF is strikingly low. A spreadsheet, a PowerPoint deck, and an invitation to any one of the myriad treasury and trade conferences is the bare minimum for yet another claimant on buyer or supplier attention. In equal measure, these new arrivals come from private equity financed ‘start-up’; and from established banks expanding their trade/treasury/payments product range.
Buyer RFPs for an SCF programme might now often run to 30 invited participants, as overblown claims of fintech disruptors as well as every member of the latest revolving credit facility ask for the opportunity to present. Unfortunately, this clamour has many negative consequences.
The three most important may be:
Buyers find it hard to separate “the signal from the noise” and end up making poor decisions based on non-verifiable claims of experience and expertise as well as a too great emphasis on pricing differentiated only by tiny fractions of a percent.
The lack of standardisation across documentation and operational processes is making it materially harder for SCF to realise its true potential as an asset class for non-bank institutional investors. This is imposing real costs across the industry in terms not only of the available cost of liquidity to suppliers but also the resilience of programme funding that remains disproportionally reliant on bank finance.
The SCF industry is failing to gain significant advantages of scale even as the adoption of SCF continues to grow. Too many participants continue to be loss-making, even after 10 years or more of notionally successful engagement. This applies to both the specialist firms, often backed by private equity capital for which adequate returns recede ever further into the future, as well as the established banks, for whom SCF activities are more often reliant upon intra-group subsidies or transfers.
Almost 25 years – a quarter century and a full generation – after its inception, the modern SCF industry has a great deal of which to be proud. It is a widely understood and increasingly adopted core tool of both treasury and procurement management. It has proven itself both resilient and useful during many crises that have brutally exposed flaws in other parts of the global economy and financial systems. Similarly, it has evolved a broader array of related products, services and capabilities the most fully to enable fruitful collaboration between multiple departments of both buyers and suppliers.
This is, however, no time for the SCF industry to rest on its achievements. With its now widespread adoption comes important responsibilities to be part of core solutions for pressing challenges across global business. The SCF industry will be much better placed to meet these challenges if the next few years see consolidation amongst its participants. This will better enable users to evaluate services and empower non-bank institutions to participate. It will also ensure that the SCF industry itself remains resilient for the next 25 years of its growth as a core component of global finance.
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