Walking with ‘dial-up dinosaurs’: supply chain finance now and in five years
Pricing strategies, competition and the best and worst of supply chain finance. Tom Dunn, chairman of Orbian, reveals all to TXF’s Ollie Gordon.
Trade & Export Finance (TXF): Where is supply chain finance at as an industry? Are some of the early adopters who were previously in static programmes now looking to move towards more innovative solutions?
Tom Dunn (TD), chairman of Orbian: Supply chain finance (SCF) has often been described as a ‘win, win’ situation: the buyer gets to extend its payment terms, the supplier gets cheap cash – everyone is a winner. But life doesn’t work like that. The ability to get suppliers onto a programme is all part of the dynamic in the relationship between procurement at the buyer and sales at the supplier, and understanding how you can better provide those guys with a tool that enables them each to achieve the objectives they’ve been set by their respective organizations. That’s where the smart SCF programmes are now moving, that’s the way the innovators in the business are trying to take it. And frankly it’s causing a number of previous participants to chuck in the towel – they thought it was a very simple corporate finance tool and it’s actually a lot more complex than that.
They don’t want risk upsetting their clients by trying to do it and failing. That’s why you’ve now got a bunch of people pulling out of the business and instead looking to support their clients through better programmes, such as Orbian’s, which allow banks to come in, participate, be seen to be supporting their clients, but not then to be dragging themselves down with a bunch of execution risks that they’re really not capable of. That’s why, when we’re recruiting people now, our main focus is on consultant types –people that understand that relationship between procurement and sales.
The corporates who have been on static programmes for a while are in the fortunate position that they didn’t get that far, so there’s not very much to unwind. On the other hand, they may have made a significant investment of time or managerial credibility. As a result, some have since left SCF for good, and others have switched to more competent providers.
TXF: What’s the immediate outlook for the SCF market?
TD: At the beginning of the year, we presented an annual outlook to our board which set out a good, aggressive plan, but warned of headwinds relating to the global trade slowdown. The growth that we can achieve in terms of taking our business forward is massive, but things like the commodity price falls will have an immediate effect on our business because around a third of our revenues are derived directly from raw materials and commodity currencies: if the price of copper halves then that means the value of copper assets that we’re financing has halved – you’ve then got to go double something else to
make up that shortfall.
TXF: What are the key impediments standing in the way a more corporates adopting an SCF programme?
TD: It’s about correcting the expectation that you just sprinkle a bit of SCF magic dust and suddenly your working capital doubles. Corporates need to understand that this is a tool, it’s not fairy dust. So long as they do that, then they can get to work with all of the nitty-gritty that goes into making sure that the system aligns with their own purposes and works across all the group globally.
On the market level, another issue coming through will be data protection. Everybody needs to have encrypted data. If people are still passing excel spreadsheets back and forth, then more fool them – they will have breaches and security problems. Data privacy is going to be a challenge coming forth in the next few years that people will have to start addressing. The recent ruling by the European Court of Justice that basically says that if you’re loading personal information – such as the information gathered in the KYC process – it can’t be transferred to the US. Some of the big providers are US firms, who are operating global data processing and data security arrangements. So those are the kind of challenges that people are going to have to face.
TXF: Do you think that other SCF providers are marketing the product in the right way?
TD: As soon as someone mentions accounting treatment they are out of their depth and they should stop. There’s a few providers out there that are talking about something called an ‘extinguishment method’. It doesn’t work and if it gets adopted it’s going to cause people problems; but I don’t think it’s going to be adopted because I think people are sufficiently aware of it. An ‘extinguishing method’ basically means the service funder doesn’t buy the receivable, they pay the supplier, extinguish that obligation, and replace it with a new obligation from the buyer on their books. Well that, I’m afraid, is just that you’ve borrowed money to pay the supplier. The clue’s in the word ‘extinguishment’.
People in the industry aren’t stupid. This takes away the need to do a true-sale transaction around the receivable. But there’s a reason we do a true sale: the obligation to the supplier has to remain sacrosanct. If it isn’t sacrosanct, then it is a borrowing to make an early payment to a supplier and there are hundreds of different ways of doing that, of which an SCF programme is unlikely to be anywhere near the top in terms of efficiency. The concern is that this will taint the whole product.
TXF: A senior banker recently told TXF that banks are still best placed to provide supply chain finance programmes, and that the non-bank competitors are too “thinly-capitalised” and sparse of KYC and data protection to be considered safe and sustainable. What would you say to that?
TD: I can only speak for ourselves, but all our KYC and data protection are subject to outside accreditation via ISO 27001, and it is all done in accordance with the funders and our regulators. So he’s not talking about us. One of the arguments that the banks have tried to make is that they have considerably more assets and revenues than the non-bank providers. The problem is that they’re not talking about the size, revenues or assets of their supply chain finance businesses, and at a stroke of a pen – as seen with a big UK bank recently – a bank’s hierarchy can cut its SCF department. Unless the
banks are going to provide committed provisions dictating that they will always provide this service, then that argument is a nonsense. Far better to look at the size of the business, its resources, the capital that’s backing it – look at it properly, rather than just making unfounded assertions.
TXF: Is there any kind of estimate you could provide as to how big the SCF market is at the moment? And just how much more headroom there is for further growth?
TD: If we define SCF as the purchase of confirmed receivables, based on assortments of market shares we estimate that it’s probably somewhere between $20 billion and $30 billion of outstanding assets. The market is still tiny so there’s still massive room for growth. But there are different definitions for supply chain finance, so market estimates do vary hugely.
TXF: A number of corporate treasurers have complained that onboarding suppliers onto a programme is often so lengthy and cumbersome that it basically negates all the benefits? What are you doing the make process easier, and therefore more attractive, for the corporate buyer?
TD: The main thing is that the procurement o?cer at the buyer needs to be completely in tune with the sales person at the supplier. Sometimes it’s so ‘lengthy’ because the procurement guy and the sales guy aren’t committed to the process, which is being pushed by treasury. ‘Cumbersome’ is because far too many of the bank programmes have created agreements for the suppliers that look like loan agreement – 70 pages long etc. Frankly, that needs to stop; it needs to be a short, simple agreement saying that the receivable is being sold. That’s all – basically a receipt.
The documentation should be in the local law of the supplier: they shouldn’t have to hire some international law firm to review it. It should be in their local language. The KYC/AML can be streamlined where they submit the forms and reports online, with a professional on the phone walking them through the process. In sum, the supplier needs to be recognized as a client and treated accordingly.
TXF: This is an incredibly competitive market at present. What will it look like five years from now? Are there too many little fish swimming around?
TD: It is an incredibly competitive market. The idea right now is to take the spreads down as far as is feasible in order to drive out as many of the marginal players as possible. We’re adopting a policy of pricing closer to marginal cost because we know that we’re the low-cost provider. So I hope in five years’ time the market has consolidated and looks something like the Visa/Mastercard duopoly, with two main SCF providers. It would be nice if there was someone else, as the market would develop better if there were two rather than just one. But, of course, there’s always going to be the odd AOL dial-up dinosaur hanging about.
The original article can be found here.