Trends in Supply Chain Finance
by Phillip Kerle, Chief Executive Officer, Demica
Supply Chain Finance - A Background
Although definitions of SCF tend to vary, the Aberdeen Group defines it as: “A combination of Trade Financing provided by a financial institution, a third-party vendor, or a corporation itself, and a technology platform that unites trading partners and financial institutions electronically and provides the financing triggers based on the occurrence of one or several supply chain events.”
SCF 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 (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. 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.
Insurer Aon cited 'supply chain risk' as one of the most critical business issues in its 2007 survey of global risk.
Demica first published a report on the SCF market in early 2007. In our first report, we observed the unsustainable tension building in many European supply chains as Buyers continue to exert pressure on Suppliers to extend payment terms. But since the publication of our first report, the international credit crunch has begun to add to supply chain woes, prompting insurer Aon to cite ‘supply chain risk’ as one of the most critical business issues in its 2007 survey of global risk.1
The Federal Reserve, the European Central Bank and the Bank of England have all reported an inexorable tightening of credit terms from relationship banks over the last six months2. The losses - and consequent write-downs - suffered by major international banks as a result of the collapse of some sections of the credit derivative markets last autumn, have greatly contributed to this tightening of terms. So from a corporate perspective, SCF has come under the spotlight as financial directors seek ways of raising finance to free up working capital using alternative techniques, in order to substitute for part of the squeeze on normal lines of credit.
From the banking point of view, our first research report revealed high levels of interest amongst global banks in meeting the growing corporate demand for SCF. It highlighted that they viewed SCF as offering more attractive margins than traditional bank financing, as well as presenting a valuable opportunity to extend existing customer relationships. The last 12 months have seen these trends gain significant momentum. The credit crunch may well drive SCF, substantiating the view that it will be an alternative source of funding for those corporates facing difficulties obtaining bank credit.
Consequently this year’s research also quizzed banks on their views of SCF programmes in the current credit climate. Corporate receivables fall into the high quality asset bracket, where pools of invoices can be effectively diversified and structured so as reliably to mitigate the risk of sudden changes in the quality of the asset and its derivative instruments. It is therefore Demica’s experience that trade receivables have a particular suitability to the current market conditions. Indeed, respondents to the research corroborated the view that SCF is burgeoning - showing a virtual doubling of major banks offering such products to corporate clients; a 65% increase in live SCF programmes amongst those corporates; and a virtual tripling of those corporates actively assessing SCF programme suppliers.