Global supply-chain finance

Global supply-chain finance refers to the set of solutions available for financing specific goods and/or products as they move from origin to destination along the supply chain. It is related to a quickly growing use of a battery of technologies and financial business practices that allow for discounting of Accounts Receivable and financing of companies' confirmed Accounts Payable.

A global supply chain refers to the network created among different worldwide companies producing, handling, and distributing specific goods and/or products.^[1]

Overview

With the supply chain lengthening as a result of globalization and offshore production, many companies have experienced a reduction of capital availability. In addition, the pressure faced by companies to improve cash flow has resulted in increased pressure on their overseas suppliers. Specifically, suppliers receive pressure in the form of extended payment terms or increased working capital imposed on them by large buyers. The general trend toward open account from letters of credit has further contributed to the problem.

As a result, there is a need for global supply chain finance (GSCF) solutions. The market opportunity for a GSCF solution is significant. The total worldwide market for receivables management is US$1.3 trillion. Payables discounting and asset-based lending add an additional US$100 billion and $340 billion, respectively . Only a small percentage of companies are currently using supply chain finance techniques, but more than half have plans or are investigating options to improve supply chain finance techniques.

While buyers are extending payment terms to their suppliers, the suppliers often have limited access to short-term financing and, therefore, a higher cost of money. This cost-shifting to suppliers results in a financially unstable and higher-risk supply base. Overall, the benchmark report showed that companies should be pursuing three key areas of improvement: GSCF financing; GSCF technology; and GSCF visibility.

Benefits of GSCF

The role of GSCF is to optimize both the availability and cost of capital within a given buyer-supplier supply chain. It does this by aggregating, packaging, and utilizing information generated during supply chain activities and matching this information with the physical control of goods. The coupling of information and physical control enables lenders to mitigate financial risk within the supply chain. The mitigation of risk allows more capital to be raised, capital to be accessed sooner or capital to be raised at lower rates.

The need to increase capital or inject capital into the supply chain more quickly is being caused by several factors:

1.) Market trends with respect to the global supply chain have caused companies to demand an integrated approach/solution to physical and financial supply chain challenges: a.) Buyers are looking to optimize their balance sheet by delaying inventory ownership. b.) Suppliers are looking to obtain funds earlier in the supply chain at favorable rates, given buyers’ desire to delay inventory ownership. c.) middle-market companies are looking to monetize non-US domiciled inventory to increase liquidity. d.) There is wide interest in integrated supply chain finance solutions.

2.) Globalization of the United States and Western Europe’s manufacturing bases has resulted in fewer domestic assets that can be leveraged to generate working capital.

3.) Most small and medium suppliers to US and European businesses are located in countries that lack well-developed capital markets. Without access to efficient and cost-effective capital, production costs increase significantly or the suppliers go out of business.

4.) Letters of credit, a long-standing method of obtaining capital for suppliers in less developed countries, are on the decline as large buyers are forcing suppliers to move to open account.

5.) There is a desire to ensure stability of capital as supply chains elongate. Another Asian financial crisis (such as the one in 1997) would severely disrupt US buyers’ supply chains by making capital unavailable to their suppliers.

Market size

Given the competitive nature of the GSCF market (approved payable finance) and due to the fact that business undertaken is covered by customer and bank confidentiality, sources of information regarding market size and players are constrained and not widely available in the public domain. As a result, indications on the market size are based mainly on estimates. The current, global market size for Supply Chain Finance is estimated at US$275 billion^[2] of annual traded volume, which translates in approximately $46 billion in outstandings with an average of 60 days payment terms. It is still relatively small compared to the market size of other invoice finance solutions such as factoring, which remains the largest trade finance segment and is primarily domestic in focus. The potential market for Supply Chain Finance for the OECD (Organization for Economic Co-operation and Development) countries is significant and is estimated at $1.3 trillion^[3] in annual traded volume. The market serving European supply chains is approximately $600 billion.^[4] Based on these figures, the potential Supply Chain Finance market size for the US is estimated to be approximately $600 billion in traded volume per annum.^[5] A recent comprehensive research paper^[6] estimated that currently there are 200 GSCF programs of scale in place. These programs are run both domestically and cross-border and in multiple currencies. Still, the market potential is far from its capacity. If examining spending of large organizations, such as Lowe’s $33 billion in spend, it becomes apparent that Supply Chain Finance programs usually require a multi-bank platform due to the credit and capital issues associated with banks.^[7]

Market growth

Market experts estimate that only 10% of the global available marketplace has been satisfied with Supply Chain Finance solutions, revealing a large potential market for growth. The market is expected to continue to expand strongly in the coming years at a rate of approximately 20-30% per annum and 10% per annum by 2020.^[8] The highest growth of supply chain finance programs currently originates from the US and Western Europe. Asia - India and China in particular, are considered the markets with most potential in the coming years.

The driving forces behind the rapid growth of supply chain finance programs are:

• Globalisation has increased the risk in supply chains and the impact on the financials of corporations.
• Working Capital Management has risen at the top of the CFOs’ and Treasurers’ agendas.
• Strong interest from suppliers regarding the provision of liquidity and enabling lower financing costs.

Further growth potential - Challenges

Although Supply Chain Finance is experiencing significant growth in demand, financial institutions are focused mainly on the large buyer side of the trade equation. As structured solutions have been traditionally engineered and provided by banks specifically for large international trading companies, they do not use common foundations. In order for Supply Chain Finance to take off on a broad scale, a fresh impetus is needed. A “tipping point” could easily be reached by solving the following challenges.

• On-boarding of Supplier. In a Supplier Financing program, the servicer needs to on board the buyer’s trading partners - the suppliers. The multitude of such platforms generates operational issues for suppliers wishing to benefit from various Supply Chain Finance offerings via their buyers’ funders.
• Know-Your-Customer (KYC). Most funders require KYC checks to be performed on suppliers being enlisted as new trading partners. This procedure not only increases the total processing cost, but it also puts the business case for all parties including the service provider, funder, buyer and ultimately the supplier at risk.
• Available Capital and Liquidity. With 90% of liquidity in Supply Chain Finance programs provided by large, global commercial banks, there is a large amount of trade assets, which cannot be covered by such financial institutions. Further regulations such as Basel III might impact the risk appetite and funding capacity of banks and make it more attractive for non-bank funders to step in and support Supply Chain Finance facilities. Limited to large buyers. Today’s Supply Chain Finance offerings are mainly addressing the large buyers with sound credit ratings whereas the real Supply Chain Finance opportunity extends to large suppliers too, in particular in terms of payment assurance and risk mitigation.
• Proprietary legal documentation. Current Supply Chain Finance offerings use proprietary legal documentation, which makes the signing of non-standard agreements a costly, complex and time consuming process for corporate clients and their suppliers. Therefore, the market is currently facing challenges related to the absence of interoperability and legal standards.
• Standardized product definitions. The naming and definitions of the various Supply Chain Finance solutions vary from one market player to the other, which makes it difficult for corporations to compare offerings and consider switching from one provider to another.

The role of the GSCF “translator”

Physical and informational control are the keys to a GSCF solution. There is a need for logistics providers and financial services firms to join together to develop precise visibility tools that provide CFOs and global supply chain managers with the data they need and lenders with the collateral security required to provide capital. In fact, according to a November 2006 study conducted by the Aberdeen Group, large companies are four times more likely to be planning to spend over US$500,000 in supply chain finance technology over the next 18 months. Once a robust information-based system is established, trading partners, logistics companies, and banks need to be able to access the information quickly and efficiently.

The starting point for information about goods being transported must be the entity that is transporting the goods – the supply chain services provider, transportation company, and/or logistics partner. These are the entities that have the physical control of the goods while in the supply chain. Access to this information is a must from a demand planning perspective. Knowing where the goods are in transit, the financial services provider can more confidently extend financing at various milestones within the supply chain.

There is a critical role missing in this equation, however, and that is the supply chain finance “translator” – the entity that is experienced in both logistics/transportation and financial services. The translator is the subject matter expert, if you will, that can bring all entities to the table – transportation and logistics; banks; buyers; and sellers and speak the various languages and understand the needs of each party. In addition to participating in the financial transaction, the translator can help bridge the information divide between the physical and financial worlds, providing critical analysis about the information being collected from the supply chain.

The following explains this translator role:

Activity	Logistics/Transportation provider	GSCF translator	Financial services provider
Goods	Deliver transportation, logistics, and supply chain services – i.e., move the goods.	N/A	N/A
Information	Collect and provide information about goods disposition to customer, translator, and financial services provider.	Verify data transfer; aggregate, analyze, manipulate, and provide data; authorize financial transactions.	Receive data from translator in order to authorize financial transactions.
Funds	N/A	Participate in funding for transaction and assume a proportionate share of the risk.	Participate in funding for transaction and assume a proportionate share of the risk.
Sales and marketing	Identify prospects, participate in sales calls, stem commoditization.	Identify prospects, market GSCF, participate in sales calls, identify financial risks, assist in structuring credit solutions.	Identify prospects, participate in sales calls, assist in structuring credit solutions.
Financial benefits	Transportation revenue, deeper relationship with customer and translator.	Interest income, fee income, deeper relationship with customer, financial services providers, and logistics/transportation provider.	Interest income, deeper relationship with customer, translator, and logistics/transportation provider.

Global supply-chain finance solution set

Some of the product solutions that could be sold under the banner of Global Supply Chain Financing include, but are not limited to: 1.) Global asset-based lending (GABL) – Enables middle market companies to monetize off-shore or in-transit inventory. This results in increased liquidity to this class of borrower, 2.) Inventory finance – Enables companies that supply to large buyers to secure financing on inventory that they are required by buyers to hold. This results in an improvement in the net cash conversion cycle for the buyer while providing the supplier with capital at a reduced rate. 3.) Receivables management services – Provides third-party outsourcing of receivables management and collections process. It also provides financing of those receivables and guarantees on the payment of those receivables. 4.) Payables discounting -Provides third-party outsourcing of the payables process and leverages a buyer’s credit quality to obtain favorable financing rates for suppliers. This results in lower cost of capital for the supplier, a portion of which can be passed on to the buyer. 5) Insurance – Further mitigates trade risk through cargo, credit, and transaction dispute insurance.

Because of the complexities surrounding the sharing and transferring of data, the need to physically control the goods, and to maintain visibility throughout the fulfillment supply chain, transportation and logistics providers such as UPS [UPS Corporation] have unique capabilities to support and provide SCF services to global organizations due to their access to the shipping data and capabilities as a lender. In these unique situations, UPS as a translator can participate in the lending as well as collaborate with other lenders in helping to extract costs from the supply chain and ensure that the physical and financial supply chains are synchronized.

Traditionally, dynamic payables discounting, the early payment of trade payables in advance of the invoice due date, has been only related to invoices that are already approved. Given these discounted payments are paid post-goods receipt and approval, they don't carry any transaction risk which is common in cross border trade. Given the complexities of modern financing and payment techniques, invoicement including invoice automation and discount management initiatives need a framework to ensure that programs are approached on a strategic basis which bridges the supply chain, purchasing, accounts payable and finance organizations. Examples of solution providers are Misys TI Plus, TradeCard, Demica, PrimeRevenue and Manhattan Associates.

More recently, there has been a pivot back to Receivables Financing Factoring (finance) programs, primarily driven by enhancements in technology which has increased the efficiency and attractiveness of Receivables-based programs. In a Supplier Financing model there is a heavy administrative burden caused by the need to negotiate Receivables Purchase Agreements with each individual Supplier, whereas in Factoring (finance) programs only one RPA is required with the Vendor. In addition, traditionally there was a larger effort involved in calculating the Funders credit risk exposure in a Receivables-based program due to the many Buyers which needed to be credit evaluated on an ongoing basis. Technology has now automated much of the credit evaluation process allowing program Funders access to real-time Buyer risk ratings across their portfolio. This transparency generates increased credit appetites from program Funders and Credit Insurers and benefits the Vendor through attractive rates and increased program credit limits on their Buyers. Vendors can also use the receivables-based approach to increase competitiveness by extending payment terms to their Buyers Off-balance-sheet. Examples of solution providers include Global Supply Chain Finance Ltd.

Market players

Supply Chain Finance practices have been in place for over a decade. Three distinctive Supply Chain Finance structures have crystallized.

• Buyer managed platforms. In this structure the buyer owns and runs the Supply ChainFinance platform. Some large retailers such as Carrefour^[9] or Metro Group^[10] are using this structure and managing the finance program, supplier onboarding, and liquidity themselves.
• Bank proprietary platforms. The Supply Chain Finance structure is managed by large commercial banks providing the technology platform, services and funding. This structure is used by several large buying organizations such as Carlsberg, Boeing, Marks & Spencer and Procter & Gamble.
• Multi-bank platforms. The structure that has exhibited the strongest growth rate is represented by independent third party supply chain finance providers offering multi-bank platforms. This structure separates the entities, which manage the platform – a specialised service provider, from the funding partner, which provides liquidity and takes the credit risk. Based on the fact that funding in SupplyChain Finance is uncommitted, no bank can fund in every jurisdiction or currency and due to the general limitations in terms of credit risk appetite and funder concentration risk, companies such as Volvo,^[11] Siemens,^[12] KPN^[13] and other leading organizations have chosen this structure. The leading providers of multi-bank platforms include PrimeRevenue and Global Supply Chain Finance Ltd who facilitate these trades through their respective platforms.
• Market share. In terms of market share, programs are serviced and funded by a handful of players including large commercial banks such as Citibank, JPMorgan, Deutsche Bank, HSBC and Santander as well as service providers such as Global Supply Chain Finance Ltd. and PrimeRevenue. Together they manage over 40% of the market share. The rest of the Supply Chain Finance is serviced and funded by a variety of local banks and smaller, independent service providers.

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References