The global financial crisis has undeniably accelerated the adoption of financial supply chain (FSC) solutions. This trend has been the result of:
- A leaner supply chain and a focus on working capital management.
- Constrained capital markets and a decreased number of financial players.
Many corporates have consolidated the number of suppliers and distributors they deal with in order to build tighter supply chains and business partnerships with the remaining trading partners. ‘Anchor’ corporates have had to ensure that these partners are financially stable, particularly with activities such as just-in-time inventory management. In this scenario, the supply chain will be critically affected if just one supplier fails. Even if the company supplies a small component in terms of value, it can still have a considerable impact on the anchor corporate’s business. For example, a fridge manufacturer may be dependent on a specific component, e.g. a fan, to finish its product. If the fan producer goes out of business, then the fridge manufacturer will have serious problems in its production line.
As anchor clients focus on improving their own cash flow and working capital metrics, there can be a knock-on impact on trading partners who may need to carry the burden of extended days payable outstanding (DPO) in their own working capital cycles.
In addition, corporates have seen some banks simply disappear from regions or countries, as a result of government pressure for banks to focus on their home markets. This means that there are now fewer players who can provide traditional financing instruments for smaller suppliers that have greater working capital demands.
A lack of financial players and less available credit in the capital markets, as well as the strategic importance of a single supplier to the physical supply chain, has completely changed many corporates’ operating environments. Therefore, it is now more critical than ever to have a banking partner focused on the entire supply chain – one with a global presence that is able to support those trading partners no matter where they are.
Choosing the Right Bank for FSC Solutions
When choosing a banking provider of FSC solutions, corporates need to evaluate seven areas:
- Long-term relationship.
- Structuring and on-boarding experience.
- Cross-border capability.
- Financial stability and credit capacity.
- Risk management.
- Extended services.
- Technology and operations infrastructure.
Corporates should approach a strong relationship bank when implementing a FSC programme, mainly because it is a long-term proposition. It requires a considerable amount of preliminary groundwork and time from all sides of the equation: the corporate client, its trading partners and the bank. Therefore, it must be viewed as a partnership, creating a win-win solution for all parties involved. A corporate’s core or top-tier relationship banks are the most likely to provide high quality FSC solutions.
Structuring and on-boarding experience
Corporates should only consider a bank that has experience in rolling out FSC solutions – specifically a bank that is able to provide the client with advice on how to structure these solutions in order to make it beneficial for all parties and ensure the correct accounting, legal structures, etc.
A bank needs to have:
- A robust on-boarding capability, including ‘feet-on-the-street’ in a local market.
- The ability to segment suppliers into different categories in order to tailor the on-boarding process to their needs.
- Various telephone and internet tools to train people to use the platform.
The prospective bank needs to have extensive experience with on-boarding trading partners. A significant challenge of a FSC programme is not necessarily getting the anchor corporate to buy into the solution, but encouraging its hundreds or thousands of trading partners to actively use the FSC platform so that all the parties can benefit from the solution.
Additionally, if a corporate wants to implement a global programme, its FSC bank needs to understand the local requirements of the supplier’s market – knowledge that is gained by operating in those markets. For example, although there has been an increase in technology and processing capability across the globe, certain markets such as Spain and Turkey still need semi-manual handling. Consequently, a corporate needs a global bank that is also able to support these types of market users, which is also a critical part of the on-boarding process.
These may seem like minor points in a global strategy, but they will make the difference between a successful programme and simply having a programme.
Corporates should look for a bank that can work seamlessly across borders and in many regions. Increasingly, anchor corporates have foreign suppliers and/or distributors, so they need a bank that can structure attractive FSC solutions for suppliers or distributors in different markets. A FSC solution must be a global solution, which requires a bank with global capabilities but also on-the-ground presence in the major sourcing and distribution markets around the world.
Financial stability and credit capacity
A corporate that is considering a long-term FSC solution needs a bank that has a strong financial position, is a ready liquidity provider and can assist its supply chain partners in accessing comprehensive FSC facilities, either through the bank’s own balance sheet or by working with other banks through club deals or syndication-type arrangements.
A FSC bank must also have sophisticated risk models, which allow it to extend credit, not just in the name of the large anchor corporate that is usually investment grade, but also pre-shipment finance or downstream distributor finance in the name of the smaller, less creditworthy trading partner. The bank needs to develop risk models to assess the overall supply chain relationship so that it can extend credit more flexibly on better terms than it would on a stand-alone basis with the smaller trading partner.
Corporates also need a bank that can provide a full range of related capabilities. This goes beyond simply discounting invoices to helping automate payments, reconciliation, liquidity management and foreign exchange (FX). A FSC bank needs to be able to provide the full range of related trade, including documentary trade services.
Technology and operations infrastructure
A FSC bank also has to have strong technology and operational capability in this area to be able to fulfil the above criteria. Increasingly, corporates are looking to their relationship bank to help them connect with their trading partners in a more automated way, to be able to exchange purchase orders (POs) and invoices, and improve reconciliation between invoices and payments, or between POs and invoices, through matching and other related activities. Corporates need a high level of straight-through processing (STP) and integration, but they don’t want to have to radically change their internal processes.
Remaining Obstacles to FSC Adoption
One obstacle to the adoption of FSC solutions is that they are still relatively new compared to more traditional credit products and therefore participants have to climb a steep learning curve. Within the anchor corporate’s organisation, there are a number of people that need to be educated on, or ‘sold’, the solution – it is not just a treasury or a finance function, but can involve procurement, logistics and accounts payable (A/P). Beyond the anchor corporate, suppliers and distributors need to be convinced as well.
Because of the numerous parties involved, a FSC solution takes longer to set up than a traditional bilateral type trade or another type of credit facility. There are also different legal structures, accounting issues, and cross-border concerns.
These are all learning points that reinforce the importance of experience. Corporates need a bank that has had experience in setting up FSC solutions and one that will help them quickly climb the learning curve and overcome any obstacles in their path.
The Future of Supply Chain Finance
The take-up of FSC solutions has accelerated over the past few years and clearly the financial crisis was behind that acceleration. As the world returns to a more ‘normal’ state, some people have questioned whether the demand will subside.
The simple answer is no. Looking ahead, the drivers may be somewhat different but the world has passed the point of no return in terms of adoption. Corporates are looking at FSC solutions because they want better working capital management and cash flow in order to free up funds for investment and other activities. That scenario is not going to go away – in fact, it is more pronounced than ever before as corporate treasury functions are increasingly engaged in ensuring that companies have better working capital metrics.
The lack of liquidity is clearly a driver for FSC solutions because it forces companies to be less reliant on unstable sources of funding. Corporates appreciate the fact that trade finance tends to be available through the good times and bad. And although currently the world as a whole is experiencing a small economic recovery, the financial crisis is not over.
Now is the time that companies need to deliver – they need to return to a more normalised production cycle, having managed the downturn successfully by decreasing inventory. But now they need to build up stock and buy materials. The big corporates might be able to return to the capital markets, but the smaller suppliers won’t be able to access credit there.
Looking out into the future, will there be a recovery? Will it be back to the good old days, or will there be a prolonged time of tight liquidity in certain markets and geographies? The latter scenario will accelerate the trend towards more types of supply chain finance solutions for the mid-market.
It is important to understand that, although the financial crisis brought the situation to a head, other drivers have clearly made the adoption of FSC solutions an irreversible trend. The pace of uptake may change but, as of now, the demand from clients is escalating and it will continue to grow at a very healthy pace for the foreseeable future.
Case Study: Retail Industry
The most common examples of FSC solutions are in the retail or consumer products industry where an anchor corporate may want to extend its DPO in order to improve its working capital. For example, instead of paying its suppliers in 45 days, the company may try to stretch that out to 60 days. Although this approach will improve the anchor company’s working capital, it may be detrimental to its smaller, less creditworthy suppliers who may not be able to afford the extended terms.
At this point, a FSC bank can step in and take advantage of the arbitrage opportunity. A large creditworthy retailer or consumer product company can borrow, for example, at LIBOR plus 100bps, but its suppliers may not be able to access finance at any price; or if they can, it may be at LIBOR plus 300, 400 or 500bps. The large company will look for a FSC bank to finance those extended terms at a rate that reflects its risk as a more creditworthy anchor client.
This creates a win-win solution because it gives the anchor client the ability to extend and standardise payable terms with its suppliers, while overcoming the obstacle to its suppliers’ inability or unwillingness to extend those terms because of the cost.
The proposition is reinforced by other benefits that a FSC bank can provide, such as the visibility of transactions so a company can easily see the status of its invoices. Small suppliers can access better information through automated connectivity with major anchor clients, improve document and data exchange, and also use the bank’s platform for other related services, such as making or receiving payments, FX transactions, etc.
The key is creating a win-win situation between the anchor client, in this case a large retailer, and its small suppliers, in order that all participants have an incentive to get on board and use the services.
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