Navigating the minefield of financial regulation

The financial world has weathered some rough storms in recent years, leading a number of global economies perilously close to being dashed on the rocks. Governments have seen regulation as the mechanism to provide more safety to enable banks – and so economies – to stay afloat during the inevitable future storms. At the same time, the potential impact of that regulation, not only on banks but also corporates, can make it challenging to navigate financial decisions.

Banking regulations

Since the early 2000s, various regulations have been put into place with the intention of strengthening the banking system and preventing future financial crises. The most prominent regulation in terms of impact is Basel III, which has expanded on the original briefs in the first and second Basel Accords to ensure that banks hold enough liquid assets in relation to liabilities to keep them solvent.

The Basel III liquidity coverage ratio demands that banks have an adequate stock of unencumbered high quality liquid assets (HQLA) that consists of cash or assets that can be converted into cash at little or no loss of value in private markets, to meet their liquidity needs for a 30 calendar day liquidity stress scenario.

Given the restriction on the bank, this has ultimately led to an increase in the cost of credit for corporates and a reduction of lending to higher-risk companies by banks. The result has been a global imbalance of liquidity: larger corporates with strong credit ratings enjoying cheaper credit whilst stockpiling cash versus a diminishing pool of lending and an increased cost of borrowing for the small to medium enterprises (SMEs).

The effects of these regulations mean different things to different banking customers. Large companies find themselves in a position where it’s too expensive for them to deposit their cash due to low interest rates and new bank fees. At a time when many companies have large cash reserves, this is particularly challenging. Meanwhile, Basel III regulations regarding debt to income ratios mean that SMEs are finding it more difficult than ever to get bank financing, as banks shore up their reserves and make less cash available for loans.

Anti-Money Laundering regulation and payables reclassification

To correct this imbalance, there has been a significant growth in supply chain finance (SCF) programmes. Here again, however, regulation has had unintended consequences. Although SCF looks to leverage a buyer’s credit rating to provide cheaper financing to suppliers, its reach is limited due to the anti-money laundering (AML) regulation requirements for banks.

Regulation directly affects more than just the banks. The attraction of SCF to corporates has been the ability to raise cheap cash on the balance sheet through a payment terms extension with their larger suppliers. This practice has now been attracting the attention of auditors, who are questioning the viability of accounting for the programme as trade payables rather than debt. The reclassification risk is certainly a concern that corporates have been attempting to navigate.

Prompt payment regulations

Additionally, the general public’s perception of the practice of extending payment terms has led politicians in Europe to introduce regulation to restrict the practice through Directive 2011/7/EU, which required a maximum of 60 day payment terms unless directly agreed with the supplier. These regulations have limited the potential impact of many supply chain finance programmes on the financial objectives of chief financial officers (CFOs) and treasurers.

In the US, the Federal government and various local governments must adhere to similar rules when paying their own suppliers and contractors, but there are no such legal requirements for other businesses. However, the White House rolled out its own initiative called SupplierPay Initiative. This is a Washington-sponsored programme in partnership with the Small Business Administration (SBA) where large corporates have voluntarily “signed up” and committed to making early payment to their suppliers.

It is a similar story in the UK, with the Department of Business Innovation and Skills (BIS) supporting the Prompt Payment Code (PPC) that sets the standard for payment practices. Although covering prompt payments and wider payments procedures, big businesses are only voluntarily required to sign up to become a part of this scheme.

Dynamic discounting techniques to ease regulatory concerns

The latest dynamic discounting solutions allow companies to optimise their working capital positions in a live marketplace without intermediaries to find a real-time rate for cash flow. Companies across the globe use these solutions to increase their operating income while simultaneously producing vital working capital flows to their supply chain.

Here are some of the ways in which the latest, market-based dynamic discounting model eliminates regulatory worries for businesses:

Banking regulation: The best dynamic discounting models provide a solution for large corporates and SMEs alike. They give large companies the opportunity to offer early payments to SMEs using their cash reserves. Given the low and even negative interest environment this is a much more effective use of cash. The SMEs gain the liquidity they need at a reasonable cost while the corporates get higher returns on their cash and de-risk their supply chain at the same time.
Anti-money laundering regulation and payables reclassification: True dynamic discounting programmes stand apart from the actual payment process, acting merely to find the common ground between a buyer and its suppliers to agree on an early pay cash discount. This means the buyer is still paying the supplier, albeit sooner than the original terms, but with its own cash pool (as opposed to a bank making payment on the supplier’s behalf). Because the buyer is using their own cash to pay suppliers early, there is no risk that the classification of trade payables will be altered or that the amount paid early will be deemed debt, as the cash used to pay early is not from a bank.
Prompt payment regulations: With or without regulations requiring prompt payments, dynamic discounting works to a buyer’s advantage to help them maintain the health of their supply chain by ensuring that their suppliers have the working capital they need to sustain and grow their businesses. It also gives buyers a yield on their excess strategic cash of an average annual percentage rate (APR) of 6.8% with an average days paid early of 21 days. Ultimately, if suppliers have the opportunity to request early payment, buyers automatically adhere to prompt payment guidelines.

By utilising new technology and best of breed collaboration techniques to create transparency between buyer and supplier, the latest, truly dynamic discounting solutions help to eliminate risk and ease regulatory worries for corporates and the businesses that comprise their supply chains.

Other articles by Andrew Burns

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