Supplier financing has historically been an alternative source of financing that improved the obligor’s balance sheet at lower costs on covenant-light terms, thus optimising liquidity management. Most supplier financing is in the form of trade credit or financial lease to fund the working capital cycle or capex, while credit risk is mitigated by credit insurance; banks including export-import (exim) banks; or an alternative financier/investor.
Supplier finance has helped companies expand and grow their business, raise trade debt and working capital without recourse to the banking industry, and seamlessly repay their obligations from operating cash flows. Equipment vendors also appreciate a supplier’s credit, as deals happen quicker on multi-year contracts. Small to medium enterprise (SME) suppliers find discounting their credit-superior customer’s receivables cheaper compared to their own funding costs; many sophisticated suppliers’ credit solutions are also able to earn a spread between a financing solution competitively priced compared to their customers’ credit premium.
Extended payment terms, camouflaged gearing and supply chain risk
Many corporates, aiming to manage their balance sheets, have successfully negotiated extended payment terms from their suppliers. Firms receive easy credit – compared to that available from the bank or capital markets – while credit is accounted as trade payables that camouflages bank indebtedness.
Supplier financing – when not credit rated and priced for risks – can weaken the supplier’s or the financer’s balance sheet and credit rating and the pose a major risk to their industry supply chain, lenders and shareholders. The dependency on supplier’s credit can also place obligors at the risk of loss of control over their business. Suppliers may negotiate special terms such as preferred off-take at off market terms, concessions, higher financing costs, a lower cost of commodities, convertible debt or nomination of a director. Bundling and tie-in arrangements with supplier credit are open to regulatory and anti-competitive scrutiny, while government-linked vendors and banks may face political or security scrutiny, and exchange control may restrict tenors.
Both customers and vendors must spend extra time and due diligence on their selection criteria and a like-for-like comparison of terms. They must also rank business criteria such as financing terms and total cost, technology and customisation support, reliability of service, vendor reputation and integrity, supplier-linked government intervention, legal considerations and security.
Suppliers credit a catalyst for infrastructure and novel technology
Suppliers of equipment for a number of industries have used structured credit solutions to negotiate favourable terms – they include telecoms, power generation, rail infrastructure, mining and extraction, steel mills, aircraft and shipbuilding.
The commercialisation of novel and unproven technologies such as solar energy, energy storage equipment, robots and cloud computing is increasingly done using innovative financial engineering solutions such as supplier credit tied to sales and operating profits.
Information communication technology companies such as Google are providing support ‘in kind’, such as equity or loan to start-ups, whilst repayments are linked to the future sharing of revenue from products or services.
The China factor
Over the past 10 years, China-led infrastructure development in emerging markets has accelerated due to the regulatory- and covenant-light export-linked financing supported by Chinese state-owned banks. Most equipment supplies are wrapped with the supplier’s credit, while loan repayment is tied to sales revenue and cash flows of the customers or loans are offset against the supply of commodities for China’s industrial growth or to fuel demand for Chinese consumables and services.
China has provided more than US$100bn over the past 10 years in long-term supplier financing to develop emerging market infrastructure. The Asia Infrastructure Investment Bank (AIIB), the New Development Bank (NDB) and the Japan Bank for International Cooperation (JBIC) will encourage funding and the development of infrastructure and capex in emerging markets.
No rocket science in product offering!
Suppliers such as GE, Caterpillar, Siemens, Huawei, and ZTE, as well as commodity companies, have structured finance teams that collaborate with their business units to provide innovative financing solutions tailored to their suppliers’ core products. These teams also collaborate, structure and distribute credit and financial risk to banks; financial institutions; export credit agencies (ECA) that promote local exports; exim banks and insurance companies.
Companies that sell vehicle and farm equipment, appliances, telecom and computer equipment are also structuring, originating and distributing supplier’s credit or leasing obligations through their non-banking financial companies, trusts and special purpose vehicles (SPVs) or collaborate with credit card issuers to finance credit.
The financial platforms of insurance companies, investors, peer-to-peer (P2P) corporates, eBay and Chinese e-commerce giant Alibaba have also emerged as fierce competitors to the banks.
Banks have also set up structured finance desks to provide off-the-shelf structured funding solutions covering long-term supplier’s credit, leasing, and sale lease-back. Competition so far has proven to be agile. However, banks are slowly regaining their market share by developing their technology solutions and acquiring fintech companies.
Tighter banking regulation and fintech has made entry easy for the unregulated agile investor
A range of different factors have combined to disrupt banking solutions: they include tighter regulation; credit exposure limits on borrowers; stringent know-your-customer (KYC norms); severance of ties and activities by banks; industry layoffs; unregulated investors flush with liquidity; and technology platforms using financial tech (fintech) solutions
Digitisation allows corporates to partner, communicate and collaborate electronically with investors and banks that provide acutely time-sensitive, efficient, cheaper and globally scalable opportunities to finance suppliers. Most fintech solutions freely ride on cloud computing and the operating platforms of corporates banks, and insurance companies to create global product offerings.
The modus operandi is simple, seamless, user-friendly and app-driven on handheld devices. Once system deployment and the on-boarding of the supplier are completed, it takes just a few clicks to approve invoices by customers and payment by suppliers. Payment by investors to suppliers and repayments by customer are automatic, via bank accounts.
Making large corporates bite isn’t easy
Treasurers cannot ignore the proliferation of fintech solutions. Among the many offerings are supply chain financing solutions; receivables exchange; shared cash and trade finance ledgers; shared KYC and credit profiles; P2P lending platforms; handheld automated teller machine (ATM) apps and in-house bank platforms.
Fintech solutions will make corporates agile on managing technology risks, cash flows and repayment commitments to highly-leveraged investors, who share the same flexibility and reputation for managing unforeseen short term cash gaps as the banks. However, non-payment via auto debit by investors could potentially trigger potential credit default and cross default risks for the corporate.
Investors will aggressively offer extended credit terms using fintechs, although it is not easy to make major corporates bite. Companies will assess their data and IT protection policies, cash management systems, credit rating agencies, auditors and forensic experts. They will also canvass the opinion of their suppliers on the acceptability of the system and their banks on available banking solutions. Lastly, corporates will evaluate the ability of a bankrupt or dominant investor to create a liquidity scramble or dictate restrictive practices that potentially bring down the company’s supply chain, credit and reputation
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