The Next Generation of Supply Chain Finance

During the past 12 to 15 months, there has been a significant increase in the supply chain financing business due to the effects of the economic downturn and the contraction of available credit in the market, leading to an increased need for bank financing. When liquidity solutions previously provided by the market, such as asset-backed securities, all but disappeared, supply chain finance solutions became much more popular and generated huge international demand.

To cope with this new demand, most of the bigger transactional banks concentrated on providing buyer-based supply chain financing for their corporate clients. The banks mainly focused on investment grade companies as buying entities and provided funding based on their credit standing, as well as extending credit to their important suppliers.

On the whole, the banks responded quite quickly by developing both domestic and international solutions, which have different requirements. Domestic solutions are simpler because they operate in a single-language environment and legal/regulatory jurisdiction, with usually only one payment format or infrastructure involved.

International solutions, on the other hand, are much more complex, with multiple challenges: multi-currency, multi-language, and multiple legal jurisdictions with distinct legislation affecting both procurers and suppliers. The lien of an accounts receivable, for example, is a challenge because of the local laws and regulations in place in different countries.

From the technical viewpoint, by going global with a project, a bank will have to set up a number of booking centres, which increases the complexity of the IT: multiple host-to-host connections or other information exchange solutions. The commercial side of an international solution is also more complex, with different supplier buying behaviour in different markets, which again is dissimilar to operating solely in one domestic market. In summary, the key challenge for an international supply chain finance solution is to integrate the commercial, technical and legal aspects to achieve an efficient end-to-end process flow.

Supply Chain Risk

Today, many corporates are facing an extremely volatile market with fluctuating currencies, as well as risks concerning the performance of supply chain partners. This has meant that buying entities are now much more concerned about the financial performance of their supplier partners. As a result of the financial crisis, there is greater pressure to integrate the supply chain and break down business unit silos within a company.

Corporates know that it is critical to ensure the optimum timing within the physical and financial supply chain and improve overall cost management. This includes physical materials and services, logistics, inventory, cash flow, and financing, as well as risk management. The corporate objective is to remove any obstacles to a free flow of information within the entire supply chain. This includes the financial situation of their suppliers.

For example, Deutsche Bank is working with WMF AG, a corporate client in the consumer industry, to help optimise its procurement business from Asia to Europe. In the past, all the issues related to the payment and delivery terms, but today the client is also interested in sharing as much information as possible in order to create real-time visibility of upcoming order volumes. The company wants its large trading partners in Asia to be more involved and to create a ‘pull’ co-operation, rather than the existing ‘push’ co-operation. It wants to engage with them so that they are positioned to provide their services or goods in a more efficient manner than in the past, when companies have worked in a more fragmented fashion.

Consequently, now when the company does a turnover estimate, it can break it down into planned purchase orders (POs) that will be provided to the individual trading partners in the future; the company shares that information much earlier. It is also working more closely with its suppliers to understand their capital and capability constraints, and to have a much more robust and integrated co-operation than was standard practice in the past.

Trends for 2010

Looking forward into 2010, despite the fact that the global economy appears to be slowly coming out of recession, the trend of increased use of supply chain financing will continue. Currently, the objective of generating additional liquidity and increasing profitability is driving this type of solution.

Today companies are also enjoying a relatively low level of financing in many currencies. However, refinancing costs are expected to increase in the future, which in turn means that companies may find that their ratings are downgraded by one or two notches. The refinancing spread will also increase, as the risk-driven part of the overall financing cost.

Consequently, because companies may not be able to improve their financial standing in the near term, overall financing costs will increase. At that point, the financial cost and cost efficiency become important factors. Therefore, a customer’s financing solutions that ensured cost efficiency, with all the other benefits already addressed above, will continue to drive uptake of supply chain financing solutions and to favour alternative financing rather than just to simply return to direct lending, capital lending, etc.

Another trend that will continue into 2010 is an extension of the partner network to include banks, logistic companies, buying entities and suppliers, in order to work much more closely together and ensure improved visibility and cost efficiency. This trend has only just started, as corporates begin to realise the importance of linking processes and breaking down silos, whether human, treasury, or company silos, or silos between the buying entity, logistics company, suppliers, or other servicing companies. If the whole end-to-end supply chain process is interlinked, then the transparency and visibility gained can be used in joint planning initiatives, which will reduce costs, such as capital, materials, as well as logistic costs, etc, and have a positive impact on the balance sheet.

Corporate clients are also looking for comprehensive solutions that cover financing, cash management, foreign exchange (FX) management, and risk mitigation, etc. Potentially it brings companies’ procurement sales and treasury departments much closer together, with the aim to merge the financial and physical supply chain, so that companies can achieve greater efficiency than in the past.

Another trend seen at many C-suite levels across all industries is that the working capital objective is being combined with the objective of supply chain efficiency, so there is also a growing desire of merging these areas into a joint initiative.

A New Generation of Supply Chain Finance

Looking further into the future, to a new generation of supply chain finance, the solution models will be customised to the individual needs of the involved party. Currently, there are standardised solution sets, i.e. one programme serving different company and need profiles. This means that the portfolio of participants is automatically reduced by the nature of a delimited standardised solution.

Banks are now looking to achieve a much more detailed analysis regarding profile needs. Take, for example, a supplier portfolio where there are large, mid-sized and smaller enterprises involved. Today, a similar supply chain finance solution will be offered to all of them. In the future, the offering to the individual supplier will be customised according to their balance sheet objective, based on the need analysis of this portfolio and risk policies, as well as financial needs. Hence the offering will be much more flexible and tailored to suit the individual customer profile.

In order for this to happen, the bank has to perform a balancing act, because it is not efficient for a bank to treat each individual party completely separately – the trick is to extend standards from the current models. It is necessary to build standards but to be flexible in terms of different local requirements, client needs and profiles.

One example of this methodology is the supplier finance programme developed by Deutsche Bank for Deutsche Post DHL (DP DHL). Based in Bonn, Germany, DP DHL is the world’s largest integrated mail, express and logistics provider. With a presence in more than 220 countries, DP DHL was looking for a reliable partner with global reach and strong local presence.

During the economic downturn, DP DHL wanted to provide financial support and additional liquidity to its important suppliers to improve efficiencies and transparency in procurement processes, strengthen its supplier relationships and achieve cost savings. Deutsche Bank is providing DP DHL with a fully automated supplier finance programme via an internet-based portal.

Deutsche Bank views this as a way to develop supply chain finance solutions to cover international portfolios, encompassing different legislation, profiles and markets, and using the bank’s international network in a proactive way for the supply chain finance business. The bank iscurrently enhancing its financial supply chain management (FSCM) portal to bring together its trade and cash management capabilities in order to offer flexible financing solutions and be integrated with payments, reporting and SWIFT’s trade services utility (TSU). Additionally, Deutsche Bank is augmenting its risk management methodologies to provide more flexible, event-driven finance.

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