Supply Chain Financing – The Present-Day Trojan Horse?

Desperate to jettison the valley of economic downturn, businesses of all sizes are increasingly turning to this form…

Desperate to jettison the valley of economic downturn, businesses of all sizes are increasingly turning to this form of finance, dubbed a “sleeping risk”, for short-term credit. Yet, SCF has hardly turned out to be the knight in shining armour.

As superficial and buccaneering as it sounds, cash is king – to all businesses. The current economic climate has accentuated that the endeavour towards enterprise continuity is capital intensive. So yes, any financing is good financing.

Supply chain finance is defined by the International Chamber of Commerce (ICC) as the use of financing and risk mitigation practices and techniques to optimise the management of the working capital and liquidity invested in supply chain processes and transactions.

In a typical SCF arrangement, a bank will pay a discounted sum of receivables due to a company’s supplier at a period earlier than the pre-agreed payment terms between the supplier and the company. The supplier, in turn, agrees to further extend the payment period for that company. With improved working capital, the company makes a final payment to its supplier and honour its debt obligation to the bank. For every stakeholder involved in a SCF transaction, the value proposition goes three-way and entails a “win-win-win” backdrop.

But anxiety and fear are simmering, and for well-founded reasons. The Carillion collapse in early 2018, linked by critics to its misuse of SCF, is one tipping point. Major credit ratings agencies such as Moody’s and Standard & Poor’s have averred that the misclassification of up to £498m in financial liability to banks as “other creditors” instead of “borrowing” by the former construction giants had concealed the true implication of its debt.

Carillion is just the tip of the iceberg. A slew of high street retailers has since announced plans to either fall into liquidation, administration or launch company voluntary arrangement deals. The Arcadia Group, for example, has accrued approximately £250m worth of invoices from its suppliers, and it looks inevitable that those suppliers will merely recoup scraps of what is owed to them.

The desolate finale ascribed above has prompted rating agencies to issue a clarion call for the reclassification of SCF payables as bank debt. At root, the problem lies in a lack of transparency. One remedy to this complication is to homogenise disclosure through the development of clear guidelines for the identification of SCF debt, and subsequently enact corresponding legislation in respect of disclosure. Based on the disclosed information, rating agencies will then be able to adjust their rating metrics and provide more accurate ratings. Such a cycle of transparency would go to great lengths to minimise credit risk and bad debts.

In the US, the Securities and Exchange Commission has ramped up scrutiny over how companies disclose existing SCF arrangements to curtail the potentially misleading portrayal of overly optimistic financial health. Since the past year and a half, letters have been sent to companies including Keurig Dr Pepper, Procter & Gamble, Coca-Cola and Boeing, requiring further disclosure on their respective utilisation of SCF. However, no major rule changes have been made.

Unsurprisingly, the popularity of SCF soared during the coronavirus pandemic as businesses seek to bolster their working capital to cushion the temporary demand shock. While not all SCF arrangements are doomed to fail, it is still too early to tell whether this financial gambit will eventually pay off. If it doesn’t, a similar fate that befell the kingdom of Troy awaits.

Total
0
Shares
Leave a Reply

Your email address will not be published. Required fields are marked *

Related Posts