Europe’s supply chain finance solution fuels hidden debt fears

LONDON (Reuters) – European businesses hit by the coronavirus crisis are increasingly turning to a complex financial tool to pay their suppliers, sparking investor concerns over ‘hidden’ debt.

Supply chain finance, whereby companies can get cash from banks and funds to pay their suppliers without using working capital, likely hit an all-time high in 2020, the data shows.

The world’s largest banks are set to make $ 27 billion from funding supply chains this year, data from research firm Coalition shows, as biggest borrowers, mostly in Europe, scramble to help stricken suppliers by the pandemic.

This represents an increase of around 5.5% in 2020, compared to an average increase of 2% over the previous four years.

While supply chain finance is a legitimate business tool, the high-profile bankruptcies of companies like Britain’s Carillion, Spain’s Abengoa and United Arab Emirates NMC Health have raised concerns among investors.

“Supply chain finance is the latest financial engineering that could have serious consequences on working capital,” said Pierre Verle, chief credit officer and portfolio manager at French asset manager Carmignac.

“I’m not sure many investors realize how bad this is.”

An essential source of credit in a crisis, supply chain finance, also known as reverse factoring, can mask the true level of debt and cash flow issues that businesses may face because it does not. ‘does not appear on balance sheets as debt, investors and analysts said.

It is accounted for as a trade debt for the buyer and a receivable for the supplier, although it is more akin to bank debt in the opinion of some rating agencies and industry experts.

THE X FACTOR

In a typical example of supply chain finance, a company such as a supermarket chain, concerned about the health of its small food suppliers during a temporary shock like the pandemic, approaches its bank.

Small suppliers issue invoices to the supermarket, which confirms to the bank that they are valid, then these suppliers receive the money immediately rather than having to wait maybe 30 days or even months to be paid by the retailer. .

In some cases, this acceleration in cash flow can mean the survival of a supplier, with financing also being much cheaper as it is usually paid off in a matter of weeks rather than months.

During this time, the bank is making money on the loan.

“This product has been very popular during the COVID-19 pandemic as it provides working capital for companies facing a temporary demand shock,” Eric Li, research director at Coalition, told Reuters.

There is no official data on supply chain finance, but bank revenues provide some insight. Lenders are a key source of this finance, although it represents only a small part of their overall trade finance activity.

Investment funds, which are not covered by the same type of capital requirements as banks, are also increasingly providing supply chain finance, but visibility into their exposures is lower.

Greensill, backed by Softbank, the largest non-bank provider of supply chain finance, has also seen its volumes and new business increase this year, a spokesperson told Reuters.

“This year, supply chain finance has been put to the test as a new asset class and as a way to get capital into the real economy where it’s needed most.” , said the spokesperson.

Greensill says its technology-driven approach helps improve transparency and accountability in the asset class.

“We have always said that we believe that a dollar owed to a customer on an invoice is no different than a dollar owed to an indebted bank, both should be fully transparent.”

Companies are not required to disclose the use of the technique, and the International Monetary Fund said in June 2019 that the lack of available data on trade finance has been recognized as a problem since the 2008 financial crisis.

“There are many examples of companies with hidden debt, and these are often the ones that cause the most problems,” said Justin Jewell, portfolio manager at Bluebay Asset Management.

NMC Health is the most recent high-profile corporate crash that used supply chain finance. Part of this was only revealed when short seller Muddy Waters released a memo detailing his hidden debt levels.

Moody’s also linked the undisclosed supply chain financing to the 2018 collapse of UK construction firm Carillion, which owed some £ 498million ($ 670million) through a ‘ease of payment’ deal. anticipated ”with suppliers.

Moody’s said this hid the real debt owed to the banks providing the funding.

Accounting firms, rating agencies and regulators in the United States and Europe have called for greater disclosure.

In June, the U.S. Securities and Exchange Commission issued a notice requiring companies to disclose more about how COVID-19 is affecting their cash flow, including a specific mention that they should disclose more about it. use of supply chain finance.

However, regulators and professional accounting bodies have not implemented any major changes to the rules.

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