Supply chain finance

Supply chain finance (SCF), also known as supplier finance or reverse factoring, comprises a suite of financial solutions that aim to manage working capital and liquidity for businesses within a supply chain. These arrangements are typically initiated by a buyer to allow their suppliers to access funding for their accounts receivable at interest rates based on the buyer's credit rating, which is often lower than the supplier's own cost of capital. The process is intended to provide financial stability to the supply chain by reducing costs for the participating parties.

A 2015 report estimated that SCF had a potential global revenue pool of $20 billion.[1]

Reverse factoring differs from traditional factoring, where a supplier independently seeks to finance its receivables through a third party. As of 2011, the reverse factoring market was estimated to represent less than 3% of the total global factoring market.[2] The technique has also been associated with financial controversy; for example, it was utilized in schemes that contributed to the collapse of the Evergrande Group, China's second-largest real estate company.[3]

Method

The reverse factoring method, still rare, is similar to the factoring insofar as it involves three actors: the ordering party (customer), the supplier, and the factor. Just as with basic factoring, the aim of the process is to finance the supplier's receivables by a financier (the factor), so the supplier can cash in the money for what they sold immediately (minus any interest the factor deducts to finance the advance of money).

Unlike basic factoring, the initiative does not come from the supplier who would have presented invoices to the factor to be paid earlier. With supply chain finance, it is the ordering party (customer) who initiates the process – usually a large company – choosing invoices that they will allow to be paid earlier by the factor. And then, the supplier will themselves choose which of these invoices he will need to be paid by the factor. It is therefore a collaborative initiative involving the ordering party, the supplier and the factor.

Because it is the ordering party who starts the process, it is their liability that is engaged and therefore the interest applied for the deduction is less than the one the supplier would have been given had they done it on their own. The ordering party will then benefit of a part of the benefit realized by the factor, because they are the one to allow this. And the financier for their part will make their profit and create a durable relation with both the supplier and the ordering party.

Reverse factoring can be used by companies outsourcing a large volume of services (e.g. clinical research activities by pharmaceutical companies).[4] The benefit to both parties is that the company providing the services can receive payment within 10 days or less, compared to the normal 30 to 45 day payment terms, while the ordering party can delay actual payment by 120 to 180 days, thereby improving cash flow.

Concept

To understand how reverse factoring works, one needs to be familiar with trade discounts and factoring. Reverse factoring can be considered a combination of these two methods, taking advantages of both in order to redistribute the benefits to all three actors. There are 8 individual aspects of those three financing methods:

History

The concept of reverse factoring started with automobile constructors, including Fiat in the 1980s, who used this kind of financing process for its suppliers in order to realise a better margin. The principle then spread to the retail industry because of the interest it represents for a sector where payment delays are at the heart of every negotiation.

In the 1990s and the early 2000s, reverse factoring was not used extensively due to economic contexts that did not allow it to be an efficient way of financing.

Aberdeen Group research published in 2006 highlighted the central role of a technology platform in realising a supply chain finance solution, defining it as a combination of trade finance functions and technology platforms.[5] A Demica research report published in 2007 noted that businesses in the Nordic region, especially Sweden, made more extensive use of supply chain finance than elsewhere in Europe.[6] In September 2009 the Bank of England invited relevant UK financial bodies to establish a working group in order to review the supply chain finance market at that time. The working group was chaired by the Association of Corporate Treasurers

Advantages

Market size

Given the competitive nature of the SCF market (approved payable finance) and due to the fact that business undertaken is covered by customer and bank confidentiality, sources of information regarding market size and players are constrained and not widely available in the public domain. As a result, indications on the market size are based mainly on estimates. As of 2013, the global market size for Supply Chain Finance was estimated at US$275 billion of annual traded volume, translating to approximately $46 billion in outstandings with an average of 60 days payment terms.[10] It is still relatively small compared to the market size of other invoice finance methods such as factoring, which remains the largest trade finance segment and is primarily domestic in focus. The potential market for supply chain finance within the OECD (Organization for Economic Co-operation and Development) countries is significant and is estimated at $1.3 trillion in annual traded volume.[11] The market serving European supply chains is approximately $600 billion.[12] Based on these figures, the potential supply chain finance market size for the US is estimated to be approximately $600 billion in traded volume per annum.[13] These programs are run both domestically and cross-border and in multiple currencies.

Market growth

In 2011, the reverse factoring market was still very small, accounting for less than 3% of the factoring market.[15] As of 2013, market experts estimated that only 10% of the global available marketplace had been "satisfied" with supply chain finance, revealing a large potential market for growth. The market was expected to continue to expand at a rate of approximately 20–30% per annum and 10% per annum by 2020.. During this period, the highest growth of supply chain finance programs originated from the US and Western Europe. Asian countries, India and China in particular, are considered the markets with most potential in the coming years. The driving forces behind the rapid growth of supply chain finance programs are:

• Globalisation has increased the risk in supply chains and the impact on the financials of corporations.
• Working capital management has risen to the top of the Chief Finance Officers' and Treasurers' agendas.
• Strong interest from suppliers regarding the provision of liquidity and enabling lower financing costs.

Further growth potential and challenges

Although supply chain finance is experiencing significant growth in demand, financial institutions are focused mainly on the large buyer side of the trade equation. As structured finance has been traditionally engineered and provided by banks specifically for large international trading companies, they do not use common foundations. In order for supply chain finance to take off on a broad scale, a fresh impetus is needed. A “tipping point” could easily be reached by solving the following challenges.

• On-boarding of Supplier. In a supplier financing program, the servicer needs to on board the buyer’s trading partners - the suppliers. The multitude of such platforms generates operational issues for suppliers wishing to benefit from various supply chain finance offerings via their buyers’ funders.
• Know-Your-Customer (KYC). Most funders require KYC checks to be performed on suppliers being enlisted as new trading partners. This procedure not only increases the total processing cost, but it also puts the business case for all parties including the service provider, funder, buyer and ultimately the supplier at risk.
• Available Capital and Liquidity. With 90% of liquidity in supply chain finance programs provided by large, global commercial banks, there is a large amount of trade assets, which cannot be covered by such financial institutions. Further regulations such as Basel III might impact the risk appetite and funding capacity of banks and make it more attractive for non-bank funders to step in and support supply chain finance facilities. Limited to large buyers. Today’s supply chain finance offerings are mainly addressing the large buyers with sound credit ratings whereas the real supply chain finance opportunity extends to large suppliers too, in particular in terms of payment assurance and risk mitigation.
• Proprietary legal documentation. Current Supply Chain Finance offerings use proprietary legal documentation, which makes the signing of non-standard agreements a costly, complex and time consuming process for corporate clients and their suppliers. Therefore, the market is currently facing challenges related to the absence of interoperability and legal standards.

Structures

Supply chain finance practices have been in place for over a decade. Three distinctive supply chain finance structures have emerged:

Often the reverse factoring is used with the dematerialization to speed the process. As the whole goal of it is to make money available to the supplier as fast as possible, a lot of companies decide to dematerialize their invoices when they start a reverse factoring system, because that way it saves few more days, plus all the advantages of the dematerialization (less expensive, and benefic to the environment). In average, it can shorten the delays by 10 to 15 days.

• Buyer managed platforms. In this structure the buyer owns and runs the supply chain finance platform. Some large retailers such as Carrefour or Metro Group are using this structure and managing the finance program, supplier onboarding, and liquidity themselves.
• Bank proprietary platforms. The supply chain finance structure is managed by large commercial banks providing the technology platform, services and funding. This structure is used by several large buying organizations such as Carlsberg, Boeing, Marks & Spencer and Procter & Gamble.

See also

• Financial deregulation
• Paperless office