Supply chain management: Towards fewer, stronger chains?

ONE OF THE hottest topics in transaction banking and trade finance over the past few years has been supply chain finance. International and regional banks have increasingly responded to corporate demands to increase efficiency in their financial supply chain in line with efficiency gains the companies themselves are achieving in their physical supply chain.

Supply chain finance is part of a broader concept of financial supply chain management that involves the management of creditor, country and foreign exchange risk and documentation that supports the supply chain. However, most important to corporates – because of its cost-cutting potential – is management of payments and funds across the supply chain process.

Supply chain finance is primarily associated with managing supply finance, including pre-shipment finance, in-transit finance, distribution and warehousing finance, and post-shipment finance. It is most frequently usually used as a synonym for reverse factoring or payables finance, where invoices are used to lend to suppliers at a cost closer to that of the buyer than the supplier.

Although figures are not available, anecdotal evidence suggests that supply chain finance has grown hugely in the past five years. But to what extent has this growth depended on a benign credit environment and cheap and easy money? With the liquidity tap for banks turned off and concerns raised about the creditworthiness of many exporting firms in the face of a US recession, will supply chain finance be able to weather the storm?

The effect on pricing

The credit crisis has clearly had an impact on financing costs for corporates. "We started to see it in the US about four months ago and in the last two months it has spread to Asia and the Middle East," says Tan Kah Chye, global head of trade finance at Standard Chartered in Singapore. "The cost of liquidity [90- or 180-day funding] has soared by as much as 100%, while credit pricing has also increased because of the increased perception of risk," he says.

"The secondary market for buyer risk – a major issue for some banks – has tightened considerably" Stuart Nivison, HSBC

The increase in the cost of liquidity stems, most obviously, from banks’ high borrowing costs. "Banks’ costs have risen, so some of those costs must be passed on to corporates," says Tan. Moreover, as Stuart Nivison, head of trade and supply chain, Europe, at HSBC in London, notes: "The secondary market for buyer risk – a major issue for some banks – has tightened considerably." This has further increased liquidity costs. Another issue limiting liquidity has been the decision by manufacturing countries such as China to restrict lending in a bid to slow inflation, according to Nivison.

Meanwhile, import volumes into Europe from Asian suppliers have remained strong despite the broadening financial and economic crisis over the past nine months. The picture in the US is less sanguine, with imports of manufactured goods into Los Angeles Longbeach from Asia, for example, falling every month since August 2007, according to Drewry Shipping Consultants. Nevertheless, with underlying trade flows remaining strong overall, exporting companies are being forced to look for alternative sources of working capital.

Is supply chain finance an alternative?

As exporting companies have scrabbled around for alternative sources of funding, there has been an unsurprising increase in interest in supply chain finance. Reverse factoring or payables finance uses the interest arbitrage between suppliers’ borrowing costs and those of buying organizations to lower these costs. However, the credit crunch – as well as its present geographical scope – throws up an immediate barrier.

"Supply chain finance is certainly on the desk of CFOs of major companies," says Ohse at Deutsche Bank. "But what is different today is that the previous substantial interest arbitrage opportunity between buyer and supplier borrowing costs does not exist any more in many cases." He explains: "With Asian pricing relatively stable and US and European prices going up, the easy margin swap [has largely disappeared] – at least for the financing of European or US corporates with Asian suppliers."

In addition, as already mentioned, banks are facing difficulties in raising funds, so adversely affecting their ability to lend – whether for working capital or to finance the supply chain. "Many banks do not presently have easy access to credit, and this will filter through to the cost and availability of many supply chain financing arrangements," says Nivison. Ohse adds that "the growth of the supply chain portfolio is being checked – it is simply a matter of risk and return".

However, Nivison is adamant that "it’s not all gloom". He explains: "In times of crisis, lenders will look closely at what their money is being used for and where their repayment will come from. This will provide new opportunities for all forms of trade and supply chain finance." And Tan believes that for banks, supply chain finance could prove more attractive than working capital lending. "It’s better for banks to lend on trade flows rather than on the corporate’s own balance sheet," he says.

Of course, supply chain finance is not simply about bank lending at lower rates. For buying companies, which often have strong cashflows, reverse factoring also represents an additional business opportunity to loan some of their excess capital to their supply base in the form of early payment discount. However, in the current financial environment, Tan says that there is a greater reluctance by the corporates to use their own liquidity to support supply chain finance. "There’s certainly a concern about liquidity and credit quality. There is now an ever increasing focus on their days sales outstanding."