Rise of self-funded supply chain finance threatens banks’ business models

By:
Rebecca Brace
Published on:

Cash-rich companies are self-funding their supply chain finance (SCF) programmes, in a growing sign of disintermediation. Simplicity and cross-product offerings are key to ensuring banks adapt to the growing popularity of self-funded structures.

When SCF became an area of focus for banks, one of the drivers was perceived to be the disintermediation of banks from global trade.

Faced with the demise of the letter of credit and the rise of open account trading, banks were looking to find a way back into trade relationships. However, as SCF continues to evolve, it is taking on different forms, not all of which involve bank participation.

SCF is a structure in which large corporate buyers offer their suppliers the opportunity to finance their receivables based on the buyer’s credit rating. The suppliers receive finance at a lower cost and can access funds earlier than they otherwise would.

Meanwhile, the large corporate buyer often seeks to improve its own working capital position by extending suppliers’ payment terms.

During the financial crisis, SCF began to look much more attractive to corporations. The economic environment and the credit squeeze put pressures on smaller suppliers. Larger companies became more aware of the impact on their own businesses if the key supplier failed – and became more interested in participating in models designed to support their supplier ecosystem.

However, as SCF has become more mainstream, companies have been looking for other ways to achieve the benefits of SCF, not all of which involve bank participation. One trend that has recently attracted some attention is the phenomenon of the self-funded SCF programme.

Self-funding approach

Companies built up large cash reserves during the financial crisis, but low interest rates have meant there is little opportunity to get a return on that cash.

One possibility that has attracted some interest is the possibility of using that cash to fund a SCF programme. However, as one commentator observed: “The definition of self-funded SCF is so wide you can drive a truck through it.”

At the simplest level, a company looking to self-fund a SCF model can do so by making use of early payment discounts. This model has been around for a long time and predates SCF, but some experts report there has been a recent resurgence of interest in this technique.

Under this model, the supplier offers a discount to its customers for early payment, typically on the basis of 2/10 net 30 – which means that if the customer pays within 10 days instead of 30, they will receive a 2% discount. This enables the supplier to receive payment much quicker than they otherwise would. However, this comes at quite a cost: a 2/10 net 30 discount works out at a very generous annualized 36.7%.

More recently, this area has seen the arrival of dynamic discounting platforms, which allow suppliers to choose which receivables to discount and when payment should be received. These platforms provide more flexibility than the traditional early payment discounts model.

A less common and more complex form of self-funded SCF has also emerged in the past couple of years. As with traditional SCF, companies set up a programme that allows suppliers to receive early payment on their receivables, which the corporate buyer does not pay until later on. The difference is that in a self-funded arrangement, the corporate buyer provides some or all of the funding themselves – in other words, buying their suppliers’ receivables.

The advantage of this model is that the company is effectively lending money to its suppliers for a return far greater than they could get by depositing the cash with a bank. What’s more, the company is investing in their own corporate credit risk. In other words, the only risk that the company incurs is the risk that the company does not pay its own suppliers.

Despite the sizeable advantages of the model, only a very small number of corporations have opted to use it because of the question mark over the accounting treatment. There is an argument that companies financing their suppliers in this way should take their trade payables off the balance sheet when the company purchases them – for example, on day five after the invoice has been issued.

However, from an accounting point of view, the company’s objective is to hold the trade payables on the balance sheet until day 90, for example, when the invoice is settled. Companies using this model might have secured opinions from their auditors that they are comfortable with – but within the industry this is still widely regarded as a grey area.

Shareholder pressure is another consideration for the self-funding model.

“Shareholders are traditionally not keen on companies sitting on a lot of cash,” says Avarina Miller, senior vice-president at Demica, capital solutions advisory group. “Are they going to be a little more tolerant of that if it’s being put towards the supply chain or is that something that will continue to be a concern?”

Another area of discussion is the corporate buyer’s level of commitment to supplying the funding, says Miller. “Does the buyer intend to fund the model itself, or will it be an occasional participant in an SCF programme which is mainly funded by one or more banks?” she asks.

Under pressure

Should banks be concerned about corporate interest in self-funded structures? Some believe banks have not approached SCF as effectively as they could have done.

Enrico Camerinelli, senior analyst at Aite Group
“Banks saw SCF as just another set of products that they could sell,” says Enrico Camerinelli, senior analyst at Aite Group. “They should have approached SCF by combining it with trade management, cash management, payments and even FX – transaction banking, basically.

“Instead, every bank has a separate SCF business unit, as though it is somehow separate from cash management and trade finance. The corporate client then has yet another person to talk to at the bank, which generates complexity instead of simplifying things.”

While adoption of the buy-your-own model might be limited, the fact remains that companies have moved away from viewing SCF purely as a bank offering and are considering a variety of other models – some of which require little or no bank involvement.

In addition to self-funded models, initiatives such as the Receivables Exchange and MarketInvoice allow suppliers to auction their receivables on an eBay-style internet platform.

Should banks be concerned about these developments? There is arguably plenty of room for all of the existing SCF models to co-exist – but complacency might be unwise.

Banks have done a good job in promoting SCF as a mainstream offering during the past few years, but continued attention is needed if they are to deliver the flexibility that companies are looking for.