EU payment regulation shake-up could boost supply chain finance

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While European Union proposals to limit the time corporates have to make payments in commercial transactions will bring relief to some suppliers, many buyers will face higher debt and lower liquidity. Supply chain finance could be a practical and effective solution to managing working capital efficiently under the EU payments directive, says RBS’s Ugur Bitiren.

By Ugur Bitiren, Director, Corporate Advisory, RBS
Efficient working capital management, including extended payment terms, is critical for many companies, becoming a powerful way to manage the financing of a business as well as serving as a barometer for its long-term health.

However, extended payment terms are set to be regulated by the new EU Payments Directive, which limits the time companies can take to make payments in commercial transactions.

This directive is widely viewed as an aid to small and medium-sized enterprises (SMEs), limiting the impact of so-called ‘late’ payments in an effort to free up hard-to-obtain working capital.

On the flip side, cutting payment terms could have huge implications on the operating cycle of purchasing companies, effectively increasing debt and reducing short-term liquidity.

Facing the impact of the new EU Payments Directive, supply chain finance can serve as an effective solution. It enables purchasers to continue benefiting from extending payment terms while simultaneously freeing up liquidity for suppliers at an early date, and frequently at a rate of interest superior to the supplier’s own.

The power of supply chain finance as a solution to ‘late’ payments has even been recognised by authorities, as evidenced by UK Government recommendations to accelerate its adoption.

Furthermore, in May 2012, the UK Government gathered a number of leading global banks, including RBS, to promote supply chain finance as a vehicle to support liquidity for SMEs. It also delivered the same message to the finance directors of a wide range of major corporates. Following the UK example, some other EU member states are likely to act in a similar manner. Some governments either haven’t taken any action yet or are keen to decrease payment terms at once, which could create different outcomes in different countries.

EU late payment concerns

The EU sees ‘late’ payments in commercial transactions as a major problem, in particular what the commission regards as large buyers forcing SMEs to accept payment terms detrimental to their working capital and cash flow.

These concerns have risen in recent years as the level of working capital has increased. In the UK, for example, money owed to suppliers rose by 27 per cent in the two years to the end of 2011, reaching GBP113.1 billion (see chart – UK plc working capital by constituent).


This increase in payables is seen as particularly damaging for SMEs. As many large corporates have payment windows of more than 100 days with their suppliers, UK SMEs are now owed an all-time-high GBP33.6 billion by buyers (according to the Forum of Private Business). In addition, there is also a knock-on effect with more than 60 per cent of small companies admitting that they in turn delay paying their suppliers.

To tackle late payments, especially in cases where it is seen that the buyer is procuring additional liquidity at the expense of the creator, the EU published Directive 2011/7/EU designed to combat late payments in commercial transactions.

The EU member states are expected to enact laws enforcing the Directive by March 2013. It will limit payment periods in commercial transactions between two or more European companies to 60 days but extensions can be agreed if they are not grossly unfair to the creditor and are in-line with good commercial practice. In addition, invoices will have to be settled within 30 days if no period is set.

While nothing has explicitly been stated on this, we believe it is safe to assume, given its political nature, that large companies forcing suppliers to agree extending payment terms beyond 60 days without being able to receive funding earlier via supply chain finance will be deemed ‘grossly unfair’.

Effects of the EU Payments Directive

The Commission estimates its Directive will free up the equivalent of an extra GBP150 billion for businesses across Europe by improving cash flow and reducing SME exposures to late payment negotiations with larger customers.

The downside will be felt by corporates which currently benefit from extended payables but which may now experience disruptions to operating cycles and a drop in liquidity.

Also, few companies are likely to admit to such behaviour but some may look at using suppliers from outside the EU, beyond the reach of the directive.

Supply chain finance as a solution

Supply chain finance promotes efficient working capital management to purchasers, frees up liquidity for suppliers and incentivises purchasers to continue to buy from Europe.

While supply chain finance has not been referred to as a clear solution within the EU directive itself, and we expect there will be different interpretations between countries, the UK Government example shows supply chain finance is certainly being considered as an alternative solution to decreasing payment terms.

As shown in the flowchart below, supply chain finance is a structured receivables discounting programme that gives suppliers the option to discount receivables against buyers. Suppliers can obtain liquidity at an earlier date and frequently at a rate of interest far superior to the supplier’s own.

Compare the situation of two suppliers:

Supplier A sells to the buyer at 60-day terms as stipulated by the EU Directive. It has to finance itself from its liquidity sources at an interest rate of 8 per cent p.a.

Supplier B (which also funds at 8 per cent p.a.) joins the same buyer’s supply chain finance programme. By taking part in this programme, Supplier B agrees to 90-day payment terms but then also elects to receive its cash in 5 days, discounted to the buyer’s superior funding cost of 3 per cent per annum.


Though Supplier B has longer standard payment terms, the ability to discount its receivables at a better rate means it is much better off than Supplier A – in this case 5 thousand of annual interest costs savings for every 1 million sold.

Supply chain finance also removes the payment risk from the supplier’s balance sheet and in addition reduces the need for expensive insurance cover.

In fact, we have experienced a number of cases where a supplier has applied for bankruptcy and the court has allowed the funds received under a supply chain finance programme to remain separated from the pool of assets, while restructuring the company out of bankruptcy.

Furthermore, our experience in this area has revealed that suppliers who are part of a supplier finance transaction often enjoy preferred status.

We believe that there is sufficient room to suggest that the treatment of Supplier B in its commercial relationship with the buyer cannot be seen as ‘grossly unfair’. With this reasoning, buyers should be able to maintain payment periods beyond 60 days and yet comply with the EU Directive.

How RBS can help

RBS can help you structure the best supply chain financing solution for your organisation and your suppliers. With a team of supply chain finance advisors and specialists dedicated to supply chain finance for implementation, system integration, supplier on-boarding and processing, the bank is at the forefront of this business. The industry acknowledges our position – RBS has been named ‘Best Supply Chain Finance Provider Western Europe’ (Global Finance) from 2008-2012, and has won the ‘Global Best Implementation of a Supply Chain Financing Solution’ (Global Finance) award three times in that period.

We also offer a full analysis on how to optimise your company’s working capital, from cash to trade solutions, and can help find the best solution for your organisation. 

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