Supply chain finance: The chain takes the strain

By:
Laurence Neville
Published on:

Supply chain finance has come of age in the post-financial crisis period with a growing acceptance among buyers and suppliers and a greater breadth of offerings from banks. Laurence Neville reports.

The global financial crisis and the patchy recovery that has followed in much of the developed world have highlighted both the fragility of companies’ global supply chains and the increasing importance of optimizing working capital. As a result, supply chain financing (SCF), has become a mainstream working capital management tool for many global companies.

Chris Bozek, BAML
“The financial crisis dramatically reinforced the notion that a chain is only as strong as its weakest link,” says Chris Bozek, managing director, global trade and supply chain product head at Bank of America Merrill Lynch. “As supply chains became ever more extended in an effort to source at the lowest possible unit cost, the risks of doing so were not always fully appreciated.”

In response, companies have made SCF a mainstay alongside traditional trade finance tools, such as letters of credit, to meet the need for alternative sources of liquidity and supply chain security, according to Jonathan Richman, head of trade finance North America and financial supply chain, Americas, at Deutsche Bank. “During the financial crisis, these instruments remained more accessible than many other forms of capital and, as such, have become good supplements to the treasury toolkit for managing working capital.”

As market turbulence and credit constraints look set to continue for the foreseeable future, there is continued growing interest in how SCF can be used to improve cash flow and counterparty relationships, and further promote supply chain sustainability for all parties in the chain. “Over the past 18 months we have seen a dramatic shift in the approach that organizations are taking towards risk and resilience of financial supply chains,” says Mike Smith, senior product development manager at SunGard Availability Services. “Businesses are understanding that resilience cannot be compromised, even when costs are being stripped to the bone, as this may well prove a false economy should disruption occur.”

However, SCF faces challenges. “For financial institutions, the challenge is how to deliver efficiently and profitably both the credit capacity and global network required of a full programme rollout – and to do so in the current headwinds created by increasing competition and higher costs stemming from Basel III,” says Bozek. For technology providers, the challenge is to invest enough to keep pace with the speed of innovation – and to make the right bets on where the market is headed.

A new approach

In the period before the financial crisis – when SCF was less common – the goal of buyers (which almost always instigated such programmes) was usually to improve their working capital and lower costs. Now, corporate clients, especially the ones with dominant buying or selling power, no longer want simply to impose payment conditions, says Markus Wohlgeschaffen, head of global trade finance and services at UniCredit. Instead, they analyse how to support strategic partners along their value chains. “Mid- to long-term strategic considerations have become increasingly important,” he says.

Corporates have also broadened their view on their upstream value chain. “Instead of only looking at their direct suppliers, they understood that a portion of the purchase price consists of accumulated financing costs,” says Wohlgeschaffen. “The more players in the value chain, the higher the accumulated financing cost. Thus, we see more and more corporates that support supply chain finance programmes in which their tier one partners act both as suppliers and buyers.”

Bozek at Bank of America Merrill Lynch says that supply chain disruptions beyond the control of corporates (such as political unrest or natural disasters) have prompted companies to re-evaluate the risks of far-sourcing versus near-sourcing, as problems with a supplier or logistics partner in a remote part of the world can cause widespread issues with management of receivables, payables and inventory.

“Collaboration, both internally and externally, is the biggest single consideration today,” says Bozek. “Major financial supply chain decisions are guided by a strategic framework that balances cost, risk, supplier diversity and sustainability. No single department has complete responsibility for supply chain management; hence the need for an enterprise management approach that considers all stakeholder interests (procurement, treasury, accounts payables, technology and operations) with an emphasis on collaboration, integration and shared metrics.”

While many parts of a company are involved in a supply chain, treasurers and CFOs have the major role to play in scrutinizing and optimizing their company’s supply chain processes. “They see the financial supply chain as the driver of the company’s working capital and are deploying enterprise goals and metrics deep into the operational processes to drive this enterprise collaboration,” says Bozek. “Forward-thinking companies have established the executive role of head of supply chain management to drive senior-level visibility and collaboration.”

The geographical nature of SCF is also changing. “Global companies want greater consistency of programmes,” says Adrian Rigby, global deputy head of trade and receivables finance at HSBC. “Why? Because some programmes in the market have been ineffective, not replicable and funding appetites from some institutions have changed.” Bozek agrees that most clients are looking for a global solution and “a provider that has a footprint to match their own”.

How banks have responded

Given the growing importance of SCF to corporates, many transaction banks have been broadening their geographical coverage and product offering. “We’re now able to offer supply chain products to clients in 45 markets, up from 20 just two years ago,” says Mike McDonough, global head of supply chain finance at JP Morgan. “In key markets like China, we navigated the complexity of a dynamic regulatory environment combined with free trade zone requirements to deliver solutions using the renminbi as a currency for both local and cross-border trade.”

Bank of America Merrill Lynch has launched Trade Pro and Trade Pro SCF to enable buyers and suppliers globally to transact in nine languages, using reporting, calendaring and event notification tools to maximize user efficiency. Trade Pro is fully integrated with CashPro Online, the bank’s treasury portal, to deliver a complete treasury and trade view. “Beyond expanding our global SCF and accounts receivables financing core products, in the past year, we have launched customized, domestic and pan-region Chinese renminbi, Brazilian real and Indian rupee open account financing products,” explains Bozek. “In 2012, we expanded our São Paulo-based trade operations to further support the growing South-South trade finance flows, and have established a worldwide network of investor banks to strategically manage growing global programmes.”

Ashutosh Kumar, global head of corporate cash and trade at Standard Chartered, says that much of the bank’s recent focus has been on the dematerialization of paper documentation. “This has been driven by the convergence of technological know-how and industry and regulatory advocacy as well as the demands for greater efficiency in an increasingly globalized world economy,” he notes. Kumar says that clients expect their banking partners to provide supply chain solutions that encompass both trade finance and cash management. “They are also more aggressively leveraging SCF and adopting industry innovations when structuring their business ecosystems to increase working capital efficiency,” he notes.

SWIFT developments

André Casterman, SWIFT
While banks are expanding their offerings, there are also industry-level efforts under way to advance SCF. In 2013, the International Chamber of Commerce (ICC) and SWIFT will introduce new technology-neutral rules and standards to accelerate the uptake of SCF. “These standards will enable banks to inter-operate through their correspondent banking agreements in order to provide risk mitigation and pre/post-shipment financing in the four-corner (or two-bank) model,” explains André Casterman, head of corporates, trade and supply chain at SWIFT. “The combination of legally binding rules with electronic messaging and matching offers unique efficiency benefits that, until now, have never been [available] in the trade industry.”

Traditionally, SCF works as a three-corner model with the buyer and supplier having separate contracts with the same bank as part of the same network. In a four-corner model, a corporate can interact with a corporate or bank in another network. Each corporate’s bank manages the connectivity through SWIFT with the other corporate’s bank.

The instrument chosen for this model is a new payment method to secure and finance trade transactions called a bank payment obligation (BPO). The BPO will be easy to use for corporates: it is simply another payment term option (to complement letters of credit, demand guarantees, advanced payment and open account payment).

To offer BPO-based services, banks must implement the interbank Uniform Rules for BPO (UR BPO) as well as the underlying messaging standards (ISO XML 20022 and SWIFT’s central transaction matching application, the Trade Services Utility [TSU]). For banks, the BPO will be easy to use, as it is already integrated in existing correspondent banking agreements between banks for international payment and trade transactions. (Figure 1 shows how the BPO and the underlying ISO XML 20022 standards enable banks to extend their SCF offerings to higher value services. Figure 2 shows how the BPO fits into the four-corner model and re-uses the correspondent banking practices so that corporates can benefit from BPOs with multiple banks.)

Standard Chartered Bank recently partnered with BP Chemicals and petrochemicals firm Octal to facilitate the first end-to-end automated trade finance transaction with BPOs through Straight2Bank, the bank’s online banking and cash management solution. “BPOs are expected to be a welcome alternative to letters of credit as it will enable the financial sector to close the gap in speed between financial and physical supply chains,” says Kumar. “It will also give clients the best of both worlds: the efficiency of an open account transaction and the payment certainty of a letter of credit.”

Bozek at Bank of America Merrill Lynch says that one important decision made by SWIFT is that the BPO will be technology-independent, and not limited to using the TSU. “This development has the potential to drive significant innovation among technology providers, as both corporates and banks develop new ways to use the BPO,” he notes. Nevertheless, Bozek says that given the unique transaction characteristics and global reach of trade, common data standards and formats are some way off. “Our corporate clients would be best served if the industry placed a higher focus on global connectivity versus driving global standards,” he adds.

Advances in e-invoicing

E-invoicing has long been a goal for both buyers and suppliers because of its potential to improve efficiency and enhance working capital management. According to Eric Lemmens, global head trade finance product at RBS, there have been advances in technology that make it possible for data and information to be exchanged and translated from one system to another. “File formats have [changed] from EDI to XML, while document formats and conversion can be outsourced, and prepared in formats that can be received by suppliers and customers,” he explains.

Nevertheless, e-invoicing has yet to become a reality because SMEs, which necessarily make up a large part of the e-invoicing chain, have been unable to access e-invoicing services cost-effectively. “The most common adoption barriers cited by suppliers are a poor business case, or return on investment, and technology capability or capacity,” says Bozek at Bank of America Merrill Lynch. “Compounding the challenge is that e-invoicing networks, unlike established many-to-many e-payment networks, are one-to-one relationships, which prohibit suppliers’ scalability. Buyers will drive market adoption; the key is getting receivers or buyers to insist on an e-invoice or no invoice environment.”

This article was originally published in The 2013 guide to Technology in Treasury Management.