FREQUENTLY ASKED QUESTIONS FOR FINANCIAL INSTITUTIONS
Efficient working capital management is a key component in the current era a of challenging economy and lengthening of supply chains globally. There is much urgency for corporations to optimize their cash conversion cycle without disadvantaging their supply chain partners namely suppliers.
This summary explains supply chain finance technique and how risk is mitigated to understand conflicting demands between buyers and suppliers in this new revolution of finance.
1. How is supply chain defined?
Supply chain finance (SCF) can be defined as the use of financing and risk management techniques to optimize the management of working capital and liquidity and support the financial supply chain. The term encompasses a range of financing and risk mitigation practices – from payables finance to pre-shipment finance. The need for SCF is usually triggered by supply chain events, such as purchase orders, invoices, receivables and other related pre-shipment and post-shipment processes. One major aim of SCF is to decrease the cash conversion cycle which is efficient management by a technology platform.
2. What is payables finance?
Payables finance in the most commonly used SCF techniques. It is a buyer-led supply chain finance technique through which sellers in a buyer’s supply chain can access liquidity by means of receivable purchase (selling their trade receivables held against the buyer). Using payables finance, a seller of goods is provided with the option of receiving the discounted value of its receivables (represented by outstanding invoices) before the due date, and typically at a more attractive rate than it could normally obtain, given that the financing cost is aligned with the higher credit rating of the buyer.
3. What is the key to successful payables finance?
Supply Chain Finance was established due to the emergence of the complexity of trade finance over time in terms of regulatory, legal and operational challenges. At the same time, the buyer's goal to ensure that trade payables remain payables on their balance sheet and off-balance-sheet as a source of liquidity is created for the supplier. While it is a programme that benefits all parties, its key success is pinned on many factors.
1. Each SCF programme differs from one corporation to another via straight-through processing (STP) mode for all three parties – the buyer, the supplier, and the provider. The ultimate success would be a programme that ensures that payments due to funders are settled in a timely manner.
2. Suppliers must be fully supportive of the programme, hence awareness and communicating through the workflow must be effectively implemented with the minimal burden imposed on them.
3.Each SCF programme must ensure its safety and sustainability is supported with well-executed documentation, processing and operational steps and legal set-up.
4. Seamless global capabilities to address the need for a client’s business and supplier relationship is also important for SCF programme to be effectively implemented.
4. What are the challenges of the supply chain finance (SCF) industry?
SCF industry has a number of challenges to navigate. Over time the size of payables finance is beyond the capacity of internal treasury, hence structured programme requiring capacity beyond a single source of the fund will need to be constructed.
This is where the bank-funded payables finance risen with rates that reflect the risk of the better-rated entity in the supply chain. The counter-party risk is transferred to a separate Special Purpose Vehicle comprising of various funders for a particular structured programme.
With payables finance being on an open account term, buyer is directly responsible for meeting the payment obligation in relation to the underlying transaction. The transition to a situation where the vast majority of trade takes place on open account terms has challenged the utility of traditional trade finance instruments (such as letters of credit) and fuelled the expansion of SCF.
5. What differentiates third-party providers?
Third-party providers place emphasis on their funder-agnostic digital interfaces and tools, simplified implementation and on-boarding processes and altered business models. They typically offer products such as auction-based digital solutions, solutions incorporating dynamic discounting (a variant of payables finance whereby the buyer may utilise its own funds to pay an invoice or account payable prior to the original due date) and platforms for smaller suppliers.
Not all third-party fintechs are the same – there are multiple providers, all of which offer slightly different solutions, with slightly different key strengths. For TFX Global, it has the strength of support from established principals that brings more than 50 years of experience in consultancy, technology, trade, finance, banking and asset management complemented with Trade Receivable Asset Management Platform. According to a PwC/Supply Chain Finance Community SCF Barometer published in December 2017, fintech platform suppliers now hold 14% of payables finance programmes.
The rise of corporate responsibility and the growing prioritisation of long-term sustainability
payables finance is not only about managing working capital and mitigating supply chain risk – but also about managing a corporate buyer’s reputation. The notion of company values and long-term commercial sustainability, improving points of vulnerability and treating suppliers fairly all have reputational benefits. In fact, for some, extending payment terms may no longer be the reason for utilising SCF.
There is much progress on the development of SCF programmes in partnerships between development and commercial banks to release liquidity to SMEs in recent years. An example of this is the deal announced on 22 November 2017 by Deutsche Bank and Asian Development Bank to provide more than US$200m a year in financing to Asian SMEs located mainly in Bangladesh, China, India, Sri Lanka and Vietnam.
6. What is The Bank's advantage with global supply chain financing (SCF)?
There is ongoing speculation that a combination of new technology, corporate balance-sheet muscle and the emergence of new funding sources will eventually lead to significant bank disintermediation in the SCF market. However, this seems unlikely. The emergence of new business models and an evolving competitive landscape may even prove to be an opportunity for banks.
There are a number of reasons why banks will remain key players in the payables finance business:
1. Banks have trusting long relationship with their clients that would still have faith in the banking system. Evolving products such as SCF will not only strengthen the relationship but advantage the clients business in many aspects.
2. While corporations lack the expertise in supply chain finance, banks lack the ability to develop technology component that can link into the corporations supply chain management. Platform development to bind, originate to meet external and internal compliance and standards is not an easy task in a bank. Data is king and this can only achieve if a 3rd party enabler structure and align the entire supply chain workflow for all collaborative parties involved. Operational costs are also hugely reduced.
3. Within a structured programme, banks counterparts risk is transferred to the Special Purpose Vehicle that will hold the funds collectively for buyers and all funders. It is more efficient when supported with a technology platform that holds data for credit risks, performance and fraud risks to be addressed.
4. Banks tend to focus on 20-30% covering 70% of procurement volume, but 3rd party enablers such as TFX focuses on small and medium-size invoices due to the efficiency and speed of the platform.