Scarcity of credit, the need for working capital, and a requirement for risk reduction are turning supply chain finance (SCF) into the flavour of the year in international trade, analysts say. Implementation of SCF is being facilitated by growing automation of invoicing and payments. Robin Arnfield reports.

SCF is a form of asset-backed lending based on the discounting and payment of invoices. A bank undertakes to pay a supplier’s invoices early in exchange for an agreed discount charged to the supplier. The buyer agrees to pay the invoices to the bank and is charged extra for extended payment periods. As a result, the supplier decreases days sales outstanding (DSO), the buyer increases days payables outstanding (DPO), and the bank charges a fee for providing finance to the two parties.

According to the Celent report, Supply Chain Financing: Flavour of the Year? SCF volumes will grow from 8 percent of global trade – or US$4 billion – in 2010 to 16 percent by 2015. Traditional trade finance, involving the exchange of letters of credit guaranteeing payment by a bank, will see its share of global trade volumes fall from 14 percent in 2010 to 8 percent in 2015, the US-based consultancy says.

Factoring, where a corporation sells its accounts receivables to a bank at a discount, will see its share rise from 11 percent in 2010 to 15 percent in 2015. Open account transactions, where a seller allows a customer to buy on credit without a formal borrowing agreement, will decline from 60 percent of global trade in 2010 to 55 percent in 2015, Aite Group says.

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Reduced risk

Interest in SCF is growing because it allows all participants – suppliers, buyers and banks – to provide and receive finance at reduced risk, says Enrico Camerinelli, a senior analyst at US-based consultancy Aite Group. An important factor in the reduction of risk offered by SCF is the increased visibility of invoices and payments that comes with automation, Camerinelli says.

Asset-backed finance based on invoices should not be viewed as being in the same category as discredited mortgage-backed securities, says Axel Pierron, senior vice president at Celent. “Unlike mortgage-backed securities, which are based on the future value of real estate, invoice-based asset-backed lending is based on the real-world economy,” he says.

Pierron goes so far as to suggest that governments should provide SCF in order to help their countries’ real-world economies. “When there are financing constraints for SMEs, governments could consider using state-owned banks to provide loans for SCF,” he says.

Interest in SCF is growing because it allows all participants – suppliers, buyers and banks – to provide and receive finance at reduced risk, says Enrico Camerinelli, a senior analyst at US-based consultancy Aite Group. An important factor in the reduction of risk offered by SCF is the increased visibility of invoices and payments that comes with automation, Camerinelli says.

Asset-backed finance based on invoices should not be viewed as being in the same category as discredited mortgage-backed securities, says Axel Pierron, senior vice president at Celent. “Unlike mortgage-backed securities, which are based on the future value of real estate, invoice-based asset-backed lending is based on the real-world economy,” he says.

Pierron goes so far as to suggest that governments should provide SCF in order to help their countries’ real-world economies. “When there are financing constraints for SMEs, governments could consider using state-owned banks to provide loans for SCF,” he says.

Banks

Avarina Miller, senior vice president at London, UK–based Demica, which provides banks with technology for managing their corporate clients’ working capital, says SCF should be considered less risky for banks than business loans. “Supply chain lending is short-term and a self-liquidating asset, so the risk and cost of capital are lower than for long-term lending,” she says.

According to a September 2011 survey by Demica, 75 percent of top European banks believe growth prospects for SCF are “strong” or “very strong”. Respondents told Demica they expect SCF to grow by 10-30 percent a year in mature markets, and 20-25 percent a year in emerging markets. Unsurprisingly, in the light of recent financial turmoil, this is more cautious than Demica’s findings from its December 2010 survey. At that point, according to Demica, 90 percent of top European banks were experiencing “very strong” growth in demand for SCF offerings and some reported a doubling of volumes in the previous two years.

In Camerinelli’s opinion, banks are not necessarily taking the lead in providing SCF. “SCF is being driven more by corporations in their need to find sources of cash and support their suppliers than by being a true business opportunity for banks,” Camerinelli writes in the Aite Group report Supply Chain Finance: A Taxonomy.

Camerinelli thinks banks might be avoiding providing SCF because they would have to aggregate lucrative product lines, such as letters of credit and factoring, which are currently sold separately to their clients. Banks may also be deterred from providing SCF by the rigorous capital allocation restrictions and minimum liquidity requirements specified by regulations such as Basel III.

Corporations

Corporations providing SCF are typically multinational, cash-rich organizations with extended supply chain networks made up of mid-size companies, Camerinelli says. These corporations are funding the SMEs which are members of their supply chain in order to ensure their financial health in difficult market conditions.

In addition, corporations are providing SCF because they have cash available. “Due to the financial crisis, corporations are sitting on a pile of cash,” says Pierron. “For a corporation, the return on their cash investments is low. With slow growth prospects, there is also not a lot of opportunity for investing in their own company. However, investing in SCF is profitable.”

One advantage that corporations have in funding their own supply chain is that they know their suppliers better than the banks do, Pierron says. “Often, these suppliers are tied into the ERP (enterprise resource planning) system and logistics of the buying corporation,” he says. “Furthermore, corporations are not subject to the same regulatory capital constraints as banks in providing loans.”

When SCF funding is provided by banks, an important advantage to SME suppliers is that funding and discount rates for early payment are based on the buyers’ credit ratings, which are likely to be stronger than the SMEs’ ratings. According to research by Demica, some suppliers are saving 3-4 percentage points on their cost of borrowing by participating in SCF programmes.

Demand for SCF programmes is coming principally from the manufacturing, retail, automotive, mechanical engineering and food production industries, with more modest levels of demand from sectors such as pharmaceuticals, technology and telecoms, Demica says.

Developed markets such as the US and Europe, are showing the strongest demand for SCF, while larger emerging economies such as China and India are expected to take the lead in the next few years, Demica says.

“While European SCF programmes are normally associated with cross-border programmes, many of the large programmes in Latin America are run domestically, with buyers and suppliers being based in the same country,” says the Demica report “Growth Trends in Supply Chain Finance: the Views of Europe’s Top 40 Banks.”

Technology

IT applications are key to the provision of SCF, since they create an infrastructure that automates the execution of transactions, says the Aite Group report Supply Chain Finance IT Solution Providers. The report says important IT enablers of SCF include applications such as e-invoicing; document management; invoice and purchase order matching, reconciliation and approval; automated accounts/payables management (also known as e-payables); multi-bank connectivity enabling a single view of all a corporation’s accounts with different banks; automated cargo insurance and claims management; and payment execution and tracking.

“If the purchase order, the invoice, and the payment are electronic, everyone has visibility,” Camerinelli says. “Suppliers can see invoices, payments and receivables on a browser or portal and can ask their bank for accelerated payment on these receivables. Because the trading information is visible earlier, the supplier can obtain credit sooner against discounted receivables, and the bank can earn fees for a longer period.”

“Automation speeds up the approval process by the buyer, which turns the invoice into a payment obligation and reduces the risk to the bank,” says Miller. “The bank is protected against the risk of paying fake invoices and facing buyer default.”

Demica’s web-based SCF platform captures all purchasing and invoice information and makes it visible to the partners online. Suppliers are able to see and select the discount terms for receiving cash advances against individual invoices from the bank. Alternatively, they can elect to let the platform deal automatically with the invoices based on pre-defined terms. The platform then sends payment and settlement instructions to the bank.

Bank can either create their own proprietary SCF platforms, or they can use an open standards-based platform from a technology provider. Besides Demica, other SCF providers include ACI, Ariba, CGI, Fundtech, Misys, S1, SunGard, Visa and U.S. Bank’s Syncada subsidiary, Taulia and TradeCard, according to Aite Group. The global SCF technology market is worth around US$500 million a year, the consultancy estimates.

Aite Group says that SCF software vendors’ platforms are bank-agnostic, as they comply with open standards such as SWIFT’s ISO 20022 financial messaging standard.

Case study: MaxTrad

Royal Bank of Scotland (RBS) operates MaxTrad, an online trade finance and supply chain finance platform. Designed for large companies with global supply chains, MaxTrad is available in 36 countries across the Americas, EMEA, the UK, and Asia.

RBS has nearly 3,000 clients using MaxTrad for services such as web access to trade import/export transactions, SCF, and outsourced document checking and preparation, says Madhav Goparaju, head of global channel developments, global transaction services at RBS.

“Over 80 percent of MaxTrad transactions take place in our growth geographies, Asia, the UK, EMEA and Mexico,” Goparaju says. “Our largest clients are located in 14 countries including Singapore, Hong Kong, the US, the Netherlands, the UAE, the UK, India, Mexico, and Malaysia. RBS is also the preferred trade bank for other financial institutions that want to outsource their trade business.”

Goparaju says that MaxTrad’s SCF service has 30 buyer programs with over 1,300 suppliers on-boarded in 32 countries including Brazil, Canada, Chile, China, France, Germany, the UK, India, Mexico, Switzerland, and the US. “The average monthly supply chain finance transaction volume processed via our channels is 18,000 invoices worth £562 million (US$904 million),” says Goparaju.

MaxTrad is able to integrate with clients’ ERP systems for direct data file transmission, and with their cash management systems for making payments, Goparaju says. It allows clients to use multiple banks to fund their SCF credit facility requirements and to process supplier payments.

“Using MaxTrad, clients can view their entire trade business and trace and track transactions on a single portal,” Goparaju says. The platform is able to accept digitised copies of traditional trade finance instruments such as commercial letters of credit, enabling buyers and sellers to view and approve documents electronically.

In MaxTrad’s SCF service, the buyer’s ERP system send approved invoices automatically to MaxTrad. Once it receives the invoices, MaxTrad automatically notifies the supplier, who then logs on to MaxTrad, selects the invoices they wish to discount, and issues a purchase request to RBS. Alternatively, suppliers can select all invoices for discounting automatically without the need to go into the platform.

RBS emails an automated notice of assignment for each discounting trade via MaxTrad on behalf of the supplier to the buyer. The invoices selected for discounting are processed automatically, resulting in a discounted payment to the supplier’s bank account. On the invoice’s due date, the buyer pays the full invoice amount to RBS.

In addition to SCF and traditional trade finance, MaxTrad offers open account transactions. Its open account service enables the buyer’s purchase order information to be transmitted direct to the platform from an ERP system. “MaxTrad provides secure electronic exchange of purchase orders and sellers’ invoices and shipping data between parties,” Goparaju says. “It audits the data to detect discrepancies, notifying users when any are found. Payment is automatically generated on the due date, provided that no discrepancies exist.”