Elucidating supply chain finance

June 2016  |  EXPERT BRIEFING  |  BANKING & FINANCE

financierworldwide.com

 

The use of supply chain finance (SCF) in both domestic and cross-border trade has grown exponentially over the past few years, helping to optimise the management of the working capital and liquidity invested in supply chain processes and transactions.

Yet, despite its benefits, a lack of clear and consistent terminologies is stunting its future growth and development. Indeed, its fast and largely uncoordinated growth across the globe has led to practitioners using an array of different terms to describe the same techniques and processes. For example, ‘payables finance’, ‘reverse factoring’, ‘confirming’, ‘approved payments finance’, ‘confirmed payables’, ‘trade payables’, ‘supplier finance’ and ‘supply chain finance’ have all been used to describe the same technique or solution.

In addition to creating confusion and inhibiting communication across the industry, the lack of consistency around terms could deter those companies which might benefit from SCF solutions and techniques.

To address this industry-wide issue, a new set of standardised definitions of the principles and core techniques of supply chain finance was officially unveiled at the SCF summit held in Singapore in March, hosted by the International Chamber of Commerce (ICC) Academy.

The purpose of supply chain finance

So what is SCF? SCF has been defined, clearly and intentionally, as programmatic in nature – encompassing a wide range of techniques, solutions and products employed in both domestic and cross-border trade with the dual aim of financing trade and mitigating its risks. SCF also promotes an ecosystem-based view of commerce, including cross-border trade, in the context of complex supply chains that can involve supplier communities and service providers numbering in the thousands, even tens of thousands. This contrasts sharply with the bilateral, one-buyer, one-seller view of trade associated with traditional instruments such as documentary letters of credit.

At its most basic level, SCF uses finance to bridge the gap between the needs of the supplier and of the buyer. It is both in the supplier’s interest to be paid as early as possible, and in the buyer’s interest to delay payment. While this basic tension is intrinsic to trade, it may be exacerbated by complex supply chains – leaving suppliers without money for long periods of time while they still have to meet their own expenses, and forcing sellers who trade on open account terms to operate without a guarantee of payment.

Payables finance, one of the techniques of SCF, can help suppliers by advancing finance to them on the strength of their unpaid invoices and their buyer’s creditworthiness. However, SCF also benefits buyers, allowing them to negotiate better terms without having to make early payment and thereby forego liquidity, and ensuring their suppliers (including all-important ‘strategic suppliers’) remain well-inclined and – crucially – financially viable.

What’s more, SCF also provides buyers and sellers with the efficiencies of process automation. Very often it is delivered through a technology platform, providing the trading parties with real-time transparency into their physical and financial supply chains. And this can offer a further benefit: the insight into where their working capital is tied up may motivate trading parties to organise their business more efficiently, putting that working capital to better use.

Boosting SCF use

While the benefits of SCF are clear, its rapid growth in popularity is also due to the increasing volumes of trade globally completed on an open account basis.

Historically, a large proportion of global trade has been supported by trade finance instruments such as documentary letters of credit. However, while such trade instruments are familiar, well-tested and offer balanced security to buyers and sellers, managing them can be onerous, requiring specialist knowledge and administrative resources. A letter of credit, for example, involves completing a large number of documents correctly and submitting them to a strict deadline.

As such, many parties are increasingly choosing to trade on an open account basis instead – the seller produces and ships goods, with payment agreed either at a point in transit (when the goods are loaded onto a vessel, for example), or on delivery, with payment terms potentially extending 30, 60 or 90 days from contract date, leaving the seller exposed to adverse working capital impact. Today, more than 80 percent of global exports are settled by this type of settlement option, and this is expected to grow further. Of course, the rise in the use of open account trade has in turn encouraged many traders to consider SCF – attracted, in large part, to its cost-effectiveness, transactional efficiency and flexible financing options, as well as emerging risk mitigation capabilities. Indeed, nearly 41 percent of respondents to the ICC Banking Commission’s 2015 Global Survey on Trade Finance report an increased interest in SCF solutions.

New standard definitions

However, while the rise in SCF is significant, it has yet to completely fulfil its potential. Yet in order for it to progress, there must be more clarity around terminologies.

It is for this reason that the new standard definitions for the techniques of supply chain finance were drafted by the Global Supply Chain Finance Forum, established in 2014, facilitated by the ICC Banking Commission and comprising BAFT, the Euro Banking Association (EBA), Factors Chain International (FCI) and the International Trade and Forfaiting Association (ITFA). This was a global, multi-association initiative, created with input from a wide spectrum of different industry players and stakeholders from around the globe, and aimed at fostering clarity and a common understanding of SCF across the industry.

The resulting document published at the ICC Academy SCF summit contains detailed definitions and descriptions of eight core techniques of SCF, plus the bank payment obligation as an enabling framework for SCF, each illustrated by a transaction flow. These will be useful not just to providers of finance and their corporate, commercial and SME clients, but also to investors, regulators, professional service firms, accountants, lawyers, IT and infrastructure providers – indeed, to anyone who comes into contact with supply chain finance.

Defining the future

Of course, publishing the new terminologies is just a first step – the next challenge will be to ensure their widest possible adoption by the industry.

SCF is a complex and fast-evolving set of practices, and new terminologies themselves need to evolve further in response to industry feedback and SCF’s further development. While flexible, the clarification now introduced by the terminologies will allow counterparties, finance providers and other stakeholders to state their needs, and explain their offerings, clearly and unambiguously.

We are only just observing the start of the rise of SCF, as it allows trade across supply chains to be efficiently and securely managed in a way that addresses the needs of every single vital link. And the clarification of terminologies will clear the path of SCF to thrive and spread across the globe, and for its techniques to be further elaborated to fit new circumstances and counterparties.

 

Alexander R. Malaket is the president of OPUS Advisory Services International Inc, and Deputy Head of the Executive Committee, International Chamber of Commerce Banking Commission. He can be contacted on +1 (647) 680 6787 or by email: ar.malaket@opus-advisory.com.

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BY

Alexander R. Malaket

International Chamber of Commerce Banking Commission


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