The news of Greensill’s collapse into administration dominated the headlines of financial publications in March and continues to draw the media’s attention. A swift demise of Lex Greensill’s empire, filled with politicians, industry moguls and numerous plot twists, makes for a gripping story that has transfixed both media and the public. Yet, amidst all of this noise, it is crucial to understand what underpins this epic debacle.
Greensill’s collapse had nothing to do with SCF (supply chain finance) as a product, which financiers have practised for centuries. The failure was mainly rooted in an overall lack of transparency and controls, a divergence into more exotic long-term financing structures and the way Greensill products were managed, which allowed questionable practices to pass unnoticed.
A crisis – years in the making
In February this year, Bloomberg was heralding Lex Greensill, the company's founder, as "the king of SCF", who had been touting a whopping valuation of $7BN for the company. Shortly after, Greensill turned out to be yet another of Softbank’s investments gone wrong.
Although it may look like a recent development to the naked eye, this crisis had been years in the making. Two particular events unravelling at the same time brought the firm to its knees and forced the company to file for bankruptcy protection in the UK and Australia.
The first and most critical trigger was the non-renewal of $4.6BN of credit insurance covering potential non-payment by Greensill clients on March 1st this year by Australia’s Bond and Credit Company (BCC), whose parent company is Japanese insurance giant Tokio Marine Management. This triggered a chain reaction on the same day when Credit Suisse decided to suspend $10BN worth of funds managed by Credit Suisse Asset Management (CSAM) with assets originated and structured by Greensill Capital. Credit Suisse has stated that its priority remains the recovery of funds for CSAM’s investors and is working closely with the administrators of Greensill Capital, Grant Thornton, and other parties to facilitate this process. Initial redemption repayments totalling $3.1BN across the four funds have been made starting on March 8th. It is clear that the cancellation of the insurance cover was a critical factor in the decision to suspend the funds as the credit rating of the assets could no longer be based on the strength of the insurer.
The decision by Tokio Marine not to extend its insurance cover was likely due to the deterioration of the underlying assets in Greensill’s portfolio, concerns over concentration and transparency as well as a general contraction of the insurance market amidst the Covid-19 crisis. Tokio Marine notified Greensill on 1 September 2020 that it did not wish to renew its insurance cover stating, according to GTR, and that “given the current situation… we will not be able to bind any new policies, take on any additional risk nor extend or renew any [Greensill] policy past what had previously been agreed”. Greensill then failed to find an alternative insurer and tried its luck in the Australian courts as a last resort by seeking to force a new cover but received an unfavourable ruling.
Adding further fuel to the fire, the second trigger was unfolding at the same time in another part of the world. German regulator BaFin launched a legal probe into Greensill Bank, a German entity that is part of the wider Greensill group. The regulator’s concerns were centred around the concentration of the bank's exposure to a single name: Sanjeev Gupta, a well-known UK steel industrialist who was one of the first clients of the firm and one of its shareholders. A probe by KPMG at the behest of BaFin focused on “receivables” finance facilities the bank provided to Gupta’s companies, which are designed to be repaid by a group’s customers, as the Financial Times reported. This allowed the bank to classify the risk as split between a number of different companies, rather than one significant exposure to Gupta’s businesses, which might have breached rules. During its probe, KPMG struggled to verify the existence of some of these invoices, said several people familiar with the investigation. It also determined that “advanced receivables” facilities, whereby debt would be repaid by hypothetical future invoices, could be construed as an unsecured loan to Gupta’s companies. As a result, on 3 March 2021, BaFin froze Greensill Bank’s operations in the interest of depositors and creditors.
All of these developments had been in the making over the last three years. In late 2020 Softbank had already silently written down most of its stake in Greensill, although the writedown was only publicized at the beginning of March. Greensill was forced to seek a sale of parts of its operating business to Apollo Global Management, the investment firm, in early March. Talks with Apollo did not progress as shortly after Taulia, Greensill’s key technology platform partner, secured a liquidity line led by JP Morgan worth over $6BN with participation from a number of other banks. Taulia’s involvement seems to be a key factor in securing this huge liquidity line. We expect that the new lending facility will be used to provide the necessary liquidity to the SCF deals in place. Taulia effectively absorbed a portion of Greensill’s portfolio directly onto the very platform that had previously been servicing these transactions using its technology. In this way, clients that formerly relied on Greensill funding were able to continue accessing liquidity with minimal disruption to their operations.
“It seems that JP Morgan has done a better job than Softbank and even General Atlantic at segmenting the market and understanding where the real value resides in the value chain. Digital platforms like Taulia or Finverity that have the unique and sticky technology required to originate the best deals and service them efficiently turned out to be a much better investment than Greensill itself, whose main value add was in financial engineering and its access to funding, which is replaceable” Viacheslav Oganezov, CEO & Co-founder of Finverity
Supply chain finance as a product
- Corporate buyer sets up a supply chain finance program with the funder (bank/alternative provider), so its suppliers can get paid early for invoices.
- Funder bridges payment gap (usually 30, 60 or 90 days, but can be longer)
- Suppliers benefit from buyers higher credit rating to gain financing at lower rates.
- Buyers often use supply chain finance to negotiate extended payment terms with suppliers to free up cash.
- This buyer-centric method is also known as payable financing or reverse factoring.
Supply chain finance is a loose term that is used to refer to a variety of financing techniques, including factoring, payables finance and pre-shipment finance, all of which share a common theme but have subtle differences. With payables finance, one of the most common forms of SCF, sellers of goods or services in a buyer’s supply chain receive an early discounted payment from a third party financier prior to the due date of their invoices, thereby unlocking working capital. The ‘discount’ or fee they pay for this funding reflects the creditworthiness of their typically larger buyer rather than their own, making it more affordable than most other forms of borrowing, especially for SMEs. Despite this fact, only a fraction of SMEs ever get access to this kind of service at present.
As the financing of international deals migrates rapidly to open account trading, and Covid-19 stimulates a surge in firms’ appetite for liquidity, SCF is experiencing unprecedented growth. And not without good reason. With a global revenue pool of between $50 billion and $75 billion even pre-pandemic, according to the International Chamber of Commerce (ICC), SCF offers investors low-risk exposure to deal flows that fuel and sustain the real economy. For SME suppliers, SCF provides an affordable liquidity boost while promising their buyers a more resilient and reliable supply chain. The market has grown significantly in recent years, to a total value of financing worth $1.31 trillion in 2020, according to a recent World Supply Chain Finance Report, published by BCR.
Banks remain the largest lenders in the space, but there has also been increasing interest from non-bank lenders seeking to enter the asset class in search of reliable, uncorrelated yield. Greensill, as an alternative provider, catered towards that and played an important role in bringing this asset class to investors, with Tony Brown, CEO of The Deal Advisory, a deal finance consultancy, being quoted in an interview as saying “Greensill really did put this technique on the map. They deserve kudos for that”. The problem was with how Greensill placed SCF on the map.
“With the help of Softbank Funding, Greensill was able to grow at breakneck speed. However, in order to maintain that growth rate and justify its valuation and status, certain decisions were made that led to their demise. It is crucial to understand the lessons that can be drawn from this for both industry players and investors looking at the asset class. We can only prevent disasters from occurring if we are willing to learn from them and implement corrective measures”. Alex Fenechiu, COO & Co-founder of Finverity
Key lessons learnt for the SCF industry – 3 key lessons
1. Transparency as a guiding star
The first and most pronounced issue in the Greensill situation was the lack of transparency with regards to the underlying exposures and assets owned by the lenders. It seems that in the case of Greensill, the actual concentrations were not clearly visible to either the lenders in the funds or the regulator and perhaps not even to Greensill itself. Yet without clear visibility, it is very difficult to manage a portfolio and understand its actual risks.
Transparency should therefore be SCF’s guiding star if lending to the sector is to grow on a sound footing. Attention should be placed not only on the aggregate, top-line numbers provided via spreadsheets and reports, but also on the granular data at an invoice / payable level, and on making this accessible in near real-time at the click of a button.
Technology platforms such as Finverity’s are specifically designed to provide lenders with such data. Transparency should focus on real-time portfolio management, segregated investment infrastructure and full ownership traceability, by providing:
- Real-time portfolio management. This is achieved through the provision of granular data on exposure and concentrations at both the obligor and invoice level, allowing lenders to fully understand their risk exposure and manage their portfolios effectively.
- Segregated investment infrastructure. This is achieved by providing each lender with direct control over the funds used for transactions through segregated, named bank accounts and assets owned via a trust structure. This removes the originator/servicer’s counterparty risk while maintaining automation of servicing.
- Full ownership traceability. This is achieved by providing a breakdown of the underlying receivables over which the lender has full ownership as well as by providing supporting documentation such as actual invoices, re-assignment deeds and the real-time statuses of each transaction in order to provide full traceability.
As a result of Greensill, we expect lenders to gravitate towards those platforms that meet the highest levels of transparency and controls. Nowadays, platforms such as Finverity’s use top-tier legal and payment infrastructure paired with automation to run a successful supply chain finance programme. This allows lenders to scale up their SCF programmes in a safe and sustainable manner.
In our view, this is the clear route to making SCF a truly scalable and liquid asset class.
2. Diversify, diversify, diversify
The second key issue was the level of concentration that Greensill had to some major clients. This included not only Gupta’s GFG Alliance at the centre of media attention or even the Softbank-funded startups, which were a significant portion of the book. Rather, we can see a clear bias towards large, seemingly safe, names that have misfired repeatedly for Greensill in the past such as NMC, the London-listed healthcare giant from the MENA region. Yet the lessons had clearly not been learned by Greensill as around 90% of its business derived from just five clients, according to court documents sourced by Bloomberg. This is the same problem that banks have often faced in trade and supply chain finance, when they lend excessive amounts to a big name that goes belly up and wipes out a large portion of the lending book. The reaction then is a knee-jerk pull-back from the space, but is that really the most effective way to tackle the problem?
A much more sensible approach, and one that keeps liquidity in place to fund the growing demand for SCF, is to diversify more and to diversify better. Supply chain finance has traditionally been reserved for large corporate and investment grade clients. This is a very crowded segment of the market, where diversification is difficult as origination is a long and complex process with a limited number of companies that are not already well serviced. However, with ticket sizes in the billions, it allows large AUM figures to be quickly reached.
For far too long, providing lending to mid-market companies has been overlooked as an effective diversification strategy in SCF. The main reason is the high operational cost arising from each deal, which in the absence of automation and technology makes the business model economically unprofitable for smaller ticket deals that do not generate as much revenue. This limits banks’ appetite for offering SCF to SMEs. The second reason is the “higher risk” label that has been traditionally associated with smaller entities. Yet there are many mid-sized companies that have very strong credit profiles despite their smaller size. As history shows, bigger does not mean safer!
Finverity’s platform is designed specifically to offer lenders access to a pre-qualified top-tier deal flow of mid-market SCF transactions spread across markets and industries. By providing the necessary controls, transparency and automation required, the best platforms offer an attractive diversification tool for lenders, especially alternative lenders, who do not want to employ the large human operational resources needed to service such transactions at scale. Furthermore, deals sourced via a platform can be syndicated with other lenders to share risk, whilst credit rules can be hardcoded into algorithms that will ensure mandates are never breached. Finally, the risk-adjusted returns in mid-market SCF are also significantly more attractive, allowing more cushioning in case something does go wrong within the underlying portfolio.
Diversification of lenders has become a key criteria for corporate buyers when they choose an SCF provider and that trend will only continue. Stories like Greensill’s demise, which led to a loss of liquidity overnight for the NHS amongst others, as well as of banks repeatedly pulling lending out of industries with very little notice, have made corporates aware of the shocks their businesses have to endure in such situations. Platforms become the obvious solution to this problem as they provide a diversified lending pool to the corporate through a single gateway, mitigating the risk of lender concentration. Furthermore, they provide easy to use, integrated front and back-end technology that enhances operational efficiency and reporting, whilst at the same time significantly reducing the workload for corporate treasury and finance departments.
The fact that Taulia, Greensill’s core tech partner, was able to land a $6.8 BN liquidity facility from JP Morgan and a range of other banks just days after the debacle, underlines the attractions of a strong platform to both lenders and corporate buyers. Lenders who clearly still view SCF as an attractive asset class despite the Greensill collapse are now increasingly seeing technology platforms as an effective way to participate in it and a gateway to the best clients. To the buyers on the other hand the real value-add comes from the tech-enabled servicing and operational benefits the platforms offer beyond financing. To them, the capital on the other end is replaceable. After all, cash is homogenous.
3. Sustainable growth
The third key issue at Greensill was a hyper-growth mentality at the cost of sound due diligence and underwriting. When Greensill received a $1.5BN investment from a large investor such as Softbank, the focus was on rapid growth to justify increases to an already ballooned valuation. Hypergrowth may work in industries such as e-commerce, tech or even payments, but it can be deadly in a balance sheet lending model. In its search for bigger volumes, many core risk mitigation principles fell by the wayside.
Around 2015, Greensill started to deviate from traditional SCF, which is essentially focussed on short-term exposure to creditworthy buyers, as the growth rate being generated was not fast enough and margins were thin. Greensill moved into long-term structured finance, which has a completely different risk profile and used an over-reliance on insurance wrapping, thus creating structural risk. At the same time, Greensill also aggressively leveraged its network to generate higher credit risk clients such as Gupta or Norwegian Air but where execution could be fast. It is quite unfortunate that Credit Suisse and GAM allowed the mixing of such assets with traditional SCF transactions in their funds, or perhaps they were unaware of the full extent. In any event, if mandates had been strictly defined and hardcoded into a technological system that oversees lending deployment such a massive investment style drift would have been much less likely to have taken place.
A quote from Lex Greensill published in a Greensill white paper still available online sums up much of Greensill’s thinking
The structure is the same whether it’s a seven-day trade receivable or a 12-year aeroplane lease cash flow or indeed a payment 25 years into the future for hydroelectric power. It uses a combination of capital plus risk mitigants—largely insurance—to deliver to our investors a product that allows us to unlock working capital for our clients so they can put it to work.” – Lex Greensill
The above statement draws attention to the excessive over-reliance on insurance by Greensill, which led to a significant fall in underwriting standards across the company. This brings flashbacks to the 2008 mortgage crisis, whereby sub-par assets were bundled together and wrapped to obtain a better credit rating with very little knowledge or visibility into the underlying assets for the end purchaser of the security.
A lesson we should have all learnt over 10 years ago taught us this is not the way forward. Sound due diligence and a solid understanding of underlying risk have to be a given in any well-managed lending business, whether insurance is available as an additional credit enhancement or not. However, it becomes untenable for lenders to manually perform a high level of due diligence whilst growing their AUM at hyper-growth speed. The operational workload is simply too great.
One viable solution to this issue lies in working with platforms such as Finverity that offer both origination of high-quality SCF deals and technology-enabled servicing of these. By performing the data collection and a vast majority of analysis before a deal is matched with the lender, Finverity acts as a filtering mechanism, ensuring lenders only see deals that they are likely to fund, which significantly streamlines their due diligence. Deal acceptance rates at Finverity are below 20% and the platform comes with automated risk monitoring tools and fraud prevention features such as automatic blocking of transactions arising from suspicious trading patterns. This allows lenders to sustainably grow their book without sacrificing underwriting quality.
Greensill, like many other innovators, opened up a new approach to an established product. This approach is now being iterated, improved and executed by many players around the globe with various degrees of success. Supply chain finance is at the start of its growth period as an asset class outside the traditional domain of banks. The Greensill chain of events simply proves what most specialists already knew: technology will play a crucial role in the development of a sustainable and robust SCF environment.
For anyone who looked closely enough, and knew where to look, Greensill was littered with warning signs. The Greensill debacle has brought to the table a long list of red flags to watch out for and has put the spotlight on an asset class that is currently being discussed in boardrooms all across the world. Greensill’s demise may be the sector’s blessing in disguise if the lessons arising are learned and implemented, paving the way for a sustainable and transparent growth of the sector.
Our view at Finverity is that strong technological platforms will have a key role to play in this process. Not only by making SCF accessible to a growing number of alternative lenders in a transparent and reliable way, but also by enabling a more efficient functioning of the financial markets as a whole by directing liquidity in the real economy to where it is most needed.