The Greensill debacle contains lessons from reforming government lobbying to ensuring that supply chain financing technology provides the asset transparency, processing efficiency and operational control that lenders need. Among those key lessons is a throwback to the 2008 financial crisis: concentration kills.
The financing of payables is almost as old as the saying ‘don’t put your eggs all in one basket. Unfortunately, markets tend not to have a particularly good memory when it comes to evaluating old risks in ever-so-slightly new clothes.
Greensill’s core business model was not new: take a set of contractual obligations to pay, bundle them together and use the receivables as backing for a note or bond issue. In the case of SCF-backed funds, those contractual obligations to pay were supposed to be invoiced from suppliers approved for payment by creditworthy corporate buyers. Pools of these would create predictable cash flows that could be used to service coupon and interest payments on notes which could then be sold to investors looking for higher yields but still creditworthy paper.
In this case, there were additional intermediaries – GAM and Credit Suisse funds. Greensill SPVs owned the underlying invoices and issued mainly three-month asset-backed notes against them. These notes were then bought by the funds using money from investors who invested in shares in the funds.
As previously discussed, it turns out the underlying assets were often not just standard SCF receivables. But investors didn’t know that, and it seems neither did the fund managers. Credit Suisse described the investments as “quite a new category.
However, there was another problem familiar to anyone who lived through the collateralised debt obligation (CDO) crisis or is watching the arguments over correlation modelling in the collateralised loan obligation (CLO) market today. Investors in the Credit Suisse funds thought they were buying diversified assets. For example, a marketing document for the Credit Suisse Nova (Lux) Supply Chain Finance High Income Fund states that the fund is exposed to 124 obligors (companies whose invoices backed the notes in the fund), with no single obligor representing more than 3.4% of the fund and the top 10 obligors representing around a quarter of the fund’s assets.
The numbers were correct, but they did not provide the information investors really needed to assess the risks in the portfolio. What mattered more than the percentages of exposure to legally separate obligors was the relationship between them, and that was not fully explained.
As far back as 2018, the flagship Credit Suisse SCF fund had about a third of its $1.1 billion in notes linked to GFG Alliance companies or their customers. That level fell, but the exposure to a sub-investment grade steel empire was still much higher than any investor would have suspected or wanted. In addition, the Credit Suisse supply chain finance funds had at least $629 million in assets tied to SoftBank-backed companies as of late January. That is, the funds were major financiers of companies owned by SoftBank’s Vision Fund while SoftBank was itself also an investor in the funds and in Greensill.
This lack of diversification undermines the entire point of pooled assets. Properly designed, an asset pool contains a large number of uncorrelated obligors. These are unlikely to default at the same time, and the lack of correlation can potentially give the fund a higher credit rating than any single obligor. A high concentration of assets left Greensill extremely vulnerable, with the deterioration of those assets ultimately triggering the withdrawal of insurance – one of the first dominos to fall.
The fund managers understood this risk in general. Indeed, in the notes to a June 2020 update to investors, they made a point of warning that “the fund may at certain times have a relatively high exposure to a small number of obligors.”
And Credit Suisse executives understood specifically the issue of GFG concentration risk but believed that because most of the loans were to customers of GFG companies, and not GFG itself, the concentration risk was minimal.
This was at best a simplistic analysis. If GFG’s customers went bust, GFG’s receivables would be impacted, and longer-term its revenues would shrink and it could default. But also, if GFG itself went bust, its customers’ ability to fulfil their own contracts with their customers would be affected, potentially delaying cashflows or even derailing deals completely. Clearly, a portfolio that included both GFG and its customers is riskier than one in which none of the credits are linked in any way.
However, it became harder over time for Credit Suisse to evaluate this risk because the proportion of loans linked to GFG and its customers by name did fall, to be replaced with opaque counterparties with names taken from roads and landmarks around Lex Greensill’s hometown in Australia.
The SoftBank money-go-round was also noted and became public, but again, there is no evidence that end investors were told of or understood the implications. As they found out, the implications were fatal to the continued operation of the funds and will result in significant losses of principal.
The saga also demonstrates the importance of financial institutions, as well as the corporates they support, having a diversified funding base. An over-reliance on Credit Suisse, for example, proved fatal for Greensill, with its scheme collapsing once that financial institution stopped buying notes.
Diversity through technology
Greensill was unusual in the extreme concentration on a handful of corporations of its business in general, and the SCF funds in particular. However, the broader SCF asset can be subject to a version of the same issue.
Supply chain finance has traditionally been reserved by large banks for large investment-grade clients. By definition, this is a relatively small universe of companies, made smaller because only some of them want an SCF programme. If their payables are the only source of assets for an SCF asset class, it will remain hard for any securitisation, or any directly funded portfolio, to achieve sufficient diversification to avoid concentration risk.
The solution to that problem is the same as the solution to the broader problem of efficiently financing the 80% of eligible assets not yet benefiting from better working-capital management: that is, expanding SCF to mid-market companies. This huge global pool of companies and their cashflows can provide diversified portfolios of uncorrelated assets tailored to the risk and yield appetites of a wide range of investors.
To make this possible, the market must look beyond the banks. Banks’ ability to open the SCF market up to SMEs is constrained by legacy infrastructure, regulatory complexity and economics. Instead, the operational costs of onboarding SMEs and then processing the volumes of transactions required must be lowered through the use of newer platforms using automation and technology. A platform that combined the core operational processing functionality to run SCF programmes, with an onboarding and credit analysis capability able to pre-screen potential borrowers, would effectively create a pre-approved group of creditworthy companies ready for investors to evaluate and fund.
This exists today. Platforms such as Finverity exist 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 of such 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.
Like Greensill’s portfolios, the SCF market today must diversify or face the consequences.