Supply chain finance is an attractive, low-risk source of uncorrelated returns for investors and a useful treasury tool for companies of all sizes – as long as there is transparency into underlying assets and the right technology underpins programmes.
With the failure of Greensill Capital, supply chain finance (SCF) is again under scrutiny. Is it a legitimate and low-cost technique for improving the cashflows of millions of small and medium-sized enterprises? Or is it a piece of financial engineering used to artificially reduce a few companies’ reported debt and improve their return on capital employed? Is SCF-related paper low risk and easy to evaluate, or it is complex and opaque?
The Greensill affair can help answer these questions, which are critical for institutional investors, family offices and wealth managers for whom a deep and safe SCF market would provide an attractive alternative asset class. But, at the same time, it needs underscoring that for at least the past three years, Greensill’s operations had almost nothing to do with SCF at all.
From SCF to sub-prime
Greensill’s original business was a vanilla, low-risk SCF operation based on conventional receivables and payables financing. However, it did not stay that way for very long. The firm moved quickly from repackaging existing short-term invoices to securitizing ‘prospective receivables’ – estimates of cashflows that might exist in the next one to five years.
This lending was made more dangerous by its increasing concentration on an undiversified group of very large counterparties, some of which were also low credit quality. For example, by September 2019, Greensill’s lending facilities to GFG Alliance had reached almost $7.4 billion. It also made $850 million in loans, some of them based on prospective receivables, to other firms, including US coal miner Bluestone Resources.
Compounding the risk still further, the lending involved a degree of related-party activity that would have affected investors’ appetite for the repackaged debt had they understood it. Even when Greensill focused on conventional SCF, related party transactions were a red flag. For example, Vodafone used Greensill for SCF, but at the end of 2018, the firm had a €1 billion investment in the fund that bought its bills. Vodafone’s treasurer later went to work as Greensill’s CFO.
And then there is SoftBank, which was an investor in the SCF funds purchasing Greensill-originated assets. At the same time, loans to SoftBank Vision Fund-owned companies were significant assets in those same funds. For example, in 2018, SoftBank invested in struggling US construction company Katerra, whose invoices Greensill was also financing. Greensill would then sell loans associated with those invoices to Credit Suisse’s supply chain finance funds. According to the Financial Times, SoftBank had invested more than $500 million into those same Credit Suisse funds by summer 2020. On top of that, SoftBank was also an investor in Greensill itself.
Visibility is critical
All these details are important because any one of them could have raised a red flag with the ultimate buyers of the paper. But those investors knew nothing of this. They had no visibility into the ultimate assets and no way to evaluate the true risks of what they were buying.
Greensill clearly understood that scrutiny of the assets would make them difficult to sell. That’s why it added credit enhancement in the form of trade credit insurance provided by Sydney-based underwriter Bond & Credit Co (BCC), a subsidiary of insurance giant Tokio Marine Management. It was the refusal of the insurer to renew this insurance that ultimately triggered the collapse by revealing the true nature and quality of the ‘assets’ underlying Greensill’s transactions.
In other words, due to a good rating of the paper, investors believed that they were buying low-risk, short-dated receivables risk when actually they were exposed to a basket of problematic, long-term, unsecured loans and relied completely on an insurance contract they knew little about. Moreover, high-quality SCF assets were also swapped away by Greensill’s platform tech partner Taulia and refinanced by JP Morgan and other banks within weeks. So, while the collapsed funds ultimately held limited SCF assets, they do contain useful lessons for investors looking at the SCF asset class.
First, any fund-based investment puts investors at a distance from the underlying assets. If fund managers do not provide sufficient visibility into their portfolios, then questions should be asked about the managers and about the fund structures themselves.
Data, data, data
Second, and most importantly, no one in the investment process had a clear sight of the individual assets underlying the funds.
All transactions should be structured so that the exact nature of the risk transfer and recourse is clear. Do lenders have clear title to individual assets or to some other tier of lien? Does the insurance contract cover a fund or, again, specific portfolio assets?
Investors must have access to real-time granular data on exposure and transactions at the invoice/payable level, allowing the ultimate lenders to fully understand their risk exposure and manage their portfolios effectively. They also need all the supporting documentation such as actual invoices, re-assignment deeds and the real-time statuses of each transaction to be available to provide full traceability and facilitate spot checks.
Ideally, each lender should have direct control over the funds used for transactions and assets owned not to be exposed to the counterparty risk of the originator/servicer – in this case, Greensill. Access to segregated reporting and processing infrastructure that protects each lender from any contagion with others is also needed.
The right technology is here, now
The technology to provide this information and infrastructure already exists. Platforms that sit between lenders, suppliers and buyers provide tailored supply chain finance and dynamic discounting solutions in exactly this way. In fact, the best ones leverage the same data investors require for visibility to provide borrowers with visibility into their own cash conversion cycle and offer smart options on tenor and rates.
This data allows lenders to view their exposure and concentration to each party being funded on the platform at both aggregate and granular levels, and that in turn allows the platforms to intelligently match the exact yield and tenor requirements of investors with the rates corporates are prepared to pay to manage their working capital.
Ironically, Greensill itself, despite its claims of proprietary tech, turns out to have had none that was of value. Anecdotal evidence from former staff suggests it extended no further than spreadsheets. And during failed negotiations to rescue the firm, Apollo-backed Athene Holdings valued Greensill’s IT systems and intellectual property at just $60 million because all the heavy lifting was done by its technology partner Taulia.
The real future of SCF
Perhaps the most important lesson from Greensill is what it does not tell us. It adds little to any debate about the suitability of SCF assets for particular investors – because almost none of the SCF assets were involved in the meltdown.
In fact, true SCF assets historically outperformed other assets, especially in downturns. Namely, the asset class did not experience a single month of negative returns during the height of the 2008/09 financial crisis, according to Greenwich Associates. While, over the five years leading to May 2020, the drawdown on funds within the Eurekahedge Trade Finance Hedge Fund Index never exceeded 0.31%. These assets can be used to create a wide range of investments with varying tenors, stable yields, and a good degree of non-correlation with other asset classes by financing both large and smaller but healthy companies.
SCF is a genuinely valuable tool for smaller and mid-sized companies, particularly those in emerging markets, to manage their cashflows dynamically, delivering resilience and access to funding to grow their trade volumes when it is needed most. It is also well placed to deliver impact and ESG-related investments to satisfy the growing demand for those and direct the capital into the real economy.
If it will be driven by a much larger number of companies who accept the ‘vanilla’ purpose of SCF, and the right technology and information are available, volumes in the market will indeed likely hit the 15%-20% CAGR prediction made in McKinsey’s 2020 Global Payment Report.
But as Greensill ultimately proves, to allow investors to participate in this marketplace through the fund and non-fund vehicles, they require the market participants to maximise transparency in underlaying assets and give lenders control through automation and top-tier infrastructure.
Only then can SCF become what it should be: a truly scalable and liquid asset class.