TMI193 P37-43 Geneva Roundtable

insight insight
TMI
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Issue 193
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Sebastian di Paola, PwC
Welcome, everyone. I would like to start by asking Kieran to give
us an overview of what supply chain financing solutions look
like. With a variety of products available, treasurers are
sometimes a little confused about the difference between
factoring, reverse factoring and supply financing. Can you help
with this?
Kieran ORegan, J.P. Morgan
Supply chain finance, as we know it today, has evolved since the
late 1980s, initially in Spain, during a period of high inflation
and interest rates. This environment created considerable
challenges for corporates in terms of working capital and a high
cost and constrained liquidity, resulting in the launch of a
domestic product known as confirming.
Supply Chain Financing:
During the 1990s, supply chain finance started to become
more widespread in the US, initially amongst automotive firms,
as companies increasingly recognised its value in optimising
working capital. Since 2003-4, alternative financing techniques,
including supply chain finance, have also become prevalent in
Europe.
As Sebastian mentioned, one of the difficulties is the variety
of terminology that is used to describe the same solution: some
banks refer to supplier finance; others, reverse factoring; some,
supply chain finance. These typically refer to the same product:
essentially, a large corporate buyer with a high credit quality can
extend credit terms to its suppliers by enabling them to discount
their receivables. Suppliers who are most attracted to this are
typically, although not exclusively, those with a lower credit
rating and therefore more constrained access to credit. Suppliers
The following article summarises the discussion during a roundtable event in January
2011 in Geneva, Switzerland, hosted by J.P. Morgan and chaired by Sebastian di Paola,
Partner, Corporate Treasury Solutions Group, PwC.
An Alternative to Bank Lending
and Supplier Risk Management
TMI193 Geneva Roundtable:Laout 1 07/03/2011 17:40 Page 37
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can seek early payment of invoices
through the buyers bank, while the
buyer pays its bank according to the
original or longer payment terms. There
are a variety of reasons why a company
would do this:
Firstly, working capital optimisation, by
pushing out days payable outstanding
(DPO).
Secondly, pricing. If a supplier is able to
obtain cash quickly at a preferential rate
through the buyers credit, he may be
willing to provide more favourable
commercial terms.
Thirdly, supplier sustainability. This has
become particularly poignant following
the crisis, certainly in certain sectors. For
example, automobile companies found
that some component suppliers were
under particular stress, due to lack of
liquidity. This in turn jeopardised the
automobile companys supply chain.
Consequently, buyers with critical
suppliers use supply chain finance to
ensure the future viability of their
supplier community.
Martin, I know that Caterpillar has
introduced supply chain finance. What
was the main driver for you?
Martin Bina, Caterpillar
All three, in some respects. We had a
working capital focus, but we also
wanted to help sustain our suppliers
during difficult times. By offering them
alternative financing solutions, we were
hoping to see a pickup in the business
and give our suppliers the opportunity to
accompany us as we grew, without
capital constraints, the effect of which
would ultimately need to be passed on to
us in the form of increased costs.
As a result of the crisis and constrained
credit, we have also seen the need for
corporates to tap additional sources of
financing. This could be categorised
within your first heading of working
capital optimisation, I suppose, but do
you see supply chain finance as a form of
alternative financing?
Absolutely. Corporates are becoming
increasingly successful at leveraging
various forms of financing. While they
may have relied on syndicated, bilateral
and letter-of-credit facilities in the past,
a very large corporate may have anything
up to $20bn of accounts receivable or
payable on the balance sheet. These
companies have managed their accounts
receivable (AR) reasonably well over
recent years, through securitisation,
Attendees
Daniel Hartmeier,
Treasury Manager,
SITA
Patrick Hbert,
Corporate Banker,
J.P. Morgan
Kieran ORegan,
Head of Trade Sales Europe,
J.P. Morgan Treasury Services
Sebastian di Paola,
Partner, Corporate Treasury
Solutions Group, PwC (Chair)
Martin Bina,
Treasury Operations Manager,
Caterpillar
Jean-Marc Buhagiar,
CFO, Comptoir
Balland-Brugneaux
Peter Dielmann,
CIIA, Consultant,
Dielmann Services
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insight insight
factoring or other forms of receivables
financing. There has, however, been less
of a focus on payables, reflecting a major
asset on the balance sheet that is not
being monetised. As corporates and their
banks become more aware of the
opportunity that leveraging this asset
presents, solutions such as supply chain
financing have evolved and taken root.
Patrick Hbert, J.P. Morgan
During the crisis, we saw banks de-
leveraging their balance sheet,
significantly. Some banks were then
forced to reduce their credit commitment
and uncommitted lines with corporates.
Consequently, using accounts payable
(AP) as a source of financing became a
great opportunity for companies. A
supply chain finance structure is a long-
term funding solution, based on short-
term payables; not only have these
solutions helped during the recent
financial crisis, they will also be there for
the next one.
It is not an easy alternative to bank
lending, if I understand you correctly,
because there is a certain amount of
infrastructure that needs to be put in
place.
True, it is not a plug-and-play solution.
Supply chain financing should be a
strategic decision taken by an
organisation, not just from a treasury or
working capital management perspective,
but also from a commercial procurement
perspective. Another important issue is
the increasing integration of the physical
and financial supply chains. While banks
have been promoting this integration for
some time, it has taken time to gain
resonance in the corporate community.
Now, we see that many treasuries have
reached a stage of evolution where they
have set up either or both receivables or
payables factories, put core financing in
place, consolidated bank relationships
and implemented sophisticated
enterprise-wide systems. They therefore
need to find new ways of adding value to
the organisation. A key area of focus is
working capital, and treasurers and their
counterparts in procurement are now
engaged in a far more active dialogue
than we have seen in the past.
There are still some developments that
need to take place to fully enable this
integration, such as in technology. There
is discussion about order to pay (OTP), i.e.,
the ability to inject liquidity and
financing into the business and trigger
sourcing, production and distribution
activities as soon as an order is received
into an organisation. The technology to
enable this is developing rapidly,
particularly for organisations that are
very advanced in terms of payables and
receivables centralisation.
The infrastructure requirements, and the
need for treasury to work with the rest of
the business, are amongst the
distinguishing factors of alternative
financing such as supply chain financing
compared with traditional bank lending.
Who is the main partner for treasury in
this? Is it the shared service centre, the
AP/AR team or procurement?
While all of these are important in the
context of supply chain financing, the
procurement department will continue to
manage the supplier relationship on a
daily basis, and therefore their buy-in
and support from the outset is critical to
the success of such a programme. In
terms of integration, the shared service
centre and finance team will be involved
in aligning your AP processes. IT and legal
are also important.
Martin, Kieran mentioned the importance
of technology. What systems
environment did Caterpillar need as a
starting point? Are there ways of putting
this kind of solution in place without a
single ERP environment?
We dont use a single ERP indeed, we
do not just have a few, but many! Before
looking at technology, processes need to
be standardised. The faster we approve an
invoice and get it to our supply chain
financing provider, the more opportunity
the supplier has to discount it. If this
only happens two days before the invoice
due date, there is no value in the
offering.
Once you have this invoice flow
process set up, you can deal with
technology and integration. Electronic
invoice processing is clearly preferable to
a manual processing, together with
integration between systems, so an
important criterion for us was that our
supplier supported EDI.
To some extent, it is a win/win, because
enhancing your internal processes would
have been an objective even if you had
not undertaken supply chain financing.
In fact, I would see it as a triple win: we,
Caterpillar, win; the supply chain
financing organisation wins, and the
supplier wins.
Daniel Hartmeier, SITA
From what you have said so far, supply
chain finance would seem to me to be
the consolidation of certain tasks that
have always been carried out, although
there are now more sophisticated and
automated solutions available. What is
new to me is the idea of factoring
through the bank. This must be
something specific to production
companies, as my background is more in
the IT sector.
Patrick Hbert, J.P. Morgan
In regard to supply chain finance,
technology has been the real enabler, as
any type of payment terms can be
utilised by the company, thanks to a
smart combination of banks balance
sheets and online tools.
I agree with Patrick: technology has been
crucial. Without centralised payments,
enabled by specialist and ERP systems,
The
procurement
department
will continue
to manage the
supplier
relationship on
a daily basis.
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supply chain financing could not
function readily. You mention that
different sectors have differing appetites
for supply chain financing. In Europe, as
well as the automotive sector we have
already mentioned, retail companies
have also been early adopters. The
success of the larger retailers has in part
been due to their ability to negotiate
attractive terms with their suppliers.
They recognised early on that supply
chain finance was another tool they
could use to extract the benefit of the
huge payables portfolio on their balance
sheet and leverage their better credit
rating whilst enhancing their negotiating
position.
Today, working capital and supply
chain risk management are high on
CEOs and CFOs agendas, and an
increasing range of companies are
attracted to supply chain financing
solutions. We are now seeing retail,
automotive, heavy equipment
manufacturers, capital goods and fast-
moving electronics segments particularly
attracted to supply chain financing
programmes.
However, there are some examples
where a programme has been
unsuccessful. Key to success is the
quality of up-front supplier analysis and
the supplier onboarding process. While
this can be a lengthy and involved
process, it is worthwhile in order to make
the solution a long-term success.
Typically, the more comprehensive the
up-front supplier analysis, the faster and
more successful the onboarding process.
Furthermore, if the buyer organisation
does not have senior level sponsorship
and alignment of treasury, finance and
procurement objectives and KPIs, there
will be no roadmap towards the working
capital benefit they are seeking, how
they will achieve this, and measure its
success.
Peter Dielmann,
Dielmann Services
Would you say that the number and size
of the suppliers, and the frequency with
which suppliers change, is a factor of
success?
Not necessarily. We have seen successful
programmes with two very large suppliers
or thousands of suppliers. More
important than the size or number of
suppliers is the interaction with them. It
is important to understand the supplier
base, such as which groups of suppliers
are likely to be attracted to a programme
of this sort, and to adapt your objectives
accordingly. This should be a
collaborative process between the bank
and the client.
As I say, discounting receivables
through a supply chain finance
programme will not suit all suppliers.
Some may have negative pledges on their
accounts receivable; others may already
be cash rich or have a strong credit
standing.
Having deselected those supplier
groups for which the programme would
not be attractive, you can then look at
the remaining segments of your supplier
base: often 20% of your supplier base
will give you 80% of the benefit. That is
where your focus has to be. You will
have some large, strategic suppliers with
which you have a close dialogue. The
pricing you give these suppliers for
financing receivables may be different
from others. For smaller suppliers, the
bank may lead the discussion, to educate
them in the programme, how it works
and the benefits. The buying entity also
has to communicate with its suppliers
that their commercial relationships will
not be negatively impacted. They have to
be transparent about their reasons for
establishing the programme, and the
benefits to the supply relationship.
In the early days, some corporates went
out en masse to their supplier
community and dictated a change in
payment terms, say from 30 to 90 days,
and passed them on to their bank for
financing. That type of approach rarely
worked, as the trust between the buyer
and supplier communities broke down,
and the solution was not adapted to
different segments of the supplier base.
Martin, how did you go about
approaching and onboarding your
supplier community?
Firstly, we introduced the concept to our
own buyers, because they have the
dialogue with our suppliers. We needed
to have common goals and a consistent
view of success across the team, but
ultimately, our buying department would
be crucial to ensuring that supplier
community was on board. There were, of
course, some surprises. Despite
segmenting the supplier population, you
find there are differences between
countries, and some suppliers whom you
would expect to be attracted to
receivables discounting are not, and vice
versa. For example, companies with a
strong credit rating may see the
attraction as a way of diversifying their
financing.
Based on what we have discussed so far,
would it be fair to assume that while
there are benefits, the up-front costs also
need to be taken into account? One of
the benefits that you expect is that,
ultimately, you end up with a lower cost
of funding compared to traditional bank
lending. Is this the case?
In theory, yes, over the long term that
should be the case by extracting the
value from the credit rating arbitrage,
although we see well-rated suppliers
joining programmes where there is in
theory little arbitrage opportunity.
Jean-Marc Buhagiar, CBB
I understand this type of financing is
appropriate if we have received an invoice
once the product has been delivered. It
does not work for prepayment.
There has to be a financeable receivable.
A receivable becomes much easier to
finance once the buying entity has
accepted that receivable. For a
prepayment, it can still be financed so
long as it is part of a long-term contract.
As long as you enter into an arrangement
whereby you undertake to make a
payment for a specific amount on a
A receivable
becomes
much easier
to finance
once the
buying
entity has
accepted that
receivable.
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insight insight
specific date in the future, it is financeable
as pure buyer risk, even on a prepayment
basis, so long as there is a process of
accepting the invoice.
The difficulty is that prepayment
typically does not allow for critical mass.
The beauty of supplier finance is it is
based on invoice runs, ideally
electronically, on easily determinable
payable dates. Prepayment arrangements
tend to be more ad hoc and outside your
standard invoice run, so they have to be
dealt with slightly differently. So while
prepaid invoices can be included, it tends
only to be in exceptional cases.
Before we talk about risk, perhaps we
could summarise the distinction between
supplier financing and bank lending.
When you are comparing this solution to
bank lending, you are not comparing like
with like, in a number of respects. From a
buyer perspective, the working capital
benefit is achieved by extending payment
terms. A supply chain finance programme
is typically put in place to mitigate the
working capital impact on suppliers
resulting from the extension in payment
terms. While the programme provides
financing, it is not your main financing
tool, and provides many other benefits.
Over time, the working capital benefit can
have a critical impact on your capital
structuring framework. For a very large
corporate, extending DPO by one day
could deliver a working capital benefit of
anything from $50m up to $200 or
$300m each year. The benefit escalates if
this is pushed out by five or ten days, and
you could be talking about $500m or
more. That is a very powerful argument to
take to your CFO, chief executive or head
of procurement. From a supplier
perspective, they will compare the cost of
discounting their receivables with other
forms of financing as this is the primary
benefit.
We did some analysis, but we first
analysed our working capital. The main
issue was accounts payable and we
wanted to bring our suppliers onto
standard industry terms, but these
companies also need to manage their
working capital. Therefore, supply chain
financing gave us a tool that enabled us
to extend our terms, without increasing
suppliers cost and ideally benefiting
them in terms of access to credit.
Is it fair to say that while a company
may have increased its DPO, a bank
debt, a liability towards a bank rather
than towards a supplier may have been
created?
There is some historical precedent for
this view in the US, but there is now
greater clarity. Clearly every company
needs to agree such a solution with its
auditors, in order that financed
invoices remain as accounts payable on
its balance sheet and are not
reclassified as bank debt. Typically the
solution works because it is an
individual arrangement between the
bank and each supplier i.e., we have a
nonrecourse receivable purchase
agreement in place with each supplier,
on a noncommitted revolving basis,
whereby we agree to purchase the
receivables of the buying entity. We do
not have any financing arrangement in
place with the buying entity, and the
agreement between the bank and
buying entity is simply a programme
agreement to use the technology
solution. The buyer simply settles their
payable at maturity in the normal way.
As long as these parameters remain
intact, the buyer continues to treat the
accounts payable as an accounts
payable on his balance sheet, even
where they increase the DPO. Auditors
should be involved at the start of the
process to ensure compliance with the
relevant accounting regulations.
Jean-Marc Buhagiar, CBB
What happens if there is return or
claim for refund for a product, such as
a fault?
Supply chain financing programmes can
typically cater for credit and debit notes
which are handled as part of the
operation of the programme. However,
more significant events such as a material
commercial dispute on an accepted
invoice would need to be dealt with
separately and might not consititute a
financeable invoice.
Peter Dielmann, Dielmann
Services
We have described this as a win/win/win.
However, as we know, there is no such
thing as a free lunch. Somehow we have
to pay for this solution with some sort of
additional risk or inconvenience, or
perhaps less flexibility. What are the
inconveniences or additional risks that I
take on in order to pay for these
win/win/win situations?
It is clearly very important to consider
potential risk: for example, what will be
the impact on your credit capacity in the
market? How much credit will be
required for a solution like this? In some
cases, treasurers have the incorrect
perception that a lot of credit is required,
and therefore their bank credit lines will
be utilised.
Firstly, the credit requirement is not as
great as you may think. Let me give you
an example. Lets say the annual
procurement amount of a corporate is
$12bn. It has average payment terms with
a DPO of 30 days. On a resolving basis,
that is $1bn monthly. Typically in a
successful supplier finance solution, you
will have a takeup rate among your
supply community of a maximum of 30-
35%. Thirty per cent of a $1bn monthly
spend is $300m. Therefore, the maximum
you will need is a $300m revolving
programme on an uncommitted basis.
That is the rule of thumb in terms of the
credit capacity required.
Will it suck up credit capacity in the
market? Yes, it will to some extent but
many of your suppliers are probably
financing their receivables using factoring
anyway, probably at higher cost, so they
Supply chain
financing
gave us a
tool that
enabled us to
extend our
terms.
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Issue 193
Issue 186 June 10
Leveraging
Opportunities
in Latin America
Cash Management in Brazil,
Argentina and Mexico
Plus:
TenneTs High-Voltage
Financing Strategy
Going for Growth with
J.P. Morgan in Middle
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TMI 186 - June 2010
Leveraging opportunities in Latin America
Insights into Cash Management in Brazil,
Argentina and Mexico
BY HELEN SANDERS, EDITOR
Marking the establishment of LatAm Treasury Association
(LTA), we have three articles on the ins and outs...
Financing the Business
BY PETER VAN ROOD
Interview #4 with Peter van Rood, Group Treasurer, Brune
Singh, Director, External Markets and Harry Blok, Director
Corporate Finance, AKZO Nobel...
Hybrid Innovation at TenneT
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we have an
App for that
Visit the iTunes App store to download for free
42
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Issue 193
are already absorbing a large part of that
credit requirement. On a day-to-day
basis, it should have no material impact
on liquidity availability from your bank
providers, aside from any credit events or
downgrades that may happen to you as a
company.
What different types of structure are
available, such as bank-agnostic or
multiple bank programmes for instance,
and how would these affect your overall
credit capacity in the market?
Individual banks have their own
platforms, which they will finance from
their own balance sheets. There are
bank-agnostic solutions in the market as
well. They are essentially IT solution
providers: they provide the IT platform
and perform the onboarding process.
They are not banks, however, and they do
not have the balance sheets to fund it.
Buyers have successfully used both
proprietary solutions (with either one or
multiple banks) or bank-agnostic
solutions. When using a bank-agnostic
solution, is the provider financially
stable? In addition, how does this fit with
your bank relationships?
Global reach may also be important,
depending on your supplier base. There
are only a handful of banks that can
truly provide a solution on a global basis.
The technology aspect is not necessarily
the differentiating factor, it is how they
use their resources and the extent of
their geographic footprint and true
capabilities in regions such as Asia or
Latin America.
When looking at the funding sources,
do you look solely at the balance sheet of
the bank provider or that of all your
house banks? For instance, we have
clients using our solution, with some of
their core banks also feeding in through
our platform, through a risk-participation
mechanism. We can also look at capital
market solutions in which we can issue
notes of paper and fund through that
process. The bank can look at myriad
solutions on a collaborative basis.
The market is evolving in the way that
banks work together: rarely will one bank
support all your needs in every country,
and from a credit diversification and risk
perspective, you will probably want to
use multiple banks in any case. However,
you will not want to use multiple
platforms. You have to decide whether a
bank-agnostic provider best suits your
needs, given its structure, size and ability
to fund, versus your bank, one bank or a
number of banks.
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insight insight
How does the traditional supplier
financing solution compare with
alternatives such as payment cards?
In many ways, just as with bank financing
versus supplier financing, it impossible to
compare them as they fulfil different
functions. Solutions such as payment
cards provide some working capital
benefit, but their primary purpose may be
quite different. Looking solely at working
capital, supply chain finance is probably
the most advantageous with the potential
for several hundred million dollars or
euros in cash conversion on an annual
basis. However, it is a complementary
solution, not a competitor.
Is the supplier obliged to maintain a bank
account with you or can he just have a
contract or agreement that the cash flow
goes through his house bank?
That is a good question. It depends on
your provider. From a J.P. Morgan
perspective, typically the supplier will not
have to open an individual bank account
with us.
We have certainly seen that our clients
interest in supply chain financing has
increased since the crisis, for a variety of
reasons, including situations such as the
automotive sector where the financial
health of key suppliers was in question.
We saw several instances where clients
even looked into directly financing a
critical supplier that would be difficult to
replace, and may even have considered
acquiring the supplier. Do you see
supplier vulnerability as one of the main
drivers for establishing these structures in
the future, or was it a temporary blip
during the crisis?
It is a key driver only within certain
sectors, and automotive is one of them. I
have seen a number of automotive
companies critically concerned by their
supplier base and its continuity. Yes,
working capital optimisation is
important, but that would typically be a
second priority for them. In other
industries, the priority(s) may be
different.
It is also probably fair to say that, for
different stakeholders in the
organisation, there are different
expectations and therefore different
arguments in favour of a particular
structure. This is an argument that
would curry favour with an audit
committee or somebody who has an
enterprise risk management programme,
where supplier risk is an issue.
Before engaging with a bank, a company
needs to align its stakeholders internally,
understand what the key drivers for each
of those groups are and develop a
structure that aligns the benefit for each
of them.
This seems to me to be a very interesting
product for the IT industry, which
typically works with consultants a lot.
The majority of the suppliers are
consultants, who are often individuals, so
they would depend on being paid
immediately. Can they be set up for such
persons to basically have a monthly
invoice?
If you are requesting a bank to do a $1m
programme for individuals, they would
probably not be interested because it
does not have a critical mass. If those
providers are part of a $20-30m solution
and upwards, the answer to your
question is yes, absolutely. It depends on
whether you want to look at them in
isolation or as part of your broader
supplier base.
In a previous company I was running a
project that had up to 200 consultants.
Some of them may be regrouped in a
consulting company, but a lot of them
were individuals. The basic problem for a
company was that these consultants
wanted to be paid immediately on
submission of the invoice. As a cash-
poor company, you cannot provide that.
One consultant submitted one invoice a
month, and you might have a lot of these
consultants.
If these invoices go through your normal
AP process as part of a broader supplier
population, which has critical mass to
extract the working capital benefits and
it is interesting for the bank to finance,
the answer to your question is yes. If
they are physical invoices for small values
in isolation, the answer is probably no.
Kieran, in conclusion, what would be
your advice to a company considering a
supply chain finance programme? What
are the first steps?
Companies first need executive support,
someone who can help to align the
interests and objectives of the various
stakeholders. They also need an internal
champion or project manager to take
ownership of the project and drive it
through, who can work with all the
relevant internal departments, and with
the banking partner. The more
preparation that takes place internally, in
terms of reviewing the financing
structure, working capital management
and AP processes, the greater the
likelihood of success. At that point, they
can consult with their banking partners
to find the best way of achieving their
objectives.
Thanks to all of you for your
contributions and for sharing thoughts
on this complex yet highly topical
subject. Todays discussion confirms that
there is lots of opportunity out there for
companies to benefit, in a variety of
ways, from these types of solution. I
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Issue 193
For different
stakeholders
in the
organisation,
there are
different
expectations
and therefore
different
arguments in
favour of a
particular
structure.

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