European companies hit by the coronavirus crisis are increasingly turning to a complex financial tool to pay suppliers, raising investor concerns around “hidden” debt.
Supply chain financing, by which companies can get cash from banks and funds to pay their suppliers without using working capital, has likely hit a record high in 2020, data shows.
The world’s top banks are set to earn $27 billion from financing supply chains this year, data from research firm Coalition shows, as larger borrowers, mostly in Europe, scramble to help suppliers hammered by the pandemic.
This represents a rise of about 5.5% in 2020, compared with an average 2% increase in the previous four years.
While supply chain finance is a legitimate business tool, high-profile collapses of companies like Britain’s Carillion, Spain’s Abengoa and the United Arab Emirates’ NMC Health have prompted investor concern.
“Supply chain financing is the latest financial engineering that could have serious consequences for working capital,” said Pierre Verle, head of credit and a portfolio manager at French asset manager Carmignac. “I am not sure many investors realise how serious it is.”
An essential source of credit in a crisis, supply chain finance, also known as reverse factoring, can mask the true level of debt and cashflow issues that companies may face because it does not appear on balance sheets as debt, investors and analysts said.
It is counted as a trade payable for the purchaser and a receivable for the supplier, despite acting more like bank debt in the opinion of some ratings agencies and industry experts.
The X factor
In a typical example of supply chain financing, a company such as a supermarket chain, concerned about the health of its small food suppliers during a temporary shock such as the pandemic, approaches its bank.
The small suppliers issue invoices to the supermarket, which confirms to the bank they are valid, and then those suppliers get the money right away rather than having to wait perhaps 30 days or even months to be paid by the retailer. In some cases this acceleration in cashflow can mean survival for a supplier, with the funding also far cheaper because it is usually repaid within weeks rather than months.
Published in The Express Tribune, December 9th, 2020.
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