Financing the supply chain has become a popular topic in the treasury world, but many people may be surprised to learn that the origins of supply chain finance can be traced back to solutions developed nearly 20 years ago by Spanish banks. These solutions are now attracting more widespread interest in response to the challenges faced by trading partners worldwide. We look at the ways in which such solutions can be employed to add value along the supply chain.
Drivers for financing solutions
The recent interest in financing solutions has arisen due to a number of factors. Two of the most important are outsourcing and the growth of open account trading.
Outsourcing
Corporates are increasingly outsourcing production, often to other countries, in order to take advantage of lower manufacturing costs. As supply chains are extending across the globe, large corporates are realising that they need to be more collaborative and distance themselves from the traditional tug-of-war that usually takes place between buyer and supplier.
In order to maximise working capital, it may seem to be in the buyer’s best interest to increase their Days Payables Outstanding (DPO) by extending credit terms with suppliers. However, the pressure that this approach places on the supplier means that there are often repercussions for the buyer in the form of higher prices. This has recently given way to a more collaborative approach. Co-operative supply chain management is fast becoming considered best practice and supply chain finance is one of the solutions that have been adopted as a result.
Open account trading
Although letters of credit (LCs) show no signs of becoming extinct just yet, their relative market share of global trade is decreasing and 80% of global trade is now conducted on open account. Open account trading has its advantages. Letters of credit are generally regarded as time consuming, paper intensive and prone to delays as the documents on which payment is contingent are often rejected when first presented by the exporter. Open account, meanwhile, is less complex, as suppliers simply submit an invoice and receive payment in due course. From the buyer’s point of view this arrangement is ideal.
Despite the overall growth of open account, LCs are still important in certain countries and in particular circumstances. LCs are widely used in Asia, for example, where they are particularly valued as a source of integrated pre- and post-shipment finance. Open account is more open to abuses such as late payment and is therefore more suitable for adoption in well-established business relationships. LCs still have a significant role to play in new trade relationships when the counterparties do not know each other very well. In such cases, a bank guarantee can give counterparties added comfort when trading with each other. Similarly, LCs are often used in support of high value transactions and specialised industries, such as oil trading.
The switch to open account trading, on the other hand, can put suppliers at a disadvantage. For them this is a riskier method than LCs because they have to ship goods without receiving any guarantee of payment. This is of particular concern in today’s global environment, where suppliers may be funding the shipping of goods to the other side of the world without knowing for certain if they will be paid. The onus is on the suppliers to find additional forms of financing while they wait for payment, without the comfort of a LC from the importer’s bank.
Receivables financing
Various traditional forms of receivables financing solution exist, including factoring and invoice discounting. In this type of arrangement a financier advances a percentage of the funds due to the supplier before the customer has actually paid.
In a factoring solution, for example, the financier (factor) will advance the supplier up to 80% of the face value of the invoice. The factor will then chase payment from the buyer. Once the buyer has made payment, the factor will then pay the supplier the remaining percentage of the invoice’s value, minus a fee or discount.
One of the problems with this type of solution is that banks do not know whether or not the buyer has approved the invoice when they advance funds. More recently, there has been a surge of interest in the area of supplier financing, which is structured to take the buyer’s creditworthiness into account, rather than just the supplier’s.
Supplier finance
Supplier finance, or supply chain finance (SCF), works in a similar way to factoring, hence its alternative name of reverse factoring. In this type of arrangement, the financer gives the supplier 100% of the due payment upfront, minus discounting charges. Unlike other receivables financing arrangements, which are generally initiated by the supplier, a supplier financing arrangement is initiated by the buyer through the buyer’s own bank.
Spanish origins
Spain has a history of developing financial instruments for the improvement of working capital management: bills of exchange were already used as a type of commercial credit back in the 15th and 16th centuries, and more recently Spanish banks were ahead of their time in realising the importance of the invoice in financing solutions. If the buyer approves an invoice then a bank is better able to mitigate risk and offer reduced financing costs. The crucial role of the invoice is at the heart of many of the financial supply chain products that are available today, including supplier finance.
Supplier finance originated nearly 20 years ago in Spain, for similar reasons to those that have brought it to the forefront of treasury management today. The conflict between the needs of buyers and the needs of suppliers was heightened by Spain’s traditionally long credit terms. This encouraged the development of a new solution that provided suppliers with additional finance without antagonising buyers.
The development of supplier finance was also stimulated by the local practice of charging stamp duty on bills of exchange which were widely used for raising working capital finance. Santander was the first bank to develop a reverse factoring solution in Spain, called Confirming® (see interview box).
The process
Supplier finance provides suppliers with reliable finance at a lower cost than other solutions. This is achieved by using the buyer’s stronger credit rating or access to better credit conditions, which allow the buyer’s bank to offer finance on more favourable terms than the supplier can normally achieve. A corporate´s balance sheet size, bank relationships and country risk premium can vary widely from those of its suppliers, especially when trading partners are located in different countries. In this way, corporates can negotiate or ‘arbitrage’ trade terms according to the relative value they attribute to reducing working capital compared to other factors such as cost of goods, as well as local financing costs versus proposed supply chain finance costs.
In some scenarios, buyers can benefit from both longer payment terms and a lower cost of goods, due to the reduced pressure on the supplier. The involvement of the bank as an active third party in the transaction creates a win-win situation and a happy compromise between the needs of the buyer and those of the supplier.
Benefits for suppliers
Opportunity for early settlement of invoices.
Suppliers receive a higher percentage of invoice face value upfront than under traditional arrangements.
Funding is non recourse and off-balance sheet, and can consequently reduce existing bank debt.
If the supplier and the buyer have differing access to credit or have different financial objectives, the cost will often be lower than the cost of conventional financing methods.
Visibility and information throughout the transaction.
Benefits for buyers
Reduced cost of processing supplier payments.
Improved visibility of outgoing cash flow.
Fewer queries regarding the status of invoices as suppliers can check this on the bank’s multi-language portal or contact centre.
Opportunity for improved (ie longer) terms with suppliers, hence improving their working capital position.
Opportunity to negotiate lower cost of goods from suppliers, due to improved financing terms achieved.
Liquidity management
Financing solutions are not the only way to add value to the supply chain. Efficient movement of money, maximisation of interest and minimisation of costs are key elements to any supply chain management solution.
Cash pooling is an effective way to manage liquidity, particularly within large companies operating in many different countries. By setting up a cash pool, either domestically or cross-border, a company is able to retain central control of the group’s liquidity while maximising the interest gained on individual account balances.
Notional pooling, in which funds are not physically moved but rather considered together for interest optimisation purposes, allows subsidiaries to maintain their own independence and has the benefit of not creating inter-company loans. Pooling through zero balancing, on the other hand, physically concentrates funds into a single master account.
Interview
Santander’s Confirming® solution
Carlos Rodriguez de Robles
Managing Director and Head of Global Transaction Banking
Why did Santander develop the Confirming® solution?
Confirming® was first developed nearly 20 years ago as a cost effective alternative to discounting commercial bills of exchange on which stamp duty was payable. The solution has evolved into a highly successful web-based payment and financing solution, which enables creditworthy corporates to optimise working capital through Days Payable Outstanding. At the same time, it permits suppliers to accelerate cash flow and reduce Days Sales Outstanding by discounting confirmed receivables on a non recourse basis.
How does it work?
Buyers use Confirming® to outsource to Santander their supplier payments, both domestically and internationally.
Buyers upload files of approved or ‘confirmed’ invoices to Santander.
Santander advises suppliers that payment is due to be made to them at invoice maturity and offers to discount these payments.
Suppliers accepting this non-recourse early payment complete a receivables assignment short form contract and receive discounted payments into nominated accounts with any bank.
At invoice maturity buyers settle with Santander.
Buyers and suppliers can access Santander’s platform and download extensive reporting and reconciliation information.
How is it different to other supply chain financing solutions?
The main difference between Confirming® and other types of payer-backed reverse factoring programmes is that Confirming® has already been adopted on a large scale in our core markets – Spain, Portugal and Latin America – with hundreds of thousands of buyers and suppliers using Confirming® via the web and with tens of billions of euros of invoices being settled in this way each year. Over the years, our Confirming® platform has undergone a series of enhancements ensuring a flexible range of capabilities in terms of financing, reporting and reconciliation, which we believe give us an edge over more recent solutions in the market.
With our international track record, Confirming® is now being extended into other geographies, with the required expertise to add value to our customers’ supply chain management. Significant effort has been invested in understanding legal and accounting issues, such as the importance of perfecting receivables assignment under local laws of the supplier, which in turn helps buyers to avoid needing to reclassify trade payables on their balance sheet as bank debt, which would otherwise impact negatively on debt gearing.
What future developments do you think we will see in the area of supply chain finance?
Supply chain finance based on discounting approved invoices would benefit from faster approval of invoices, since this enables a bank to make earlier discounted payment to suppliers. Hence innovative banks are integrating e-invoicing solutions into their supply chain product range in order to deliver greater working capital benefits. We also see significant value in delivering solutions to streamline corporate processes earlier in the supply chain trade cycle, for example by helping our customers to distribute purchase orders efficiently and providing matching services against invoices.
This approach not only reduces costs and raises efficiency, but also creates opportunities for pre-shipment finance as well as post-shipment finance, with significant working capital benefits. These solutions of course involve integrating more closely with our corporate clients’ ERP systems, enhancing information flows between ourselves and our clients and delivering improved straight through processing (STP).
Banks are also streamlining their documentary trade finance solutions through use of the web and scanning so that it is easier and more cost effective for their clients to manage their letters of credit, bonds and guarantees and collections, which remain valuable instruments in certain scenarios, geographies and early stages in a business relationship. We believe this holistic approach to trade and supply chain will continue to be of value to our clients, combining open account and documentary trade finance solutions.
Electronic banking
Most international banks offer electronic banking platforms that allow companies to move cash efficiently between entities. These platforms facilitate the processing of high volumes of transactions, coverage of a wide range of locations, automated procedures, such as payment and collection reconciliation, and connectivity to a company’s ERP system. Banking networks such as SWIFT, meanwhile, now allow corporates to use one platform to connect to a range of banks.
In emerging markets, where local requirements vary from one country to another, it is important to work with banks who have a strong local presence, with the necessary in-country expertise and reach to provide regional cash and liquidity management solutions.
Industry initiatives
The growing focus on SCF and supply chain optimisation has led to a number of interesting initiatives. SWIFT’s Trade Services Utility (TSU) is a bank-to-bank solution which matches data in certain types of trade document. Corporates effectively outsource the matching of documents such as purchase orders and commercial invoices to the banks involved in the TSU.
TSU Release II, due towards the end of 2008, is expected to include a Bank Payment Obligation instrument. This will be a guarantee to pay a bank a certain amount on a specified future date, providing a particular condition is met – such as a match of certain data presented through the TSU. The automation of this bank guarantee model will allow banks to develop new variations on current financing solutions.
A range of other solutions have been set up to streamline the flow of trade data for corporates and banks. Bolero, one such initiative, developed a multi-bank platform that enables large corporates to issue import LCs and be notified of export LCs in a highly automated and paperless way. The platform can be directly linked to corporates’ ERP systems and to banks’ back-end trade finance processing capabilities, improving straight through processing for all participants. However, such solutions still need to reach critical mass in order to provide an effective solution, and so far no single multi-bank platform has emerged as an overall winner in this area.
The future of supply chain finance
Over the last few years, the European Commission has begun promoting e-invoicing as a valuable means of reducing processing costs. The Euro Banking Association (EBA) is also investigating the possibility of offering e-invoicing services as a logical extension to their payments and collection work regarding the Single Euro Payments Area (SEPA).
Although these are medium- to long-term initiatives, banks are already collaborating on e-invoicing developments. In addition to cutting processing costs, e-invoicing has the potential to ensure that greater volumes of invoices are processed in a shorter space of time, accelerating cash flows for suppliers. A central role for banks in e-invoicing would be consistent with their current positioning in payment and collection processing. There are numerous initiatives to enhance processes in the corporate to bank space in terms of cash management, trade and supply chain solutions, such as TWIST, Bolero and TSU. There is still some uncertainty over which of these will prove most successful, but one would anticipate that those industry-wide initiatives with backing from banks and corporates will eventually prevail.
Supplier finance has been around for longer than most people realise but is now widely recognised as an effective solution for buyers and suppliers. It has spread from Spain into Portugal and Latin America and is now increasingly becoming available in other regions, supported by technological advances in the treasury field. As payment and invoice processes become increasingly automated, it is likely that the evolution of supplier finance will continue to embrace change and refine supply chain finance and working capital management even further.
Santander
Santander (SAN.MC, STD.N) is the largest bank in the euro zone by market capitalisation and fifth in the world by profit. Founded in 1857, Santander has €912,915m in assets and €1,063,892m in managed funds, 65m customers, 11,178 branches and a presence in 40 countries. It is the largest financial group in Spain and Latin America, and is the sixth largest bank in the United Kingdom, through its Abbey subsidiary, and the third largest banking group in Portugal. Through Santander Consumer Finance, it also operates a leading in 12 European countries (Germany, Italy and Spain, among others) and the United States. In 2007, Santander registered €9,060m in net attributable profits, an increase of 19% from the previous year.
Global Transaction Banking is part of Global Banking & Markets and focuses on delivering transaction banking solutions to our large clients. We pride ourselves on a global approach, bringing together specialists with skills in a range of instruments and asset classes to provide customer-focused solutions:
Structured solutions which mitigate risks of doing business in complex markets.
Export finance, backed by Export Credit Agencies, Multilateral Agencies and insurance companies.
Web-based solutions to streamline letters of credit, collections and guarantees.
