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Ratings agencies take aim at SCF

Close up of dart hitting bullseye

If your company has a supply chain finance programme, it may be a good idea to have a chat with your ratings agency about it.

Credit ratings agencies want treasurers to talk more openly to them about supply chain finance (SCF) amid growing concerns about solutions that they say have ‘debt-like characteristics.’

SCF often cannot be identified in standard credit metrics since companies usually include it as part of trade payables in their accounts. That presents a problem for ratings agencies like Moody’s who say some arrangements should be considered as financial debt rather than trade payables. A particular concern of the ratings agencies is companies using such financing arrangements, which are typically uncommitted, to “artificially inflate” Days Payable Outstanding (DPO) and thus avoid using more traditional financing tools, such as revolving credit facilities.

Calls for greater transparency are now growing. “We want to encourage issuers and auditors to be more transparent about SCF and allow us to look into the programmes,” says Matthias Heck, VP-Senior Analyst at Moody’s Investor Service. “We would like companies to proactively communicate their SCF activities, either on a confidential or a public basis.”

The case of Abengoa

A research report published by Moody’s late last year says the accounts of the financially troubled renewable energy giant Abengoa supports their claim that, in some SCF programmes, a buyer’s payables can bear similarities to debt liabilities.

Last year Abengoa’s balance sheet included around €3.7bn of trade payables (around €5.1bn in 2014), €1.3bn or 34% of which were “confirming without recourse” (€2.3bn or 44% in 2014). In Moody’s view, the size of the programme had the effect, analytically, of increasing leverage. Moreover, it presented a liquidity risk to the company since banks could unwind the arrangement at short notice.

As a matter of fact, as financial pressures on Abengoa intensified in Q32015 working capital contracted by approximately €400m, the report notes. Moody’s claims this may have played a small, but nevertheless noticeable, role in the company’s collapse into insolvency protection.

“In the quarters leading up to the default we saw that net confirming lines minus cash collaterals was declining by approximately a €100m a quarter,” says Heck. “Given the size of the company this was evidently not the key driver to the default situation. But it certainly contributed to the company’s complicated financial structure, which was a concern for both investors and ratings agencies such as ourselves.”

Calls for transparency

Abengoa’s case may not be unique. While SCF was once practised mainly by big aerospace and manufacturing companies, today SCF solutions are used by companies of different sizes right across the economy.

And the growing use of SCF, and its potential to distort working capital metrics, has not escaped the attention of the regulators. In a statement last year, the European Securities and Markets Authority (ESMA) joined the ratings agencies in calling for more openness from companies.

“Considering the potential impact of SCF arrangements on the statement of cash flows and statement of financial position,” ESMA wrote in October 2015, “issuers should analyse the substance of those arrangements. In particular, issuers should assess whether the trade payables should be reclassified as financial liabilities towards banks and whether its cash flows should be presented as operating or as financing cash flows.”

Since SCF does not substantially change contractual terms and conditions between the buyer and the seller, the practice of including it as part of payables in their accounts is accepted by auditors. It is also in line with existing accounting standards. This wouldn’t necessarily need to change, were companies to improve disclosure of the activity in financial statements.

Heck says companies need to understand that such communication is not contrary to their best interests. He points out that not all SCF has debt-like features. There are many companies, especially in the investment-grade area, that are not using SCF in the way that Abengoa did and whose ratings would not, therefore, be materially impacted.

But in the absence of issuer communication, the ratings agencies cannot be as accurate as they would like to be. “If we do not know whether a company is doing SCF and its trade payable days seem suspiciously high we might assume it is being boosted artificially, and reflect that in the credit rating,” he says. “Of course we wouldn’t be able to do that as precisely as if we had full transparency. However, when there is doubt a more cautious approach might be required.”

On that basis, some companies might find a bit more candidness around SCF is actually much to their advantage. There are many benefits to SCF for both suppliers and corporate buyers; benefits that need not come at a cost to the company credit rating.

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