By Chartered Banker Institute, UK

The supply chain is a simple enough concept: a business works with a series of different suppliers to help construct a product or service that then relies on being sold on to various buyers. The timing, location and financing of all the necessary components needed to come together to make things happen, all stand or fall on the ability of everyone across the chain to execute and manage their responsibilities sufficiently well.

Unfortunately for businesses of all sizes, the realities of factors outside their control – from sudden geopolitical shocks, to legislation, environmental or natural disasters – have made supply chain management a business-critical issue that is now a strategic as well as a logistical concern.

For financial services providers, the change in focus over the past decade to prioritise a more holistic engagement strategy with corporate banking customers has brought with it various opportunities. These include building out more innovative financing instruments that can help support the cash flow and working capital needs for the ambitious company with targets to meet.

With this in mind, supply-chain-specific financial products have gained much traction in recent years as an enlightened solution to the commercial challenges companies face in navigating increasingly complex supply chains.

But what does supply chain finance (SCF) currently look like and what makes it a compelling proposition for businesses?

Matthew Davies, Director of Invoice Finance & Asset Based Lending, UK Finance, says that, although it is often referred to as ‘reverse factoring’, the term actually encompasses a greater diversity of products intended to help free up cash across the supply chain.

“Everybody typically defines SCF slightly differently,” he points out. “But at a high level we would define it as simply a buyer-led finance facility – where it is put in place by the corporate buyer of goods or services in order to support the businesses that supply it. It can be provided on a reverse factoring basis, but that’s only part of the story.

“Generally, the corporate buyer would set up an SCF scheme with a funder – often but not always a bank – so that its suppliers can elect to get approved invoices ahead of terms. The funder is there to bridge the gap until the invoice would be contractually deemed payable, whether this is 30 or 60 days or whatever is agreed.

The counterparty will essentially be the buyer – usually a corporate – rather than the suppliers. Used in this way, Davies adds, the suppliers can benefit from the buyer’s often higher credit rating to obtain cheaper finance and the buyers can support their supply chain without impacting their own balance sheet and cash flow. But while SCF is not new, the opportunity or willingness among corporates to use it has not been so clear cut.

A myriad of limitations – from their over-reliance on old, paper-based processes to a lack of understanding as to how it can work for them – has hindered its uptake. Davies argues that technology and digitalisation have become a principal driver in helping present the case for SCF.

“SCF has been ‘the future’ for a number of years, and until now it has never quite realised that goal,” he says. “Technology is finally making it more accessible.” This viewpoint may just have been borne out by the research. According to a report carried out by supply chain technology firm Taulia, 38% of companies were using SCF in 2021 to ensure smooth payments, compared with only 19% in 2018. Additionally, interest in the process has grown to 22% in 2022 from 15% in 2018.

Davies’ colleague at UK Finance, Director of Commercial, Mike Conroy, echoes the “enormous potential” for SCF, describing it as a “helpful means of releasing finance into the market”. He argues that the importance of resilient supply chains is greater than ever, particularly for financial resilience, and the facility is welcome among those companies deeply embedded in highly complex Asian supply chains.

“People are starting to realise that it can be a very effective form of finance,” he says. “As the UK looks to trade in other parts of the world – particularly in Asia – then we can see this shift of supply chains into places such as Vietnam, Bangladesh and Indonesia where we’re seeing rapid growth.

“The challenge is, that to get it to work really well, you need to tap into the sort of technological and digital advances that enable you to track goods, determine what is where, and enable it to be financed.”

Again, the numbers are suggesting that the corporate community likes what it sees in the SCF space. The volumes involved in SCF have hit USD1.31 trillion in 2020, according to Boston Consulting Group’s World Supply Chain Finance Report for that year. Banks and lenders are also riding high on the potential for expansion: revenue from SCF programmes is predicted to have a compound annual growth rate of 3.2%, reaching USD11 billion by 2030.

Davies and Conroy report large SCF clients from sectors including telecoms and construction in particular as fitting examples of its success. Many of the large UK and international banks are big players in the sector, along with a number of specialist bank and non-bank providers.

Everything Works Fine Until It Doesn’t!

While there is an understanding that technology in itself has accelerated the momentum behind SCF as a proposition, other external pressures have more recently conspired to push the issue of supply chain resilience to the top of the boardroom agenda. Supply shocks, whether environmental, viral or logistical, have come at quite a pace over the past three years or more, something that Davies and Conroy recognise as causing a tangible uplift in interest.

“We did detect a more enlightened approach to supporting supply chains at the onset of the Covid pandemic,” says Davies. “This was probably a combination of altruism as businesses recognised we’re all in this together, with a more pragmatic reaction to the limitations of ‘just-in-time’ supply models.”

But events such as the blockage of the Suez Canal by the container ship Ever Given, part of the Evergreen fleet, last March, or even the risks surrounding ongoing military conflict, are also a timely reminder of the vulnerabilities businesses need to work around on a daily basis. It’s the tight integration of supply chains that can on occasion be their downfall when faced with shock events.

As Davies points out: “Everything works fine until it doesn’t! And it is times like these that the real challenges come to light. Plan A is no longer good enough.”

The immediate impact of Brexit also provides a salutary lesson to UK buyers and suppliers, following the initial growth in red tape that has forced a fresh awareness of needing to maintain resilience. “Combine the challenge of getting goods from A to B with the added complication of the pandemic,” says Conroy, “and shortages can creep quickly into consumers’ lives.”

A Seller-side View

For Ian Tandy, Managing Director, Global Trade & Receivables Finance, HSBC UK’s Global Trade & Receivables Finance division, shock events are simply part of a longer continuum of developments that have prompted corporate clients’ interest in SCF. Put simply, the direction of travel has for a number of years already been towards a growing recognition that the strategic imperative behind good supply chain management often calls for complex financing solutions from banks.

Tandy explains: “If we look back to the recent trade challenges concerning China, EU and US, as well the impact of Brexit on UK trade policy, which involved negotiations right up to the last minute; the rising costs of transportation linked to the pandemic, which had left ships effectively caught in the wrong part of the world, and increasing commodity prices – the reality of the situation is that companies have had to think very carefully about what they’re sourcing from and what their sourcing plan is moving forward.

“The biggest single impact I have seen is companies increasing their focus significantly on supply chain. Supply chain, its costs and the potential disruption associated with it, have become a C-suite issue. Before, supply chain management was sufficiently smooth to run a just-in-time model in many sectors. Now, the challenges being thrown at businesses at an ever-increasing frequency mean they need to be nimble in their thought processes.”

In Tandy’s view, the bounceback following the pandemic in the UK has been strong and this has led to plenty of opportunities for business to sell their goods and services. The changed landscape post-Brexit, too, has not knocked the confidence of the business of international trade.

“After Brexit was finalised,” he continues, “we worked with businesses to get a sense of what new opportunities they could see – and what we have seen is that the global supply chain is pretty resilient, save for a few notable examples such as shipping or semiconductors.

“To me, this is a clear demonstration that businesses have really thought deeply about where they are, where they’re buying from and where they’re selling to. They have put together strategies to reduce the risks wherever they may arise and I think they have been incredible in the face of those challenges coming in thick and fast.”

For the larger international traders, Brexit is just one element of a range of external forces they face. They have been confronted with the complexities of international trade for many years, and for those companies that were previously operating exclusively within what was a larger domestic economy, they are rediscovering a global way of doing business.

This, for Tandy, is where banks are naturally keen to provide support.

“Before the various challenges we have been facing in the past seven years, supply chains were very lean. Companies have moved from a just-in-time model where everything had worked more or less seamlessly, to a just-in-case model. We’re seeing increasing inventory being held, and businesses are much more likely to prepare for any likely supply chain disruptions by thinking more carefully about where and when they buy.”

HSBC can point to its presence in 53 markets when it comes to understanding the vagaries of good supply chain management. The Chinese market is clearly strong territory for the bank, and that intelligence can go far in shaping the bank’s conversations with corporate clients, who strive for a deeper level of market awareness in decision-making.

“Shipping times have been extended significantly, for example,” adds Tandy. “So, if a business pays at the point of shipment and that shipment takes 50% longer than previously, it eats into the working capital. At its fundamental level, it’s this understanding that we believe businesses are looking for from banks.”

Pushing the Sustainability Button

However, one of the most marked changes in the SCF story has been the opportunity for banks and providers to respond to the global urgencies of social, climatic and environment risk by applying sustainability metrics to the finance models available.

UK Finance’s Conroy agrees that the sustainability imperative is undoubtedly helping reshape SCF as a product for the better.

“Larger purchasers will invariably bear the brunt of reporting requirements when demonstrating progress against net-zero targets, for example – so you can see that support from their suppliers to meet these requirements could be formalised more successfully via an SCF programme,” he explains.

“Supply chains are highly integrated into processes for large firms, so SCF is a natural extension of the drive to improve them. Without doing so, valuable time can be wasted trying to find solutions outside the finance ecosystem to validate sustainability requirements.”

The application of SCF, in Conroy’s view, should be a seamless addition to all businesses, with an eye on strong ethical and sustainable – as well as commercial – performance.

For its part, HSBC has advanced its sustainable SCF products with enthusiasm to meet the challenges of the time, but as those challenges shift, providers overall are needing to adapt accordingly to ensure the client gets what they need.

The metrics of ‘good’ ESG and sustainability are, however, also a moveable feast. In one major initiative, HSBC in the US joined forces with Walmart to try to address the long-standing dilemma of how to measure positive sustainable impact by aligning science-based emissions reduction targets to the company’s supplier SSCF (sustainable supply chain finance) programme, itself running since 2019. The overall objective is that Walmart suppliers can access better financing terms if they meet the set targets, but the message is clear: goals have to be authentic and verifiable to mean anything.

“ESG and sustainability is such a huge challenge for all of us, whether in business or not,” says Tandy. “But of course, companies themselves are asking, ‘Where are our suppliers?’ and, ‘Where are our customers?’ as well as, ‘What is the environmental impact of working with them in this way?’

“Sustainable SCF is still evolving in the UK,” he adds, “but it’s becoming a more frequent conversation across our client base. But, in essence, it’s a natural extension of the conversation we have anyway about where their tier one, two and three suppliers are.

“Those businesses that want to ensure that their sustainability principles are embedded through their supply chain, can work with banks’ ways to utilise that information, and introduce strategies such as incentivisation of suppliers to help them adhere to their principles.”

What Does Future Success Look Like?

UK Finance’s Davies is optimistic about the potential of SCF as a product, especially in the sustainability space – though the challenge remains cascading it down through extended supply chains.

“Some of the bigger buyers have done well so far in getting SCF integrated into their tier one suppliers. But how do we ensure the benefits are passed further down the tiers in supply chains, particularly to the smaller businesses that may need the most support? Again, technology is making SCF more viable to cascade down the supplier ecosystem, and make it more accessible for mid-market buyers too.”

“Digital tech has simply transformed the supply chain landscape,” agrees HSBC’s Tandy. “Digitalisation and the ability to utilise that data and insight for good, has become a priority for businesses across the board.

“The principles of global trade of course haven’t changed – but technology has smoothed the way. It’s easy, too, to forget the background impact of legal and regulatory pressures that are brought to bear on SCF’s continued evolution.

“It’s helpful that we’ve seen real interest from the UK government in the transformation towards digital trade – its priority is efficiency and visibility, and ideally, all the players that are involved in getting goods from A to B, can eventually work to a consistent framework.”

Global trade has always been rules based, he concludes – whether from the standardisation of shipping containers or recognised payment protocols. It’s simply the opportunities afforded by their continued digitalisation that are cause for excitement in an area with much promise.

This article previously appeared in the Chartered Banker magazine, UK, Spring 2022 edition.