Critical factors in running a successful Supply Chain Finance programme in Asia

Supply Chain Finance will be a high-growth area for not only major global banks but also for banks in the emerging markets

Parvez MurshedParvez Murshed
Published : 24 August 2022, 10:07 PM
Updated : 24 August 2022, 10:07 PM

Professor Dale S Rogers, Rudolf Leuschner and Thomas Y Choi in their book, “Supply Chain Financing Funding the Supply Chain and the Organisation” mentioned, “The supply chain can be a source of funds for the firm; a firm can use its supply base to generate funds and act as a sourcing of funding for the organisation. Additionally, helping one’s suppliers fund themselves is an integral part of SCF.” They have defined SCF as, “SCF is using the supply chain to fund the organisation, and using the organisation to fund the supply chain.”

In this article, we discuss the critical success factors for a successful Supply Chain Finance (SCF) programme conducted through a bank. We look at the roles of the three key players in a bank-led SCF programme - the Bank, the Buyer and their Suppliers.

A. Bank:

The bank will ascertain and provide the credit facility on the Buyer and based on that they will provide funding to the suppliers by purchasing their receivables. This provides a more attractive discounting rate to the suppliers compared to what they will receive from the market based on their own credit rating. This helps the suppliers with quicker access to liquidity. There are tremendous benefits as SCF programs provide certainty of payments to the suppliers. A successful SCF programme has to be a win-win proposition for all three parties-the Buyer, the Supplier and the Bank. Banks usually provide the SCF programme through a digital banking platform, either could be their own or provided by a third party. Most banks will provide their SCF programme either through a bank-owned platform or through a third-party platform. The client sends a future dated payment file to the bank which the bank will notify the suppliers as approved payments from the Buyer which the Supplier can choose to discount from the bank.

B. Buyer:

When a bank engages with a Buyer, their client, to discuss the Supply Chain Finance program, it will usually start with the treasury team of the client which spells out their Working Capital objectives from the SCF program. Clients with solid credit ratings must be chosen for SCF programs as the Bank relies solely on the Buyer for fulfilling payment obligations on the due date without recourse to the Supplier. The Buyer’s credit should be reviewed periodically for all also any potential downgrades due to macroeconomic situation or industry development. It will be very difficult to unwind an SCF programme if the Buyer goes into bankruptcy. The bank should be monitoring the credit limits and work with the Buyer on how to navigate through such situations. A water-tight agreement with the Buyer and proper perfection of the purchased receivables from the Suppliers are critical to protecting the interest of the bank.

C. Suppliers:

Usually, suppliers are not clients of the Bank. They have a commercial agreement with the Buyer and the Buyer chooses which suppliers will participate in the SCF programme in collaboration with the Bank. The supplier will execute a Receivables Purchase agreement with the Bank. They can choose to manually discount their invoices approved by the Buyer and presented to the Bank or they can choose for discounting all receivables through the “auto” discounting option indicated at the initiation of the program. This “Auto” discounting is more common in Asia. However, this should never be imposed by the Bank on the Supplier as default and the Suppliers should have a clear understanding of their option and the pricing should be negotiated between the Bank and the Suppliers without the involvement of the Buyer.

For a successful SCF program, several parties on both sides are involved and all these parties must be engaged right from the start, preferably even before the Request for Proposal (RFP) submission process. We visit some of these important parties and critical factors for below which could determine the success or failure of an SCF programme:

1. Implementation:

Usually, Bank will have a project management/implementation team who will work with the client to roll out the SCF programme once the client has mandated the Bank. The client should also have an implementation team on their side. If the designated implementation managers are introduced to each other, they can work together in developing the project plan which should spell out the timeline for each work stream, and ownership on both sides and this project plan should be mutually acceptable to the Bank and the Client/Buyer. This should be diligently tracked by the project managers on both sides through weekly calls and they should engage the seniors on both sides through steering calls at least once a month, in the beginning, to update on the status of the project and also seek senior intervention, guidance and support as required.

2. Legal:

One of the most overlooked areas in the SCF launch is the time taken in negotiating the legal agreement between the Bank and Buyer. This usually takes in the form of a Paying Services agreement which the Bank provides to the Buyer to execute. Typically, Banks will have a standard master paying services agreement and will expect all clients to sign this. If this is to be signed between a global client with a global bank, a master agreement can have options for joinders to be signed between the subsidiaries of the clients and the local branches of the bank. When clients insist on signing individual paying services agreements in each market, then this can prolong the turnaround time due to negotiations between the local subsidiary and the local branch of the Bank. There could be clauses about indemnities that clients may negotiate with the Bank. This is where the legal teams of the Bank and the client take a long time to negotiate to exchange marked-up versions. Often a huge time of up to 2-3 months can be spent here even on negotiating cosmetic terms like the definition of the headers etc. The Banks needs to preserve the Buyer’s unconditional and irrevocable obligation to pay the Bank on the due date as this is the sole client commitment based on which the bank is purchasing receivables from the Suppliers of the Buyer with whom the bank does not maintain any credit relationship. The Bank will solely rely on this and the client/Buyer will have to commit to enabling the bank to debit their account on the due date or provide funding to the Bank on the due date. Any dispute between the Buyer and the Supplier will have to be outside of the purview of this agreement and typically banks will sign separate agreements with the Buyer and the Suppliers except for markets like Japan where tripartite agreements are signed due to local requirements.

There are several ways that both the Banks and the Buyers can save project time on the legal workstream. A few effective ways are:

• A conference call is far more effective between the legal team of the Bank and the Buyer to thrash out the agreement rather than exchanging emails which prolongs this process.

• The business sponsors on both sides should be present on this call at an appropriate seniority level where they can make the business call on what is acceptable and what is not in terms of the negotiated clauses. Often, this could make or break a programme as a lack of flexibility on either side could lead to a dead end. Often compromise on some clauses which do not negatively impact either party, could lead to a quick resolution of the conflict which otherwise could become quite onerous.

• Banks can develop a frequently negotiated grid of clauses and have an auto-approval from business seniors for this to enable quick negotiations with clients.

3. Supplier Engagement:

There is a popular saying that nothing happens until the cash register rings. This is so true in SCF where a lot of celebrations happen when a bank wins an SCF mandate from a client, yet it could be months or years until any revenue is made until Suppliers start discounting with the Bank. This “second sale” to the Suppliers will have to be done by a Supplier Onboarding team from the Bank. Often this is undermined and sometimes viewed as a back-office operational activity. The positioning and the strength of the Supplier Onboarding team could make a big difference between a successful versus dormant SCF program. Once again, the engagement between the Supplier Onboarding team and the Buyer’s Procurement team should begin right at or before the RFP stage. The Buyer should share their Supplier file and spend details with the Bank’s Supplier Onboarding team. Detailed analysis of these suppliers should be done to identify which suppliers could benefit from a Bank’s SCF program. The procurement organisation of the Buyer should be directly and actively engaged with the supplier onboarding team in this process. Often programs fail if the procurement organisation is not engaged and not in sync with the objective of the SCF programme set out independently by the treasury team without consultation with the procurement team. It is critical to engage and onboard the procurement organisation right from the beginning and to keep them aligned and engaged throughout the life of the SCF programme.

The supplier onboarding can happen in phases and sometimes this can go on over many months and even years. For the Buyer, it is important to onboard the Suppliers with the highest spending to derive the maximum working capital benefits. This is where the analysis of the spend and credit rating of the Supplier helps in addition to whether the Supplier is already engaged in an SCF programme which establishes their eligibility, familiarity and willingness to join an SCF programme.

The right message and communications to suppliers are also critical in explaining to them how the SCF programme benefits them. Supplier onboarding will not succeed if supplier information is not complete or accurate. Just providing the name and spend of the supplier is not sufficient, the supplier marketing team should have detailed information on the Supplier like who to contact, their phone number, email address etc.

In some markets in Asia, Banks successfully participate in supplier conferences organised by the Buyers. Usually, the Buyer invites the key Suppliers and explains why they are rolling out the SCF program. The Bank can then present its SCF programme and establish contacts with Suppliers that can be followed through. In large markets like China, and Vietnam this can be very successful in reaching out to suppliers who may span across multiple smaller cities where banks may not have local staff presence.

One of the most debatable questions for Banks is how to form a Supplier Onboarding team in a diverse region like Asia which is not homogenous like North America or Europe, where multilingual skill sets are not that uncommon. There are questions on where Supplier Onboarding should be housed in the Bank - should it be a back-office function or a front-office function? Could this be outsourced to a vendor? Could this be centralised from one location? Different Banks handle this differently. In Asia, it is important to take into cognizance of the local language requirement as many local suppliers may not be conversant in English and thus unable to communicate with someone calling them from a hub location to explain the SCF programme who does not speak the local language or dialect. The regulations in Asia also vary from market to market. Markets like China and Malaysia do not allow marketing to suppliers from overseas. There are market-specific regulations in markets like Vietnam where further due diligence has to be done on the Supplier including a brief credit appraisal, certification of ownership etc. Purchase of receivables is also with recourse to the Supplier in Vietnam. In India, the Priority Sector Lending (PSL) suppliers are also treated differently. While a centralised database in markets like Australia makes it easier to onboard suppliers with light documentation, local documentation and Know Your Customer (KYC) requirements will once again vary depending on the local regulations and could be heavy in markets like India, Indonesia and Vietnam. In markets like Indonesia and Vietnam, documentation will also have to be bi-lingual per local regulations.

4. Resourcing:

SCF is a resource-intensive business. Sometimes Banks do not allocate resources in areas like service, operations, and project management which are critical for rolling out and running successful SCF programs. This is annuity revenue and takes time to build but investment in core areas of the business will help drive & accelerate the growth of the business.

Sometimes large SCF programs fail to take off for a lack of resources in the Buyer’s organisation whether it is in procurement or IT. The client will have to dedicate project resources including the budget for host-to-host technology integration with the bank. Seniors will have to support the procurement and IT teams in successfully delivering the SCF program. The payment file formats must be agreed upon between the Bank and the Buyer. Host-to-host integration could take weeks to set up through testing but could be seamless from an operational point of view without manual intervention on either side once this is in operation.

5. Tax & Accounting Treatment:

Banks should consult with their tax consultant on the treatment of tax on the discounting income earned from suppliers onboarded from overseas markets like from Asia into global SCF programs administered out of the US or in Europe. Asia typically is the supplier region with China being the factory of the world where most suppliers are located while large Buyers are primarily located in the US and Europe. Many Asian local corporates are replicating supplier finance programs for their suppliers in Asia, especially in markets like Vietnam.

While terms extension could be the underlying reason for launching the SCF program, clients should always look at preserving the accounting treatment of payable for their SCF programs. Extending terms beyond industry norms could lead to a question on the accounting treatment of this and clients should also visit the disclosure requirements for SCF. This should be discussed between the Buyer and their accounting firm which should review the agreements and the programme materials that the Buyer is running through the Bank.

It is also important that SCF programs are not misused from their intended purpose of supporting the underlying commercial flows between the Buyer and their Suppliers. This should never be used for Capex or long-term financing. The programme should maintain an arm’s length distance between the Buyer and the Supplier and the Buyer should not have visibility on the individual level discounting activities or discounting rates of the individual Supplier. They should also not be used for funding inter-company Suppliers. Focus on these areas should help to maintain the accounting treatment of the SCF program.

6. Programme Management:

For successful SCF programmes, it is important to monitor not only Supplier onboarding but also the status of the programme utilisation. If a programme is not utilised, it could be for various reasons other than Supplier onboarding. The Bank should see how attractive is the programme for the Supplier in terms of rates, ease of onboarding and ease of availing of the funds. In a multi-country program, a programme could be successful in one market but may not be successful in others due to local market conditions, engagement of local teams etc. Here clients will have to be engaged at local, regional and at global levels for periodic review on the success of the programme and finetune the programme accordingly.

7. Supply Chain Disruptions and Its Impact on the SCF Programmes:

The disruption in Supply Chain, first due to COVID and now due to the Russia-Ukraine conflict, has further increased the demand for SCF programs. The underlying value of the commodities, raw materials etc. has increased significantly thus increasing the size of the programs and demand for more credit lines. Banks will successfully have to churn their books by selling these assets to investors to be able to maintain support for their Buyers and their Suppliers. As we see trends like near-shoring and on-shoring, the demand for SCF will continue to increase in the years to come and banks will have to be ready to support the ever-increasing number of suppliers from various exotic countries with an understanding of local nuances to be able to perfect these receivables, be local tax compliant in the Supplier’s country and claim successfully should there be any conflict or bankruptcy in future as inflationary pressure continues to rise with the fear of recession on the horizon.

8. ESG:

The Environmental, Social and Governance (ESG) factors are becoming increasingly important for the end consumer. Buyers are asking for ESG-compliant SCF programs from the Banks which could stand the scrutiny of regulators from any probable “greenwashing” accusations. Banks may partner with third-party independent ESG rating companies for verification and certification of the Suppliers to be eligible for the SCF programs. The client has to spell out their ESG goals which the Supplier will have to attain which could be in a progressive manner over a while and in the process gain incentive on their discounting rates. This has to be independently verified by the third-party ESG rating company. Clients can ask their bank about their ESG framework and how this can align with the clients' ESG goals and their suppliers. While Banks can develop their ESG framework, this should be able to withstand any regulatory scrutiny. Suppliers working towards less carbon emission, water conservation, and reusable energy could qualify under such a framework. It will be important to make this commercially viable as suppliers should get lower discounting rates progressively as they attain the agreed ESG goals while Banks will have to lower their earnings to facilitate this. This could help the Bank to attain better ratings on the capital invested in ESG.

9. Dynamic Discounting:

In a rising interest rates environment, clients with excess and trapped liquidity in markets like Vietnam could ask their bank for providing a platform for their suppliers to bid for early payments using the Buyer’s funds. In such Dynamic Discounting solutions, Banks are merely platform providers here while clients utilise their surplus cash to earn attractive returns directly from the supplier. The platform should be able to provide the ability for the Suppliers to bid and for the Buyer to choose the highest return on their funds.

10. Deep Tier:

Most Banks focus on the top 20% of Suppliers of the Buyer who may have up to 80% of the spending from the Buyer. This leaves a large number of long-tail suppliers out of Supply Chain Finance solutions from the Bank. There are also suppliers to the suppliers who require financing. This deep-tier financing today is not supported by most Banks. This will be a space to watch as the financing requirements of the small suppliers are currently not addressed by the Big Banks. Banks will have to think through how to take the risk on the Suppliers of the Supplier of the Buyer, which is their client. Slicing and dicing these invoices and their purchase is complicated and questions like perfection, repayment risk etc. will have to be addressed.

11. FinTech:

This article focused on the Bank-led Supply Chain Finance solutions. There are many FinTech companies out there who are providing platforms and solutions in this space. Some banks like JP Morgan have partnered with Taulia for a platform for speed to market as developing its platform takes time. Standard Chartered Bank and DBS are also using Linklogis for providing deep-tier financing to Suppliers. There is FinTech which specialises in providing KYC information on Suppliers. Partnering with FinTech, Banks can leverage their flexibility in bringing solutions faster to the market.

JP Morgan in their Working Capital Index Report 2022 has mentioned that $523 billion of estimated working capital can be released across the S&P 1500 companies. This indicates significant room for working capital improvement for major companies. Supply Chain Finance will be a high-growth area for not only major global banks but also for banks in the emerging markets who have access to a large number of local corporates and their suppliers. The opportunity space here will be even higher than that of the S&P 1500 companies and a space usually not catered to by the large global banks who are today the major players in the SCF space.

[Parvez Murshed was the Supply Chain Finance Head for Citigroup for the Asia Pacific region from 2016-2020. Views expressed here are the author’s own and do not reflect the views of or any particular organisation.]

Toufique Imrose Khalidi
Editor-in-Chief and Publisher