Moderated by Anita Hawser
Companies and their banks are working together to develop finance solutions encompassing the entire supply chain.
Anita Hawser: How are current market conditions impacting the development of Supply Chain Finance (SCF)?
Eric Lemmens, global head, trade and supply chain, RBS: CFOs and treasurers have an interest in supply chain finance which comes and goes, depending on their needs and economic circumstances. But looking at the last couple of weeks and months, specifically, all of us are being called to, from time to time, to come up with ideas on how to generate liquidity for our customers. Because of the current uncertainties and volatility, total liquidity is more in demand, and it is more on offer at banks that are more focused on these types of facilities in the long term.
Mike McDonough, managing director and head, trade product management, BNY Mellon: I don’t think the current economic situation has caused anyone to stop looking at supply chain finance. People who want to get into that space still look forward to doing that. We’re seeing the sort of thing we saw in 2008, which was a very material flight to quality, with people moving back to stronger levels of credit risk mitigation because of the severity of the crisis. Currently, banks haven’t materially profited from this trend, that will depend on their trade business plan. Banks are looking at their own risk issues and deciding what to do with the assets they originate.
Thomas Dunn, chairman, Orbian: Since 2010 the overall environment for supply chain finance has been very good. Corporate treasurers are more supportive of the need for collaboration across the physical supply chain. There’s been a growing acceptance among banks and other investors as to the attractiveness of the asset class, and the absolute level of interest rates being so low has also been good because the nominal level of the discount has been very appealing to suppliers. We’ve seen all of these things remain largely intact over the last 18 months.
As we sit here today, the heightened level of volatility in the marketplace, particularly in the market for liquidity, is giving considerable cause for concern around some of the old-style, traditional, single-bank models of supply chain finance. That there may be disruption to liquidity in those models would be very unfortunate, because everyone was supposed to have learned their lessons in 2007 and 2008 about the risk of single-bank models, and it would be unfortunate to repeat some of those mistakes again now. That is the only cloud that I can see on the overall, still pretty sunny, horizon for supply chain finance.
"If you speak with corporates, they perceive that supply chain finance starts much earlier and includes a variety of products, whether it’s straightforward short-term lending, leasing, or inventory finance. As banks and service providers, we need to carefully consider and offer to our customers an all encompassing solution"
– Eric Lemmens, RBS
AH: Who are the leaders and laggards in supply chain finance?
TD: Much of the impetus and the push is still coming from banks and financial institutions that are pressing this as an opportunity, as a new service or as an application to put alongside some of their traditional trade services businesses. For those clients that have moved to open account trading, it’s a very logical step to put a supply-chain-finance solution alongside that.
The interesting question is, why are some people leaders in this and why are some people laggards? Whether it falls on the bank and service provider side or on the corporate side, the difference really comes from the fact that the leaders are those people that view the service as a holistic capability that extends from IT through legal and audit into procurement and the customer service of the suppliers.
The laggards are the people that don’t view things like that and try to separate things out and make a separate decision based on the IT versus the arrangement of liquidity, and then what tends to happen is that the suppliers drop through the middle. You have a big expensive IT system on one side and you’ve got lots of liquidity lined up on the other side but you’ve got no assets sitting in the program. Without relentless focus on suppliers and creation of assets, the puzzle is missing its defining piece.
EL: Thomas has raised some excellent points, and you’re also raising the definition of supply chain finance. Depending on whom you speak to, the definition can differ very much, and maybe what we have spoken about so far is reverse factoring or discounting. However, if you speak with corporates, they perceive that supply chain finance starts much earlier and includes a variety of products, whether it’s straightforward short-term lending, leasing, or inventory finance. As banks and service providers, we need to carefully consider and offer to our customers an all-encompassing solution. Looking at it from a wider, more complete picture, it’s more interesting for our corporate customers than just looking at supply chain finance in terms of reverse factoring.
MM: The leaders are those that have been willing to invest the capital in the integrated systems. They’re also the people with access to the large-scale companies that are actually participating in supply chain programs. So there is a very thin layer of banks and corporates at the top of the market that are doing this business—they’re the leaders. The laggards, for lack of a better term, are everybody else in the market, from both the bank and the corporate sectors, that still have to get more actively involved so as to get this market rolling.
"One of the holy grails here is definitely the idea of giving suppliers a consolidated view of their receivables. Giving them the kind of feedback that enables them to really streamline what they’re doing is real motivation for them to sign up for a program"
– Mike McDonough, BNY Mellon
AH: What is it going to take to get a critical mass of companies interested in supply chain financing? Is it about the banks’ offering a broader solution than just reverse factoring?
MM: Deploying supply chain finance programs using some of the most recognized names in the market isn’t the most daring thing ever done, from a credit perspective. The potential differentiation of one bank from another, especially in terms of their willingness to participate as they move downstream, begins when you start to consider the needs of smaller companies. They’re going to need access to these sorts of services, and that’s where the credit challenge arises.
EL: Take it one step further and it’s the combination of being a successful provider of these products, having a global network, partly the offering of individual products and scale—if you don’t have scale, you can’t make the investment. Some banks are in a better position to build scale, mostly in their home markets. Others have more of a global footprint and focus more on the high-end customers and do not have access to the SME markets. So it is a combination of having SME access in some markets, also being a global provider in multiple countries, and having the scale to invest in technology. That separates the top from the rest. I predict that the laggards over time will actually be less interested in investing, which will leave space open for the top five banks.
TD: That leads us into an interesting area in terms of how is the industry going to consolidate? At the moment, I would say that, from a return on investment in the narrower supply chain finance part, the reverse-factoring product, the market is not in a very good place right now. If the growth rate in the market were five times higher, everybody who’s involved would all be making a lot of money. If the growth rate were 20% of where it is today, a number of the marginal players would leave.
The market will consolidate around three or four leading players, and then we will be able to drive some industry standards and a robust set of scaled platforms.
Right now, and this is a little bit of the elephant in the room, there’s too much capital—not in terms of the financial assets, just in terms of the investment of resources into the marketing and presentation of programs to alternative buyers. It’s starting to confuse the buyers. How do they differentiate between some of them? They can’t decide. More importantly, it makes it hard for the natural three or four leaders to consolidate position and earn a decent return on investment in the business.
AH: When it comes to new product development, is there recognition now that supply chain finance solutions need to move beyond the focus on large, cash-rich buyers?
TD: Product development will extend across the life cycle of a trade from earlier in the process to later in the product cycle stage. There’s going to be a lot more emphasis on finding ways to have the supplier drive the program rather than the buyer pushing the program and the supplier pushing back up. And then also, extending down to smaller companies, weaker credit and slightly different ways of financing the assets. One of the things that we find is how much easier and shorter the sales cycle is when you’re focused on the supplier. For the buyer, the benefits are second order. It’s all about extending their payables and securing the physical supply chain. But for the supplier, the benefits are all about immediate cash. The quicker you can get things into a format that is financed according to some of the principles we have established, they will do that in a matter of weeks as opposed to a matter of quarters.
"The heightened level of volatility in the marketplace, particularly in the market for liquidity, is giving considerable cause for concern around some of the old-style, traditional, single-bank models of supply chain finance"
– Thomas Dunn, Orbian
EL: The suppliers are not always the largest entities, and that’s when the banks need to adjust their approach to make sure they can actually service them more readily. Going back to an earlier comment I made, to have access to suppliers you also need a global footprint. Not all the global supply chain finance players have the global footprint with companies. So I see there are different roles for different banks in different home markets in bringing those suppliers together.
MM: One of the holy grails here is definitely the idea of giving suppliers a consolidated view of their receivables. Giving them the kind of feedback that enables them to really streamline what they’re doing is real motivation for them to sign up for a program. The sky’s the limit almost in terms of new products and programs. The key questions will be, who can hold the assets generated by these programs, and to whom can these assets be distributed? To the extent that you can find investors for the products that the market is demanding, then I think that you can do just about anything. The fact is that up until now, banks have tended, with a few exceptions, to look to hold all of the assets they originate. In our view, developments like Basel III and the like are going to significantly enhance the role of banks as distribution agents. To the extent that investors are out there with appetites, opportunities are going to be there. I think inventory finance is a next step, with other trade-related supply chain services to follow. You could branch out from there.
AH: Let’s move on to regulation. Certain regulators want banks to lend to SMEs but other regulators or regulations are asking the banks to hold more capital on their balance sheets. How do banks reconcile the two?
EL: For the banks, this is a very challenging topic, and we need to pursue careful co-ordination between banks, customers and government. Governments, in general, want us to finance SMEs. In many countries, governments are the largest buyer, and governments tend to buy from their local, domestic SMEs. I believe that local governments have an interest to work together with banks to see how they can somehow set up supportive programs and help us cover a part of the risk that we would like to take on with SMEs.
MM: The problem doesn’t exist if you can get SMEs to pay the price that earns for the banks the return on equity they need. The challenge is that buyers typically won’t pay that price. The equilibrium isn’t there in the market across a number of products, and not just lending.
TD: Eric makes an excellent point that for SME lending, governments could play far more of a role in their position not as regulators or supervisors but in their simple position as customers of those suppliers and those small businesses. They could be playing a transformational role, but they find it very hard to form a coherent strategy around that.
AH: Do regulations like Basel III favor SCF, given it treats trade guarantees and letters of credit as off-balance-sheet items?
TD: In absolute terms, no one can take away from the fact that the objective is to increase the amount of capital the banks are holding against everything. On a relative basis, however, Basel III clearly favors supply chain finance as an alternative against a traditional, longer-term commitment.
It’s a far better return on capital than undrawn commitments that have been a big part of banks’ exposure to the major corporations. And as I said, structured appropriately, it’s a very distributable risk and one that the banks could move on and off their balance sheet, where they could create utility.
EL: The unintentional consequences of Basel III are particularly on the traditional side of the business. However, there are also unintentional negative consequences related to supply chain finance. I believe that this asset class has been overlooked and needs to be looked at again.
MM: Regulators today are saying they’re not convinced that what we call supply chain finance is “trade finance” in the traditional sense of the word. Their preference is to call it “corporate finance,” which carries a more onerous treatment under Basel III. Eric is right, however, that we have to get the regulators to look at this as simply a 21st-century version of the letter of credit. That argument is key to getting the regulators to consider the kind of evidence that will support this business.
Head of global trade and supply chain finance, RBS
Eric Lemmens is responsible for RBS’ global trade and supply chain finance business within the GTS product management organization.
In this position he focuses on delivering working capital improvement solutions to the bank’s customers and their trading partners, leveraging RBS’ penetration in its home markets, global footprint and its proprietary technology.
Prior to joining RBS, Eric lived and worked in seven countries during 20 years. During that time he was COO corporate banking in Saudi Arabia, country head in Slovakia and senior credit officer, EMEA trade finance head based out of London, corporate bank head in Colombia, and deputy division head for CEEMEA based out of Frankfurt. He started his banking career as a senior relationship banker out of Amsterdam. Eric holds an MBA from I.E.S.E. in Barcelona and an undergraduate from Nijenrode Business School in the Netherlands.
Managing director, BNY Mellon Treasury Services
A managing director of BNY Mellon Treasury Services, Mike McDonough has served for the past five years as head of BNY Mellon’s global trade product group. Prior to his current role, he was responsible for all trade finance business development for BNY Mellon’s Latin American and North American bank clients. After beginning his career with the US arm of National Westminster Bank, he spent eight years with The Bank of New York and its predecessor, Irving Trust Company, managing a number of Latin American and international corporate finance efforts.
He went on to serve in the international capital raising group at Banc of America Securities, and later managed all Latin American capital markets business and underwriting activities at Yamaichi Securities. Before returning to BNY Mellon in 2004, he managed a variety of responsibilities in the international treasury group at Verizon Communications.
Mike holds a Bachelor of Arts Degree in International Affairs from Lafayette College and a Master of Business Administration Degree from the Columbia University Graduate School of Business.
Thomas Dunn is the chairman of Orbian, a leading supply chain finance company. He is also the chairman of Raglan Capital, a privately held company focused on investment opportunities in, and related to, credit markets.
Prior to the establishment of Raglan Capital, Tom worked from 1987-2003 at JPMorgan in London, Melbourne, Sydney and Tokyo, ultimately being responsible for all of JPMorgan’s credit businesses in the Asia Pacific region. Tom has an MA in Economics from Cambridge University.
Europe Editor, Global Finance