The collapse of Greensill, will reignite the debate about the balance sheet reporting of supply chain finance.
According to recent news items, the companies that Greensill was financing employ around 50,000 workers and with the sudden cessation of funding, their jobs are now seen to be at risk unless an alternative funding provider can quickly be found – it’s an emotive scenario that is being used as a powerful stimulus for re-examination of the supply chain finance sector. As Greensill enters into administration it is an unfortunate reminder of a small number of darker moments in the recent past of what is still considered a relatively new and fast expanding form of receivables finance. The collapse of Carillion plc in 2018 prompted rating agency Fitch Ratings to claim that SCF was a ‘key contributor’ to the liquidation of the British construction giant because it obscured some of the firm's financial difficulties. That arguments are about transparency and particularly lean on the balance sheet treatment reflecting SCF arrangements i.e., should it be shown as trade payables on their balance sheet or, instead, be reflected as short-term debt obligation. Rating agencies have argued that the distinction is of critical importance for proper financial disclosure since it affects many aspects, particularly investor analysis, loan covenants and executive pay. Other high-profile corporate failures have been Greensill clients – renewables firm Abengoa, NMC Health, rent-to-own retailer BrightHouse, and Singapore commodity trader Agritrade – the latter three, last year and within three months of each other. Now it seems more of Greensill’s clients may be at risk due to the failure of Greensill itself.
Even without these failures there has been criticism from business commentators saying that while the use of SCF to support suppliers is a positive move, the extension of payment terms is not. Indeed, despite Carillion being signed up to the UK Government’s Prompt Payment Code to pay suppliers within 60 days, some were being paid in up to 120 days just prior to the facility being put in place. There is also the additional concern that should a SCF facility be withdrawn, for whatever reason, the suppliers could be left with an impossible cashflow position.
The widely reported corporate collapses and the rating agencies’ highly publicised concerns about masking true financial positions on balance sheets, have meant significant criticism for the sector as a whole. But in the vast majority of cases SCF works very well with both suppliers and corporate buyers happy with the arrangement. Client failures are actually rare, but when they happen, they receive a lot of publicity because they are large corporates and many of their suppliers are put at risk. But, even during the current pandemic, despite the fears that it would cause banks to pull out of SCF structures, so far there has been little sign of this.
Greensill and banks operate their SCF programmes in different ways. Banks have more clients and largely share risk with other banks and underwrite that risk themselves or if using credit insurers have the balance sheet strength to absorb any unexpected shocks or disturbances. They are also highly regulated. A heavy concentration of clients with at least one, GFG Alliance, being high risk, was a significant weakness for Greensill.
This weakness was dramatically exposed last week when Greensill’s insurers refused to take on new risk. This in turn precipitated the freezing of the Swiss funds used to finance Greensill’s clients. Greensill had been warned about withdrawing cover by their insurers some months earlier when the risky nature of the assets being covered was discovered (how the insurers got themselves into such a position in the first place is unclear).
The fallout of the Greensill drama will undoubtedly have rating agencies and regulators once again scrutinising the way SCF operates and potentially imposing new rules and restrictions. But questions may also be raised as to why rating agencies published many warnings about supply chain finance in general but were still rating highly bonds investing in Greensill-originated assets.
In terms of the impact to the sector, a lot will depend on what happens in the coming weeks and months in terms of the size of any losses and/or insurance claims, whether claims are met or not and the public perception about the use of such structures if large job losses take place. Supply chain finance has been growing very rapidly in recent years and successfully used globally by many large corporates to provide low-cost finance to their suppliers and thus strengthen supply chains. Nevertheless, the sector and its representatives will need to think hard about what can be done to limit the potential damage to its reputation caused by the intense publicity of Greensill’s demise.
BCR will hold a roundtable webcast on the fallout from Greensill this Thursday at 11.00-12.00 GMT. To register go to https://bcrpub.com/events/examining-greensill-fallout
Photo: the autor, Michael Bickers, Managing Director of BCR Publishing Ltd.