Greensill scandal will end trade finance party
The bankruptcy of the financial company highlights the risks of helping companies pay their suppliers
The supply chain finance party is coming to a stormy end. The bankruptcy of Greensill Capital has once again exposed the hidden risks of the business – of 1.1 trillion euros – of helping large companies to channel payments to their suppliers. The combination of scandal and spotlight should produce a smaller and more boring industry.
The seemingly routine practice of using borrowed money to pay suppliers continues to appear in corporate bankruptcies. The collapses of Abengoa in 2016, of British contractor Carillion in 2018 and of UAE hospital operator NMC Health last year had to do with an over-reliance on, or hidden use of, invoice financing.
Now a pioneer in supply chain finance is on the brink of bankruptcy. Former banker Lex Greensill’s namesake company quickly grew to become a key player in the market, transacting $ 143 billion in funding in 2019. It secured the backing of SoftBank and hired former British Prime Minister David Cameron as an advisor. But now it looks on the brink of insolvency after Credit Suisse has frozen 10 billion of funds that included assets originated by Greensill.
The Greensill saga reveals just how far supply chain finance has strayed from its roots. The business of loans against unpaid bills is as old as the bank itself. More recently, large companies have reversed the practice, using their borrowing capacity to lengthen payments to suppliers. Thus, a car manufacturer can ask a bank or investor to pay its supply chain earlier than usual, with a slight discount on the value of the invoice. The lender then claims the full amount from the manufacturer, usually at a much later date, and the difference is pocketed. Suppliers get an advance payment, while the buyer of goods keeps the cash. In addition, it manages to declare the liability as a commercial account payable,
Greensill arranged many such deals for first-rate customers, such as Vodafone and AstraZeneca. But instead of keeping the loans on its balance sheet, it packed many of them into securitized bonds and sold them to third-party funds, such as Credit Suisse and Swiss asset manager GAM.
The Australian-born finance company pushed the model to its limits. To start with, Greensill offered its services to higher risk companies. His clients included NMC Health and British rental-to-own firm BrightHouse, which went under in 2020. He arranged funding for cash-melt startups from SoftBank’s Vision Fund portfolio, such as Indian hotel company Oyo. And it was a great provider of credit for industrialist Sanjeev Gupta. Credit Suisse’s decision stems in part from concerns about exposure to Gupta’s opaque steel empire.
Greensill also used much more exotic structures at times. One transaction, which went to a GAM fund settled in 2018, included securities backed by lease payments for aircraft operated by Norwegian Air Shuttle. On another loan, related to coal miner Bluestone Resources, Greensill took stock warrants as payment, which he kept on his own balance sheet.
To help reassure risk-averse fund investors, assets used to be insured against default losses. But when insurers began to worry about the quality of creditors last year, especially in relation to Greensill’s exposure to Gupta, they refused to expand their coverage. That’s another reason for Credit Suisse’s move.
Rivals contend that Greensill sector is an outlier. Big banks, like Citigroup, can use their own balance sheets to fund payments, rather than relying on fickle outside investors. But the Greensill bankruptcy will hurt them. On the one hand, it highlights the risks that companies run by relying heavily on financing linked to their supply chains. Greensill customers will have to look elsewhere for money. Some may even collapse, the group’s lawyers argue, putting up to 50,000 jobs at risk. Although banks may have a greater ability to roll over credit, they have little incentive to do so when a business is in serious trouble, as Carillion found.
One of the positives is that it can lead to changes in accounting. Rating agencies like Fitch argue that supplier credit should be declared as debt rather than included in trade accounts payable. That would give a more accurate picture of financial health, and remove incentives to use bill finance, which can sometimes be more expensive than short-term debt markets. But accounting agencies have historically resisted change.
Even if the official accounts do not change, shareholders, creditors, auditors and directors will begin to demand more information from companies about their dependence on supply chain financing. The more this practice is exposed to the spotlight, the less appetite there will be for incurring large obligations in the form of debt. Trade finance will outlive Greensill, but in a more muted and diminished form.