Fitch warns of commercial debt financing loophole

Trade finance is an essential part of trading across borders, especially for small businesses. The explosion of different types of trade finance allows companies to address multiple areas of cash shortfalls for buyers and suppliers, all with the same goal: to keep the gears of global trade turning.

But a recent warning from Fitch Ratings could make some companies wary of some trade finance opportunities.

According to the analytics firm, there is a flaw in corporate accounting related to trade finance that could be widespread in the United States and Europe, and could contribute to longer payment times for suppliers. Described in the Fitch Ratings report, “What Investors Want to Know: Supply Chain Finance,” this loophole allows companies to extend their current payable days by using supply chain finance through a third parties, which need not be classified as debt, allowing those companies, in essence, to hide that debt.

“We believe the magnitude of this unreported debt-like financing could be significant in individual cases and have adverse credit implications,” Fitch said in the report.

Also known as reverse factoring, supply chain finance allows companies to sell unpaid invoices once they are approved by a business buyer. Business buyers then have more time to pay those invoices, while suppliers are funded faster. While the trade finance solution can be a useful cash flow strategy for both ends of a trade deal, Fitch noted that business buyers – who need to repay financing – may classify debt as “other debts”.

Fitch warned that this classification allows business buyers to operate with a lack of transparency in their finances. According to Fitch, former UK government contractor Carillion, which faced high-profile bankruptcy earlier this year, engaged in the supply chain finance that ultimately contributed to its demise.

Supply chain finance programs offered by banks and alternative lenders do not necessarily require disclosure of debt under corporate accounting standards.

A survey of 337 companies in the United States and Europe, the Middle East and Africa (EMEA) found that the median number of days in debt increased by 14 days in 2014, reaching its highest level in 2017 The survey traced vendor payment practices back to 2004. Collectively, the total value of debts increased by $327 billion, Fitch Ratings said.

Supply Chain Finance (SCF), however, is not solely responsible for this increase in days remaining payable (DPO); Fitch noted that other supply chain management strategies, replenishment, capital investments, mergers and acquisitions (M&A) and other factors also have an increase in DPO.

But as Carillion has shown, supply chain finance “could have a potentially large impact on vulnerability to default for specific issuers, which makes awareness raising essential.”

However, business enterprises should not neglect supply chain finance entirely. In addition to supporting cash flow for buyer and supplier, Fitch noted that the trade finance product allows sellers, who are often SMEs, to take advantage of the credit strength of their corporate customers to raise finance. their bills, rather than having to become the direct borrower themselves.

On Tuesday, July 31, trade finance platform PrimeRevenue released data on the adoption of supply chain finance. According to a business survey on its platform, 90% of suppliers on a PrimeRevenue program have accepted payment term extensions from their corporate customers, up from 78% in 2015.

A more in-depth report published by PwC and the Supply Chain Finance Community last December also concluded that the use of supply chain finance is on the rise. In the ‘SCF Barometer’ report, analysts found that banks’ reverse factoring offerings remain the most popular with businesses, with companies citing working capital optimization as the top reason for adopting a financing program of the supply chain.

Meeting supplier liquidity needs and improving the relationship with suppliers were also key reasons, according to PwC. Overall, companies surveyed by PwC agreed that their supply chain finance programs have been successful and most said they plan to expand their SCF initiatives.

But the advice from Fitch Ratings flags a downside to supply chain finance in the way companies using the cash flow management strategy can hide their debts – and, if Carillion is any sign, it could have disastrous effects for corporate buyers and their supply chains.

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