Igor Zax, CFA, Sloan Fellow (LBS) Managing Director, Tenzor Ltd Trade Credit: the nature of the risk and its implications for SCF 6th Annual Supply Chain and Finance Symposium, Madrid, Spain Igor Zax, CFA, Sloan Fellow (LBS) Managing Director, Tenzor Ltd © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Receivable risk-unique characteristics Trade receivable presents a mixture of four different types of risk: Credit risk - ability and wiliness to pay undisputed debt Dispute risk - existence or amount of debt may be affected by contractual disputes Fraud risk - buyer, supplier, other providers Timing risk- delay in payment with or without a reason © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Trade Credit Risk characteristics Short term revolving nature. Most of the risk models are calibrated on loan data- short term risks have different nature Structural aspects Normally at operational subsidiary level, often different from the “normal” corporate debt Continues Nature Unlike loan/bond credit decision made by a supplier often on a daily basis. Key supplier default may affect underlying ability of the company to produce cash © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Trade Credit Risk characteristics- cont. Security While most of trade creditors are unsecured, clauses like Retention of Title provide some degree of protection--actual ability to enforce depends on jurisdiction, nature of goods, type of locations, etc. Supplier Dependency In pre-insolvency and even in insolvency (where some of the subsidiaries may still be a going concern) suppliers tend to be treated unequally, with those that are indispensable having better terms, given that their withdrawal may disproportionately harm all creditors. © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Agency Problem-Supplier vs. Financier The nature of the risk changing when it is passed from supplier to financier? Framework of supplier/financier cooperation Difference in knowledge Difference in approach/regulatory framework Different interests Co-operation models and game theory approach to supplier/financier issue © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Dispute and Fraud Risks Frequency and Severity While there is limited data, anecdotal evidence (such as performance within securitization conduits) shows that these risks are often larger than credit Correlation to Credit Risk Many high profile fraud cases happen with the company entering credit distress Significant product issues are both causing large dilutions (through product recalls etc.) and increasing the credit risk of the supplier. Similarly, distressed companies tend to have lower focus on quality etc., thereby causing higher dilutions. © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Supply Chain Finance-definition SCF Definitions Normally refers to financing of approved payables In 2016 an attempt by Global Supply Chain Forum (led by ICC and industry associations) to broaden definition to include invoice discounting, factoring, forfeiting, payables finance (what was “traditionally” named SCF, loans against receivables, distributor finance, loans against inventory and pre-shipment finance (http://www.iccwbo.org/Data/Documents/Banking/General-PDFs/Standard-Definitions-for-Techniques-of-Supply-Chain-Finance_Global-SCF-Forum_2016/) Separation of credit risk creates a different asset class where payable is confirmed © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Supply Chain Finance: risk profile Relying on approved payable as oppose to seller information potentially eliminates both performance and fraud risk if correctly documented and implemented Individual risks Typical program relies on large corporate buyers Both rating agency and internal models do not differentiate the risk from “traditional” loans and bonds Ability to enhance may interfere with accounting treatment Risk offloading - syndication, credit derivatives, insurance © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Supply Chain Finance- portfolio approach and its risk In addition to the buyer centric model, confirmed payables may be used for multiple buyers from the same seller Combining benefits of portfolio diversification with separation of credit and performance risk Ability to apply various tools to historic portfolio performance Understandable product for insurance and potentially re-insurance market Low severity of loss © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

SCF (approved payables) - accounting, rating and legal challenges Accounting treatment by seller of goods - transfer of financial asset - US GAAP and IFRS Accounting treatment by the buyer Rating agency challenge of buyer treatment post Abengoa Rating agency challenge on securitizations and other receivable sales © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Non-receivable forms of SCF Other forms of converting contractual risk to credit risk - multiple obligations Example - PO financing. Buyer credit risk of paying when delivered Risk of non-performance Seller credit risk based on recourse to them for non-performance How do one manage combined risk? What are the correlations? © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

Performance risk in complex chains Platform companies and multi-layered chains Multiple dependencies Integration - risk migrant or risk multiplier? Could performance risk be converted to credit? Could data analytics help measuring performance risk? Could financial institutions/regulators absorb performance risk based products? © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

© Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential

© Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential Thank You and Good Luck! Igor Zax, CFA, Sloan Fellow (London Business School) Managing Director, Tenzor Ltd. (London) Tel: +447775708426 E-Mail: igor.zax@tenzor.co.uk Web site: www.tenzor.co.uk © Tenzor Ltd 2009-2016 www.tenzor.co.uk Confidential