1. 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
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2. 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
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3. 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
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4. 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.
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5. 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
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6. 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.
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7. 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 (
Separation of credit risk creates a different asset class where payable is confirmed
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8. 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
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9. 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
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10. 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
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11. 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?
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12. 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?
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14. © 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:
Web site:
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