The Challenge in Diversifying Supply Chain Finance Funding Sources

As Adam Dener, managing principal at Fermat Capital Management, conveyed on our recent webinar Funding Modern Supply Chains, understanding how investors approach the risk-reward of SCF is fundamental to understanding non-bank investors main barrier to execution.

Due to the non-standardized, private placement structure of these assets, the primary risk for investors to consider is the operational risk around ownership (i.e. what do investors own? How is ownership established?) and dilution (i.e. What protections exist securing full and timely payments?). There are a variety of ways SCF assets are manufactured and each comes with its own set of documentation (usually on the order of hundreds of pages), so evaluating these risks is costly and requires specific domain knowledge that isn’t reduced by the presence of a public credit rating.

Tune into the replay of Funding Modern Supply Chains here

It’s therefore very important for investors to understand how SCF prices relative to comparable risks, as investors must be compensated for the cost of evaluating the non-standardized risks associated with the assets. For SCF, Fermat believes that the most basic way of evaluating reward is to compare the SCF funding spread for a single obligor against the implied spread over benchmark rates for the same obligor’s corporate bonds. There are a variety of other comparisons that can be drawn, but understanding the purpose investors see SCF fulfilling (e.g. asset-liability management, income or quality needs, etc.) and how SCF fits into the broader context of an investment portfolio (e.g. credit constraints, floating vs. fixed rate, working capital vs. fixed-income, etc.) is key to understanding what other assets are appropriate for investors to benchmark SCF against, and will not necessarily be the same for all non-bank investors (note that when a bank is purchasing SCF assets, they typically are doing so within the context of a dedicated Trade Finance department… which most non-bank investors don’t have).

These risk-reward barriers are difficult to overcome as there is often a knowledge gap about SCF amongst non-bank investors. This knowledge-gap will make the logical non-bank investor space for SCF initially narrow, as non-financial corporates who are involved in SCF as suppliers selling their receivables or buyers approving invoices will naturally have a better understanding of the risk-reward inherent to the assets, and therefore will be an easier group to target when looking for non-bank funding sources. However in the medium-term, engaging specialty service providers may help broaden the target non-bank investors space, as investors unfamiliar with SCF can leverage the domain knowledge of these service providers to effectively lower their barriers to execution, making the assets more accessible.

Tune into the replay of Funding Modern Supply Chains here

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