Greensill Capital’s troubles, supply chain finance — and where do we go from here?

Securitization + Trade Credit Insurance + Intercompany Borrowings — who would have thought this would end badly?

The future of the supply chain finance firm Greensill Capital is on shaky ground, and after our initial coverage of its impact on SCF, let’s look ahead.

News about Greensill broke this week when an insurer gave notice of intention not to renew a policy, triggering uncertainty about Greensill’s value. The trade cover insurance provided to Greensill is in the order of US$4.6 billion, in respect to about 40 clients. This forced Credit Suisse Group AG to freeze a client fund that bought the debt — and has rocked the supply chain finance industry.

Greensill’s troubles are all playing out in real time, and things are happening fast, but I jotted some notes on where we go from here.

There are a few key areas to watch:

• Investor demand — How does an investor market that is not homogeneous react when trade credit insurance is not renewed and redemption restrictions are put on (e.g., Credit Suisse Asset Management suspended redemptions and subscriptions in supply chain finance funds and has not been able to value their NAV calculation as of March 1). Looking ahead, investors who would normally be attracted to the higher yields from the paper on these deals may now think twice about this asset class given the Greensill news.
• Networks using Greensill Capital for third-party funding — While Greensill is continuing talks with the combination of Athene Holding Ltd. and Apollo Global Management Inc. to sell its operating business, source-to-pay vendors and marketplace auctions, and other software vendors that use Greensill as a broker-dealer with their securitization structures may find they need alternative funders and structures.
• Credit insurance and pricing — Pricing to suppliers in this business has typically been tied to the buyer risk and the buyer’s short-term borrowing. Has risk been mispriced? If you really price risk, you put a capital loss on expected loss and it’s a premium to that tied to your cost of funding and operations cost. If a bank buys a AAA government bond, its capital cost is zero. U.S. treasuries are not really risk-free, but that is what how they are treated from a regulatory standpoint.

For SCF programs, the key question is if the expected loss (“EL”) for the contract for that party is assessed properly. Expected loss is tied to the covenants of the program as well. What has been done to drive down this risk is the use of credit insurance to provide cover to Greensill, and to its funding partners, against non-payment by the account debtors and Greensill’s clients.

How will credit insurance be used and viewed moving forward?

Also, funders will use what is called an Irrevocable Payment Undertaking. According to Mayer Brown, buyer-focused programs typically involve, at the very minimum, the buyer entering into a written agreement with the finance provider that contains an irrevocable and unconditional promise to pay monetary obligations represented by approved invoices submitted by the buyer to the finance provider (or otherwise approved or accepted by the buyer), free and clear from any withholdings, deductions, setoffs, counterclaims or similar defenses (an “irrevocable payment undertaking,” or IPU). Although, there are exceptions, in most programs provided by most of the larger finance providers in the market, these IPUs are provided directly by the buyer to the finance provider.

• KYC arbitrage — Non-banks like Greensill can play KYC arbitrage compared to banks, which have strict “know your client” rules. Interpreting KYC regulation to onboard suppliers is all about a “principles-based” approach. Basically the governments in different jurisdictions set the principles to follow and leave banks to determine how. Often, banks will go above and beyond what is required for KYC in an effort to make sure all of their bases are covered. It is the chief reason why SCF programs center on top-tier suppliers with banks. Remember, banks typically don’t bank these suppliers already — see: KYC for Supply Chain Finance is an Unmitigated Disaster

So how do fintech vendors ensure the suppliers they are financing have been KYC checked? Of course, there are the use of databases to facilitate, including OFAC, PEP and others, and many will just use sanction lists from government sources to integrate into their technology. It’s not that non-banks don’t do KYC, it’s just KYC lite. This may need to get tighter in lieu of the intercompany borrowings issue at the heart of the Greensill debacle.

Unfortunately, these events can put a big stain on supply chain finance and can have a domino effect on others. It’s very early days, but many in Financial Twitter (#FinTwit) are commenting, and some have very little understanding of the space. Please feel free to reach out to us if you would like to discuss the fallout of Greensill’s troubles.