How the Contagion Effect Could Blow Up Network Finance

In the real world, you plan for an event and it works out for a while. Then things fall apart. So you react and plan more — hoping to stop the problem from creating a contagion effect.

And here you are, thinking that you built this nice network finance model to finance your suppliers not just on approved invoices, but invoices that have been issued, or even more upstream, purchase orders that have been issued. And things have been working smoothly for a couple of quarters, or maybe for even a year or two.

But then it happens. More things fall apart. Yeah. Not good, typically unpredictable.

There’s a reason investors don’t buy approved invoices unless backed by a large company’s irrevocable payment undertaking, or IPU. I mean the National Association of Insurers (NAIC) rolled out a program and specifically required that all insurance investors in SCF paper must ensure the obligors have an IPU — see NAIC section below:

Confirmation Process

  1. In the case of a purchase, the investor shall verify, prior to the sale that the obligor has confirmed the respective amounts, payment dates and related invoice numbers’ specified dates and has waived all defenses to payment. In the case of a participation, the finance agent must verify that the obligor has confirmed the respective amounts, payment dates and related invoice numbers’ specified due dates, and has waived all defenses to payment in accordance with the confirmation process.

Yes, this stuff is complicated and risky. Sure, intuitively you think, well, I have the data from a P2P platform or marketplace network, I can see historical transactions, so I can ring fence this and manage the risk. Sure you can, but look at it this way. What happens with that supplier you are doing financing with on the P2P platform for its Macy’s receivables but not for his sales to Walmart, Target, Home Depot and other large box retailers has a hiccup.

What’s a hiccup. It’s the things that can start a contagion effect. For example, his largest specialty resin supplier will not provide him the credit he needs to fund his customer growth, and now he has a major packaging problem. Which turns into short deliveries, late deliveries, etc. And the customer service starts to deteriorate and tough choices have to be made. This kind of problem could spiral out of control.

Sure this is one example. And I am not an economist and going to begin to try to examine the potential risks currently in the system — from wage inflation to stagflation. But new models of network finance or P2P platform finance that have assured themselves they can manage the risk based on historical data plus an issued invoice or purchase order better hope their models can manage the contagion risk that happens when things fall apart.

As one of my favorite groups, The Tragically Hip, says in its song “Boots or Hearts,”

See when it starts to fall apart 
Man, it really falls apart
Like boots or hearts, oh when they start
They really fall apart …

David Gustin runs a research and advisory practice centered on helping financial institutions, vendors and corporations understand the intersection of trade credit, payments and the financial supply chain. This post was written while David worked on a special project with The Interface Financial Group. He can be reached at dgustin (at)

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