SUPPLY CHAIN FINANCEREPORT OF THE SUPPLY CHAIN FINANCE WORKING GROUP • JULY 2010

Published by ACT on behalf of the working group:

1.0 Executive summary1.1 In September 2009 the Bank of England asked UK

stakeholders to form a working group to review thesupply chain finance market.

1.2 The supply chain finance working group (SCFWG) waschaired by The Association of Corporate Treasurers(ACT) and commenced its work at a time when banklending to smaller companies was described by theBank of England (BoE) as constrained. In the past sixmonths there is no doubt that lending conditions haveimproved but there still remains a key role for supplychain finance. The lending market can benefit and isbenefiting from supply chain finance structures.

1.3 The working group included a broad range ofstakeholders but we should, in particular like toacknowledge the contribution from the followingorganisations;n Asset Based Finance Association (ABFA)n KPMGn Legal & General Investment Management Limitedn Orbiann Squire SandersA number of other organisations that participated withenthusiasm have, in the end, decided to remainanonymous.

1.4 Terms of reference for the SCFWG and the group’s keyfindings are as follows:

1.5 To take a view on whether there is demand for anexpansion of the SCF market and what the currentimpediments to expansion are.n The level of understanding of the differences betweenthe various SCF mechanisms is generally poorn UK SCF market is funded by relatively few banks n The use of SCF mechanisms is often viewednegatively – incorrectly so in our viewn Complexity and uncertainty of the accounting for SCFmechanisms is unhelpfulBut there is a growing demand for SCF mechanisms andvolumes are increasing as are the number of providers.

1.6 To evaluate the various structures of SCF programmesThere are several supply chain finance structures:n Supplier driven programmes – receivablesfactoring/discountingn Inventory finance

SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010 3

EXECUTIVE SUMMARY

Contentspage

1.0 Executive summary 32.0 Introduction 53.0 The market 54.0 Observations 85.0 Investors 96.0 Credit ratings 117.0 The way forward 118.0 Conclusions 129.0 Next steps 12

Appendix 1 - Terms of reference 13Appendix 2 - Key elements of Buyer Driven Receivables Programme 13

n Buyer driven programmesThe report gives an overview of the main characteristicsof the main structures.

1.7 The SCFWG finds that these structures have developedto suit a variety of needs and that no one structureshould be singled out as the preferred option. However,in market conditions where lenders are concerned withcredit quality we do believe that buyer drivenprogrammes can and will help ease funding conditions.

1.8 The two key benefits of buyer driven receivablesprogrammes (BDRPs) that are attractive to lenders arethat:n The buyer (not the lender) takes the responsibility forthe supplier for example dealing with adjustments forgoods returned or faultyn The funding is based on the credit standing of thebuyer and not the supplierAs a result a BDRP is less complex than other structuresand funding is likely to be less expensive for supplierswhere the buyer’s credit is stronger than those of itssuppliers. The SCFWG is aware of new programmesbeing introduced recently and more importantly someof these new programmes involve banks that have notpreviously participated in the SCF market in the UK.

1.9 To determine if it would be useful to establish a set of(voluntary) principles and/or standard documentation forSCF programmes and if so what they should be.n The short answer is yes it would be useful to do son As part of this report we have included a frameworkthat outlines the key aspects of a BDRP (see Appendix 2)n To prepare industry-wide principles and standarddocumentation is outside the brief and resources of theSCFWG but it should be possible to establish anindustry body to take this forward. Such a body willneed, at a minimum, to include lenders, buyers,suppliers and legal representation. We believe that theinvolvement of Her Majesty’s Government andpotential non bank investors will be positive and help indeveloping wider investor interest in SCF structures.

1.10 Evaluate whether it would be possible for an SCFprogramme to issue a tradable asset that could bepurchased by a range of investors and if there would be amarket for such an instrument.n Since we began work on this report, there is no doubtthat growth in the use of BDRPs has encouraged morebanks, including overseas banks, to participate in this area

n For the moment there is no evidence that a lack offunding is constraining the growth in the SCF market,but inevitably any extra liquidity would be beneficialn Non bank investment interest in SCF was mixed:

nn Some investors such as money market funds areunlikely to be able to buy SCF assets at the momentnn Non bank investors are risk averse and lackedresources to evaluate numerous and varied structuresthat lacked scale. UK non bank investors favouredformally rated corporate bonds or commercial papernn In our discussions with investors it was clear thatthey would consider investment in SCF structures (inparticular BDRPs) but further market developmentsand standardisation were required. As a result we seedevelopment of a tradable instrument as a longerterm goal

n Asset backed commercial paper is an establishedfunding mechanism that could produce a tradableinstrument based on SCF assets in the future, but otheroptions are also available.

1.11 In conclusion – SCF can help ease lendingconstraints for small to mid tier companies or thosewith a weaker credit standing.At a time when bank lending is constrained somecompanies have turned to public debt markets for theirfunding needs. However, there remain a considerablenumber of small to mid tier companies that cannotaccess non bank funding. SCF, in particular BDRP, offersopportunities to expand lending to smaller and mid-tiercompanies and the larger companies – the “buyers” –can play a significant role by facilitating BDRPs thattheir supply chain can participate in. The benefits tosuppliers can feed back as a benefit to buyers in termsof better relationships with suppliers and a reduction inpossible financial weakness/instability of suppliers.Banks that have not participated in supplier driven SCFstructures are starting to enter the UK SCF (BDRP)market.

We do believe that the SCF market would benefit froma coordinated industry focus on increased transparencyand standardisation. In the longer term this would leadto non bank investors entering the market.

Stuart Siddall, Chief Executive, The Association of Corporate TreasurersChairman, supply chain finance working groupJuly 2010ssiddall@treasurers.org

EXECUTIVE SUMMARY

4 SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010

2.0 Introduction2.1 This report summarises the findings from the SCFWG

set up at the request of the Bank of England (BoE) inaccordance with the terms of reference included inAppendix 1.

2.2 This report focuses solely on supply chain finance withinthe UK.

2.3 The SCFWG included interested parties from the mainstakeholders – UK banks, buyers and suppliers from thecommercial sector, systems providers, UK investors,financial consulting and lawyers. In addition the SCFWGsought views from outside the core working group.

2.4 Supply chain finance covers a wide spectrum of fundingactivities including;n Supplier driven programmes - receivablesfactoring/discounting both with and without recourseto the seller of the receivables;n Purchasing cards n Inventory – supplier owned and funded inventoriesn Buyer driven receivables programmes.

3.0 The supply chainfinance market3.1 Supply chain finance (SCF) is a term used to define the

financial relationship linking the buyer and the suppliertogether in terms of payables and receivables. Severaloptions and solutions are available in the market today,each with a variation on the offering.

3.2 Before deploying an SCF solution it is important tounderstand the drivers. Traditionally it has been used bybuyers or suppliers to address adverse market conditions.These conditions have led many organisations’ purchasingdepartments (buyers) to extend payment terms with theirsuppliers. Suppliers are being forced in turn to look foralternative solutions to receive their payment in a timelyfashion. The most commonly recognised forms of supplierled SCF in the marketplace (e.g. factoring and invoicediscounting) have often had a stigma attached (wrongly inour view) when buyers discover suppliers are using them.

3.3 Within a SCF solution there are typically four involvedparties:n The buying organisation “the buyer”

SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010 5

INTRODUCTION

Table 1

DEPARTMENT ROLE

Executive BoardWherever possible a programme should be sponsored by a member of the executive boardwith the CEO or Managing Director supporting

ProcurementVital that procurement understands the programme as they own the supplier relationshipProcurement will lead the negotiation and placement of contracts with suppliers

LegalThe correct contract structure is critical to ensuring the right implementation for the buyer(financial treatment)

Financing / TreasurySourcing funding (internal/external) and liaison with banks and internal stakeholders,including setting expectation for returns from the programme

IT ERP interfaces to platform provider and where appropriate funding banks

AccountingDetermine accounting treatment to ensure business needs are met with regard toconsolidation as debt or trade creditor

Transaction processingManagement and ownership of the invoice approval and payment process (efficiency is a key success factor)

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Table 2: SCF Solutions

TYPES APPROACH BENEFITS POTENTIAL ISSUES

BUYER LEDOPTIONS

PURCHASINGCARD

n Buyer agrees contract with PCardprovider to provide solution for ad-hoc expenditure.n Buyer/PCard provider set limits onspend per transaction and per cardon a month by month basis.

n Excellent tool for consolidatinglow spend / high numbers ofsuppliers.n Accounts Payable efficiencybenefits and rebates available fromsuppliers.

n Only applicable for ad-hoc / lowspend suppliers (the “tail”).n Transaction fees charged by cardprovider make it expensive financingfor the supplier.

BUYERDRIVENPAYABLES

n Buyer organisation funds their ownprogramme. Benefit driven fromrelease of early payment discountfrom suppliers.

n Buyer organisation uses a financialinstitution with supportingtechnology to implement theprogramme. Early payment discountsare released from suppliers.

n If transaction fees are set at theappropriate level, it can create areturn for Treasury functions oncommitted cash in excess of othertraditional methods of cashinvestment.n Early payment discounts releasedfrom suppliers at a morecompetitive rate than otherwiseavailable.n Benefits & facility requirementseasy to plan – suppliers are eitherin / out of a programme.n Reduced supply chain risk.Early payment discount offsets costof external financing.Cash benefits can be released.Benefits & facility requirementseasy to plan.n Reduced supply chain risk.

n Need to ensure that transactionfees are set at an appropriate level tooffset opportunity cost of capital.n Negative cash impact for buyer.

n Accounting treatment needscareful consideration if it isimportant that the facilityconsolidates as a trade creditor (SeeAppendix II paragraph 7.0)

BUYERDRIVENRECEIVABLES

n Similar to supplier led receivables,bank funded. This relies on thesupplier selling their invoice. Howeverunder this model the discount rate isdependent on the buyer’s creditstanding.

n Cost of funding based on “buying”organisation which may be cheaperthan that available to suppliers.n Competitive market – many banksoffer this service.n Suppliers can release 100% ofinvoice value early.n Reduced supply chain risk.

n Relies on supplier sellingreceivables.

SUPPLIERLEDOPTIONS

SUPPLIERDRIVENRECEIVABLES

n Solutions such as factoring orinvoices discounting, rely on suppliersselling their receivables to a bank,receiving a percentage of theirreceivables early for a discount.Discount is based on supplier creditstanding.

n Reduced financial risk in supplychain.

n Funding availability is reducing forsuppliers or costs are increasing.n Only 65% - 90% can be releasedearly by supplier.

INVENTORYFINANCING

n Solutions such as VendorsManaged Inventory; suppliers ownthe stock held on buyerorganisation’s site until the buyerorganisation uses the product.

n Less cash tied up in stock forPurchasing organisation.

n No reduction in supply chain risk.n Can result in increased cost ofgoods.

n The organisation supplying goods / services “thesupplier”n A technology platform “the technology or system”n A funding institution “the funding provider orinvestor” (can be internal, external or institutional)n There is a further role for an integrator. The fundinginstitution or the technical platform might take the roleof integrator.

3.4 It is important, particularly within the buyerorganisation that the correct parties are engaged toensure that the benefits are realised. SCF is often an“afterthought”, a reaction to an instruction by treasury /finance departments to extend supplier payment terms.To deploy an SCF programme successfully, it isimportant that it is viewed as an initiative that requiresthe involvement of key departments within the buyer(see table 1).

3.5 SCF does not replace the service agreement betweenbuyer and supplier. It does however impact on thecommercial agreement where payment terms areaffected or supplier discounts are being employed.Depending on the requirements of the buyer or thesupplier, appropriate choices can be made on theselection of the best SCF programme to be deployed.

3.6 A technology platform is required to bring together thepayment mechanism and triggers. This sits between thebuyer, the supplier and the funding mechanism.Technology solutions differ across the marketplace andin many instances either are or resemble EIPP(Electronic Invoice and Payment Processing) systems.The principal five activities performed by thetechnology are:n Purchase order generation, approval and receiptn Goods delivery/received datan Invoice receiptn Invoice matching, reconciliation and approvaln Payment processing.

3.7 Depending on the SCF programme deployed, thetechnology may be provided by an independentsolutions provider or by the funding institution. Many ofthe banks offer their own platforms for buyer-ledreceivables and supplier-led receivables financing. Thereis similar choice on the payables financing with specialistpayment technology existing that facilitates the process.At the ad-hoc end of payables financing (e.g. PurchasingCard or PCard) the current systems can provide less

information due to limitations at the acquirer end and itis rare that the system will receive a purchase order,invoice, perform the reconciliation and release payment.A PCard system is far closer in type to a traditionalcredit card released for ad-hoc corporate expenditure.

3.8 The role of the integrator is to provide advice andassistance to organisations who are embarking on thedeployment of a SCF solution. The integrator shouldprovide expert input in the selection of the appropriatesolution, the accounting structures and tax implications,the selection of funding source (internal / external) andthe ‘on boarding’ (recruiting) of suppliers.

3.9 As table 2 shows, the solutions split into two principalareas. In buyer led programmes, any funding is basedon the buyer’s credit standing as the buyer accepts therisk of managing the suppliers and it is the obligor tothe funder. Under supplier led programmes, thefunder’s recourse is only to the supplier.

3.10 PCard programmes are typically associated with ad-hocsupplier expenditure and form a convenient way inwhich to consolidate many small suppliers into onesingle consolidated invoice. They are an establishedproposition and arguably have the highest level ofexpenditure transacting through programmes in today’smarket. Suppliers are charged a transaction fee by thePCard provider for early payment. The buyer settles withthe PCard provider on their pre-agreed terms (typicallyinvoice cycle plus fourteen days). This approach is rarelyapplicable to suppliers where the buyer spends over circa£25,000 per annum due to the relatively high cost of thetransaction fee compared to other sources of financing.

3.11 Buyer driven payables programmes are relatively newto the market. In a similar manner to PCards,transaction fees are set based on the buyingorganisation credit standing but are incurred by thesupplier. Fees are typically lower than PCardprogrammes (research indicates it can be 50% lower).Under this programme there is the option for buyingorganisations either to seek third party funding orshould their cash position support it, self fund theprogramme. In self funded programmes the earlypayment discount released from the suppliers replacesthe income that treasury/finance departments wouldotherwise have made using more traditional methodsof investing funds.

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SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010 7

3.12 Buyer driven receivables programmes are growingstrongly. In the market many of the major banks andspecialist providers offer a solution. On occasion theseprogrammes are referred to as ‘reverse factoring’. In anygiven invoice cycle the supplier has the option to selltheir receivables at a discount. Differing from invoicediscounting/ factoring, under this model funding isprovided to the supplier while the cost of funding is basedon the credit standing of the buying organisation. Thebuying organisation can self fund their own programme.

3.13 Supplier driven receivables programmes are commonlyreferred to as factoring / invoice discounting. Underthese programmes suppliers will, via a relationship witha financial institution have a facility available based ontheir receivables book. They can draw against thisfacility, selling the associated receivable to the financialinstitution for a discount. This is a convenient way forsuppliers to control their own day’s sales outstanding,however because the discounts are typically based on acombination of supplier credit standing and buyer risk, this can be an expensive form of financing for asupplier.

3.14 Inventory financing can take many forms and is again awell established offering in the market. This can rangefrom inventory financing solutions provided by financialinstitutions through to supplier led programmes wheresuppliers will self fund the cost of inventory with buyingorganisations, typically for an increased cost on thegoods. These programmes are typically referred to asconsignment stock or vendor managed inventory (VMI)within manufacturing and production environments.

3.15 Globally there are a number of markets where SCFprogrammes are well developed. Developed marketstypically have one to four providers, mature marketstypically have over four providers able to supply theservice.

3.16 The SCFWG only found reference to the UK market sizeof the buyer led receivables financing programmes. In2008 the market was in its early stages with circa£100m outstanding. By 2009 this had grown to £700mand it is anticipated that by end of 2010 this will becirca £1bn. Market size is extremely difficult to estimateacross each of the different SCF offerings.

3.17 The elements of a BDRP have been documented and areincluded within Appendix 2.

4.0 Observations associated with supplychain finance4.1 From discussions within the SCFWG and with other

interested parties the following observations emerged.

4.2 Accounting treatment seen as key by some buyers.

4.3 Formal credit ratingsn Where an SCF programme is not rated money marketfunds are, in the majority of cases, excluded frominvesting in SCF instruments. n Without public ratings (for buyers) it may be difficult,but not impossible, to interest UK pensions funds toinvest in such instruments. n Some buyers see SCF programme credit ratings aspotentially negative for their overall company debtrating as there is a perception that rating agencies maytreat rated SCF programmes as debt.n Rating agencies and particularly ratings for assetbacked products have been tarred by the recent crisis.n The BoE has only acquired rated paper as part of theAsset Purchase Facility (APF). This implies that anunrated SCF programme cannot benefit from activitiessimilar to APF in times of poor market liquidity.

4.4 General level of understanding of SCF products is poor.Often people hold a negative view of SCF (narrowlyviewed as invoice discounting). In particular there is aneed to educate analysts and commentators about themerits of SCF.

4.5 BDRP seen as simpler / more efficient than traditionalinvoice discounting. It focuses on the buyer rather thanperformance of the supplier and eliminatesuncertainties that banks etc cannot manage. It shouldenable many suppliers to secure funding at better ratesthan they could on their own balance sheet.

4.6 No secondary market exists for SCF products. It isbelieved by some that a secondary market woulddevelop naturally as the market size increased andcomplexity reduced.

4.7 It was initially discussed that the fact that a SCFprogramme may not be permanently drawn and hencefluctuating in size might be an issue for some non bank

OBSERVATIONS ASSOCIATED WITH SUPPLY CHAIN FINANCE

8 SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010

investors but this became less significant as weinvestigated the market.

4.8 Hedge funds are unlikely to be investors in SCFprogramme as they probably would obtain inadequatemargin pick up.

4.9 With the current steep upward sloping yield curve,investors may compare long term bond yields with verylow yields on short term instruments. This implies thatthe yield on SCF short term instruments needs to behigh relative to market interest rates to attract newinvestors.

4.10 As of autumn 2009 the number of investors in UK SCFprogrammes was relatively limited but is growing in2010.

4.11 Those providers that focus on a particular section ofSCF seem very, but probably needlessly, defensive oftheir own specialty.

4.12 Despite obstacles new investors have started to enterthe market in search of relative yield and might beinterested in SCF as increasing market size andstandardisation of ‘white labelled’ platforms develop.Pension funds, sovereign wealth funds and banks notcurrently operating in the UK but familiar with SCFproduct are potential investors in SCF.

4.13 Platforms that are bank/investor independent arehelpful to broader market availability but need to bemore open to alternative funding sources.

4.14 Independent platforms need a strong market positionto gain credibility in this market or a strong balancesheet to stand behind self certification of systems togive funding providers (and where relevant ratingagencies) confidence.

4.15 A BDRP should respond to many of the issues set out inparagraphs 4.2 - 4.14 of this report.

4.16 The following are the principal issues that such aprogramme may not address:n Non bank funding appetite within UK institutions –e.g. pensions fundsn Secondary market tradingn Risk based capital allocation of SCF assetsn Ratings

Whilst the SCFWG believes that wider promotion of aBDRP will assist the development of funding for thesupply chain it is concerned that attracting non bankfunders into this market represents a significantchallenge.

5.0 Investors in supplychain finance5.1 Traditionally investors in SCF have been banks providing

external financing either directly or via financial serviceplatforms/providers. The credit crisis over the last twoyears has seen the rapid withdrawal of some banks fromthe SCF market and others who raised credit qualityrequirements and in some cases decreased funding.

5.2 A natural second investor would, in the past, have beenmoney market funds, also known as AAA rated orliquidity funds. However the credit crisis has alsoseverely affected the type of investments which thesetypes of funds can invest in and retain their status.

5.3 Therefore in order to identify new investors in the SCFmarket we have held discussions with potential marketparticipants. Three over-arching criteria were flagged inthese discussions;n A return relative to the risk of the facility and the timean investor would need to consider the asset –commercial paper and corporate bonds were seen asbenchmarksn A secondary marketn A clean asset/obligation – this favours the BDRPagainst traditional invoice discounting.

5.4 Essential to all investments is the requirement for somereturn relative to risk. The level of risk can bedetermined by many things. In the case of BDRP thecredit risk and need for a clean asset is resolved by thestrength of the buyer and the buyer managing thesupplier issues.

5.5 The investor will consider the return to be relative tothe amount of time and effort it will take them toreview the programme given the amount of disclosure.

5.6 The majority of asset classes need a secondary market.This has been made very evident over the last two years

SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010 9

INVESTORS IN SUPPLY CHAIN FINANCE

as investors struggled to sell assets out of funds or toprice them correctly. A secondary market can become aself fulfilling prophecy so long as the SCF investment‘has an out’- this could be either as a guaranteedpurchaser (inclusion in the Bank of England assetpurchase facility) or an investment fund. Once themarket is aware of the ability to trade the asset then itwill be more seriously considered as an alternative totraditional money market instruments.

5.7 Are there any new investor classes that may considerSCF in the near future?

Our opinion is that the SCF market is specifically suitedto the banking sector. There is a perception in themarket that it is not possible for new banks to gainentrance as it is being restricted by the lack of opencompetition and the large market shares of existingparticipants. However the number of participants in themarket is increasing.

5.8 The SCFWG has considered the appetite of newinvestors for a BDRP and we set out some observationsin table 3 below:

INVESTORS IN SUPPLY CHAIN FINANCE

1 0 SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010

Table 3: Review of potential investors

INVESTOR GROUPS COMMENTS SCFWG ASSESSMENT

Money Market Funds n An obvious investor with significant funds to deployBUT…nn Would require facility to be rated investment gradenn Would require liquidity guaranteesnn Likely to be restricted by new regulations

n Unlikely to invest in SCF assets intheir current form

Corporate Bond Funds n Currently a steep yield curve and therefore woulddemand high returns relative to short term yieldsn Tend to look at fixed returns over several years

n Possibly an investor in the mediumterm

Hedge Funds n Inadequate return relative to bench mark assets n Unlikely to invest in SCF assets

UK StateOwned/ControlledFinancial Institutions

n Currently purchase these assets n Ongoing investor

Financial Institutions n Some currently fund SCF outside the UK market n Ongoing investor outside UK

Local Authorities n Highly restricted asset classes that can be consideredn Direction could come from the government and/orexisting suppliers but they would need skills to evaluateinvestments

n Ratings may enable LAs to invest

Pension Funds n Risk aversen SCF could offer improved returns and adequatesecurity for short term surpluses

n General acceptance of the instrumentmight attract pension funds over time

6.0 Credit ratings –from rating agencyperspective6.1 Although faith in credit rating agencies has, in the view

of some commentators, greatly declined as a result ofthe crisis and their performance in respect of structuredinvestment vehicles a rating for a BDRP is an importantbut not essential accreditation for investors. A rating isoften seen as the ‘door opener’ to investors consideringa new investment and also a way of reducing the yieldcost to issuers.

6.2 The SCFWG spoke to two major rating agencies and thecomments are summarised below:n The best rating that BDRP could secure would be apass through based on senior unsecured debt of thebuyer. Depending on which industry and corporateanalyst’s review, it is possible that the rating for the SCFwould be a notch or two lower than for the ‘parent’n The rating agencies, in the working group’s opinion,would not view a BDRP as detrimental to other ratingsof the buyer so long as the programme did not increasetheir debt capacity or put another way ‘so long as theSCF remained as a trade creditor for accountingpurposes’ n For large companies with good cash flow the ratingagencies would view a BDRP as rating neutral. In someindustries and for weaker companies however theremay be concern that prime purpose is other than tostrengthen the supplier chainn Rating agencies would need to do enough duediligence on legal structures and platforms to satisfythemselves that overall a BDRP was fit for purpose.

7.0 The way forward 7.1 Supplier driven programmes have an important place in

this market but complexity and growing focus on riskaverse lending may constrain development of themarket as an efficient funding source.

7.2 Purchasing cards clearly have a place for low value highvolume buyers and here both convenience and speed ofpayment are key factors.

7.3 After considering a range of issues, includingperceptions associated with supply chain finance it isthe view of the working party that BDRPs can helpexpand the SCF market. If other investor issues can beaddressed it should be possible to attract non bankfunders into this market.

7.4 The key reasons for focusing on a BDRP are as follows;n The buyer is best placed to manage the risks thatinvestors do not wish to be engaged with i.e. supplierperformance, supplier credit riskn BDRP can help promote standardisation and increasetransparency n BDRP should be less complex to implement and thelevel of Investor due diligence should be reduced.

7.5 Appendix 2 sets out the key elements of a BDRP.

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CREDIT RATINGS - FROM RATING AGENCY PERSPECTIVE

8.0 Conclusions8.1 The information the working group has obtained makes

it clear that supply chain finance already exists in manydifferent guises (both buyer led and supplier led). Withinthe constraints of the various products available it isworking and fulfilling a valuable role in the provision ofworking capital to a diverse range of companies. Thefinance being provided has grown, particularly throughbuyer driven receivables programmes, and the marketingefforts of the providers implies that there is anexpectation of some further growth. However, there is abelief that there exists the potential for supply chainfinance to provide substantially more funding if certainbarriers can be overcome.

8.2 In the current markets where the access to funding forsmaller or less credit worthy suppliers is limited andunder strain, buyer driven programmes display the bestpotential for expansion. There are efficiencies in termsof the mechanics and the financing rates achievable iflarger and more credit worthy buyers take the lead inthe process. Giving the suppliers the benefit of slightlyeasier access to funding performs a valuable function intoday’s markets for the good of the wider economy as awhole as well as the individual participants.

8.3 The provision of finance, which is largely from banks atpresent, has not been the only constraining factor sofar. Rather the lack of knowledge amongst buyers and alack of the appreciation of the mechanics and benefitsmight have held back growth.

8.4 The working group concludes that increased clarity andto an extent standardisation through programmes suchas described in the Appendix 2, could contribute toimproved efficiency, an expansion of the markets andmaking it more straightforward for new funders to enterthe market.

9.0 Next steps9.1 Provision of information, education and a practical

guide to SCF is seen as the prime need to stimulate allsides of the market. In the first instance the businessesand the representative bodies involved in the workinggroup are well placed to undertake this, both directlyand by stimulating publicity around the subjectgenerally.

9.2 The recommendations of this group remain merelyrecommendations for the moment. To becomeeffective there is a need for some existing body or somenew coalition of interested parties to take forward theconcepts of SCF programmes.

9.3 Better transparency through the process will help newfunding institutions enter the market, but further workis needed on developing a funding instrument that iscapable of gaining a degree of liquidity. The workinggroup did not find that securitising the receivables andfinancing through a special purpose vehicle was aprerequisite. Simplicity and legal certainty was required,so that some acknowledgement of the payables, ortradable instrument like a bill of exchange, could bedevised.

CONCLUSIONS AND NEXT STEPS

1 2 SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010

Appendix 11.0 Supply chain finance workinggroup: terms of reference

1.1 BackgroundSupply chain finance (SCF) is a mechanism that iswidely used by large corporates and other institutionsto support the access of their suppliers to workingcapital. It is currently a small, but developing, market inthe UK. At present there are a number of differentpotential structures for SCF programmes, but nostandard set of principles for SCF programmes. TheBank of England chaired a round-table meeting of SCFmarket participants in September 2009, the outcome ofwhich was to establish this market-led working group tolook into the issues facing the SCF market, andpotential ways in which the market may develop.

1.2 Draft scope and purpose of the workn To take a view on whether there is demand for anexpansion of the SCF market and what the currentimpediments to expansion are.n To evaluate the various potential structures of SCFprogrammes.n To determine if it would be useful to establish a set of(voluntary) principles/ standard documentation for SCFprogrammes and if so what they should be. n Evaluate whether it would be possible for SCFprogrammes to issue a tradable asset that could bepurchased by a range of investors, and if there would bea market for such an instrument.

1.3 Deliverables and timetablen The working group will report back to the wider groupof market participants after each meeting to allowthem the opportunity to feed in comments.n It is the intention to publish a report on the aboveissues by which we hope would be endorsed by a widerange of market participants.

Appendix 21.0 Key elements of a Buyer DrivenReceivables Programme

1.1 OverviewThe overall objective of this appendix is to set outprinciples for a supply chain finance buyer drivenreceivables programme (BDRP) which:

1.2 Generally, make BDRP more straightforward tounderstand for all interested parties.

1.3 Specifically meet the criteria required to encourage abroader universe of investors and buyers to participatein BDRP.

1.4 Remove unnecessary complexity so discussions about,or analysis of, BDRPs are about what really matters,which include inter alia: (i) the underlying credit qualityof the buyer; (ii) the costs of the programme; and (iii)the accounting implications for the buyer.

1.5 Are not overly restrictive. There is no point definingprinciples that render BDRP non commercial and/or donot work for significant portions of the market.

1.6 Relate specifically to BDRP.

1.7 Reduce barriers to entry by all participants.We have opted to set out principles for a BDRP becausethe buyer is best placed to address issues that mayinvolve redress against a supplier. This issue relating tothe supplier can complicate many trade relatedfinancing programmes. BDRP can offer a less complexstructure which can be used by the supplier to generateworking capital to the mutual benefit of the supplierrelationship.It is hoped that the existence of a consistent approachto BDRP will ultimately lead to:

a) More buyers entering into BDRPs, both in terms ofnumber and type (for example: more medium sizedbusinesses)b) More suppliers being able to fund growth of theirbusinesses more easilyc) A wider investor base for BDRP incorporatinginvestor classes outside of the commercial banks whichhave been the main investors

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APPENDICES

d) A more robust market due to an increased ability tomanage/syndicate and transfer risk

e) More competitive pricingf) Facilitation of any oversight functions.

2.0 Definition of BDRP terms

2.1 DefinitionsThe BDRP is based upon a Buyer-led supply chainfinancing programme for Approved Payables between:a) a single Buyer b) one or more Suppliers

A “Supplier” is a company who supplies goods orservices to another company, the “Buyer”

A “Payable” arises where the Buyer has been invoicedby a Supplier for goods and/or services provided

An “Approved Payable” (AP) arises where the Buyer has,in a legally binding format, acknowledged:i) the validity of the Payableii) that the Payable will be paid without deduction or set-off at a date certain time.

3.0 Key elements of a BDRP

3.1 The following list represents the core elements whichcould comprise a BDRP:

n A Buyern One or more Suppliersn A core financial obligation – the APn Information and IT systems – required for inter

alia: monitoring / aggregating / paymentsn Legal structures – which allow end investors to

have claim, ownership or security over the APn A financial instrument(s) – which is owned by an

Investor or Investorsn Investor(s)

4.0 Overview of buyer objectives

4.1 A Buyer entering into an BDRP wants:n Accounting: the majority of buyers want acceptableaccounting treatment (see para 7.0) to ensure that tradecreditor obligations continue to be treated as AccountsPayable and not reclassified as debt. However in somecases buyers may be indifferent to this.

n Platform stability: a robust platform or structurewhich will allow Suppliers and Buyers to utilise, andhave confidence in, BDRPs on a day-to-day basisn Pricing: rational, competitive and a low varyingmargin over a trusted index n Continuity: a financing source for their Suppliers whichis reliable combining quality and possible diversificationn Standardisation: a general understanding that theBDRP programme is fit for purpose and meets a marketstandardn Non-Invasive: Changes to payment terms and cost tothe Buyer should be a matter for the Buyers andSuppliers and should not be directly affected by (butcan be informed by) changes in the financing terms ofthe BDRP programme.

5.0 Overview of supplier objectives

5.1 In general, a Supplier using a BDRP wants:n Optional accelerated paymentn Minimal impact on existing debt facilitiesn Platform stability: a robust platform or structurewhich will allows Suppliers and Buyers to utilise, and haveconfidence in, BDRP programmes on a day-to-day basisn Pricing: rational, competitive and a low varyingmargin over a trusted index n Continuity and scale: a financing demand which isreliable and of adequate scale n Standardisation: some understanding that the BDRPprogramme that has been entered into is generally fitfor purpose and market standardn Non-Invasive: Changes to payment terms and cost tothe Buyer should be a matter for the Buyers andSuppliers and should not be directly affected by (butcan be informed by) changes in the financing terms ofthe BDRP programme.

6.0 Overview of investor objectives

6.1 An Investor buying a BDRP investment wants:n Platform stability: a robust platform or structurewhich will allow Suppliers and Buyers to utilise, andhave confidence in, BDRPs on a day-to-day basisn Standardisation: some understanding that the BDRPthat has been entered into is generally fit for purposeand meets a market standardn Continuity: an investment opportunity which iscontinually available n Yield: Investment return reflective of complexity ofBDRP and analysis of such

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1 4 SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010

n Tradability secondary market which allows: theability to transfer or trade the investment with anotherInvestor in as simple a fashion as possible. Privateplacements could be accepted to a lesser degreen Buyer credit: As far as is practicable, analysis of theBDRP investment simply requires examining theunderlying credit of the Buyer and nothing else. Nocredit events from other parties (for example:originating banks, systems providers, suppliers) shouldimpact the quality of the Investment

7.0 Accounting treatment7.1 Many Buyers would see no benefit from an BDRP if the

“trade payables” were re classified as “borrowings”. Theobjective is for Buyers to maintain their payable astrade creditors despite the fact that the Supplier mayhave been paid (early) by a bank or other Investor.Some Buyers may be indifferent but the SCFWGassumes that reclassification of trade payable asborrowings would be unattractive for most Buyersconsidering a BDRP.

7.2 The working group believes that programmes thatINCLUDE any of the following features run the risk of are-categorisation into borrowings :n Funding to the Buyern Obligation from Investor to Buyer that funding (topay other than on normal trade terms) will be availableto Suppliers n Allow the Buyer to extend payment terms onoutstanding invoices or future ones 1

n Rebates to be shared between the Buyer and theSuppliern The Buyer to be a party to the arrangements betweenthe Investor and the Suppliern The Buyer has any ongoing level of control over theInvestor/funding vehiclen The Buyer’s obligation to a Supplier is replaced withan obligation to an Investor

7.3 The accounting rationale underlying much of this is todetermine whether a liability has been significantlymodified and hence deemed to be extinguished or not.IAS 39 para 40 supplemented by AG 62 introduces theconcept of quantitative 10% test when determiningthis, but there can be divergent views amongst the Big4 accounting firms about how to apply therequirements of IAS 39 to the accounting analysis ofsupplier finance.

7.4 Some of the major accounting firms consider the needto perform a qualitative analysis to be a policy choiceand others consider it to be essential and insist theirclients consider both qualitative factors andquantitative factors when determining if a liability hasbeen extinguished or not.

7.5 Whilst there are some clear don’ts, the Buyer will stillwant to ensure, if an Investor is making payments tothe Suppliers, that the Investor will make payment ontime and without set off – in themselves these areperformance obligations that the Investor is taking on in return for mandate to manage the Buyer’s payables(and should not jeopardise accounting treatment). Weare aware of a number of BDRPs where the accountingtreatment of “trade payables” has not been disturbedby the implementation of a BDRP. All of theseprogrammes were reviewed by the respective auditorsto ensure that the programmes did not convert “tradepayables” into “borrowings”.

7.6 We are also aware of several BDRPs where the Buyerhas implemented a BDRP knowing that the “tradepayables” will be reclassified as “borrowings”.

7.7 Whilst the above sets out the generalities, and the list isnon exhaustive, the issues are complex and can be quitesubtle – so we must advise all Buyers to seek a specificreview of their BDRPs before they are implemented.

1 Agreement with supplier needed as in any normal trading relationship

SUPPLY CHAIN FINANCE WORKING GROUP REPORT 2010 1 5

APPENDICES

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Published July 2010 by ACT on behalf of the supply chain finance working group (SCFWG)Printed by Pureprint GroupProduction: Bizmedia LtdCover design: Jane Denton