Moody’s Issues Another Supply Chain Finance Warning

More than a year after Fitch Ratings raised concerns about a “loophole” allowing corporates to obtain supply chain financing without classifying it as debt, Moody’s has issued its own warning over the financing solution.

In a recent announcement, Moody’s Investors Service concluded that supply chain finance, also known as reverse factoring, has the potential to weaken liquidity and limit visibility for investors and shareholders. Calling for new requirements to improve the transparency of corporates’ use of reverse factoring, Moody’s noted that few businesses actually disclose their use of this supply chain financing tool, while others may not adequately understand the risks associated with it.

Reverse factoring, in which a corporate buyer initiates an invoice financing tool for its supplier base, contributed to high-profile defaults including that of Spain energy giant Abengoa and, more recently, Carillion in the U.K.

“Users of financial statements may not be aware of a customer’s usage of reverse factoring, despite the potentially material consequences,” Moody’s Associate Managing Director William Coley said in a statement last month. “The customer itself may not fully understand the added risk that accompanies the use of this financing technique.”

According to Moody’s, corporates may deploy reverse factoring tools as part of a broader strategy of supply chain control. When reverse factoring is used to “stretch working capital,” Moody’s said, or when a customer’s credit quality degrades, risks can mount.

Supply Chain Financing Scrutiny Grows

Following the publishing of Moody’s report, the Financial Times pointed to GFG Alliance, the business empire of Sanjeev Gupta that has recently been hit with scrutiny over its finances.

“Despite efforts to raise more conventional forms of funding, Mr. Gupta’s business empire is still heavily reliant on opaque and unconventional financing linked to working capital and supply chains that can be expensive,” the Financial Times wrote, adding that while its use of supply chain finance is not debt, it can still have a financial burden on the conglomerate’s books.

“It’s just borrowing,” London Business School accounting professor Chris Higson told the publication, adding that reverse factoring and receivables financing is often a strategy for organizations unable to access more affordable financing. “It matters because the more you borrow and the more you sell receivables, then the weaker the balance sheet. And if there’s a downturn in your market and you face a setback, you’re more likely to fail.”

The publication added that Greensill Capital, headed by Lex Greensill has played a key role in GFG’s financing strategy.

Describing reverse factoring as a “signature technique” for Greensill, the publication noted that while the tool can be useful in helping large corporates smooth out cash flow, “it can also disguise a troubled company’s mounting borrowings.”

Greensill itself has been the subject of recent scrutiny, however, with reports in Financial News in May noting that investors had pulled about $1.8 billion from the GAM Greensill Supply Chain Finance investment fund, operated by GAM and Greensill. That followed previous criticisms raised by one of the fund’s largest investors, Vodafone, and its practice of delayed payments to suppliers.

GFG Alliance told the Financial Times that it is “satisfied that we have ample access to capital and headroom within our range of available lending facilities to satisfy the needs of our businesses and their growth.”

A History Of Skepticism

This isn’t Moody’s first warning over supply chain financing, however.

In late-2015 the company warned that reverse factoring has “debt-like” qualities despite not being recorded as debt in corporate balance sheets. The criticism was met with a backlash of its own, with the International Trade and Forfaiting Association challenging Moody’s position that trade debt should be classified as financial debt.

Last year, Fitch Ratings issued its own report drawing similar conclusions, leading the International Trade and Forfaiting Association (ITFA), among others, to speak out.

“IFTA had a very good dialogue with Moody’s” when it issued its own supply chain financing warning, said ITFA Chairman Sean Edwards in an interview with Global Trade Review last year. “It looks like we’re going to have to start the dialogue with Fitch.”

He added that while B2B payment terms continue to lengthen – often a catalyst for deploying trade finance solutions like reverse factoring — it doesn’t not necessarily mean that supply chain financing should be reclassified as debt.

“There has been an increase in days payable, because it is very widespread,” he noted. “But does that mean it should be treated as bak debt? I don’t think so. In abnormal cases, like possibly Carillion and Abengoa, they had additional features. In the case of Carillion, it dwarfed their other lines of finance.”

It’s unclear whether Moody’s latest report will again lead IFTA to respond.

Last year Moody’s issued a separate warning in response to mounting corporate debt in the U.S., with Moody’s Analytics’ chief economist Mark Zandi describing the similarities between the current borrowing behavior and the subprime lending surge that led to the 2008 global financial crisis as “eerie.”