FOCUS-Europe's supply chain finance fix feeds hidden debt fears

By Abhinav Ramnarayan and Lawrence White

LONDON, Dec 8 (Reuters) - European companies hit by the
coronavirus crisis are increasingly turning to a complex
financial tool to pay suppliers, raising investor concerns
around "hidden" debt.

Supply chain financing, by which companies can get cash from
banks and funds to pay their suppliers without using working
capital, has likely hit a record high in 2020, data shows.

The world's top banks are set to earn $27 billion from
financing supply chains this year, data from research firm
Coalition shows, as larger borrowers, mostly in Europe, scramble
to help suppliers hammered by the pandemic.

This represents a rise of about 5.5% in 2020, compared with
an average 2% increase in the previous four years.

While supply chain finance is a legitimate business tool,
high-profile collapses of companies like Britain's Carillion,
Spain's Abengoa and the United Arab Emirates' NMC Health have
prompted investor concern.

"Supply chain financing is the latest financial engineering
that could have serious consequences for working capital," said
Pierre Verle, head of credit and a portfolio manager at French
asset manager Carmignac.

"I am not sure many investors realise how serious it is."

An essential source of credit in a crisis, supply chain
finance, also known as reverse factoring, can mask the true
level of debt and cashflow issues that companies may face
because it does not appear on balance sheets as debt, investors
and analysts said.

It is counted as a trade payable for the purchaser and a
receivable for the supplier, despite acting more like bank debt
in the opinion of some ratings agencies and industry experts.

THE X FACTOR

In a typical example of supply chain financing, a company
such as a supermarket chain, concerned about the health of its
small food suppliers during a temporary shock such as the
pandemic, approaches its bank.

The small suppliers issue invoices to the supermarket, which
confirms to the bank they are valid, and then those suppliers
get the money right away rather than having to wait perhaps 30
days or even months to be paid by the retailer.

In some cases this acceleration in cashflow can mean
survival for a supplier, with the funding also far cheaper
because it is usually repaid within weeks rather than months.

Meanwhile, the bank makes some money on the loan.

"This product has been very popular during the COVID-19
pandemic, because it provides working capital for companies
experiencing a temporary demand shock," Eric Li, research
director at Coalition, told Reuters.

There is no official data on supply chain financing, but
earnings from banks offer some insight. Lenders are a key source
of such funding although it represents a small portion of their
overall trade finance business.

Investment funds, not covered by the same sort of capital
requirements as banks, are also increasingly providing supply
chain finance but there is less visibility on their
exposures.

Softbank-backed Greensill, the biggest non-bank provider of
supply chain finance, also saw volumes and new business increase
this year, a spokesperson told Reuters.

"This year has battle tested supply chain finance as a new
asset class and as a means of getting capital down into the real
economy where it is needed the most," the spokesperson said.

Greensill says its technology-driven approach helps improve
transparency and accountability in the asset class.

"We have said consistently that we believe that a dollar
owed to a customer in an invoice is no different to a dollar
owed to a bank in debt, both should be entirely transparent."

Companies are not required to disclose use of the technique,
and the International Monetary Fund in June 2019 said the lack
of available data on trade finance has been recognised as a
problem since the 2008 financial crisis.

"There are plenty of examples of companies with hidden debt,
and those are often the ones that cause more problems," said
Justin Jewell, a portfolio manager at Bluebay Asset Management.

NMC Health is the most recent high-profile corporate
casualty that used supply chain finance. Some of this only came
to light when short seller Muddy Waters put out a note detailing
its hidden debt levels.

Moody's also linked undisclosed supply chain financing to
the 2018 collapse of British construction firm Carillion, which
owed some 498 million pounds ($670 million) through an "early
payment facility" agreement with suppliers.

Moody's said this hid the true debt owed to banks providing
the financing.

Accounting firms, ratings agencies and regulators in the
U.S. and Europe have called for greater disclosure.

In June, the U.S. Securities and Exchange Commission issued
a notice requiring companies to disclose more about how COVID-19
is affecting their cashflow, including specific mention they
should disclose more about use of supply chain finance.

However, regulators and professional accounting bodies have
not implemented any major rule changes.
($1 = 0.7428 pounds)

(Reporting by Abhinav Ramnarayan and Lawrence White, additional
reporting by Toby Sterling;
Editing by Alexander Smith)

Carillion Plc