Cash & Working CapitalComplianceTechnology

Supply Chain Finance Faces Rising Regulatory Scrutiny

By February 4, 2020 No Comments

Founder’s Edition, by Joseph Neu

Making sense of calls to increase debt classification and disclosure requirements for reverse factoring.

I received an email recently from a consultant giving me a heads-up about a potential financial reporting change that could adversely impact the multibillion-dollar market for supply chain finance.

  • Extended payables vs. debt. At issue is the ability of companies to use a financial intermediary to pay suppliers at a discount while extending their payments terms to the suppliers (sometimes in conjunction with raising financing against their own receivables, too), or simply extend payables beyond the norm to preserve cash (aka reverse factoring, payables financing or supply chain finance). Many such transactions are not recorded as debt but rather as trade payables.

The collapse of the UK construction firm Carillion in early 2018, linked by critics to its misuse of supply chain finance, is seen as one tipping point. But the broader use of reverse financing to help firms fund themselves at lower cost that is being promoted by a growing number of financial intermediaries is also driving regulatory scrutiny. Here are some recent examples:

  • Big Four ask for guidance. The Big Four accounting firms in October took the rare step of sending the FASB a joint letter, asking it to weigh in on how companies should classify various supply chain financing transactions and what details they should disclose.
  • Rating agencies. Fitch has a formula it uses to adjust company debt ratios to reflect their use of supply-chain finance. Moody’s has issued a warning.
  • SEC calls for MD&A disclosures. At the American Institute of CPAs conference in December, SEC Corporation Finance Deputy Chief Accountant Lindsay McCord said businesses needed to use the Management Discussion and Analysis section of their financial statements to give investors insight on their use of supplier finance programs that might change their financial condition.

To get the views of our members, I reached out to a few who manage significant supply chain finance programs.

  • Transparency and standardization needed. “The significant variations among accounting professionals in how they treat SCF reporting, even within the same accounting firm, does create external reporting challenges,” one member said. He would support standardization of interpretation and transparency of reporting.
  • The ESG component. Standardization would support good governance “to remove financial engineering and creativity merely for the sake of metrics reporting (for MNCs and large corporates) that are not necessarily beneficial to the overall business environment,” the member said. SMEs can be especially victimized by extraordinary extended terms (240-360 days), he added, with settlement delays of another 30-60 days in some countries.
  • Are new rules really needed? In another member’s opinion, “Any hack analyst can tell what is going on. Yes, it is a bit of a trick with the ratings agency’s metrics, but they too know exactly what is happening.”

I think it is fair to say that audit firms should be able to come up with a more consistent application of the current principles-based approach—i.e., the extent to which an intermediary’s involvement changes the nature, amount, and timing of payables, plus the direct economic benefit the entity receives—even without the intervention of those who set accounting standards.

  • We should all support disclosures that are sufficient to determine adherence to this principal and make clear how financing techniques affect the statement of cash flows. Reputation risk and ESG ratings related to the treatment of suppliers will also help prevent abuse if capital providers are paying attention.

To see what such disclosures might look like, take a look at examples from Masco and Keurig Dr Pepper in their responses to SEC staff comment letters.

Antony Michels

Author Antony Michels

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