Opinion | Tuesday, 4th May 2021
What are the issues with supply chain finance?
Dr Craig Berry explains how supply chain finance at the heart of the lobbying saga is supposed to work
By Dr Craig Berry, Reader in Political Economy at Manchester Metropolitan University’s Future Economies Research Centre.
Following the downfall of Greensill Capital – associated with former Prime Minister David Cameron, and senior government adviser Lex Greensill – the little-known practice of supply chain finance has come to public attention.
While ostensibly useful in some ways, the growth of supply chain financing is alarming in practice insofar as it represents an example of financial intermediation - a ‘middleman’ - which, beyond the harmless façade, intensifies the risk of financial volatility for society.
Supply chain financing (or ‘reverse factoring’) is the use of financial intermediaries to ensure suppliers can be paid within a reasonable time-frame, even if their customers would prefer to wait several months before settling invoices.
In theory, the practice minimises supply chain disruption, at a relatively low cost, since suppliers (typically smaller firms) pay fees – by discounting invoices – based on the credit of their customers (typically large firms) rather than their own. This is cashing in the promise to get paid from the customer – the invoice – to get paid now from supply chain finance companies, using the invoice as a future guarantee of payment.
So far, so good. What’s the problem?
There is a both an economic and political dimension to the recent Greensill saga.
The danger of supply chain financing has to be seen in the context of a wider shift in accounting practice – in terms of how assets and contracts are valued – towards assessing anticipated future cashflows rather than past transactions, that is, rather than what a company owns or has already sold, to what it may own and may sell in the future.
As Professor Adam Leaver’s work demonstrates, this creates space for subjectivity instead of properly defined prices and costs, which in turn creates scope for exaggerated accounts of asset values and future income in order to inflate the creditworthiness and/or share price of a company. This is not only permitted by law, it is arguably encouraged by it.
In cases such as the insolvent construction company Carillion, supply chain financing was used to both report healthier cashflows and obscure its liabilities, essentially by exploiting the temporal discrepancies between cash payments to suppliers, servicing debt, and financial reporting.
We now know that Greensill in particular is implicated in the perilous situation at Liberty Steel, whose parent company relied on Greensill funds to delay payments to suppliers.
The steel industry is a peculiar case, but more generally, it is COVID-19 which means companies like Greensill came unstuck.
They were no longer able to rely on a steady stream of invoices generated by suppliers from which its fees could be extracted. But Greensill appears to have been as much a perpetrator of – as well as mechanism for – temporal manipulation. It would lend against income it expected to generate in the future, from suppliers not yet engaged by its clients, having parcelled up these anticipated income streams as securities. The prospect of future growth was assetised – turned into a financial product itself - to serve as fuel in the present for a strategy to bring about this growth.
In terms of the politics, this situation is, in a sense, a classic lobbying scandal.
Imagine a future version of yourself travelling back in time to tell you what next week’s winning lottery numbers will be. And now imagine that the information is not brought by an actual time-traveller, but rather your own projection of what the numbers might be: how many lottery tickets are you going to buy?
As I argue in my book Pensions Imperilled, futures fail: the construction of a financial system reliant on the accuracy of forecasted financial futures is fraught with danger. Whether we are smoothing supply chain vulnerabilities, or planning for our retirement, the flaws are the same.
Greensill Capital was forced to lend from its own German-based bank, Greensill Bank, as its investors and insurers began to raise doubts over whether Greensill really did have the winning ticket after all.
In terms of the politics, this situation is, in a sense, a classic lobbying scandal. Cameron used his political relationships at the top of the Conservative government and civil service to request that Greensill be eligible for government cash and loans being used to prop up the economy amid COVID-19.
It gets worse though. Lex Greensill had actually been brought into the heart of Downing Street – without a formal employment contract – via links with then cabinet secretary, the late Jeremy Heywood. Greensill advised government on supply chain finance, before winning a government contract to deliver it.
And this is where things start to look particularly bad for Cameron. Greensill was already involved in the NHS, through pilots of its Earnd app, which allowed some NHS workers to be paid their salary in daily advances (in this scenario, health workers are the suppliers, and the NHS their clients).
In April 2020, amid the first wave of COVID-19 and intense pressure on the health service, Cameron is reported to have lobbied the government for access to NHS employment data so that Earnd could be rolled out nationally.
If this sounds daft, it is because it is daft. The NHS has no need for private finance to pay its workers or suppliers. Sovereign governments can create money to service their liabilities – and in fact do, as a matter of routine, without fiscal consequence.
Involving Greensill would bring enormous and unnecessary risks to NHS operations, since any disruption to the company’s payment processes would have been catastrophic. (Note the irony of supply chain finance introducing the risk of disruption into NHS supply chains – the polar opposite of what it is supposed to do.)
In practice, this means the government could not have allowed Greensill to fail. The company would have benefited from an implicit government guarantee, for no benefit whatsoever to the taxpayer. Moreover, a former Treasury minister has argued the government is likely to spend billions as a result of Greensill withdrawing financing from Liberty Steel. Whatever one thinks of Cameron’s behaviour, this is the real scandal. We need to roll back the fantasy accounting which distorts the economy – not allow it to distort the public finances.
