Introduction
3.1
In March 2021, Greensill Capital filed for bankruptcy in what the New York Times described as ‘one of the most spectacular collapses of a global finance firm in over a decade’. The company, valued at US$3.5 billion two years earlier, was built largely on a form of business lending called Supply Chain Finance (SCF). Its collapse impacted international banks and businesses across the world, including in Australia.
3.2
It has been argued that the Greensill business model involved additional high-risk elements that set it apart from traditional SCF models. These included financing future receivables and Greensill’s use of trade credit insurance to underpin its securitisation of receivables which it then sold to financial services companies such as Credit Suisse.
3.3
Three years earlier in January 2018, the large United Kingdom (UK) construction management company, Carillion, collapsed with an estimated £7 billion in liabilities. The collapse raised questions about how the current accounting standards deal with the reporting of SCF. Some investors and credit ratings agencies argued that Carillion’s reporting of SCF obscured the true extent of its liabilities.
3.4
Although SCF is a long-established form of trade finance, its role in two different collapses has increased scrutiny over its use, its treatment under current accounting standards, and the finance entities that provide it.
3.5
Therefore, the committee decided to inquire into several aspects of SCF including:
the adequacy of the accounting standards pertaining to the disclosure of SCF in a company’s accounts;
whether there were likely to be any ramifications on the stability of Australia’s financial system from the Greensill collapse; and
whether certain riskier elements of the Greensill business model, which may have made it more vulnerable, were replicated in the operations of other SCF providers in Australia.
3.6
As part of its inquiry, the committee received five submissions and testimony from the Australian Finance Industry Association and two supply chain financiers, Octet Finance and Fifo Capital. The committee also received answers to questions on notice from the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), the Australian Finance Industry Association, Mr Lex Greensill, and the Gupta Family Group (GFG) Alliance.
3.7
This chapter begins with background information on SCF, including an explanation of SCF, the growth of SCF to facilitate trade finance, and the advantages of SCF. Next, the accounting standards for the reporting of SCF are considered. The chapter then looks at the Greensill collapse and its potential impact on the financial sector. It also considers the financial regulation of the credit provided by SCF companies and the financial regulation of the funding of SCF companies. The chapter concludes with the committee’s views.
Background on SCF
What is SCF
3.8
SCF is a generic term for instruments used to finance various parties in a supply chain. Typically, SCF involves a third party paying a supplier for goods and services on behalf of a buyer. The supplier of the goods or services has the option of receiving the discounted value of the receivables (represented by outstanding invoices) prior to their actual due date and typically at a financing cost aligned with the credit risk of the buyer. The buyer would repay the full invoice amount to the third-party funder by its due date.
3.9
Ms Diane Tate, CEO of the Australian Finance Industry Association, explained two types of SCF products, receivables finance (invoice factoring) and reverse factoring:
The first product is debtor finance or receivables finance. That involves the business receiving an up-front payment for their sales invoices, usually at a discount to the value of the invoices. This can be known as inventory finance or invoice factoring…
The second product is creditor finance, more commonly referred to as reverse receivables finance or reverse factoring. That's where businesses can settle their supplier invoices up-front and pay for them later based on their contractual terms. What this means is that the supplier receives the full value of the invoice for the goods and services, and the buyer gets some sort of fee or premium because of their ability to be given the cash or credit upfront. Sometimes this can be split across the supplier or the buyer.
3.10
Mr Clive Isenberg, founder and CEO of Octet Finance, noted that in reverse factoring, a financial institution approaches a buyer and offers credit to procure a receivable from the supplier to be paid within a set term. Once agreed, the buyer cannot dispute that invoice.
3.11
Mr Wayne Morris, CEO of Fifo Capital, considered SCF to be either dynamic discounting or reverse factoring, not invoice financing because invoice financing is a debt product to a supplier (typically led by the supplier), whereas SCF is led by the buyer.
Growth of SCF to facilitate trade finance
3.12
About 80 per cent of international trade is financed by some form of trade finance. In Australia, before the global financial crisis, banks were the primary lenders of working capital or trade finance, including SCF. After the global financial crisis, banks withdrew from the SCF market due to the increasing complexity of operations (especially if done manually) and increasing capital requirements. Non-bank lenders (shadow banks), including those with technology-based solutions, entered the SCF market to help address the financing gap for business.
3.13
Mr Isenberg noted that SCF became more prevalent during the global financial crisis when Chinese suppliers stopped providing credit terms to Australian importers and began to demand payment on shipment.
3.14
In 2018–19, PwC found that SCF use is widespread globally, with over 50 per cent of companies running an SCF program. The global user market for SCF in 2018 was approximately USD 400 billion in payables volume, equating to an amount outstanding at any point in time of USD 166 billion based on a 105-day financing period.
3.15
Nevertheless, the scale of SCF in Australia is limited. Only 7 per cent of large Australian companies used SCF in 2017, compared to 65 per cent of European companies with revenues over $750m.
Advantages of SCF
3.16
This section summarises some of the advantages that SCF can offer the supplier and the buyer in a trade relationship, including optimising working capital and liquidity, greater security of payment for the supplier, and lower fees.
Optimising working capital
3.17
In essence, SCF allows purchasers and suppliers to optimise the management of working capital and liquidity tied up in the supply chain process by allowing the purchaser the full term to pay the invoice, while the supplier collects discounted receivables much earlier. Mr Isenberg explained that suppliers are paid faster, while buyers can use agreed and consistent payment times to manage short-term cashflow and working capital.
3.18
As part of the discussion around the role that SCF can play in meeting the needs of both the supplier and the buyer, Mr Isenberg addressed the issue of extended payment terms. In doing so, he distinguished between Australian buyer / Australian supplier arrangements and the significant number of Australian buyer / international supplier arrangements. Mr Isenberg pointed out that the general trend in China is payment on shipment, and that goods from China would not arrive in Australia in 30 to 60 days. Therefore, a 120-day payment term would cover the time it takes the buyer to receive the goods, put them on the shelf, and sell them.
Security of payment for the supplier
3.19
Fifo Capital argued that, unlike other debt or equity-based finance, SCF is non-recourse for the supplier. This means the supplier has no obligation to pay the money back to the financier if the buyer ceases to trade.
3.20
In the case of the Carillion collapse, Fifo Capital noted that suppliers using SCF were paid. In contrast, other suppliers not on the SCF program would have become unsecured creditors and may not have been paid. And, if they had factored their invoices, they would have been liable for that debt.
Lower fees for SCF
3.21
The fees charged to SCF customers vary depending on factors such as the credit risk of the borrower, the length of the payment terms, the margin that the provider assigns to cover its expenses, and the costs of the insurance.
3.22
However, the fees for SCF can be lower than other types of business finance:
Business credit card13–14 per cent
Supply chain finance2–7 per cent
3.23
Mr Morris noted that the rates for a SCF product are typically lower ‘simply because the product of the business in question is the buyer and a bigger buyer typically has a better credit profile than a smaller business’. He explained that the fees for financing an invoice for 30, 60 or 90 days would be one to three per cent, but for a whole of book (that is, every invoice), four to eight per cent per annum.
3.24
Likewise, Mr Isenberg observed that reverse factoring is highly competitive compared to alternatives such as bank overdrafts, revolving corporate credit cards or general bank lending that is typically secured against company or personal property.
Advantages for the provider of SCF
3.25
SCF also provides advantages for the third-party financer. First, SCF is short-term transaction-based finance based on the credit of a prime buyer. Second, trade finance is a ‘sticky business’ as both buyers and suppliers are repeat customers. Third, the funding is uncommitted and largely unregulated, so funders have low liquidity requirements. Fourth, the short timeframe of the funding allows funders to re-price or vary their level of involvement in the market quickly if economic circumstances change. Fifth, the funding risks are relatively low, and, arguably, profit margins are healthy. Finally, the deep knowledge that funders and platforms gain about buyers and suppliers may offer significant cross-selling opportunities.
Accounting standards for the reporting of SCF
Carillion collapse and the accounting standards for the reporting of SCF
3.26
As noted in the introduction, the collapse of Carillion shone a spotlight on how SCF should be reported in a company’s financial accounts ‘because investors and credit rating agency, Moody’s Investor Service, did not see the collapse coming’.
3.27
Fifo Capital noted that Carillion ‘opted to report supply chain finance as part of their accounts payable’. However, Carillion’s aggressive business model ‘meant the financier was buying large amounts of supplier invoices for Carillion to pay later’. Fifo Capital observed that ‘because the financier’s debt remained as a trade payable’ Moody’s and investors ‘did not see it’.
3.28
In other words, Carillion’s financial statements did not adequately demonstrate the liquidity risk and the nature of the different categories of trade and other payables. In the interests of transparency, Fifo Capital stated that in such circumstances, a company’s use of SCF:
…should be either reported under liabilities as a short-term debt by the buyer or, the buyer should disclose that supply chain finance is being used and identify what portion of the trade creditors are financed.
3.29
That said, Fifo Capital also argued that a close inspection of Carillion’s accounts would have revealed that the account payable days ‘had pushed out significantly’. Fifo Capital pointed out this was a sign that Carillion was:
…paying later and that their payables ledger was showing considerably more debt past 90 days, both good indicators something of significance had changed compared to previous annual statements.
3.30
Mr Morris also stated that Carillion was another example of audit failure because the external auditors failed to inquire into why Carillion’s trade payables had increased so significantly. He told the committee that a basic inquiry would have revealed the existence of an SCF program.
Current accounting standards for the reporting of SCF
3.31
This section looks at the reporting requirements under the current accounting standards for companies using SCF. In doing so, it considers recent work by international accounting standards boards, a submission by Moody’s Investor Services (Moody’s), and recommendations made by the Australian Small Business Ombudsman.
International accounting standards for the reporting of SCF
3.32
Under the International Accounting Standards, entities should present trade and other payables separately from other financial liabilities. The liabilities of a buyer using SCF should be presented:
within trade and other payables;
within other financial liabilities; or
as a line item separate from other items in its statement of financial position.
3.33
In January 2020, credit rating agency Moody’s made a submission on accounting standards for SCF to the International Financial Reporting Standards Foundation Interpretations Committee (IFRS Interpretations Committee). Moody’s submission included research showing fewer than five per cent of the entities that Moody’s rated disclose their use of SCF and its impacts on their financial statements.
3.34
Moody’s noted several concerns with the current absence of SCF reporting because of the material impact SCF can have on a company’s liquidity and liabilities:
it is difficult for users of financial statements to compare companies using SCF with companies that do not use SCF;
disclosure of the type of SCF a company uses would enable users of financial statements to consider the different consequences of various types of SCF;
SCF arrangements can obscure the nature of debt-like liabilities;
default risk is obfuscated without adequate disclosure;
the irrevocable payment undertakings by the buyer to the SCF provider may increase obligations on the buyer relative to a trade invoice; and
SCF providers may be able to take advantage of having greater visibility of companies’ financial health than other creditors.
3.35
Considering the above, Moody’s submission asked the IFRS Interpretations Committee for guidance on:
how an entity presents liabilities to pay for goods or services received when the related invoices are part of an SCF arrangement; and
what information about SCF an entity is required to disclose in its financial statements.
3.36
In December 2020, the IFRS Interpretations Committee decided not to add a standard-setting project to the work plan, concluding:
…the principles and requirements in IFRS Standards provide an adequate basis for an entity to determine the presentation of liabilities that are part of reverse factoring arrangements, the presentation of the related cash flows, and the information to disclose in the notes about, for example, liquidity risks that arise in such arrangements.
3.37
However, several respondents to the above decision by the IFRS Interpretations Committee provided input on a possible standard-setting project by the International Accounting Standards Board (IASB) on SCF arrangements.
3.38
For example, the United Kingdom Financial Reporting Council (UK FRC) noted the gap between the prevalence of SCF transactions and the information disclosed in financial statements. The UK FRC was concerned that the IFRS Interpretations Committee decision was not sufficient to improve reporting quality and proposed the IASB conduct a narrow-scope standard-setting project.
3.39
In June 2021, the IASB proposed amendments to the international accounting standards to:
describe supplier finance arrangements in a manner that captures the characteristics of such arrangements that give rise to the particular information needs of users of financial statements;
add a disclosure objective for an entity to disclose information about its supplier finance arrangements that enables users of financial statements to assess the effects of those arrangements on the entity’s liabilities and cash flows;
add requirements for entities to disclose:
the terms and conditions of each supplier finance arrangement;
the financial liabilities and due dates for each supplier finance arrangement at the beginning and end of the reporting period;
the range of payment due dates of trade payables that are not part of a supplier finance arrangement; and
adding supplier finance arrangements as an example within the liquidity risk disclosure requirements.
3.40
In November 2021, the IASB issued an exposure draft of proposed amendments to the accounting standards intended to enhance the transparency of supplier finance arrangements. Comment on the exposure draft was due by 28 March 2022.
3.41
The Australian Accounting Standards Board (AASB) told the committee it would consider whether to provide views on the proposals to the IASB. Amendments to the existing IFRS Standards could be issued late in 2022 at the earliest, following consideration by the IASB of the responses received to the proposals in the exposure draft.
3.42
The AASB stated it expected to make the same amendments to the Australian Accounting Standards to maintain compliance with IFRS Standards. The mandatory application date for such amendments would be as determined by the IASB.
United States accounting standards for the reporting of SCF
3.43
The United States (US) operates under accounting standards set by its Financial Accounting Standards Board (FASB) rather than the IASB. The US FASB recognised that ‘no explicit requirements currently exist in the Codification to disclose information about supplier finance programs’.
3.44
In October 2020, the US FASB began a project to develop disclosure requirements that enhance the transparency of the use of supplier finance programs in response to stakeholder feedback from analysts, ratings agencies and the Big Four accounting firms:
Many financial statement users, including analysts and ratings agencies, have advocated for increased disclosure of qualitative and quantitative information about supplier finance program obligations. The Board also received an agenda request from the Big Four accounting firms on aspects of the accounting and disclosure for supplier finance programs.
3.45
In September 2021, the US FASB decided to consult on a proposed Accounting Standards Update covering:
buyer disclosure of roll-forward of the amount confirmed by the buyer that is outstanding at the end of the reporting period; and
the disclosures for each period in which a balance sheet is presented.
Australian accounting standards for the reporting of SCF
3.46
During its review of SCF, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) noted that SCF could blur the distinction between trade creditors and debt in a company’s financial accounts. Given that SCF alters a company’s cash flows and liquidity risk, the ASBFEO recommended that the accounting standards provide greater clarity and properly cover SCF to ensure that accounts cannot be manipulated, especially to mask cash flow issues and insolvency. Amongst other things, the ASBFEO recommended:
the AASB provide further education on guidance notes, including that companies must address SCF in financial reporting; and
the ASX should provide further directives to companies about disclosure of SCF offerings.
3.47
The AASB provided the following information on the implications of SCF for transparency in financial reporting and accounting standards:
The principal judgements to be made by an entity with such financing arrangements in preparing its financial statements in compliance with Australian Accounting Standards are as follows:
(a)
whether to present liabilities under such arrangements in the statement of financial position as trade payables or instead as a different type of financial liability (AASB 101 Presentation of Financial Statements);
(b)
whether to classify cash flows arising under the arrangement as cash flows from operating activities or cash flows from financing activities (AASB 107 Statement of Cash Flows); and
(c)
whether additional disclosures are needed in relation to liquidity risk –that is, the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities (AASB 7 Financial Instruments: Disclosures). Supply chain financing arrangements often give rise to liquidity risk by concentrating a portion of an entity’s liabilities with one financial institution rather than a diverse group of suppliers.
An entity would consider disclosing the effects of supply chain financing arrangements separately in its financial statements when the size, nature or function of those liabilities makes separate presentation relevant to an understanding of the entity’s financial position, financial performance and cash flows.
3.48
The ASX referred the ASBFEO recommendation to the ASX Corporate Governance Council (CGC) for consideration as part of the next review of its Corporate Governance Principles and Recommendations (CGPRs). At the time of writing, the current CGPRs which were released in February 2019 and came into effect on 1 January 2020 had not been updated to include guidance to companies on SCF disclosures.
The Greensill collapse and its potential impact on the financial sector
3.49
This section gives a brief overview of Greensill’s corporate structure and operations, its business model, and its collapse. The section ends with information on the inquiries and investigations into the Greensill collapse and their conclusions on its broader impact on the financial system.
Corporate structure and operations
3.50
Greensill Capital Pty Ltd was the Australian parent company of the Greensill Group and provided administration and head office support to the group. Greensill Capital (UK) Limited, a company registered in England and Wales, was a wholly owned subsidiary of Greensill Capital Pty Ltd. It was the primary operating business of the group, responsible for the securitisation arrangements of the group and lender to the Australian and global clients in the SCF arrangements.
3.51
Mr Lex Greensill CBE, the founder of Greensill Capital, advised the committee that Greensill Capital Pty Ltd was not involved in any regulated activity related to SCF in Australia. However, he noted that Greensill Capital (UK) Limited provided working capital finance solutions across a broad range of products both globally and in Australia, including some types of SCF:
debt solutions: instalment payment agreements, invoice extension solutions;
payables solutions: virtual card programs, supplier early payment;
receivables solutions: securitisation, data-driven portfolio financing solutions, debtor receivables financing, and contract monetisation;
inventory solutions: inventory finance, purchase order finance; and
employee pay on-demand solutions.
3.52
Greensill’s global operations included:
between 200 and 300 contracted business customers (in the pinch point in between the purchase and sale of goods and services) with millions of participating businesses in 150 countries;
funding $143 billion worth of receivables in both 2019 and 2020; and
selling assets to 52 banks.
Higher risk features of the Greensill business model
3.53
The committee received evidence that the Greensill business model combined some traditional aspects of SCF with higher risk activities including the insurance and securitisation of receivables, and the funding of future receivables.
3.54
Ms Karen Chester, ASIC Deputy Chair, described some of these elements to the committee in March 2019. Essentially, Greensill:
insured the receivables owed to them by the purchaser;
packaged the insured receivables into securities; and
sold the securities to investment funds, which offered them to wholesale investors.
3.55
ASIC also told the committee that the Greensill business model involved dealing with higher risk businesses and an undiversified portfolio with exposure to large invoices from a small number of underlying entities and businesses.
3.56
Octet Finance submitted that Greensill’s questionable use of trade credit insurance was a contributing factor in its downfall:
Greensill, its primary financier Credit Suisse, and its credit insurers Bond & Credit Company, IAG, and Tokio Marine, engaged in unacceptable underwriting practices; and
Greensill used trade credit insurance cover as its front-line credit risk process, rather than as a risk-mitigation tool.
3.57
Similarly, Fifo Capital argued that the claims Greensill made to investors about its use of trade credit insurance were poorly founded:
Greensill positioned credit insurance as underpinning their bonds to investors, such that in the event of a collapse of a client, the investor’s funds were safe. This was an exaggerated claim. Credit insurers such as Bond & Credit Co provide insurance for certain ‘trigger events’, they are not a total disaster policy.
3.58
Octet Finance also pointed to other risky features of the Greensill business model, noting that:
more than half of all outstanding receivables financed by Greensill were for related-party transactions; and
Greensill obtained financing from one of its investors and in turn used this to finance the investor’s own poor-performing affiliates.
3.59
Other aspects of the Greensill business model also drew attention. For example, the UK Treasury Select Committee questioned Mr Greensill about his company’s use of future and prospective receivables.
3.60
Future receivables relate to predicted receivables based on a client’s current customers with a regular spend pattern. Eleven per cent of Greensill’s business in 2020 related to future receivables. Seventy-three per cent of Greensill’s future receivables were sold to Greensill Bank in Germany.
3.61
Mr Greensill indicated that the nature of future receivables was fully disclosed to investors and the lending was secured against real assets. Mr Greensill argued that funding future receivables was a widely used practice.
3.62
Octet Finance’s submission was scathing about the reported use of lending against future receivables, describing it as ‘akin to financing vapor’.
3.63
Octet Finance concluded that the unique features of the Greensill model had nothing to do with traditional forms of SCF ‘and would not (and should not) be considered acceptable in a transparent, well-functioning SCF industry’.
3.64
The views of Octet Finance and Fifo Capital on the Greensill business model and its particular application of trade credit insurance are apt given that, as set out below, Mr Greensill appeared to place the blame for the Greensill collapse on the actions of one of its insurers.
The collapse of Greensill
3.65
A group of insurers insured $4.6 billion of Greensill’s working capital. Mr Greensill told the committee that the collapse of Greensill was triggered by the loss of trade credit insurance:
The removal of a vital line of trade credit insurance, however, was a principal driver of the Greensill Group’s collapse. Insurance cover was withdrawn by one provider despite many months renegotiating policy terms in good faith.
3.66
In July 2020, Greensill’s major insurer, Tokio Marine, announced it would cease providing coverage. The decision came after Tokio Marine discovered that an employee at one of its subsidiaries had provided coverage that exceeded its risk limits. Greensill tried to obtain an extension of the coverage, including taking legal action against the insurers in March 2021, but was unsuccessful. Greensill was unable to secure insurance from other firms.
3.67
In March 2021, Credit Suisse froze funds invested in Greensill financial products and held by its supply-chain investment funds. Credit Suisse's concerns about the funds came to a head because the insurance policies covering defaults in a portion of its assets lapsed.
3.68
Greensill Capital (UK) Limited entered administration in the UK on 8 March 2021. Greensill Capital Pty Ltd entered administration on 9 March 2021 and was placed into liquidation on 22 April 2021.
3.69
ASIC indicated that the parties affected by the collapse of Greensill may include:
400 suppliers which may face cash-flow and financing disruption;
Australian corporate purchasers which may owe up to $1.45 billion to Greensill;
some Australian wholesale clients invested in Greensill’s bond funds;
equity and debt investors in Greensill Capital Pty Ltd;
depositors in the German-based Greensill Bank;
investors in securities issued by Greensill Capital (UK) Ltd and subsidiaries, including:
Credit Suisse managed fund investors, and
the GAM supply chain financing fund (domiciled in Luxembourg).
Impact on the financial system
3.70
The Greensill collapse raised questions about potential systemic risks to the financial sector.
3.71
The UK Bank of England Prudential Regulation Authority (UK PRA) recognised two ways a firm or sector could affect financial stability:
if a firm or sector plays such a significant role in the provision of credit to the real economy, that disruption to that firm or sector could result in a disruption to the supply of credit to the real economy as a whole; or
the firm or sector has a high degree of interconnection with other parts of the financial system, so that problems with the firm or sector would lead to amplification dynamics that worsen a shock.
3.72
The UK PRA noted that several SCF providers, including banks, were able to lend through the COVID-19 pandemic crisis. The UK PRA also indicated that the failure of Greensill had not posed a threat to the stability of the UK financial system or the soundness of PRA regulated firms:
Analysis of UK banks’ and insurers’ exposures to Greensill and its clients and suppliers indicated that, while there were likely to be implications for particular clients, these were manageable by the relevant PRA regulated firms.
Beyond the impact on a particular grouping of clients, which has been widely reported on, we have not found evidence of a broader disruption to corporate clients of Greensill, following the collapse of the firm.
While the data available suggested overall losses across the system might be limited, the effect on the real economy could be increased if there were knock-on effects on confidence or contagion. These risks have not crystallised to date.
3.73
The UK Financial Conduct Authority agreed with the UK PRA’s assessment that the Greensill entities were not systemically important for UK financial stability.
3.74
With respect to the Australian financial system, APRA informed the committee that:
the trade finance, SCF and trade credit insurance markets are not of sufficient size to pose a risk to the stability of the Australian financial system; and
the collapse of Greensill does not pose a systemic financial stability risk to Australia.
3.75
Beyond the potential impacts on the financial system, broader questions arose about the economic impacts of the Greensill collapse, given reports of the intertwined business relationship between Greensill and the GFG Alliance.
3.76
The GFG Alliance told the committee that ‘GFG Alliances’ Australian operations do not use supply chain financing’ and that discussions to secure alternative long-term funding for the Whyalla Steelworks had been prioritised.
Financial regulation of the credit provided by SCF companies
3.77
Questions have arisen in both Australia and the UK regarding the global growth of non-bank financial intermediation, as well as about the adequacy and appropriateness of the financial regulatory settings for SCF.
3.78
Providing SCF in Australia does not require an Australian Financial Services Licence and is not a credit activity requiring an Australian credit licence. Similarly, there are no specific regulatory regimes for SCF in jurisdictions such as the UK, the US, and New Zealand.
3.79
While Australia does not have any self-regulatory codes of practice for SCF, the Australian Industry Finance Association has discussed with its members whether to set standards for SCF.
3.80
In its review of SCF, the ASBFEO expressed the view that using technology platforms to facilitate working capital between suppliers and buyers effectively creates a market, and that a financial product includes a facility through which a person manages financial risk. The ASBFEO argued that:
it is reasonable to consider that SCF is a financial product as the buyer is managing the risk of their trade payables;
this raises questions about whether an unregulated financial market is in operation; and
as SCF is driven by technology as the vehicle for the flow of capital, this emerging market in Australia requires the relevant regulatory bodies to have appropriate oversight of its operation.
3.81
The ASBFEO recommended that Treasury and ASIC review whether SCF should be a regulated financial product with coverage of rate setting.
3.82
On 9 April and 30 June 2021, ASIC and Treasury respectively told the committee that the ASBFEO recommendation regarding whether SCF should be a regulated financial product was a matter for Government, and that ASIC had not taken any action other than discussing it with Treasury. At the time of writing, the Government had not responded to the ASBFEO review.
3.83
However, the conclusion reached by several bodies in the UK (including the UK Financial Conduct Authority (FCA), Chancellor of the Exchequer, Permanent Secretary of the UK Treasury, and the UK Treasury Select Committee) was that the failure of Greensill Capital did not show a need to bring SCF within the regulatory perimeter for financial services.
Financial regulation of the funding of SCF companies
3.84
The funding of SCF companies is regulated under the applicable laws for the relevant type of funding, for example, credit, securities, securitisation, collective investment vehicle or banking laws.
3.85
In Australia, APRA regulates and prudentially supervises some Authorised Deposit Taking Institutions (ADIs) that provide SCF, and some general insurers that offer trade credit insurance. APRA has not made any prudential, or other regulatory changes that directly affect SCF markets recently.
3.86
Non-bank providers of SCF are mainly non-ADI finance companies that raise funds from wholesale markets using debentures and unsecured notes from investors. Non-ADI finance companies are supervised and regulated by ASIC and are required to meet disclosure, licensing, and conduct requirements.
3.87
While APRA does not prudentially regulate non-ADI finance companies, it has reserve powers to impose rules over non-ADI lenders that may pose a material risk to financial stability. These reserve powers enable APRA to:
make rules in respect of the lending activities of non-ADI lenders, should these activities be materially contributing to risks of instability in the Australian financial system; and
monitor the non-ADI lending sector and determine if non-ADI lenders will need to register and provide data to APRA.
3.88
APRA informed the committee that:
it was not aware of any specific liquidity or other challenges experienced by ADIs or insurers involved in SCF or trade credit insurance during the COVID-19 pandemic;
it does not hold data on how SCF is distributed between the ADI banks and non-ADI finance companies in Australia or how that distribution has changed over time; and
securitisation of SCF would not be considered material for Australian ADIs, and APRA does not hold data on structured financing or trade credit insurance for SCF in Australia.
3.89
In Australia, there is no specific legislative regime governing securitisation. Transactions are subject to the corporations law, competition and consumer protection laws, and contractual, trust and equitable principles. The RBA website lists the supervisors and regulators for most types of financial institutions but does not identify a supervisor or regulator for securitisers.
3.90
The UK Treasury Select Committee received evidence that Greensill’s securitisation activities were outside the formal definition of securitisation in the UK securitisations regulations because there was no tranching of risk. The UK Treasury Select Committee suggested that the UK FCA and Treasury consider whether the definition of securitisation should be revised to include the type of securitisation used by Greensill.
3.91
The Australian Finance Industry Association indicated that funding of SCF through securitisation is rare in the Australian market.
Broader issues in SCF
3.92
Octet Finance proposed a range of factors in SCF as it is currently conducted in Australia that deserve greater scrutiny:
many SCF providers take general security deeds over all of a suppliers receivables, rather than just the receivables they financed, without the suppliers’ specific consent;
some SCF providers promise suppliers immediate payment, but are not transparent about the time taken for buyer inspections and approval of goods;
small suppliers being takers of prices, terms and conditions due to the market power of large buyers and SCF providers; and
SCF providers offering buyers credit terms much longer than industry standards.
3.93
Octet Finance was of the view that SCF providers should not be allowed to take general security deeds over all a supplier’s receivables, and that there should be greater transparency over the time taken for buyer inspections and approval of goods.
Committee view
3.94
A corporate collapse in the financial sector typically draws attention to several factors. These may include the entity’s business model and practices, the extent to which that business model and practices are replicated in other companies, the risk of financial contagion and whether the collapse poses a systemic risk, and the adequacy and appropriateness of the relevant regulatory settings.
3.95
Following the collapse of Greensill, the committee inquired into the above matters. And given Greensill was built largely on a form of SCF and Carillion’s reporting of SCF was questioned after its demise, the committee looked at various aspects of SCF. This included the adequacy of the accounting standards as they relate to the disclosure of SCF in a company’s accounts, whether there were likely to be any ramifications on the stability of Australia’s financial system from the Greensill collapse, and whether the riskier elements of the Greensill business model were replicated in the operations of other SCF providers in Australia.
Accounting standards
3.96
One of the lessons from the collapse of Carillion is that Carillion used the option available under the current accounting standards to report SCF as a trade payable rather than as a short-term debt. The Australian Accounting Standards Board noted that an entity may consider disclosing the effects of SCF arrangements separately in its financial statements when the size, nature or function of those liabilities makes separate presentation relevant to an understanding of the entity’s financial position, financial performance and cash flows. This suggests the current accounting standards allow an entity significant discretion in how to report on its use of SCF.
3.97
And yet the Australian Accounting Standards Board has warned that SCF arrangements often give rise to liquidity risk by concentrating a portion of an entity’s liabilities with one financial institution rather than a diverse group of suppliers. The committee notes these risks are likely to increase if an entity adopts an aggressive financial strategy. Further, the lack of adequate disclosure around SCF arrangements can obscure the nature of debt-like liabilities.
3.98
The available evidence indicates that globally, reporting on the use of SCF by companies in their financial accounts is poor. As a result, it is difficult for the users of financial accounts to understand how SCF affects company liabilities, liquidity, and ratings. While the SCF market in Australia is less developed than in Europe and the US, users of financial reports face the same challenges.
3.99
The committee is of the view that the reporting of SCF needs to be clearly and simply documented. To that end, the committee welcomes the proposal put forward by Fifo Capital that SCF should either be reported under liabilities as a short-term debt by the buyer, or the buyer should disclose that SCF is being used and identify what portion of the trade creditors are financed through SCF.
3.100
The committee notes that the US and international accounting standards boards are consulting on proposed amendments to the accounting standard for reporting the use of SCF in a company’s financial accounts. The committee expects the amended standard will reduce opacity. Greater transparency will benefit multiple stakeholders, including the preparers of the financial accounts, the users of those accounts, ratings agencies, and auditors.
3.101
The committee does not anticipate any need for a change to the auditing standards. Instead, the committee expects that the judgments exercised by auditors will flow through from the new accounting standards. However, for that to occur, the new accounting standards may need to provide a level of prescription that reduces the need for auditors to make judgments. Importantly however, while changes to the standards for disclosing the reporting of SCF are welcome, this does not absolve auditors of the need to exercise sufficient scepticism and push back against large companies if disclosure is inadequate. And finally, as witnesses to this committee pointed out, investors and ratings agencies should pay attention to instances where an entity extends its payable terms beyond the industry norm.
Uniqueness of the Greensill business model and systemic risks
3.102
The committee notes that SCF is not a standardised activity and that it includes both bank and non-bank lenders. Nevertheless, evidence to the committee indicates several features of the Greensill business model were both unique and high risk.
3.103
For example, Greensill’s use of trade credit insurance and the underwriting practices associated with some of it were questionable. The committee also heard evidence that Greensill made exaggerated claims about the extent to which its trade credit insurance protected the securitised bonds that were sold to investors against loss. ASIC told the committee that the Greensill business model involved dealing with higher risk businesses and an undiversified portfolio with exposure to large invoices from a small number of underlying entities and businesses. The committee also heard that more than half of all outstanding receivables financed by Greensill were for related-party transactions, and that eleven per cent of Greensill’s business in 2020 were for future receivables.
3.104
The committee is reassured by evidence from two SCF providers in Australia as well as the Australian Finance Industry Association that they were not aware of these aspects of the Greensill business model being replicated by SCF providers in Australia.
3.105
The committee notes the UK Bank of England concluded the collapse of Greensill did not pose a significant systemic risk to the UK financial system. Given the scale of Greensill’s operations in Australia was limited, APRA considered the collapse of Greensill did not pose a systemic financial stability risk to Australia. The committee agrees with APRA’s conclusion.
3.106
Finally, the committee observes that the intertwined business relationship between Greensill and the GFG Alliance raised concerns about the potential economic impacts of the Greensill collapse on businesses in Australia such as the GFG Alliance steelworks in Whyalla. The committee notes that, at present, the GFG Alliance appears to have negotiated alternative sources of finance.
Adequacy of the regulatory settings
3.107
The committee acknowledges the reassurance received from the Australian Finance Industry Association that the SCF industry has good counterparty risk assessment, good portfolio management and good underwriting standards. The committee also welcomes assurances from the Australian Finance Industry Association and SCF providers such as Octet Finance that the financing of future receivables is not representative of SCF in Australia. The committee considers the consultation process that the Australian Finance Industry Association has begun with its members around an industry code for SCF is a welcome development.
3.108
In conclusion, while certain activities undertaken by Greensill were high risk and unwise, they appear unrepresentative of the activities conducted by SCF providers in Australia. The committee did not receive evidence to suggest the current regulatory settings for SCF need adjusting.