The Greensill debacle highlights areas which banks must scrutinise carefully when looking at supply chain finance.
Greensill Capital, the supply chain finance (SCF) group that boasted a $4bn valuation less than two years ago, recently filed for bankruptcy putting Credit Suisse, its primary banker, painfully in the spotlight.
Acting as an important link in the Greensill ecosystem, Credit Suisse sold invoices sourced by Greensill to its clients via a $10bn SCF fund. Such an arrangement allowed the bank to satisfy its clients’ demand for low-risk assets without getting into the operational details between companies using Greensill’s services and their suppliers.
While it would be unfair to totally reject the viability of this collaborative business model because of Greensill’s demise, there are urgent lessons to be learned.
The Greensill debacle highlights three key areas which banks must carefully scrutinise when looking to grow their business in the market – and especially if the banks outsource part of the value chain to third parties.
Business conduct
First, over-reliance on personal relationships is a major pitfall. As business-to-business companies, SCF operators must build strong relationships with large buyers. However, relying heavily on such individual relationships opens a business to significant risks, such as excessive exposure to a small number of clients, or bypassing risk management practices to cater for clients’ needs.
Banks must therefore ensure responsible risk management is enforced, not just within their own organisation, but also by the business partners of SCF companies.
In Greensill’s case, there were signs that it was facilitating irresponsible borrowing by its major clients, and these signs merited closer investigation. For example, the unusual ties with Tim Haywood, ex-fund manager at GAM; its complex relationship with Sanjeev Gupta and his GFG Alliance Group; and the arguably near-fraudulent “perspective receivables” financing scheme with Bluestone. Whether responding to client demand or motivated by Greensill’s own interests, such practices expose investors to excessive risk which banks should watch out for.
Transparency
Poor visibility of a fund’s composition is a further key issue. While putting assets from different companies into a fund could potentially help spread risk, diversification on paper does not equal true diversification of risk.
Greensill’s lawyer reported in court that the firm had approximately $5bn exposure to its largest client, GFG Alliance. This roughly amounts to half of the Credit Suisse Supply Chain Fund. However, according to fund disclosures by Credit Suisse, the largest borrower only accounted for 3-5% of the fund. These numbers clearly do not match, echoing previous news reports that Greensill may have used different loan names to disguise the connection between assets.
While it would be unfair to totally reject the viability of this collaborative business model because of Greensill’s demise, there are urgent lessons to be learned
As SCF deals with sophisticated business clients who are able to construct complicated structures for their own benefit, it is vital that banks conduct thorough due diligence on each of the assets in the supply chain. This includes analysing the untold connections between those assets.
Insurance
The third key pitfall bank executives must avoid is poor management of insurance policies. As SCF expands from super-safe buyers to riskier ones, credit insurance is increasingly purchased for additional security in case buyers fail to pay their bills. While credit insurance is useful, it cannot magically eliminate all risk.
One such associated risk is failure to renew existing contracts. The collapse of Greensill was directly triggered by Tokio Marine, Greensill’s major insurance provider, who refused to renew its coverage for Greensill. Tokio Marine had every right to do that. The blame lies with Greensill’s business practices, which were irresponsible (to say the least), and the bank’s failure to spot (or call a stop to) them earlier.
So it’s essential to probe for the truth. For example, why did Greensill choose Australian underwriter the Bond & Credit Company (BCC) to underwrite insurance on the majority of its portfolio, worth $7bn? The appointment pre-dated Tokio Marine’s acquisition of BCC, when its annual turnover was only around $10m. The choice is even more suspicious when the world’s top three specialist credit insurers, each with an annual turnover exceeding €1bn, are all conveniently located in Europe. These worrying signs suggest bank executives should have noticed and delved more deeply.
Another risk is policy cancellation. Unlike other insurance sectors, credit insurance generally allows insurers substantial flexibility to cancel policies during the coverage period.
Research indicates such cancellation options better incentivise insurers to provide policy-holders with valuable business intelligence; it could also undermine the security of SCF products. Therefore, it is important that bank executives and SCF professionals understand the details of credit insurance and choose cover which safeguards their clients’ particular interests.
Despite Greensill’s collapse, SCF deserves to survive and prosper for the benefit of business and society. But better controls are urgently required and banks must be keenly alert to the pitfalls.
Alex Yang is an associate professor of management science and operations at London Business School.
