EU payment regulation shake-up could boost supply chain finance in certain countries

The liquidity crunch caused by the credit crisis made corporates look for ways to optimise their supply chain without tying up too many funds for their working capital needs. This resulted in many larger companies extending their payment terms to prevent cash being tied up in their day-to-day operating cycles. An extended payment term helps in achieving efficient working capital management that is critical for many companies to manage financing as well as serving as a barometer for long-term health.

However, extended payment terms are to be regulated by the EU late Payments Directive, (the implementation deadline was 16 March, 2013) that limits the time companies can take to make payments in commercial transactions.

This directive is widely viewed as an aid to small and medium-sized enterprises (SMEs), because it will limit the impact of so-called ‘late’ payments in an effort to free up hard-to-obtain working capital.

On the flip side, cutting payment terms could have huge implications on the operating cycle of purchasing companies, effectively increasing debt and reducing short-term liquidity.

Facing the impact of the new EU late Payments Directive, supply chain finance can serve as an effective solution. It enables purchasers to continue benefiting from extended payment terms while freeing up liquidity for suppliers at an early date, and frequently at a rate of interest far superior to the supplier’s own.

The power of supply chain finance as a solution to ‘late’ payments has even been recognised by authorities, as evidenced by UK Government recommendations to accelerate its adoption.

In May 2012, the UK Government gathered a number of leading global banks – including RBS – to promote supply chain finance as a vehicle to support liquidity for small and medium enterprises (SMEs). In October 2012, UK Prime Minister David Cameron launched an initiative on this. He described it as a ‘win-win’ and hoped that up to GBP20 billion of cheaper finance would be made available because of this programme. So far big names like Balfour Beatty, Rolls Royce, Tesco and Vodafone have already signed up, with many others intending to back it.

The recent actions undertaken by some member states in the EU support our initial expectation that different countries would take different approaches in implementing this directive. For example, the Netherlands has set the payment period at a maximum of 30 days for private and public transactions and a maximum of 60 days for transactions between private parties. Sweden has kept a maximum of 30 days between private parties (unless agreed otherwise) while there is no extension for public parties. Some countries, on the other hand, are already managing the payment terms under similar laws (France, for example, has the ‘LME law’ that restricts the payment terms to 60 days). 

 

The EU sees ‘late’ payments in commercial transactions as a major problem, in particular what the commission regards as large buyers forcing SMEs to accept payment terms detrimental to their working capital and cash flow.

These concerns have risen in recent years as the level of working capital has increased.

In the UK, for example, money owed to suppliers rose by 27 per cent in the two years to the end of 2011, reaching GBP113.1 billion (see chart above).

This increase in payables is seen as particularly damaging for SMEs. As many large corporates have payment windows of more than 100 days with their suppliers, UK SMEs are now owed an all-time-high GBP33.6 billion by buyers (according to the Forum of Private Business). In addition, there is also a knock-on effect, with more than 60 per cent of small companies admitting that they in turn delay paying their suppliers.

To tackle late payments, especially in cases where it is seen that the buyer is procuring additional liquidity at the expense of the creditor, the EU published Directive 2011/7/EU ‘On combating late payment in commercial transactions’.

It will limit payment periods in commercial transactions between two or more European companies to 60 days, but extensions can be agreed if they are not grossly unfair to the creditor and are in line with good commercial practice. In addition, invoices will have to be settled within 30 days if no period is set. Though all the EU member states were expected to enact laws enforcing the Directive by 16 March 2013, only a few of the countries – like The Netherlands, Denmark, Sweden, Italy and Lithuania – incorporated the necessary and required changes into related laws before the deadline.

While nothing has explicitly been stated on this, it is safe to assume, given the political nature of the issue, that large companies forcing suppliers to agree to extend payment terms beyond 60 days, without the ability to receive funding earlier via supply chain finance, will be viewed as ‘grossly unfair’.

The Commission estimates its Directive will free up the equivalent of an extra GBP150 billion for businesses across Europe by improving cash flow and reducing SME exposures to late payment negotiations with larger customers.

The downside will be felt by corporates which currently benefit from extended payables but which may now experience disruptions to operating cycles and a drop in liquidity.

Also, few companies are likely to admit to such behaviour. Some may look at using suppliers from outside the EU, beyond the reach of the Directive.

Supply chain finance promotes efficient working capital management to purchasers, frees up liquidity for suppliers, and incentivises purchasers tocontinue to source from the European area.

While supply chain finance has not been referred to as a clear solution within the EU Directive itself, and we expect there will be differences in interpretation between countries, the UK Government example shows supply chain finance is certainly being considered as an alternative solution to decreasing payment terms.

As shown in the graph above, supply chain finance is a structured receivables discounting program that allows suppliers the option to discount receivables against a buyer. Suppliers can obtain liquidity at an earlier date – frequently at a rate of interest far superior to the supplier’s own.

Compare the situation of two suppliers:

Supplier A sells to the Buyer at 60-day terms as stipulated by the EU Directive. It has to finance itself from its liquidity sources at an interest rate of 8 per cent p.a.

Supplier B also funds at 8 per cent p.a. and joins the same buyer’s supply chain finance programme. By taking part in this programme, supplier B agrees to 90-day payment terms, but then also elects to receive their cash in five days, discounted to the buyer’s superior funding cost of 3 per cent p.a.

Though supplier B has longer standard payment terms, the ability to discount receivables at a better rate means it is much better off than supplier A – in this case by about 0.5 per cent of notional.

Supply chain finance also removes the payment risk from the supplier’s balance sheet, and in addition reduces the need for expensive insurance cover. In fact, we have experienced a number of cases where a supplier has applied for bankruptcy, the court has allowed the funds received under a supply chain finance program to remain separated from the pool of assets while restructuring the company out of bankruptcy.

Further, our experience in the business has revealed that suppliers who are part of a supplier finance transaction often enjoy a preferred status.

We believe that there is sufficient room to suggest that the treatment of supplier B in its commercial relationship with the buyer cannot be seen as “grossly unfair”. With this reasoning, buyers should be able to maintain payment periods beyond 60 days and yet comply with the EU Directive.

RBS can help you to structure the best supply chain financing solution for your organisation and your suppliers. With a team of supply chain finance advisors and specialists dedicated to supply chain finance for implementation, system integration, supplier on-boarding and processing, the bank is at the forefront of the business. The industry acknowledges our position: RBS has been named “Best Supply Chain Finance Bank in Europe” for the last three years in a row, and has won the “Global Best Implementation of a Supply Chain Finance Deal” award twice in this period.

RBS also offers a full analysis on how to optimise your company’s working capital, from cash-to-trade solutions, and can help find the best solution for your organisation. 

For more RBS Insight content, click here

Disclaimer

The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc (“RBS”) will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed.

Where the document is connected to Over The Counter (“OTC”) financial instruments you should be aware that OTC derivatives (“OTC Derivatives”) can provide significant benefits but may also involve a variety of significant risks. All OTC Derivatives involve risks which include (inter-alia) the risk of adverse or unanticipated market, financial or political developments, risks relating to the counterparty, liquidity risk and other risks of a complex character. In the event that such risks arise, substantial costs and/or losses may be incurred and operational risks may arise in the event that appropriate internal systems and controls are not in place to manage such risks. Therefore you should also determine whether the OTC transaction is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances.

RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein.

RBS is authorised and regulated in the UK by the Financial Services Authority, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the United States Securities Act of 1933, as amended. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC (www.sipc.org) member and subsidiary of The Royal Bank of Scotland Group plc. Dubai International Financial Centre: This material has been prepared by The Royal Bank of Scotland plc and is directed at “Professional Clients” as defined by the Dubai Financial Services Authority (DFSA). No other person should act upon it. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Professional Client”. This document has not been reviewed or approved by the DFSA. Qatar Financial Centre: This material has been prepared by The Royal Bank of Scotland N.V. and is directed solely at persons who are not “Retail Customer” as defined by the Qatar Financial Centre Regulatory Authority. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Business Customer” or “Market Counterparty”.

The Royal Bank of Scotland plc acts in certain jurisdictions as the authorised agent of The Royal Bank of Scotland N.V.

The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB