Both the FASB and the IASB have recently amended the financial reporting rules to provide for more disclosure about supplier finance programmes. These changes were eagerly anticipated by users of financial reports (in particular, the rating agencies) but also generated a certain turmoil in the supply chain finance world.
Within the industry, there is debate on whether an increase in disclosure could represent a step forward in pursuing sustainability in supply chain finance, impacting the third “leg” of the acronym ESG, i.e., Governance. Since the “G-leg” seems to be the most elusive profile among those that make up ESG, it could be useful to try and get a definition of what “sustainable” or “good” governance should mean in supply chain finance.
To do so, let me quote the G20/OECD Principles of Corporate Governance, according to which governance “[…] should promote transparent and fair markets, and the efficient allocation of resources […]” and also “[…] should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance […]”.
With these quotes in mind, an SCF programme can be considered “sustainable”, in terms of Governance, if it ensures transparency and fairness in the transfer of value among supply chain actors, contributing to the prosperity of all stakeholders. That is, roughly speaking, a more complex way to say that SCF should really be a win-win solution!
In this perspective, if the buyers are only seeking a simple way to finance their working capital by extending payment terms with little benefits for their suppliers, or even charging them for this, that programme should probably not be considered “sustainable” under the G-leg and will be the most likely to require reclassification. Interesting, in this sense, to quote a recent survey made by Assifact and KPMG: we found out that SCF was seen by most businesses as “a way to optimize their working capital” and “a way to extend payment terms”.
That is perfectly fine but surely might suggest that the interests of the buyer and the suppliers might be somehow in conflict. The provider of SCF solutions should then assure that the programme is not set up in the sole interest of the buyer, but actually increases the fairness of the supplier-buyer relationship, reducing the imbalances of power between the parties.
According to the Principles of Corporate Governance, Good Governance mandates “timely and accurate disclosure”. Again, if disclosure of SCF programmes can increase transparency and expose those programmes that are more geared towards acting as substitutes for financial debt without real benefits for the suppliers, that could be indeed a step forward toward good governance and sustainability.
Yet again, the principles of corporate governance tell us that: “disclosure requirements are not expected to place unreasonable administrative or cost burdens on enterprises“. Unfortunately, the current standards present some pitfalls, that have been clearly highlighted by the industry respondents to the IASB consultation.
So, in theory, disclosure is good for sustainable governance, the standards are good in the intention, and may indeed have an impact in increasing SCF sustainability, but a question remains: at what cost?
Such impact would be mostly beneficial if it increased the rigor with which buyers assess the need to classify an invoice that is part of an SCF scheme as financial debt: in this case, the added value of more detailed information is worth the cost for the buyers to gather and organize the required input. Such effect, to be material, would require that there is a material number of schemes that present borderline features and are currently not rigorously reported.
Is this the case?
The IFRS already provided all the tools needed by the buyer to decide whether to classify a liability under a supplier finance arrangement into debt or payables (see also the IASB Decision of December 2020).
Different members of Assifact studied the Decision and suggested that, among the features of a programme that should raise questions on the nature of the liabilities, attention should be paid to the simultaneous presence and extent of one or more of the following elements:
- a further extension of payment terms to the buyer
- a material difference of such extended payment terms in relation to the payables outside the programme
- the existence of an autonomous contract between the buyer and the SCF provider, providing for such an extension
- the allocation of the financial charge to the buyer
- a high penetration of the programme on total payables.
We can then conclude that disclosure shouldn’t have an impact on reclassification… unless the buyer was not already rigorous in its assessment. Assuming faithful reporting by all buyers, the additional value of more disclosure could be quite poor, while compliance costs can be material since the information required is not necessarily promptly available to the buyer and it’s likely that the information disclosed will not be easy to read (and might be misunderstood by the reader).
Therefore, headwinds for SCF volumes coming from the disclosure requirements could play out through a virtuous channel, as debt-like programmes will be uncovered (and probably will dry out), but also through a vicious channel, as good programmes could become less interesting due to high compliance costs.
Although disclosure is mandatory for “good” governance, the actual impact of the reporting rules adopted with reference to supply chain finance is still uncertain. Only time will tell whether more disclosure of supply chain finance programmes will increase transparency and fairness in the buyer-suppliers relationship or just increase compliance costs without material impacts on good governance and sustainability.