Greensill, 2021Medium

Short-dated trade receivables are close to the safest thing a fund can hold. The failure was what happened when the receivables were concentrated, extended, and in some cases not yet receivable at all.

4 min read · 675 words

What happened

• The business — supply chain finance: paying a company's suppliers early at a discount, then collecting the full amount from that company when the invoice fell due. Done conventionally this is short-dated, self-liquidating and secured by a real obligation.
• The funding — the receivables were packaged into notes bought by investment funds distributed to institutional and wealth clients, marketed on the short maturity and the credit insurance attached.
• The drift — reported concentration in a small number of borrowers, extended maturities, and in some cases financing based on prospective rather than existing invoices. Each step moved the asset further from the thing that made the format safe.
• March 2021 — credit insurance covering a large part of the book was not renewed. The funds holding the notes were suspended and then wound up, the group entered insolvency, and an associated bank was taken into administration by its regulator.
• Afterwards — parliamentary and regulatory inquiries in several jurisdictions, and a substantial rewriting of how supply chain finance is disclosed in company accounts.

The mechanism

• Self-liquidating is a property of the asset, not of the label. A 60-day invoice from a diversified pool of buyers repays itself. A 180-day claim on one borrower, secured by an invoice that has not been issued, is a loan to that borrower wearing the first one's name — and it is priced and disclosed as the first.
• Concentration removes the whole argument. The case for receivables as a low-risk asset rests on the pool: many obligors, short tenor, granular. Reduce it to a handful of names and there is no pool, only credit exposure — the same lesson securitisation records about a tranche whose diversification was assumed.
• Insurance is a counterparty, and a renewable one. Cover that has to be renewed periodically is not a permanent credit enhancement; it is an option the insurer holds. When the enhancement is what made the asset fundable, the insurer's renewal decision is the funding decision.
• A daily-dealing fund holding this is a maturity promise about a credit exposure. Once the assets stopped being short and self-liquidating, the fund's promise and its holdings were incompatible by construction — the same mismatch as Woodford in 2019, arrived at from a different direction.
• Payables financing sits between debt and trade credit in the accounts. A company whose suppliers are paid early by a financier has extended its own payment terms without reporting borrowing, which is why the disclosure rules were the first thing to change afterwards.

What it teaches

• Ask what makes the format safe, then check each property separately. Short, granular, self-liquidating, insured. Any one of those failing changes the asset; all four are stated in the marketing and only some of them are tested.
• Look for prospective rather than existing claims. "Future receivables" is a lending decision, and it belongs in a different risk category from an invoice somebody already owes.
• Treat renewable credit enhancement as an exposure to the enhancer. Read what happens at non-renewal, because that is the scenario in which it matters.
• Concentration is the first number to ask a fund for, and it is rarely the number a factsheet leads with — see reading a fund factsheet.
• Payment terms are a financing decision. For a corporate treasurer this is the useful half: extending supplier terms through a financier changes the working capital picture and the disclosure obligations at the same time — see receivables finance.

The mechanisms behind this

• Receivables finance — the transaction done conventionally.
• How a fund is built — the promise, the holdings, and where they part.
• Securitisation — pooling, and what concentration does to it.
• Liquidity — a maturity promise over assets that stopped being short.