Steel, energy pipelines, and cheese

OK, bear with me on this but there is a connection of sorts and using broad brush strokes I would characterise the links as off-balance sheet lending.

If you have read any business pages in the last month it will have been hard to miss the story of Greensill’s financial troubles and bankruptcy as well as various attempts to explain their business model, just what is Supply Chain Finance. More recently you will have seen related stories about their biggest customer, Liberty Steel and its’ boss Sanjeev Gupta.

All of this has made me think about previous collapses and most notably Enron and Parmalat. Clearly, I am not the only one as Patrick Jenkins wrote about the Enron links this week in the FT The echoes of Enron in Greensill saga | Financial Times (

However, I am not really delving into the whole Greensill story specifically, more this product Supply Chain Finance (SCF) and why there is some controversy around it.

So, what is Supply Chain Finance?

Supply Chain Finance was Greensill’s core product and one that banks, and other financiers commonly provide.

It is usually set up as a financing facility by a company that it’s suppliers can use to have their invoices paid sooner that they might otherwise have been. For example, a large clothing company in Europe might have a supply chain that includes many smaller manufacturing companies in Asia. These smaller companies make elements of the clothing and then ship them to Europe however they will not usually get paid for some set period after manufacture or shipping, for example 30, 60 or 120 days.

This delay between production, shipping and then getting paid is obviously a challenge for these small companies and they might not be able to source competitive finance in their own right. This is where the Supply Chain Finance comes in.

If the European clothing company sets up such a facility with a European bank than these suppliers can potentially use the facility to get paid for their production earlier than their contract allowed for. Crucially, and different to other trade finance products such as factoring, in Supply Chain Finance the large company is effectively the borrower and the entity which the bank or financier is taking credit risk against.

Sounds OK, why the problem then?

Yes, there is nothing inherently wrong or bad about Supply Chain Finance but as with many financial products issues can arise with how it is used. Those familiar with trade finance will likely know that this is not the first controversy with Supply Chain Finance.

In recent years we have seen the Spanish construction group Abengoa and UK facilities management and construction group Carillion both fall into bankruptcy. Whilst the reasons for their failures are many, both situations appear to have been exacerbated by their reliance on Supply Chain Finance.

In particular this type of borrowing does not always get clearly flagged up on balance sheets and annual reports as debt so can leave a misleading impression of the true level of indebtedness a company actually had. The early payment feature of Supply Chain Finance also appeals to those with cashflow challenges as there can a longer timeline before the lender needs to be repaid under this facility. All of this is important for creditors who need to see an accurate picture of a borrowers actual indebtedness.

The recent struggles of Liberty Steel (which makes high quality specialist steel for industries like aviation) are likely mainly caused by the pandemic but as with other examples their reliance on Supply Chain Finance seems to have exacerbated their problems.

But how does this link to Enron and Parmalat?

These are hugely interesting cases in their own rights with plenty written about them and it is definitely worth reading one of the books about Enron, I would recommend The Smartest Guys in the Room by Bethany McLean and Peter Elkind or Pipe Dreams by Robert Bryce.

Neither the Enron nor the Parmalat insolvencies were driven by Supply Chain Finance. They did however involve various accountancy shenanigans that created misleading impressions of both indebtedness and revenues.

Enron famously used a variety of special purposes entities to hide their true positions however they also used prepaid swaps mainly facing large financial institutions. These prepaid swaps worked in such a way that Enron often received large payments upfront and then had liabilities later on in the contract that would in some way reference commodity prices. However, these were not accounted for as loans and in some cases Enron accounted for the upfront payment as income.

Parmalat is another interesting and multi-faceted story in its own right but the point I want to draw out is the use of self-referencing Credit Linked Notes. These enabled Parmalat to create an illusions of a much healthier balance sheet than was the reality and also create a perfect storm of correlation risk by effectively writing protection on its own credit risk.

In both the Enron and Parmalat scandals some major banks were dragged into litigation due to their role in structuring and executing these derivative contracts and ended up with fines and settlements into the billions of dollars.

What can managers at financial institutions learn from this?

Firstly, that there is risk in seemingly benign products, the risks don’t all sit on the trading floor. Whilst the credit or counterparty risk might seem obvious there are other risks that might be less immediately apparent. These include reputational and regulatory risk for being deemed to be have been a facilitator of business that contributed to a company collapse, especially where that business is in the ‘real economy’ and jobs are on the line.

Secondly, that you need to think hard about clients that are reliant on you, particularly for financing. There can be valid reasons for this but as Credit Suisse recently found out it does make it harder to quickly pull credit lines. It could of course be a red flag that other institutions have found concerns about the client’s business model and you need to dig a little deeper.

Finally, that there is nothing new under the sun and companies and their managers will sometimes get creative in the search for bigger profits or just survival. Where one door closes another might open. So it is important managers and risk managers learn the hard lessons from other product areas and think how they might apply to them.


Finally, apologies to those of you who were looking for a take down on Greensill, David Cameron, Liberty Steel and Credit Suisse. I think we will have to wait to see what comes out in the wash whilst remembering that lots of decent people have lost their jobs, or are worrying about their jobs and futures.

As always, we are here at Leaman Crellin to help you manage the regulatory risk with your business so please get in touch if you would like to discuss any of this further.