TThe focus on David Cameron’s role in lobbying for Greensill Capital’s involvement in NHS payment systems has obscured a less glamorous question: how did a company involved in such a mundane part of the financial services ecology become so significant, so quickly?
Greensill Capital, which entered administration last month, provided payment services that included “factoring” and “supply chain financing.” Although the company represented itself as part of the “fintech” revolution, these services were not in themselves particularly remarkable or innovative. To understand the growing appeal of Greensill and other vendors, we need a broader lens.
Supply chain financing (or “reverse factoring”) solves a common payment problem. Businesses traditionally supply goods or services to a customer and issue an invoice for payment. While the vendor may prefer that the invoice be paid immediately, the customer may want to delay the payment. In situations where the customer is large and influential, they may insist that the supplier wait two or more months. With reverse factoring, a financial institution offers to step in to pay the provider earlier on behalf of the customer, minus a small discount that they take as their fee or part of their fee. The client then reaches an agreement with the financial institution at an agreed later date, often four to five months later. On paper, everyone wins and there are no risks.
But textbook definitions don’t always apply perfectly to the real world. In recent years, the lure of supply chain finance has included the possibilities it offers for what is euphemistically called creative accounting. Creative accounting has flowered under the fair value revolution: a shift in accounting rules towards a more market-based perspective.
Essentially, this means that the business of doing the accounts itself has shifted towards an assessment of future cash flows rather than an assessment of past transactions. Many assets are no longer valued on the basis of the price paid for them, but rather on their current market values or even modeled estimates of the future cash flows they will generate. This also applies to some contracts, where profits are accounted for on the basis of future expectations. This approach to accounting creates the space for discretion, subjectivity and speculation. It has arguably made it easier for companies to “recognize” earnings than to generate the actual cash flows that support them. And this is where supply chain financing can be misused.
The gap between cash flow and earnings was a defining characteristic of what happened to Carillion, the outsourcing company that closed in 2018. Carillion used reverse factoring to hold its cash longer and therefore report higher net operating cash flows. This accounting trick allowed the company to report a higher “cash conversion” rate (the amount of profit made as cash), which was used to calculate a portion of CEO salary. Carillion’s accounting treatment of its supply chain financing also allowed the company to disguise its debt. Carillion’s obligations to banks in the form of overdrafts and loans amounted to £ 148 million in 2016, but its financial responsibility for the supply chain was estimated to be £ 498m. This partly helped Carillion look much healthier than it was.
Carillion, like many large companies, became something of a portal, capable of moving revenues and costs in time and space based on projections of its future economic fortunes. The supply chain financing allowed them to produce operating cash flow figures that gave those profit figures some credibility. Many other companies can exploiting this lagoon, in a market estimated at $ 3.5 trillion (£ 2.5 trillion).
Fast forward to Greensill, which was not involved with Carillion but has factoring agreements with other large companies. While reverse factoring offers advance payments to a customer’s suppliers, direct factoring is when a business sells its invoices or accounts receivable to a third party at a discount. As Greensill was driving growth, the collateral underlying the transactions with some of those companies appeared to be speculative. What investigator works has shown, Greensill not only lent against the security of the invoices for transactions that had already occurred, but also lent against the “prospective receivables”The company could generate in the future. In other words, they would make loans against transactions that had not occurred and may never occur with companies that have never done business with their customers. Representatives for Greensill declined to comment.
That’s the haunting context in which Cameron’s story must be understood. Greensill carried a great risk when participating in negotiations on payment systems on the NHS. That deal, if they could have secured it, would have provided Greensill with an extremely large and almost risk-free revenue stream due to the state’s solvency. But it may also have created considerable problems too big to fail if the company became an intrinsic part of the public sector payment machine. Would the state need to support or rescue Greensill if his risky private companies produced solvency problems that threatened to disrupt the payment of salaries to nurses and doctors? Although the company did not receive this treatment, it managed to make some progress through its Earnd app and also provided financing the supply chain to pharmacies. It remains to be seen how far their involvement in public provision has extended.
Supply chain finance provides many benefits, but it can be misused when it operates as a temporary solution to a holographic and surreal form of capitalism. Greensill’s model was never going to be sustainable in the long term because at some point you have to pay off your debts. However, that wasn’t the point: it was sustainable enough for long enough for the owner of Greensill Capital, and perhaps some of his clients, to get richer. It also raises questions about the relationship between the state and private providers, and the blurring of that boundary. It has become less and less clear whether these companies really help the state with its service delivery problems, or whether the state helps them with their risk and profitability problems.