Supply chain finance is already working well for those large corporates which have successfully on-boarded their tier one suppliers. Yet for many buying organisations the real risk to the supply chain lies not with the larger tier one suppliers but with the tier 2, 3 and 4 suppliers. These lower-tier suppliers are often SMEs, who are often faced with cash flows challenges and find it harder to access capital. If SCF programmes can include this “deep tier” financing, the rewards can include lower costs, a healthier supply chain with reduced churn and early warning of potential upstream disruptions.
The problem with extending supplier finance to these deeper tiers is one of commercial privacy. While suppliers may welcome the access to low-cost finance, solutions that require revealing to their customers and partners the cost of goods from sub-suppliers or operating margins might be unacceptable. For example, a tier 1 supplier may not want an invoice from their tier 2 supplier to be available to the big buyer – yet without some level of information sharing, lower cost financing for the tier 2 supplier cannot be realised.
This is where distributed ledger, or blockchain, technology can help. Blockchain offers a shared system of record which allows all parties in a transaction to carefully manage what information is revealed, while ensuring that all information is auditable and can be validated. The blockchain provides the essential capabilities for private and auditable asset transfer between supply chain participants. Further, by maintaining their transactions, such as purchase orders (POs) and invoices, on a blockchain-based system, supply chain participants retain full control of their own data but can reveal fragments of those transactions to chosen parties in a way that assures them that the data fragments they are viewing are authentic and valid. A blockchain-based distributed ledger can be accessed by all participants in the supply chain, including financiers. For example, this allows financiers to validate the total amount on a PO or invoice, without being shown more sensitive information such as unit pricing and discounts. These capabilities of the blockchain make it possible to operate deep tier financing in a business friendly way.
Blockchain-based cash flow scrip (CFS) is one way to make this happen. A CFS is a guarantee that the buyer will pay a certain amount on a certain date (the maturity date). A CFS is classed as an asset of the holder of the CFS, but it is not a freely transferable or negotiable asset. As we explain below, a holder of CFS can only use it for specific purposes relevant to fulfilling the supply chain needs of the buyer. The buyer’s financial institution maintains a CFS redemption facility on behalf of the buyer which either buys back CFS at a discount if a holder presents CFS before maturity or pays the full CFS face amount to a holder on maturity. Scrip maturity date would be chosen by the buyer based on their supply chain needs, for example 60 or 90 days from scrip issuance.
When placing a PO with its tier 1 supplier using the blockchain-based system, the buyer would provide the tier 1 a fraction of the PO amount as CFS, for the tier 1 supplier to use with its own sub-supplier. The tier 1 supplier, in turn, can use blockchain-based escrow of a portion of the received CFS with the PO they place with the tier 2 sub-supplier. The amount escrowed as CFS would be known only to the tier 1 and tier 2 suppliers that are party to this PO. Upon confirmation on the blockchain that tier 1 has received the order from the tier 2 sub-supplier, the escrowed CFS is released to the tier 2 sub-supplier. The tier 2 can then present the CFS to the big buyer’s financial institution before maturity (or any other bank or financier willing and authorised to discount the CFS) in order to receive discounted early redemption of their CFS to help them with their cash flow. The point to note is that the discount rate would be based on the high credit quality of the buyer at the top of the supply chain, since CFS is the big buyer’s payment obligation and not that of the tier 1 or indeed the tier 2 supplier.
There are additional benefits to participants using such a CFS system. Tier 2 suppliers can use the CFS escrowed by tier 1 as proof of assured payment in order to access pre-shipment working capital financing from their own bank. Tier 2 can also use the escrowed CFS to create CFS for escrow in POs to their upstream tier 3 supplier. Such a blockchain-based system can also maintain title in the name of the big buyer for the parts delivered by tier 2 to tier 1, to reflect the fact that the CFS used as payment in the tier 1 – tier 2 transaction was in fact financed by the big buyer. Such a transfer of title for the parts that are in tier 1’s custody, allows the big buyer’s financial institution to treat the CFS redemption facility as providing inventory financing, if such treatment is advantageous. From this point of view, the CFS system is a deep tier inventory financing system.
A blockchain-based system for managing a deep tier supply chain provides a simple system of secure record keeping, that allows the bank redeeming CFS to ensure that the CFS presented by holders has been used to finance appropriate supply chain contracts. At the same time, suppliers using the system retain the privacy necessary in their financial transactions with their sub-suppliers. By providing this missing piece of the information and asset management puzzle, blockchain technology allows the enormous potential of “deep tier” supplier finance to become real.