The recent collapse of Greensill, a prominent supply chain finance company, has sent shockwaves through the financial world. Understanding how and why it happened, and more importantly, how to prevent such scenarios, is essential. In the aftermath of this debacle, the finance industry is grappling with some crucial lessons, with a resounding message: diversify or risk the perils of concentration.
The Greensill meltdown serves as a stark reminder that financial markets often forget old risks when they wear new disguises. Greensill's core business model, which involved bundling contractual obligations into assets backing bonds, was not novel. In the case of supply chain finance (SCF) backed funds, these obligations were meant to stem from creditworthy corporate buyers' approved suppliers. However, things were not as straightforward as they seemed.
The Perils of Concentration
One fundamental issue that plagued Greensill's downfall was concentration risk. Investors believed they were acquiring diversified assets, with documents stating exposure to 124 obligors, no single obligor accounting for more than 3.4% of the fund, and the top 10 obligors representing around a quarter of the fund's assets. On the surface, these numbers appeared reassuring, but they concealed the real risks.
The relationship between obligors mattered more than their individual percentages of exposure, and this was not adequately explained. For instance, the Credit Suisse Nova (Lux) Supply Chain Finance High Income Fund disclosed numbers that were correct but didn't provide a comprehensive picture of the interconnectedness among the obligors. In fact, one-third of the flagship Credit Suisse SCF fund's notes were linked to GFG Alliance companies or their customers. This concentration risk was much higher than investors expected, and it wasn't limited to GFG. The funds were deeply entwined with SoftBank-backed companies, while SoftBank itself invested in the funds and Greensill. This lack of diversification proved fatal.
The Importance of Diversification
The Greensill saga underscores the vital role of diversified funding sources for both financial institutions and the companies they support. Over-reliance on a single financial institution, such as Credit Suisse in Greensill's case, can lead to catastrophic consequences when that institution pulls out.
Diversity Through Technology
While Greensill's extreme concentration was an outlier, the broader SCF landscape faces similar challenges. Traditionally, SCF has been the domain of large banks and their large, investment-grade clients. This limited pool of companies poses a diversification challenge for any securitization or directly funded portfolio. The solution lies in expanding SCF to mid-market companies, a vast pool with diverse cash flows that can create portfolios tailored to the risk appetites of various investors.
To make this expansion possible, we must look beyond traditional banks. Legacy infrastructure, regulatory complexities, and economics constrain banks from opening up SCF to SMEs. Lowering operational costs through automation and technology is the key. Platforms like Finverity aim to connect lenders with pre-qualified mid-market SCF transactions, offering controls, transparency, and automation while providing a diversification tool for lenders. These platforms allow for syndication among lenders to share risk and ensure that credit rules are never breached.
In conclusion, the SCF market must heed the lessons of Greensill's downfall and embrace diversification. The future of SCF lies in reaching mid-market companies and leveraging technology to create diversified portfolios that benefit both lenders and borrowers.
At Lumex Trade, we understand the importance of diversification and provide a wide range of financial services tailored to your unique needs. Stay updated with Lumex Trade for more insights on the ever-evolving financial landscape.