Richard Hawkins CEO of Atlantic RMS considers the recent fall out from the Greensill case and asks how institutions can avoid making the same mistakes.

Greensill seems to be the gift that keeps on giving. If, like me, you are fascinated by financial scandals, there is a continuing narrative regarding the conduct of this business, its impact on its clients and the wider implications for businesses that operate under the general heading of supply chain finance (SCF). That said, we have come to discover that classifying Greensill as a supply chain finance business is probably inappropriate.

Greensill Capital was planning a $7-billion IPO to support the continued growth of the firm’s specialization in SCF, aka reverse factoring.  Rather than enrich its shareholders (including David Cameron, the ex-UK Prime Minister who received options for his advisory work) the business went spectacularly bust in March 2021. There has been a lot written about Greensill’s failure.

As trade financier, Tony Brown of The Trade Advisory says: “When over-aggressive investment of capital ($1.5B by Softbank) meets an hubristic ambition to stretch the boundaries of SCF to feed the greed of yield-hungry investors, calamity results.”

This article focuses on the revelations concerning the actual business activity of Greensill Capital, why it failed, and what could have been done by investors and funders to avoid loss. The answer is simple: diligence; however, the execution may be a little more complex.

Supply chain finance is a simple working capital finance technique. The financier prepays the supplier against invoices approved by the buyer and, by doing so, takes on the buyer’s credit risk whilst providing liquidity to the seller. Whilst Greensill did provide SCF, it is apparent that the Greensill offering significantly deviated away from a standard SCF model.

“Diligence is the mother of good fortune,” said Benjamin Disraeli. If diligence is to be the precursor of sound business, it must be the right sort of diligence. Lenders and investors need to move away from the tick-box response to the question: have we done an audit? And focus more on the questions that were asked during the audit. It could also be a problem of terminology because the term “audit” means different things to different people. We would describe the type of diligence that should have been carried out on behalf of the investors and or lenders as a Specialty Finance or Lender Finance Review.

This should not be limited to the onboarding diligence, but rather the deployment of an ongoing routine to establish that the circumstances and risk activity of the lender remains commensurate with its  initially sanctioned risk profile, and that there has been no deviation from understood lending activity since the initial facilities were put in place.

Of course, this assumes that stakeholders understand what they are getting into when they make the initial investment.

Frequency and depth of diligence should reflect portfolio and product dynamics  and any significant changes in operation, policy, criteria or products offered should, under normal circumstances, trigger an update review.

Credit Insurance

The withdrawal by Tokio Marine of the credit insurance on which investors relied, led to Greensill’s implosion. Many question this over-reliance and the reported claim by Lex Greensillthat everything was secured by assets backed up by insurers who would pay 100% of any shortfall.  The jury is still out on whether billions of dollars of claims submitted by investors will be paid. 

At times, some financial institutions may place an unrealistic and inappropriate level of dependence on credit insurance without understanding what risks are covered and if the underlying transactions are insured risks. Credit insurance is not a one-size-fits-all product; there are significant variations across carriers and policies. Pertinently, credit insurance does not cover performance risk. No matter how strong the buyer is, if the seller fails to perform in accordance with the contract, there is no cover. Non-delivery of goods is a major non-performance problem.

Of great importance are the (catch-all) triggers that may enable an insurer to come off risk altogether – such as whether the insured acted with “due care and prudence.” Credit insurance is no substitute for good underwriting and risk analysis and requires a regular and detailed review of the operation and administration of the credit insurance policy.

Operational Review

What is critically important and so often overlooked is understanding what business SCF providers focus on or, more importantly, what they are supposed to do. Some overarching questions need to be addressed: What is the commercial activity? What are the risks and how are these risks measured and monitored? How far from industry norms does the proposed construct stray? Are operational systems and controls adequate? How are internal approval decisions made at a portfolio and transactional level?

If the provider claims (as Greensill did) that it is a fintech, what is the strength of the predictive analytics that drive the platform? In the end, when Greensill tried to save itself from bankruptcy by selling its proprietary technology, it was found lacking.

A BBC documentary on Greensill reported that “Greensill was using its own cash to plug holes” in respect of loans to GFG Alliance (a major non-performing debtor).

How this was actually accounted for raises some interesting questions, and it would be potentially quite revealing to see what conclusions would be drawn from  the collateral-trend diagrams and portfolio categorization that would be deployed in a diligence review.

Transaction Testing

The BBC documentary talked about the misunderstanding of investors who believed that their money was being deployed against short-term, low-risk transactions supported by buyer-approved invoices.

They made various references to these Invoices, describing them as “false invoices”, ‘prospective invoices” and “imaginary invoices”.  These were the terms used to describe transactions that should have represented assets created by the normal process of goods being sold to a customer on credit terms. This should have been picked up by good old-fashioned transaction testing during an LFP or even remotely. It was interesting to watch a journalist supposedly talking on the phone to a customer of a Greensill client trying to establish if a trading relationship had ever existed between the alleged buyer and seller. Telephone debtor verification is a standard procedure during a collateral-diligence process and it can be a very simple, but effective, tool.

Portfolio Risk

We understand from papers filed in the case involving Bluestone (a Greensill client in default) that in addition to SCF and RF activity, it is also clear that there was enterprise financing involved. What is that? Well, a simple explanation is that it’s the sort of thing that you do when all the assets are gone.

It looks like there has been some confusion regarding Greensill’s activity of Future Receivables Financing (FRF) activity, where potential collateral values were, at best, guessed or, at worst, created as opposed to Future Funds Flow (FFF) financing that is often deployed where there is a contractual and predictable revenue stream against which money can be advanced.

 The Greensill FFR smacks of desperation to either support clients in an unconventional way and/or an urgency to deploy invested capital in pursuit of yield.

There also seems to be a dubious financing relationship between Softbank investees and Greensill Capital (in which Softbank was also a major investor).

Going back to the original premise: Diligence, Diligence, Diligence

There are basic principles around categorizing the universe of facilities, reconciling financing activity to the balance sheet(s). It is also key to understanding risk management, underwriting regimes and  compliance testing.

A robust diligence program utilizes data analytics to measure the quality and performance of the underlying collateral and compares against known norms. It starts with such questions as: What are they doing? How do they do it? Where are the risks? It categorizes different commercial finance products into its appropriate buckets and then measuring  performance at portfolio and transaction levels.

Obviously, the value of having someone independently reading and understanding the credit insurance policy has to happen.

The Greensill story is not over; the repercussions are still being felt by investors, lenders, insurers, suppliers and buyers. The most valuable thing that can come out of a crisis is that people learn from it and surely one major lesson in the Greenseill case has to be the importance of diligence and doing it right.

Richard Hawkins CEO of Atlantic RMS a specialist in ABL, ABS, Trade Finance Diligence and Work Outs. Atlantic RMS works for many international lenders and investor across multiple jurisdictions and Asset Classes.

Contact rhawkins@atlanticrms.com.

Thank you to Tony Brown for his contributions to this article. Tony Brown is a veteran trade financier and principal of The Trade Advisory, a 12-year-old consultancy advising lenders, borrowers, fintech’s, investors and funders on product, market and business development.  Contact Tony at tony.brown@thetradeadvisory.com.