While Brexit was sold on the prospect of a light-touch regulatory approach, Giles Wilkes says that the Greensill affair reminds us that when it comes to “FinTech”, the need for tough financial regulation is as important as ever
Like a piece of complex machinery, a financial system appears simple only when it is functioning smoothly – when all the payments settle and price movements are orderly. It is when it breaks that you learn how it really works. We saw this during the great financial crisis of 2007–09, as hitherto orderly markets froze, and horrified investors learned quickly what a basket of untradeable assets they held.
Failures also remind us how the basics of finance remain the same, no matter what new structures, technologies or markets are created. This is an important lesson for policymakers as they pursue the significant opportunities offered by “FinTech”, the umbrella term used for the intersection of new technology and financial services. Underneath any financial idea lie the same basic questions – how are funds raised, how are they invested, how are the risks managed. A failure in one, two or all of these is what lies beneath every collapse. The “Fin” part is always there, no matter what the “Tech”.
This is why financial catastrophes also enjoy a familial resemblance: excessive optimism and growth, the disguise or faulty transference of various risks, then a liquidity crisis turning into a solvency crisis. A light sprinkling of political capture is often seen, too. Many of these features can be seen in the ongoing collapse of Greensill Capital.
The opening of the Greensill bonnet has revealed all sorts of malfunctions
For those who have not been following the story, a precis: in 2011, Lex Greensill, an Australian former banker, set up his eponymous supply-chain financing company, and enjoyed such support from the Cameron-era UK government that he was granted use of an office in Downing Street and later awarded a CBE for services to the economy. Former prime minister David Cameron became an adviser to Greensill in 2018.
The business of supply chain finance involves the financier paying promptly the amounts owed by a big corporation to its suppliers, minus a discount. Later the financier collects the full amount. Hence a position where a large company owes lots of smaller companies is converted into one where all these small debts are owed to the supply chain financier instead. In the case of Greensill, to free up capital these loans were usually packaged up and sold to other investors.
Simple, in theory, and valuable to the economy if done well. Small suppliers, which are generally cash-constrained, are paid earlier. The large company preserves cash too. Investors gain access to a package of loans that pay a reasonable, low-risk return. Greensill marketed itself as bringing the advantages of this business to a new tier of customers, using the magic of technology to collect information from thousands of invoices and different customers. It was regarded as a fast-growing FinTech success story, recently listed as one of the top such companies in Europe, and apparently servicing $50bn of business in a year.
Yet supply chain finance is far from a new idea. Ideas like the bill of exchange – a way of financing trade - can be traced back to 13th century Italy; by the 16th century, the idea of one party guaranteeing a loan between two others was sufficiently mainstream for Shakespeare to put it at the heart of The Merchant of Venice.
In the past months the edifice of finance around Greensill Capital has crumbled. According to the Financial Times the first clank in the machine came in a lapsed insurance contract. Hitherto, funds buying debt off Greensill had used credit insurance to guard against default. Lacking this insurance, funds such as $10bn managed by Credit Suisse froze their involvement. This knocked away a key support for the whole financial endeavour; Greensill sued, unsuccessfully, to force extension of the insurance arrangement.
And once the bonnet was open, all sorts of other malfunctions came to light. It appears that Greensill was only able to grow so fast because of unusually concentrated and risky exposures throughout its chain of financing – in the insurers, the investor funds, and at Greensill itself. In particular there were massive loan exposures - perhaps $5bn - to GFG Alliance, a sprawling steel concern that had grown quickly thanks to funding from Greensill.  Earlier this month, Greensill filed for administration, amidst concerns that its failure could put at risk thousands of jobs in the steel industry in the UK and beyond. As well as the damage in funds like those run by Credit Suisse, the UK taxpayer may be on the hook for millions in debt guarantees offered in the coronavirus crisis. German municipalities who deposited with Greensill Bank in Germany, a key element of the Greensill financing arrangement, could lose up to E500m in uninsured deposits.
The Greensill fallout means questions for regulators and government
There will be questions for regulators from all this. A company that, instead of paying its suppliers, uses a supply chain financier to do so, has a debt to that financier; its position is similar to that of a company that simply borrowed from its bank to pay its bills. Yet the exposure is not treated in the regulatory system as straightforwardly as bank debt, a loophole that was also exploited by the failed contractor Carillion. This now looks like a dangerous blind spot– a company in effect acting like a bank, but without being strictly regulated as one – which lawmakers need to examine.
Accounting standards also need to be looked at; investors have to dig much deeper to ascertain the extent of the use of supply chain finance like that offered by Greensill, compared to straightforward bank borrowing. This impedes scrutiny, and introduces a perverse incentive for companies to complicate their financial arrangements in order to improve their numbers. The Greensill affair has also revealed a significant degree of financing between connected parties, which, regardless of legality, can make investors’ jobs much harder when it comes to judging where risk ultimately resides.
Reform should not destroy what is valuable
Whatever regulatory changes are needed must be put into effect while preserving what is valuable in supply chain finance. Often, financial innovations involve a sort of alchemy that seems bizarre. In this case, multiple small debts between varied counterparties in the steel industry ended up owned by funds managed by a Swiss bank and guaranteed by a Japanese insurer. But this does not mean something is corrupt in the very idea of supply chain finance or securitisation. Similar innovations have oiled the wheels of commerce for centuries, allowed trade to operate between far-flung places, raised cash for vital enterprises and produced useful returns for investors. They shift risk from those unable to bear it to others more willing to, for a fee. McKinsey recently put the size of the overall trade finance market at $7.1trillion, in terms of value of assets financed. Most of this is low-margin, uncontroversial and valuable.
The ultimate collapse of Greensill showed the market system working, but only eventually. A new company, claiming a fast-growing business and a rich valuation, inspires a number of questions. Where are the funds raised, at what cost and on what terms? Where are they invested? How is the risk managed, and what are the costs of so doing? When answers are not easily produced, investors become wary. Finance is competitive – supply chain financing is usually seen as a low margin business – and so fast, that valuable growth merits particular scrutiny. The refusal of investors and funders to maintain support is what brought about the beginning of the end and showed that private incentives are still valuable. Among the sceptics might be listed the UK Treasury, which last year resisted lobbying (including from David Cameron) to include Greensill in one of the larger coronavirus related loan schemes, and imposed a much lower cap on exposures allowed through another.
But the story also shows that markets are far from sufficient. It is not just in hindsight that signs of trouble could have been seen. In 2018 a fund manager got into trouble having been overinvested in “obscure and illiquid securities linked to Greensill”,  and last May Greensill had to report significant client defaults, including one linked to the failure of a FTSE 100 healthcare provider.  The close interdependency between Greensill and GFG Alliance, the steelmaker, was public knowledge for years – and yet both continued to grow.
Fin tech is still much about the Fin as the Tech
There is considerable ambition in the UK to become a leading centre for FinTech; according to government figures, more was invested in UK FinTech in 2020 than in the next four EU countries combined. Chancellor Rishi Sunak launched a review into the industry at his first Budget and has showed support such as through a review of the listings regime and proposals for a visa scheme aimed at attracting entrepreneurial talent.
There are good grounds for this emphasis, including the City’s traditional pre-eminence in finance and the UK’s burgeoning reputation for digital innovation. Given the soaring valuations of tech companies in the past few years, there is a natural incentive to emphasise the tech side. But the saga of Greensill reminds us that FinTech is just as much about the financial aspect too. Moreover, in light of the collateral damage wrought by financial failures, the stance regulators take towards financial activity has to be different to that applied elsewhere, too.
For all the talk of the great advantages of a new, lighter regulatory approach post-Brexit, in finance the UK should congratulate itself on the tougher line it took after the banking crisis. When the Covid pandemic hit, this toughness meant our banks were in a much stronger position to cope. While the ‘tech’ side will lobby for rules to be quick, versatile and light-touch, financial businesses need tough regulation and relentlessly sceptical investors. The story is still developing, but both appear to have been missing in action in the case of Greensill.
- https://www.ft.com/content/9741d707-1be2-4c15-a78f-aca1c5fb6781 has a good concise explanation, and this from Tom Braithwaite, www.ft.com/content/30069077-b966-4f41-a4df-f79aadcf0479
- The way the Wall Street Journal describes it here is “use technology to digitize the piles of paper invoices that clog up deals.” See e.g. PRNewswire, “Greensill provides much needed cash to England's Pharmacies”, 6 July 2020 https://www.prnewswire.co.uk/news-releases/greensill-provides-much-needed-cash-to-england-s-pharmacies-817747508.html https://www.brightnetwork.co.uk/employer-advice/greensill/meet-greensill-team-technology/ provides more insight into the apparent technological bias
- “Carillion Debt Classification Loophole May be Widespread”, Fitch Wire, 27 July 2018, www.fitchratings.com/research/corporate-finance/carillion-debt-classification-loophole-may-be-widespread-27-07-2018
- A good discussion of some of these can be found in Matt Levine’s newsletter for Bloomberg, and also the Financial Times story www.ft.com/content/b1ce1ab2-46d0-4005-a633-b38a4ee16aac 16th March 2021, “Greensill financed Gupta based on invoices from ‘friends of Sanjeev’”
- McKinsey, “Supply-chain finance: A case of convergent evolution?”, Chapter 3 of “The 2020 McKinsey Global Payments Report”
- Financial Times, “David Cameron lobbied for Greensill access to Covid loan schemes”, 18 March 2021 https://www.ft.com/content/6ed619c0-bb9a-44dc-a2f6-c5596a958ca8
- See “Asset management: inside the scandal that rocked GAM”, Financial Times, 18 March 2019
- See Robert Smith, “SoftBank-backed Greensill suffers raft of client defaults”, Financial Times, 4 May 2020. Ironically, in the same story, Lex Greensill is reported to have told the Financial Times “that he believes rating agencies should consider credit provided by suppliers to be a financial liability.”