• King's Global Markets

Big Read: Greensill’s Downfall – Did we see it coming?

By Chloe Chan, Research Analyst at King’s Global Markets

The Greensill scandal is arguably one of the most prominent collapses of a large-scale financial institution during the COVID-19 pandemic. It has sparked debate over the issue of accountability, financial risk assessment and leverage within the industry. In order to understand the numerous intricacies of the matter, there are a number of questions that we have to pose. This allows us to obtain a more thorough understanding of the operations and consequently the rise and fall of Greensill and the resulting implications on the industry.

What is Supply Chain Finance?

Supply chain finance refers to a set of technology-oriented solutions that aim to enable various parties involved in a supply chain or sales transaction to benefit from lowering financing costs and improved efficiency. The technology involved in the process focuses on automating transactions and tracking when invoices of transactions are approved and settled. Under this model, buyers would agree to approve their suppliers’ invoices by a financial institution (bank or outside financier), which is commonly referred to as “factors”. In return, both parties would receive short-term credit that optimises working capital and ensures liquidity. The primary advantage of this process is to allow suppliers to gain quicker access to funds that are owed and more time for buyers to settle their payments.

What is Greensill?

Greensill was a UK-based financial services company that focused on supply chain financing and related services. It was founded by Australian businessman Lex Greensill CBE in 2011. Greensill became defunct after it filed for insolvency protection on 8th March 2021.

When Greensill was first founded in 2011, its primary focus was offering supply-chain finance. However, since then it has diversified its revenue streams, expanding to different geographical coverage. Greensill offers conventional banking services through its German subsidiary Greensill Bank, fund management with partner organisations and also the sale of bonds through debt that it has purchased.

Greensill’s initial backers included American private equity firm General Atlantic with a $250 million investment into the company in 2018. This began Greensill’s rise to fame and entrance into the media’s spotlight.

Following that, SoftBank invested a total of $800 million into Greensill through its Vision Fund. This fund primarily focused on placing SoftBank as a market leader, backing businesses that create a long-term impact and have scalable vision. This subsequently led to a delay in Greensill considering other alternate options for financing an IPO. This was the pivotal point in time for Greensill as their balance sheets boomed. They were not only pursuing investors that offered around $500 to $600 million, which would allow them to complete their IPO within two years, but they were also seeking new auditors as they “outgrew” their then auditor Saffery Champness.

A concise timeline of what exactly happened to Greensill

“Decades in the making but days in its downfall”

There is no better way to sum up the rise and fall of Greensill. The entire process from Greensill entering a state of distress to the announcement of the company filing for insolvency all happened within the time span of a week.

To understand what happened simply, we first have to examine Indian-born British businessman Sanjeev Gupta and his family businesses GFG Alliance. The Gupta family primarily owned businesses in the mining, manufacturing and trading. Specifically, GFG owned Whyalla Steelworks which was situated in Southern Australia. On paper, Greensill looked like a provider of supply-chain finance, yet in reality, experts consider them to be gambling with “unsecured credit”. What ultimately landed them in trouble was not the financing of small businesses, but rather huge loans made to big businesses.

Gupta’s business has expanded across various continents and now owns aluminium smelters in France, Scotland, and steel mills in the US, Australia, Romania and the Czech Republic. GFG Alliance, as a company, also employs nearly 35,000 in 30 different countries. This relates to Greensill rising to the spotlight of regulators and raising “red flags”. In 2020, German regulator BaFin raised the concern that Greensill Bank “was unable to provide evidence of the existence of receivables in its balance sheet that it had purchased from the GFG Alliance Group”, essentially reporting on business that has not occurred and also Greensill’s substantial exposure to Gupta’s businesses.

By early 2021, Gupta’s business owed Greensill up to $6.5 billion that it did not have. This alarmed one of Greensill’s backers, Credit Suisse. On 1st March 2021, Credit Suisse froze $10 billion funds that were invested in Greensill’s financial products and held up by its supply-chain finance related investment funds. This was backed by the reasoning that Credit Suisse was concerned about the lapsed insurance policies that covered the defaults for a portion of Greensill’s assets.

Following that, Greensill considered filing for insolvency due to insufficient funds. During this time, Greensill appointed accounting firm Grant Thornton to prepare for a possible restructure and insolvency proceedings. On the very next day 2nd March 2021, Greensill Capital announced that it was considering selling the remaining operating arms of the business to Apollo Global Management or an associated firm Athene Holding. However, the deal fell through within a fortnight, on the 12th March 2021. Prior to that, Greensill filed for insolvency protection, on 8th March 2021, as it was unable to repay the $140 million loan it took from Credit Suisse and Gupta’s GFG Alliance defaulted on the loans it took out from Greensill.

It was also reported that Greensill has been sued for fraud by Bluestone Resources Inc. The allegations were based on the fact that Greensill’s practices within supply chain finance were not properly regulated and the speculative nature of their transactions.

As of right now, the worst hit backer of Greensill is Credit Suisse. The bank’s management has already ousted their head of asset management Eric Varvel and has suspended bonuses for senior executives as it investigates the Greensill scandal further. This subsequently led to an increase in concerns over Credit Suisse CEO Thomas Gottstein’s leadership capabilities as this scandal is just one of many missteps Credit Suisse has faced in the previous year. On 22nd March 2021, co-founder and now-former CEO of Apollo Global Management also announced that he would step down from the firm’s leadership. It is not confirmed as to whether this decision is related to the initial possible purchase of Greensill. However, the timing seems rather convenient for both events to occur within such a short time.

How has Greensill’s collapse affected various stakeholders?

In Australia, Greensill has entered court proceedings which has meant its shareholders and customers are facing a rather turbulent period. As mentioned earlier, Sanjeev Gupta and his family business GFG Alliance are facing troubles financing their business as they defaulted on loans from Greensill. Alongside that, Gupta will most likely be dethroned from the title of “the saviour of steel”, which came after his industrial empire bought up a lot of struggling factories.

In the UK, nearly 5000 jobs are at risk. This is caused by the financing issues faced by the UK’s third largest steel producer – Liberty Steel Group, which is a part of Gupta’s conglomerate GFG Alliance. This has also affected the plants across the channel in France.

In Germany, Greensill is facing criminal lawsuits. Several municipalities’ governments backed the local subsidiary of Greensill Bank and therefore have suffered losses of millions of dollars and are requesting for the federal government to cover the losses. Personally, I believe this is a bad investment decision made on behalf of the municipality governments.

Dissecting Greensill’s collapse

There are a few possible explanations I have come up with to dissect the root cause of this scandal:

1. Collateral of Pandemic Suffering

This is a rather intuitive explanation of the fall of Greensill. Simply understood, small businesses have been taking a hard hit since the initial stages of the COVID-19 pandemic. Considering the fact that Greensill primarily served small businesses and thus has affected the flow of capital back into the bank. Furthermore, an increased pile of defaulted debt has also substantially affected Greensill’s liquidity, which ultimately led to their downfall.

2. Accounting loophole

This is a relatively convincing argument. An obscure rule in accounting allows companies to put Supply Chain Finance in the “accounts payable” column on a balance sheet. Although quite marginal, it does add up to a substantial amount when there are a large number of debtors.

3. Credit quality

This is probably the most important explanation. Greensill focused too much on high yield and deeply distressed credit. The entire idea of supply chain finance is that the credit issued is based on the payables as opposed to the receivables of the corporate buyer. These buyers mostly have a very good credit rating, with AAA. However, their expansion into lower quality assets such as CCC rated risky assets has created a difference in risk that corporate buyers were possibly unaware that they were exposed to.

Does this reflect upon underlying or hidden problems within the industry?

Following this scandal, many have called for deeper investigations especially surrounding accountability. It has also brought up several questions as to whether this uncovers deeper rooted issues inherently present in the industry.

One main debate is the problem of financial risk assessment and possible overleveraging occurring in Greensill. Although investigations are still underway and there is information pending release, based on what we understand, it is safe to conclude that Greensill was too heavily reliant on the capital stream from Credit Suisse. As a financial institution, they almost have no independence at all. This is problematic because the shutdown of one capital stream and the inability of one debtor to repay their loans should not completely paralyse an entire credit facility. Unfortunately, this was the case for Greensill. To understand this in simpler terms, Greensill “bit off more than they could chew”.

Another question raised is that Greensill claimed that its establishment was for the purpose of making finance “fairer”. However, it is worth considering, is it really fairer if in order to get paid on time, small payments have to accept a reduced payment? Not to mention, supply chain finance generally advocates for shorter repayment times of 30 days or less, whereas most of the small businesses were receiving terms that were ranging from 45 to 92 days. In order to refine Greensill’s iteration of supply chain finance, they should not have sought out third parties in order to improve their creditor’s cash flow and liquidity at the expense of small businesses.

Most importantly, the biggest problem is possibly systemic. Regulators do not seem to have fully understood what Greensill was doing and allowed problematic invoice structures to be packed into bonds and then sold to pension providers and other investors. In my opinion, bonds should be structured, where at the least, regulators should understand the risks and where they lie. This gives out hints of the 2008 subprime mortgage loan crisis, whereby regulators were unaware of the risks of the products sold in the open market.

It is no secret that financial markets are constantly evolving. A main takeaway from the Greensill scandal is that the business world also follows Darwin’s rule of natural selection. Only businesses with leaner business models are able to survive. Especially in turbulent times as a global pandemic, the management of risk is of paramount importance. Most importantly, as financial markets change and evolve, so should market regulatory standards. Regulators and financial authorities need to adapt to the changing needs of the market and be able to protect various parties on different ends of transactions in order to prevent history from repeating itself.

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