Supply Chain Insurance and Finance 2.0

Today I came across a piece in the FT about a UK Government proposal to include a supply chain insurance plan in its forthcoming budget proposal.

From FT:

A state guarantee scheme to underpin vital supply-chain insurance is set to be announced by Alistair Darling, chancellor, in next week’s Budget, according to government insiders.

The scheme will form a centrepiece of the Budget initiatives to help small to medium-sized businesses cope with the recession. Its unveiling marks the culmination of months of negotiations with insurers spearheaded by Lord Mandelson, the business secretary.

The initiative responds to concerns that hundreds of supply chains are threatened by the recession-fuelled reduction in credit insurance, which protects companies that supply goods on credit against the risk that they will not get paid.

Industry has been lobbying for the government to step in for months. The EEF manufacturers’ organisation warned weeks ago: “The speed at which credit insurance is being withdrawn threatens the supply chains that are the heart of the UK’s manufacturing base.”

By the scheme, the government will target medium-risk businesses. It is expected to offer guarantees for companies that have seen cover reduced but not withdrawn. The scale of the scheme is still to be finalised by the Treasury but government insiders suggested it may fall short of the £5bn cap the industry hopes for.

FT Alphaville says that this is due to the lack of capacity in reinsurance markets for trade credit and surety lines.

In fact, as with so much in this crisis, much of the recent ructions in trade credit can be traced back to the activities of very small specialist units at financial sector firms. In the case of trade credit and surety, the activities of the reinsurers are crucial. And the reinsurers are pulling back.

FT Alphaville understands that Swiss Re has cut 45 of 65 jobs in its credit and reinsurance department, with a view, we believe to quitting the trade credit insurance and surety bond reinsurance sector entirely by year end.

Swiss Re confirmed to FT Alphaville that activities are being reduced but precise numbers could not be confirmed.  “We will continue to accommodate the needs of key core multi-line clients” a spokesman for the company said.

The numbers might seem small, but such re departments are of huge importance.

Much like the way AIG FP functioned, trade credit and surety reinsurance operations write contracts with, effectively (though not necessarily we stress, directly) a huge amount of leverage, based on the notion that such contracts being written are virtually risk free. (Indeed historically the industry was renowned for reinsurance contracts that came with secret confidential ’side letters’, hidden from regulators, promising in legally binding terms that their contracts would never be exercised). Just as AIG’s 650 people were a primary force in the explosive growth of the multi-trillion dollar CDS market, so too are small trade credit and surety reinsurance departments like Swiss Re’s, then, critical for the functioning of trillions of dollars of global trade credit insurance further down the chain.

And while Swiss Re is not the largest reinsurance player in the trade credit space,  it’s pullback is nonetheless instructive. It seems representative of a broader trend – one that has the potential to be so damaging that the UK government is forced to make filling the vacuum in the trade credit space a centrepiece of its upcoming historic budget.

Yesterday in my post on Ztail, I mentioned the reluctance to hold inventory as a trend that Ztail could step in to help take advantage of.  I wrote:

“One trend that we are going to see in an deflationary environment is a reluctance to hold inventory of any sort.  When prices are rising and inventory can get turned over quicker, holding inventory isn’t so bad.  But when prices are falling nobody wants to hold anything.  This can have an awful impact down the supply chain so someone like Ztail by getting active in the secondary market will bring value to the market as a whole (and should be rewarded for that).”

I find this post interesting because it shows how Finance 1.0 has failed and where Finance 2.0 can step in.  I really see this as an opportunity for technology and new markets will form down the supply chain the same way they did during the evolution of  the grain exchanges and the futures markets.  Farmers had similar problems and markets formed to combine hedgers and speculators and reduce the cost of carrying inventory.  I fear, however, that Government intervention and reliance on the “old ways of doing things” will prevent progress from happening.

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