Why EU Late Payment Regulations Could Do More Harm than Good

For over a decade, the European Union has attempted to use the legislative process to curb late payments for B2B transactions, and with good intention. Late payments account for a significant portion of all payments processed, and the impact on suppliers – particularly small and mid-sized businesses – is undeniably negative.

The EU first acted on this in 2011 with the Late Payment Directive. Corporate enterprises “had to pay their invoices within 60 days, unless they expressly agree otherwise and provided it is not grossly unfair.”

Thirteen years later, however, has the directive been effective? Many would argue “no” as late payment is still a problem in the EU. Ambiguous wording, weak enforcement, and a reluctance for suppliers to call out their customers has led to little meaningful change in business practices.

In response to this, in September 2023, a Late Payment Regulation was proposed by the European Commission. This differs from the previous directive in several ways:

• It shortens the maximum payment terms for all commercial transactions to 30 days. There is no latitude for extension.

• Late payments will automatically be subjected to penalty interest calculated at the European Central Bank’s refinancing rate plus 8 percentage points.

• There are stronger enforcement measures. EU member states will be required to establish dedicated complaint mechanisms and to impose penalties for non-compliance.

At present, there are a lot of questions surrounding the regulation. What is the likelihood it will become law? Will it be more effective? What intended and unintended implications should be considered? For a deeper dive, I encourage you to read our recently published perspective on the topic: Decoding the European Commission’s Late Payments Proposal: Boon or Bane for Business?

Perhaps the biggest question of all is this: If it passes, will the EU Late Payments Regulation cause more harm than good? For all the good intentions behind the EU Late Payment Regulation, there are several unintended consequences that would likely occur if the regulation went into effect in its current form.

A significant adverse financial effect on EU buyers that will subsequently affect suppliers and consumers.

The regulation as it currently stands would increase the working capital requirements by many billions of euros for companies operating in the EU. To put this into context, for every €10b of trade in the EU, each day is worth €27m in working capital. If payment terms go from 60 days to 30 days, companies would need to find €833m to plug into operations per €10b of spend. That is €833m less to invest in things like growth and energy transition – arguably one of the top strategic priorities for EU member states and companies for the next decade.

Discontinuation of early supplier payment programs that are critical to cash flow management.

Globally, suppliers depend on early payment programs to enhance their cash flow. They mitigate the effects of extended payment durations by enabling suppliers to receive payments in under 30 days. Concurrently, these programs permit buyers to adjust their payment schedules in line with their specific cash conversion cycles. Suppliers accustomed to receiving payments on Day 7, 10, 15, or 20 will in effect be looking at extended payment terms. In reality, buyers will lack motivation to pay before the 30-day mark and financial institutions will be unlikely to offer financing for 10 to 20 days.

A Balanced Approach for Solving the Late Payments Problem

The EU Late Payment Regulation will no doubt spurn significant debate. Is the regulation in its current form helpful, or harmful – not just to buyers but the very suppliers it aims to protect? Have regulators adequately considered the long tail implications – like the possible elimination of early payment programs? It appears they have not.

And, at a macro-level, should government institutions or markets and businesses set the terms of trade? Perhaps the answer is a bit of both. There is typically a political fault line on this question, and it’s hard to ignore the political currency that could be applied. We’d argue that in the current economic climate, businesses need access to diverse liquidity options – especially low-cost options that don’t negatively impact the balance sheet. And they also need a legislative framework that can deal with late payment.

If a business has 120-day payment terms, nobody will object if that company was severely fined for paying on day 121. That is what causes the stress – a business not getting paid when it’s supposed to. Tens of thousands of suppliers in the EU participate in early payment programs that take late payment out of the equation, while also providing affordable access to capital. Perhaps it would make more sense that the EU mandate the roll out of supplier financing for all companies of a certain size to solve the problem of late payment. There is no shortage of appetite for financial institutions to plug that gap and it’s a great way to channel capital from where it is plentiful (large businesses) to where it is needed (small and medium size businesses).

Whatever the solution, one thing is clear. One-size-fits-all supplier payment terms sounds great on paper but would have negative implications up and down the supply chain in reality.