Historically, global trade has driven increased standards of living, a reduction in poverty and the promotion of prosperity in the developing world. As distant partners began to trade, and shipping routes circled the globe, banks took a prominent role: providing liquidity and establishing standards in financial instruments and due diligence by understanding and managing the financial (will I get paid?) and performance (will I get my goods?) risks in the supply chain.
More recently, firms have found themselves managing a new set of risks driven not only by the goods they trade, but how they produce and trade them. What are the risks to the environment? How are people’s living conditions affected by the industry the trade supports? These risks are real – and firms suffer real penalties where they damage the environment or cause people harm – and banks can again play a role in managing these risks.
With massive value at stake, the largest firms have for some time required their suppliers (and prospective suppliers) to provide data on their impacts on climate change, deforestation and social policy for use in selection decisions, and banks have begun to incorporate Environmental, Social and Governance (ESG) factors into their product design and credit policy – often using differential pricing to reward clients performing well against ESG criteria. We have also begun to see collaboration between banks, corporates and non-governmental organisations (NGOs) driving the progressive integration of ESG standards into Trade and Supply Chain Finance product offerings.
- In 2014, the Banking Environment Initiative (BEI)2 partnered with the World Bank to develop the ‘Sustainable Shipment Letter of Credit’. This initiative was designed to provide discounted financing for trade in agricultural goods that met certain ESG production standards
- Global brands with international supply chains have been working with their banking partners to incorporate ESG criteria in their supply chain finance programmes, rewarding better-performing suppliers with favourable pricing or other terms
- In project finance, we see two innovation types growing in popularity:
- ‘Green Loans’ that fund initiatives that will have a direct positive impact on the environment, and
- ‘Sustainability-linked Loans’, which are contingent facilities that grant funding and/or more favourable rates based on compliance with certain ESG standards
Like so many others, this trend is likely to accelerate as corporates rebuild from the pandemic. The events of the past twelve months have exposed the fragility both of supply chains and trade routes, leading to a renewed focus on sustainability as corporations rebuild and prepare for a post-COVID world.
While the sustainability momentum is growing, legacy barriers prevent many smaller, less mature companies in emerging markets from participating. For example, the difficulty in producing and sourcing sustainability data mean that verification and standardisation remain a big challenge for many banks.
Similarly, trade and supply chain finance remains largely reliant on paper-based and manual processes. A single transaction can involve the interaction of more than 20 entities, dozens of paper documents and thousands of data field exchanges. The incorporation of ESG criteria into due diligence process risks increasing this complexity yet further.
So, what can be done?
- The availability of reliable ESG data points continues to improve and Banks should rethink their approach to ESG data management in order to facilitate their use both internally (incorporating them in the credit decisioning processes, for instance) and externally (facilitating upstream collection from their clients and downstream reporting to government bodies)
- Banks should redesign their trade and supply chain finance processes to make them less onerous for clients and their counter-parties. Simple, easy to use, online portals with a high degree of automation can help streamline interactions between the different parties. Government initiatives (such as Faster Payments) have been gradually driving down administration and compliance costs for SMEs. The adoption of distributed ledgers and smart contracts can increase the transparency around ESG performance across the supply chain and enable automated access to funding
- Finally, for most organisations the journey to implementing a sustainability-focused trade and supply finance strategy will begin with collaborative engagement with experienced peers and delivery partners in roundtables and cross-industry network events, fostering an exchange of best practice and collaboration