Funding & Investing

Information underpins evolution of sustainable trade finance

Published: Nov 2022

As ESG data becomes more accessible, companies need to ensure that they can stand over their environmental and social metrics.

A sustainable trade finance solution is by definition a financing solution facilitating trade while having a material and positive contribution on either environmental or social aspects. This ESG impact is sought either directly in the underlying project/asset financed or facilitated, or indirectly through the ESG performance of the borrower.

Sanjay Sandarangani, Head of Sustainability Propositions, Global Trade and Receivables Finance at HSBC explains that there are two broad categories of sustainable trade finance transactions – use of proceeds; and transition financing.

“Metrics and underlying targets need to be relevant and ambitious based on historical performance and industry best practice,” he says. “In both scenarios there is a requirement for annual reporting by the client to confirm that the intended purpose or target was met.”

Key components of sustainable supply chain finance include track-and-trace, certification, and financial incentivisation.

“Assessment of the customer’s economic activity or line of business and/or relevant industry certifications of their ESG goals and actions taken to achieve them are crucial when a bank looks to finance a sustainable trade,” says Sriram Muthukrishnan, Group Head of Product Management, Global Transaction Services at DBS.

The certification process needs to be supported by a robust traceability process and data-led, while potentially enabling the completion of financing and settlement processes simultaneously. This means clients should utilise data directly from business processes to enable tracking, certification and financial arrangements.

The first step in assessing suitability for sustainable trade finance solutions is to understand where the client is in their ESG journey explains James Binns, Global Head of Trade & Working Capital at Barclays.

“Some clients may provide products to the market that meet the relevant industry standards for being ‘green’, but may not have developed external reporting for their broader ESG goals,” he says. “This could mean that sustainable solutions that link to the purpose of transactions are appropriate.”

Other clients may offer a suite of products which are both ‘green’ and ‘non-green’ but have developed their ESG goals and regularly report on their progress towards these goals. In this scenario, solutions that link to attainment of targets linked to their ESG goals are more appropriate.

“Both of these solutions enable the client to speak to stakeholders (suppliers, buyers, regulators, employees and shareholders) about their commitment to supporting transition to a more sustainable economy,” adds Binns.

Ahmed Benraissi, Head of Strategic Advisory, Global Trade Solutions at BNP Paribas observes that the first movers tying their sustainability commitments to their trade and supply chain financing were listed and large corporates from Europe, APAC & North America.

“We expect this movement to extend to all regions and clients segments including mid-corporates, who typically face significant challenges in complying with sustainability standards, either through top-down or bottom-up pressures and incentives,” he adds.

Case study

German adhesives and consumer goods giant Henkel recently confirmed that it had integrated sustainability criteria into the largest segment of its supply chain finance programme.

The programme – which Henkel has been running with Taulia since 2015 – now provides flexible financing options to the company’s suppliers with preferential rates depending on their ESG ratings. EcoVadis was chosen as a co-operation partner for the programme, allowing for a globally consistent rating mechanism.

Since each country and region is different, it is very important to take local aspects into account and at the same time not lose sight of the need for consistency regarding impact. For this reason Henkel applies one consistent scale to measure sustainability using the same ESG provider worldwide.

The company does not expect sustainability to have any negative impacts on its supply chain in terms of additional costs or complexity.

“While the positive funding impact is still hard to measure, we expect sustainable programmes in the future to gradually receive funding at preferred rates from financial institutions,” says Ulrich Borgstädt, Head of Group Treasury. “This requires their refinancing for green programmes to be cheaper than funding costs for ‘classical’ programmes.”

Henkel has set a target of achieving 100 million tons of CO2 reductions together with its customers, consumers and suppliers between 2016 and 2025.

The company has been using ESG ratings as a criterion for selecting suppliers for a number of years. Its sustainable supply chain finance programme incentivises suppliers to improve their ESG rating using a multi-dimensional approach on sustainability beyond pure carbon reduction.

Muthukrishnan refers to increased interest in sustainable trade finance solutions globally, with European-led corporates in particular driving demand as larger corporates ramp up efforts to transform their procurement operations to meet international sustainability standards and/or targets.

“In terms of specific sectors we see a sharp pick up in interest from the apparel, footwear and textile industries, especially from Asian suppliers located in markets such as Bangladesh, Vietnam, China and India,” he says. “The renewable energy segment in Greater China also remains active and we have supported several projects in the region over the years.”

Sustainable solutions are in their infancy within the trade and working capital market with many banks still developing solutions to meet this client need according to Binns.

“So far, we have seen a similar level of use for sustainable trade and working capital products across all geographies and client size,” he adds. “However, we are noticing an increasing requirement from clients as knowledge of these products and the benefits they can bring to the client and their stakeholders increases.”

Greenwashing and reputational risk are important issues to factor into any sustainable finance solution according to Donna McNamara, Global Head of Trade Product Commercialisation & ESG Strategy at Citi Treasury and Trade Solutions.

“To help mitigate these risks, data validation is at the centre of the procurement practice and the financing,” she explains. “Banks and corporations have a similar approach to validation requirements and have built it into their respective procurement strategies.”

Many organisations have started to address their direct emissions, but not enough has been done to reduce indirect emissions, including Scope 3 emissions arising from their suppliers according to Sandarangani.

“On average, more than 80% of a company’s carbon footprint resides in its supply chain, which means delivering on Scope 3 emissions won’t happen unless more is done to help small and medium sized suppliers,” he says. “Anchor buyers are in a unique position to influence positive change across their supply chains by helping their suppliers with know-how and financing tools to enable the transition.”

He suggests that buyers need to identify metrics (which need to be robust, ambitious and in line with industry best practice) for their suppliers to improve against and which can help address the buyer’s own ESG strategy.

Buyers also need to consider the social aspects of their supply chains, such as human rights. “While the EU and UK have had ESG disclosure requirements for public entities for many years, this is now being enacted into law,” adds Sandarangani.

To remain relevant, companies will need to align profitability goals with meeting the needs of society – to demonstrate their efforts in supporting the betterment of lives and livelihoods, and show how the organisation is changing and investing in business practices to encourage a more sustainable future says Muthukrishnan.

“Banks can also work with corporates to provide working capital to suppliers and improve financial inclusion of SMEs while at the same time enabling and incentivising the achievement of agreed sustainability goals,” he adds.

Assessment of the customer’s economic activity or line of business and/or relevant industry certifications of their ESG goals and actions taken to achieve them are crucial when a bank looks to finance a sustainable trade.

Sriram Muthukrishnan, Group Head of Product Management, Global Transaction Services, DBS

When asked to outline the sort of advice he would offer to companies looking to incentivise their supply chains to implement sustainable practices, Binns says he would start by recommending that they define and understand their ESG goals internally to ensure they have a compelling story to present to the market.

“Companies can then focus on those elements that are influenced by their supply chains, for example, reducing the end-to-end carbon footprint of the goods or services that they provide,” he continues. “This can then be used to incentivise their supply chain to improve those elements by provision of key metrics that are externally verifiable on a periodic basis.”

In a similar vein, clients can use their goals to make positive changes to how their supply chain operates – addressing the social and governance elements of ESG – by agreeing targets and pricing linked to the achievement of these changes with these suppliers, which will have a positive influence towards their own goals whilst providing leadership within the industry.

According to Benraissi, the success of this kind of supply chain financing programme relies on a number of factors including:

  • The capacity of the buyer to convince its suppliers of the criticality of the ESG topic.
  • The reliability and robustness of the ESG data.
  • The appeal of the incentives.

“Research shows that the financial performance of companies corresponds to how well they manage ESG and other non-financial matters,” says Benraissi. “However, for SMEs – especially in less ESG mature countries – there are still challenges in complying with sustainability standards and allocating time, money and resources. Those challenges are amplified if they need to demonstrate transparency and initiate sustainable actions to many buyers with different expectations.”

He suggests that integrating these supply chain financing programmes within a digital platform enables suppliers, buyers and banks to interact seamlessly by connecting ESG data to financial metrics, speeding up access to early payments, while having a concrete and positive ESG impact.

Another consideration for corporates is the extent to which sustainability has a negative impact on supply chains in terms of additional costs or complexity.

Binns acknowledges that some supply chains will bear greater costs, for example where processes need to change or where increased monitoring and governance results in changes to suppliers. Accessing the data required to measure the ESG credentials of supply chains can also be complex and lead to increased costs. “However, this should be viewed through the lens of initial investment costs,” he says. “In the current climate of the high price of utilities impacting the bottom line of supply chains, the time required to recoup the initial investment for making sustainability-linked changes is reducing.”

This process is necessary over the long-term and will ultimately result in more sustainable and resilient supply chains, adds Binns. “Governments and regulators are also putting increased focus on transition to sustainable solutions, so if supply chains delay implementing these they risk negative reputational impact.”

Muthukrishnan accepts that lack of supply chain transparency and control can be a source of business disruption and non-compliance to sustainability policies, resulting in financial and reputational losses.

“However, there has been a marked improvement with the advent of digital tools such as the internet of things to collect data, 5G networks to transmit this data more efficiently and cheaply, machine learning to make real time decisions, and blockchain to enable supply chain traceability and visibility,” he concludes. These technologies can provide corporates with critical early warning signals to potential disruptions and help them manage exposure to risks and verify that products are procured sustainably.

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