Insight & Analysis

One small step for trade finance, one giant leap for ESG

Published: Jun 2020

With the constant focus of corporate life on ESG, what role does trade and supply chain finance have in delivering a sustainable future?

Looking through a lense

It is becoming an essential part of the bank/treasury conversation these days to view products and practices through an environmental, social and governance (ESG) lens. But more needs to be done. An increasing portion of these discussions are around trade and supply chain finance, and it may just make the difference.

The general level of ESG discussion demonstrates advancement, in corporate financial terms, from the debt and capital markets niche of green bonds and linked loans, into a broader realm, where ESG practices are being implemented in day-to-day corporate financial activities.

But trade finance and procurement activities have an immediate connection with the advancement of ESG thinking, because trade itself is vital to all corporate operations, and the interactions between companies and their suppliers that this generates is profound. Embedding ESG at this level could be significant.

Data quest

However, with supply chains typically being widely spread across multiple geographies, and supplier-size varying widely too, when companies start implementing ESG policies, difficulty in quantification can make ESG practices more challenging, notes Baris Kalay, Head of Trade Finance for GTS EMEA, Bank of America (BofA).

Although various independent bodies are attempting to bring about a more coherent approach at least to the reporting of these individual elements, they can use slightly different methods. How then do companies assess the relative merit of supply chain partners in this context?

The short answer is that it can be a challenge. For now, data from the main ratings agencies, and independent reports from firms, can be useful in this respect. But third-party reporting still relies on individual suppliers making certain disclosures, notes Kalay. The diversity of supplier-types and geographies is still apt to frustrate proper understanding and measurement of success.

Of course, asking suppliers to self-assess may produce less credible responses. However, corporate buyers will know their supply chains better than any bank or independent reviewer, and herein lies the hope for Kalay. “What buyers can do is to use the strength of their relationships with their suppliers to ask for documentation and other information supporting any ESG statement,” he says.

Securing the right data and metrics to be able to inform a balanced approach to ESG means participant functions in trade, such as treasury and procurements, need to be included in formal policy and strategy documentation. This is now happening. “Some of our clients are becoming increasingly structured in terms of applying an ESG lens to the management of their supply chains,” notes Kalay.

He believes that although applying an ESG lens to individual functions and specialisms across the organisation can produce different opinions, having an understanding of how the different functions see ESG can also generate more informed interactions between them.

Small steps

Indeed, it may become easier to create a unified organisational approach based not on the imposition of one rule from above, but on the collective understanding of the different functions’ drivers and needs.

It’s here that companies can begin to see both the cross-functional and ESG benefits of, for example, moving from plastic payments cards to virtual cards (improving the T&E end-user experience, strengthening security processes and deepening supplier relationships, whilst removing yet another plastic product from the world).

In itself, this may not seem like a great step forward, but for Kalay it is these “small incremental improvements”, derived from closer interaction, that make the difference in ESG. It creates a “domino effect”, changing the views of the different functions across the trade process.

“There are many such efficiencies that companies can create that could trigger an ESG response on the supply chain side,” he notes. Indeed, even with some suppliers, where the interaction is based on traditional paper-intensive products such as letters of credit, working with different stakeholders to shift some of the paper-based documentation to an electronic format can drive the ESG process.

Whilst encouraging the use of electronic letters of credit, bills of lading and other shipping documents has been an aim of the industry for some time, success is muted. The ICC claims that up to four billion paper trade documents are still being generated each year.

“It is always more difficult in trade finance because of the number of counterparties involved, but the industry is taking steps,” comments an optimistic Kalay. He anticipates greater uptake of data analytics, facilitated by AI and robotics, as another means of advancing ESG thinking.

Until then, with multiple sources of trade data collection and generation across different locations and supplier-bases, corporates face a major challenge. It is here that banking partners need to step up, using their own data and analysis to help clients quantify supplier performance in appropriate sectors and geographies, even providing industry and sector benchmarking data. “And whilst each client may attach a different degree of importance to certain ESG elements, we can learn from them just as they can learn from us,” says Kalay, believing ESG to be a shared responsibility.

Tectonic shift

Although recent BofA research predicts huge changes in global supply chains, Kalay says the critical nature of those internal and external relationships means the changes will mark (as the report’s title states) a tectonic shift; slow but substantial.

“The more transparency there is around the data held across all trade participants, the quicker the change will happen,” he says. And it will be the deeper interactions and data-led understanding of elements – such as the direct and indirect impacts of having production facilities far from the home market – that will drive this tectonic shift.

If change of this nature is inevitable, then all treasurers need to start considering their day-to-day operations, including trade and supply chain finance, through an ESG lens, says Kalay. Although major supply chain projects involving buyers, suppliers and bank relationships, can be costly and time-consuming (and thus rejected), those small incremental changes can begin driving progress, he says. A programme of digitisation to remove paper will create a shift in thinking across the business, helping with buy-in for more substantial programmes of change.

And if ESG is a shared responsibility, banks need to respond too. Even here those incremental moves count. Trade finance products can be subject to subtle changes to become a subset of the current product set, suggests Kalay. Last year saw BofA establish an ESG-related trade finance facility for a letter of credit where, for instance, individual suppliers could demonstrate more environmentally-friendly production. “We are currently discussing how we can create differentiation for Letter of Guarantees for the support of environmental projects.”

If both banks and clients have a fuller understanding of how an ESG lens can be applied to the supply chain, then these incremental changes will make a difference. As their visibility increases across the supply chain, so application of the ESG lens to trade and all other functions becomes the norm. The technology will follow. And that is how progress will be made.

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