Financial institutions face a raft of environmental, social and governance issues as they navigate trade in 2024. Jenny Messenger examines the latest evolutions in sustainable trade and supply chain finance, and how firms are keeping track of their value chains in the face of an ESG-related regulatory onslaught.
Last year, ocean and land temperatures shattered previous records, sea levels reached new highs and extreme weather caused death and destruction worldwide.
The year ahead looks likely to bring another round of soaring temperatures and catastrophes such as drought, flooding and wildfires, all exacerbated by climate change.
Financing the green transition In the world of trade and supply chain finance, green and sustainable products have developed significantly in recent years, driven by regulatory pressures and the need for rapid decarbonisation. Nearly all corporates are feeling the heat to align with environmental goals and help governments keep global warming within 1.5°C.
Emerging market and developing economies (EMDEs) stand out as particularly vulnerable and in critical need of financing, representing some of the nations most at risk from the effects of climate change.
According to the World Economic Forum, Sub-Saharan African countries such as Burundi, the Central African Republic and Chad top the list of countries most exposed to ecological threats while also having low societal resilience. Yemen and Afghanistan also rank among the top 10.
While the International Energy Agency has emphasised the significant opportunity presented by clean energy in EMDEs, attracting substantial levels of financing remains essential for the transition to clean energy projects.
A plethora of green and sustainable deals have been announced in recent months, from the Asian Development Bank’s US$100mn risk-sharing agreement with the UK’s development finance institution to support renewable energy deals in South and Southeast Asia, to Standard Chartered’s launch of a sustainability-focused trade loan for its financial institution clients.
Pressure on banks to stop funding the fossil fuel sector has also remained high. Earlier this year, Amsterdam-headquartered ING became the first major lender to restrict finance for new coking coal mines – the type of coal used in steelmaking – as well as the expansion of existing mines, earning praise from NGOs.
But calls to halt funding for polluting projects are growing. In February, campaign groups, including Stand.earth and BankTrack, urged lenders, insurers and private equity firms to end financing for liquefied natural gas projects or risk a future of stranded assets.
Regulators in the UK and EU have also moved to crack down on greenwashing in financial services, targeting scenarios where lenders make claims about combatting climate change while also supporting the fossil fuel sector.
Last year, the UK’s Financial Conduct Authority announced plans for closer scrutiny on all financial products using terms such as “climate”, “green”, “net zero”, “transition” or “responsible” in their marketing material.
The European Banking Authority also said it was looking at potentially recommending regulatory changes to root out greenwashing, with a final report due in May this year. It drew attention to a lack of binding standards for sustainability-linked loans, noting that borrowers receive a discount if they hit targets but face no penalty if they do not.
Jennifer Wainer, head of ESG for treasury and trade solutions at Citi, tells GTR: “One of the biggest challenges is how to help hard-to-abate sectors, and ‘green-’ or ‘sustainable-’labelled products may not be the preferred solution for companies in these sectors. More transformational industry-wide solutions and incentives may be needed to decarbonise at scale.”
“The key will be to focus on the impact, rather than the labelling. The market seems very focused on things that can be called ‘green’, ‘social’ or ‘sustainable’, but the scope for sustainable trade finance should be anything that helps business operations and value chains use less carbon, reduce waste and water usage, cut pollution, reduce the impact on nature, support biodiversity and become more socially responsible and inclusive,” Wainer adds.
Christopher McClure, partner and ESG services leader at public accounting, consulting and technology firm Crowe, tells GTR that one vital way of navigating this kind of territory is to ensure different teams are talking to one another: “You have to make very sure now whatever you say in the regulatory space is aligned with what you’re saying in the sustainability and other public spaces.”
McClure explains that sustainability teams tend to “err on the side of sharing more narrative information”, whereas those who manage financial statements and regulatory reporting often take a more “narrow perspective of materiality and regulatory obligations”.
“The big challenge is deciding as an organisation what you’re going to say, how and where. The worlds of sustainability and financial and regulatory reporting are colliding,” he adds.
To aid lenders in adhering to the patchwork of regulatory standards, a number of initiatives have also been established in recent years around standardisation in trade finance.
These initiatives look set to develop further this year, with examples including the International Chamber of Commerce’s trade finance sustainability standards, which were recently widened to include the energy, automotive and agriculture sectors, and the International Trade and Forfaiting Association’s sustainable audit council.
Wainer notes that standardisation is “an important enabler, but efforts to reach industry-wide consensus should not distract from the main focus of helping companies to take forward-looking and impact-oriented actions towards sustainability immediately”.
Supply chain scrutiny
Corporates are also coming under closer scrutiny to eradicate environmental and human rights abuses from their supply chains.
This year began with a raft of tighter legislation under discussion in Europe, including a provisional deal to ban products made using forced labour from being sold on the EU market.
One far-reaching piece of legislation that has led to uncertainty for businesses is the EU’s Corporate Sustainability Due Diligence Directive (CSDDD), which looked on track to be given final approval, but stalled in February during a crucial members’ vote.
Germany, France and Italy scuppered the draft law at the last minute, leaving the fate of the legislation – which currently doesn’t include the financial services sector – up in the air.
A letter seen by Reuters from two German ministers – both members of the country’s Freie Demokratische Partei – suggests that Germany’s opposition centres on fears the directive will put businesses under increased bureaucratic strain and risk opening up firms to unmanageable liability, as well as doubling up on the country’s existing supply chain due diligence law.
The latest version of the CSDDD was endorsed by the EU’s committee of permanent representatives and the European Parliament’s legal affairs committee in March after the text was altered to reduce the number of companies included.
Firms with more than 5,000 employees and €1.5bn turnover will be captured at first, with smaller organisations phased in over subsequent years.
This is a substantially diluted version compared to the previous text, which would have initially covered businesses with more than 500 employees and €150mn in net global turnover.
Speaking to GTR before those revisions were made, Tim Figures, partner and associate director, EU and global trade and investment at Boston Consulting Group (BCG), says that one of the most crucial aspects of CSDDD is the requirement for firms to publish reports of their audits.
“If [firms have] identified gaps between the audit and the directive’s requirements, they’ll have to set out an action plan for closing those gaps. I think we can expect groups like investors, civil customers and civil society organisations to look quite closely at these reports and action plans, and track the progress of larger organisations over time to check that they are actually moving into compliance,” Figures says.
As of press time, the draft law still requires formal approval from the European Parliament, but it seems likely a watered-down version will eventually be passed.
Silke Goldberg, partner and global head of ESG at Herbert Smith Freehills, warns that the weakening of the proposals “will create ripples of uncertainty across boardrooms, supply chains and the interconnected fabric of our world”, leaving corporates with “more questions” than answers.
This reaction to more stringent environmental regulation has been dubbed a ‘greenlash’, exposing schisms in how various sectors respond to the demands imposed by net-zero targets.
In another example, farmer protests in the Netherlands, France, Germany and elsewhere have stemmed in part from opposition to the European Green Deal, which includes measures to cut methane and nitrogen pollution, as well as changes to diesel tax.
And in the US, environmental and social factors have become increasingly politicised among a faction of Republican politicians and the fossil fuel sector, which argue that decisions based on ESG undermine returns.
Earlier this year, BlackRock, JP Morgan and State Street along with several other asset managers scaled back their involvement with Climate Action 100+, the world’s largest climate investor coalition.
Some firms have also argued that better communication is needed between lawmakers and businesses.
Discussing the US’ Uygur Forced Labor Prevention Act, which came into force to stop the import of goods made by Uyghurs detained in camps in China’s Xinjiang region, Ted Murphy, partner in Sidley’s global arbitration, trade and advocacy practice, notes that “the law changed dramatically, and it takes time for the market and for companies to adjust”.
If the US Department of Homeland Security identifies a firm as using forced labour or working with the Xinjiang government in connection with forced labour, it adds it to a list of companies that are banned from importing their goods into the US.
Murphy adds that if firms are put on the Forced Labor Enforcement Task Force entity list, the explanations for that can be limited.
“If US Customs Border Protection detains a shipment and determines the importer’s submission is not sufficient, they issue a form letter that says ‘what you submitted was not sufficient’. The letter does not specify what the concern is. It just says sorry, your merchandise is being excluded from the United States,” he says.
Climate crackdown
Meanwhile, the EU’s deforestation-free regulation (EUDR) will come into force at the end of the year. This legislation targets palm oil, cattle, wood, coffee, cocoa, rubber and soya, as well as some derived products, such as chocolate and furniture.
Goods produced after the cut-off date of December 31, 2020 must be “deforestation-free”, with traders required to trace commodities back to the plot of land where they were produced.
“What companies need to be doing now is understanding the audit, due diligence and reporting obligations, and being ready to comply with those from December 30, 2024,” says Figures at BCG.
This might include “tracking each consignment’s origins, in terms of its coordinates, and maybe using satellite imagery to prove there was no forest there prior to 2020”, he says.
Companies will be at different stages of preparedness, Figures says, with some already signed up to voluntary schemes like the Rainforest Alliance.
However, other deforestation legislation, including the UK’s 2021 Environment Act, which bans imports of palm oil, cocoa, beef, leather and soya made from illegally deforested land, and the US’ Fostering Overseas Rule of Law and Environmentally Sound Trade (Forest) Act, have made limited progress.
According to Citi’s Wainer, trade finance is one way firms can improve oversight of goods’ environmental and social impact.
“Many parts of the sector are rich sources of data on the carbon footprint of global trade activities but are being under-utilised from an ESG perspective. Exploring these opportunities will also help to make quantifying impact easier,” she says.
Wainer adds that while ESG-linked supply chain finance products have “a lot of scope” to evolve and become more sophisticated, they are currently in their infancy.
“As supply chain finance matures, it will have a growing role to play in sustainability across value chains,” she says, including “sharing of data to help both buyers and suppliers make better decisions”.
The carbon border adjustment mechanism (CBAM) is also ushering in a big change for European companies, imposing taxes on importers of emissions-intensive goods such as steel, cement and fertilisers.
Crowe’s McClure says companies need to make sure ESG teams are talking to other parts of the business. This is particularly true for CBAM, McClure says, which requires a “cross-functional team”.
“It’s ESG because it’s requiring embedded carbon measurements for the first time and requires people who understand greenhouse gas emissions, but then it’s really a trade, customs and tax issue because you have to have your registered importer carry out the registrations through each country and identify the products,” he says.
Simon Geale, executive vice-president at supply chain consultancy Proxima, underscores the importance of organisations having the right expertise in place for scope 3 emissions reporting, in particular.
“What we found is that the greatest levels of maturity come in organisational strategy and target setting, such as saying, ‘we’re going to be net zero by 2030’. Some of the lowest levels are in actually having the people and the tools to be able to achieve it,” Geale says.
As 2024 progresses, ESG is set to continue dominating conversations, bringing further complexity for firms and lenders as they explore fresh ways to reach their net-zero targets and hope for greater regulatory certainty.
