Promoting sustainability is not only about doing the right thing – it’s now essential if banks want to meet customer demand. Sanne Wass explains some of the green products emerging in the trade finance market.
As the name would suggest, this is a loan instrument to finance green projects. In March 2018, the Loan Market Association together with other industry bodies released the so-called Green Loan Principles, which state that the “fundamental determinant of a green loan is the utilisation of the loan proceeds for green projects” – this could, for example, be within the sectors of renewable energy, waste reduction and clean transportation, and also cover related and supporting expenditures such as research and development.
One of the key challenges hampering the growth of sustainable financing is the lack of standards. That’s why the Green Loan Principles came about: their aim is to promote the development and integrity of the product by creating a framework of market standards and guidelines.
Trade finance players have increasingly been looking to issue green loans. In late 2018, for example, BBVA granted a five-year €16.5mn loan to a hydroelectric project in Colombia with backing from Cesce, Spain’s export credit agency, which was certified as ‘green’ by consulting firm Aecom in line with the Green Loan Principles.
Barclays, meanwhile, offers a dedicated ‘green trade’ working capital product, which it launched in the UK in 2018. Under the scheme, the bank provides facilities of minimum £250,000 to eligible green initiatives. Barclays has its own Green Product Framework, developed in 2017 with specialist research firm Sustainalytics, which defines whether a financing proposal qualifies for green funding. This includes projects to promote energy efficiency, eco-friendly transport, waste management, renewable energy, sustainable food, agriculture and forestry. A number of other banks are exploring similar initiatives.
A sustainability-linked loan covers “loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivise the borrower’s achievement of predetermined sustainability performance objectives”. This definition is set out by the Sustainability Linked Loan Principles, which were released earlier this year as a follow up to the Green Loan Principles.
Contrary to a green loan, a sustainability-linked loan product can have non-green purposes, such as the financing of general corporate purposes (although a loan can be structured under both principles at once).
Essentially a sustainability-linked loan links the terms of a loan, often the pricing, to the borrower’s performance against specific sustainability targets. These targets are typically negotiated and agreed between the borrower and lender group for each transaction.
Over the last few years, the commodity finance market has seen a growing number of such loans. In 2017, for example, ING restructured a proportion of an existing US$150mn revolving credit facility (RCF) with commodity house Wilmar so that the company pays lower interest if it meets targets around areas including biodiversity, greenhouse gas emissions, renewable energy, social standards, bribery and corruption and sustainable agriculture.
In July this year, China’s Cofco International closed a US$2.1bn sustainability-linked loan with a consortium of 20 banks that will be used for refinancing existing term and revolving credit facilities. The deal includes margins savings based on its performance against environmental, social and governance targets, one of which notably relates to the sustainable sourcing of soybeans in Brazil.
Food and agribusiness company Olam, meanwhile, has tapped the sustainable finance market on several occasions. Most recently, in September, it raised a triple-tranche US$525mn sustainability-linked RCF. The interest margin on the facility is linked with the achievement of certain improvement targets that have been identified as part of Olam’s sustainability strategy, covering farmers’ and food systems’ prosperity and local communities. It follows the company’s signing of a similar US$500mn RCF in 2018.
Sustainable supply chain finance
This covers supply chain finance practices and techniques that integrate environmental, social and/or governance considerations with a view to drive sustainable behaviours in global supply chains.
Essentially, this method rewards suppliers for being sustainable. According to Charlotte Bancilhon, manager at BSR, a global non-profit organisation that helps businesses become more sustainable, the rewards can take different forms: for example, a supplier with good ESG performance could get better rates or terms than other suppliers, or even gain access to a supply chain programme in the first place.
She explains that such programmes are typically led by the corporate buyers and are implemented as a tool to incentivise a more sustainable supply chain.
“Global brands have been implementing sustainable supply chain programmes for the last 25 years,” she says. “Usually these programmes are based on auditing: big brands have hundreds of internal auditors. But on the ground we haven’t seen radical improvement in the performance of suppliers. So sustainable supply chain finance is seen as really the only tool a buyer has to provide their suppliers tangible cash incentives to improve their sustainability performance.”
One of the world’s first sustainable supply chain finance programmes emerged in 2014, when jeans manufacturer Levi Strauss & Co partnered with the International Finance Corporation (IFC), the private sector arm of the World Bank Group, on a scheme to provide cheaper working capital funding to emerging market suppliers if they perform well against certain ethical, environmental and safety criteria.
In 2016, European sportswear brand Puma joined the same IFC programme, with BNP Paribas as a parallel lender. It involved the IFC adopting a financing structure with tiered pricing of short-term working capital, offering lower costs for those suppliers that achieve a high score in Puma’s supplier rating system.
More recently, Walmart and HSBC developed a sustainable supply chain finance programme, which allows Walmart suppliers that demonstrate progress on a sustainability index to get preferential pricing.
While the interest in sustainable supply chain finance is growing, the uptake so far is “still very marginal” and limited to “a handful buyers”, according to Bancilhon. Among the barriers, she adds, is the low awareness of sustainable supply chain finance as well as limited access to supply chain data to support such programmes.
Sustainable shipment letter of credit
The Sustainable shipment letter of credit (SSLC) is a green financing product developed specifically for trade finance. The concept was launched in 2014 by the IFC and the Banking Environment Initiative, a project involving some of the world’s largest banks and convened by the Cambridge Institute for Sustainability Leadership in a bid to expand the global trade of sustainably sourced commodities.
The letter of credit designation allows for discounted financing for trade in agricultural goods that meet internationally-recognised sustainability standards. To qualify, evidence of the appropriate sustainability stamp must be included as part of the letter of credit documents. Palm oil with an RSPO (Roundtable on Sustainable Palm Oil) certificate, which is designed to ensure the product isn’t made to the detriment of any forests, people or communities, was the first use case for the product.
The SSLC, however, never saw significant uptake by banks and their clients. Sources speaking to GTR give a number of reasons for this, one being that it was based on the letter of credit in a time where the market was generally moving away from such traditional trade finance instruments.
Another challenge faced by the SSLC was the fact that it was a paper-based solution, making it more vulnerable to fraud. “The principles are right: if we can prove that this product comes from sustainable forces, then a bank should be able to confirm that letter of credit at a lower rate,” explains Shona Tatchell, CEO and founder of Halotrade, and former head of trade and working capital innovation at Barclays. “The banks tried really hard to adopt it, but the solution was ahead of its time. It was created before the technology was there that could actually make it workable. Just a stamp on a bill of lading is something which can be easily forged.”
Smart contact-based sustainable supply chain finance: Trado
Released in September this year, Trado is a new sustainable supply chain finance model developed by a consortium including big banks and corporates such as BNP Paribas, Barclays, Rabobank, Sainsbury’s, Standard Chartered and Unilever, and led by the Cambridge Institute for Sustainability Leadership.
The model is built upon the same ideas as existing sustainable supply chain finance structures but is new in that it utilises technologies such as blockchain and smart contracts to collect and record social or ecological data on suppliers, who in return get preferential access to trade finance. As such, Trado attempts to address the challenges that existing programmes have around supply chain transparency.
The model was tested in a live pilot earlier this year, which saw the usage of blockchain technology to track tea from farmers in Malawi being sold to Unilever and financed by BNP Baribas. It was done on an Ethereum-based blockchain solution developed by Provenance, a social enterprise that helps firms track their supply chains using blockchain, and Halotrade, a fintech firm that uses smart contracts to convert supply chain sustainability data into automated access to trade finance.
The pilot saw Meridia, a data collection company, amass a range of data on the individual smallholder farmers supplying the tea, all verified by IDH, a sustainability NGO. This included democratic data (such as gender and educational level), economic data (for example, type of transport and source of income), financial data (such as savings and borrowing) and agricultural data around the crop. All information was recorded on the blockchain using Provenance’s application. Furthermore, production data (quality, quantity, date, price and sample approvals) was provided by Unilever’s direct supplier, in this case a local tea factory, recorded on the blockchain and shared with Halotrade’s system to enable invoices to be approved earlier than usual.
In return, the local factory was given earlier access to Unilever’s supply chain finance programme. This is what the Trado model calls a “data-for-benefits swap”: the improved visibility on the supply chain gives the buyer the confidence to instruct its bank to release supplier financing early, namely as soon as the goods have been produced.
Under traditional supply chain finance programmes, a buyer only approves financing for a supplier once the goods have been boarded onto a ship and the buyer has received relevant documentation such as the invoice and bill of lading.
Outlining the model in a new report (titled Trado: New technologies to fund fairer, more transparent supply chains), the consortium explains: “In the period between producing the goods and those goods being boarded, a supplier would normally need to rely on more expensive local financing. With the Trado model, however, the supplier can borrow sooner at the buyer’s lower rate from the buyer’s bank when the goods have been produced.” In the Malawi pilot, this time difference was 35 days.
“We’ve been able to give Unilever the visibility of the contract being fulfilled, and they know everything that they could possibly want to know about that tea,” explains Tatchell of Halotrade. “It’s because of that trust and transparency that Unilever was prepared to take the pre-shipment risk and give a payment obligation to its bank before the goods had even left the factory.”
So far, Trado has only explored the possibility of paying a supplier earlier, not at cheaper rates than a bank would traditionally offer. In fact, the report notes that the Trado model does “not create any material disturbance to business-as-usual banking processes”, meaning there are no changes in the underlying risk evaluation.
However, the consortium says that data generated through the model could be analysed to identify whether the credit risk is better for suppliers performing well from a sustainability perspective.
If so, that might lead to preferential financing by banks through a change in their credit risk.