Sustainable finance deals have become increasingly frequent of late, as banks seek to do the right thing as well as meet growing customer demand for practices and techniques that integrate environmental, social and governance considerations. But with no standards around how such facilities are put together, measured and enforced, does sustainable trade finance risk becoming simply another means of greenwashing? Eleanor Wragg reports.
From HSBC’s mammoth sustainable supply chain finance programme to support Walmart’s Project Gigaton to aluminium and alumina producer Rusal’s US$750mn sustainability-linked syndicated facility, trade, supply chain and commodity finance has – ever so slowly – started to drive the conversation around the environmental, social and governance (ESG) impact of economic activity.
The most common model in the market at the moment is that of a margin ratchet, where a company or its suppliers are rated against external sustainability guidelines, getting a reduced rate on financing if they comply. This is more of a carrot than a stick approach, as failure to comply is met only with a reversion to a normal margin for the financing type.
“What I have seen in the space is the identification of green suppliers or suppliers on sustainability programmes, which involve lending to qualified suppliers at lower rates. Primarily, banks at the moment are doing it for strategic reasons: you want to be lending to clients that have demonstrated a degree of sustainability,” says Michael Vrontamitis, head of trade, Europe and Americas transaction banking at Standard Chartered Bank.
A serious problem demands a serious answer
Notwithstanding a few detractors, it is largely agreed that climate change poses an existential threat to the lives and livelihoods of vast swathes of the global population. Meanwhile, areas such as child labour or corruption – the ‘S’ and the ‘G’ in ESG – have deleterious effects on the wellbeing and development of entire communities. Given the topic’s gravity, should banks treat borrowers who fail to meet standards as having defaulted on their financing agreement, as opposed to simply taking away their discount?
“I think there are two ways that could potentially happen,” says Alexander Malaket, president of Canadian consultancy Opus Advisory Services International and deputy head of the ICC Banking Commission’s executive committee. “One is that the lenders themselves say they want to drive this kind of behaviour. The other pathway could be that the regulatory authorities start to push that kind of definition.”
For many, the idea is an attractive one, but there is serious groundwork to be done before it can become a reality.
“In order to have a proper covenant, you need to have a proper definition,” says Roberto Leva, trade and supply chain finance relationship manager at the Asian Development Bank (ADB) and chair of the ICC’s sustainable trade finance initiative. “Looking at the non-performing loan perspective, the challenge I am seeing in the agreements is not to make people agree to a specific threshold. That’s part of the conversation, but that is not the painful bit. The painful bit is making everyone agree on what the definition is of a non-performing loan. I would like to try and avoid this in sustainability.”
Definitions are the key sticking point. The line between what is brown and what is green changes depending on which financial institution is looking at a deal. Just to take one example, for some, coal power financing is a red line. For others, coal is the only way to ensure electrification in developing nations.
“We made a stance on coal,” says Standard Chartered’s Vrontamitis. “That puts the onus on us to track and measure it, but the lack of standards makes it difficult to implement for anybody in the industry today.”
Meanwhile, there is no central body which audits sustainability-linked financing programmes, meaning that there are as many as 400 different assessment techniques and scales and ways of looking at ESG. “If you are in this space and you can’t even agree what you are assessing, how do you move forward?” asks Malaket. “With the ICC, we published in 2016 the standard definitions for supply chain finance techniques. It took us two years to come up with these definitions. We had 30 practitioners involved in the drafting effort, we had a steering committee that was overseeing the work, and we had a whole series of input and thought around what we mean when we talk about supply chain finance. Looking now at the ESG space, we really are at the very start of this process, in that stakeholders, including banks, company executives and investors can’t even agree yet on what constitutes an ESG investment, what is an ESG standard, what is a green instrument, and what that looks like from a loan perspective or a covenant perspective,” he adds.
Multiple frameworks, multiple standards and multiple formats aren’t only a headache for banks. Stuart Tait, regional head of commercial banking in Asia Pacific for HSBC, says that, far from promoting greater sustainability among corporates, these issues are actually holding them back. “Our recent Trading with China report shows that the biggest challenge for companies in implementing sustainability is really around finance, and without clear standards and a clear format, the amount of work that people have to put in to get the information they want is significant, and this can create a challenge to getting the financing that is needed,” he says, adding that the lack of consistency among metrics also opens the door for corporates to pitch themselves as sustainable, when this might be far from the truth.
“Different standards capture certain information, and then they miss other metrics. Therefore, companies have the freedom to effectively self-select the details that they believe to be material, and so marketing and public relations objectives might sometimes outweigh the disclosure of real, specific and more significant information. On the non-financial topics, it is really the lack of objective and accurate measurement tools that is a challenge. Even when there is a single sustainability standard that is used, and there are measurement tools out there, there is no real standardised format of reporting,” he says.
Another consequence of standardising sustainability definitions across the market could be the ability to tap into greater pools of liquidity from ESG funds. Currently, it is difficult to match up funds’ objectives with sustainable trade finance criteria, but a single, unified index would go some way to help. GTR has learned that Swift is considering partnering with other industry players to build such an index, in the style of its KYC registry, which will enable everyone in the space to share data on ESG compliance, although the payments network is yet to confirm this.
“Everyone wants liquidity in the secondary trading market, and standardisation and confidence in how sustainability is being reported can only help with that liquidity,” says HSBC’s Tait.
Creating measurable, consistent standards
In an attempt to make progress on the issue, the ICC sustainable finance working group is adding two streams into its activities. The first one is around building a taxonomy of definitions of ESG practices, which it is doing by tapping into a European Union initiative. Agreed between the European Parliament and Council at the end of December, the EU-wide classification system for sustainable economic activities will create a common language that investors and financiers can use everywhere when investing and funding projects and economic activities that have a substantial positive impact on the climate and the environment. The ICC working group is now working to provide the EU initiative with a set of definitions of sustainable trade finance, for inclusion in the overall list.
A second stream, on financial rewards for sustainable practices, seeks to open the way for the trade finance industry to have a dialogue with regulators about a lowering of capital requirements for sustainable financing activity. This is currently of great interest for banks, which are keen to see better regulatory treatment of sustainable finance, given that lowering margins to incentivise sustainable actors cuts into their bottom line. “The challenge in the next couple of years is that we want to have standards in the space, and we can then work to those standards. But are they going to lead to a reduction in pricing? At the moment, we don’t know, because the capital model is not changing, so banks may have to take a stance,” says Vrontamitis.
The ADB’s Leva, who is leading the work, cautions against too much optimism about the prospects of getting the regulators on board in the short term. “This may take some time, because the industry is still trying to explain to the regulator what trade finance itself is, so moving to explaining what sustainable trade finance is will be very complicated,” he says. However, following the model of the ICC Trade Registry, which successfully proved to regulators that trade finance as an asset class is less risky than other types of lending, the ICC is now working on proving the business case – and lower default risk – of sustainable trade finance, with the hope of achieving some sort of capital relief in the longer term.
“You can’t go to a regulator with a gut feeling. It’s the same principle as the trade registry. Logically, everyone knows that if you are a company and you start having trouble, the last person you stop paying is your supplier, because then you are literally cutting your lifeline. However, before having a conversation with regulators on the statistics there, we needed to bring something to the table in terms of empirical data,” says Leva. “If you think about it in basic logic, if you look at the long-term lifespan of a company that uses, say, solar energy instead of fossil fuels, it’s kind of obvious that they will have a better lifespan, not just because they are not polluting but because their resources are not going to run out.”
There remains a long way to go before the trade finance industry can truly say it is doing all it can to promote, encourage and support sustainable actors across global supply chains. But with industry bodies and banks working in concert to engage regulators and put in place clear standards, the foundations are being laid for a future whereby banks lead the conversation in doing the right thing.