Francisco Javier Fernández de Trocóniz, Head of Global Trade & International Banking at BBVA, shares his views on what players across the trade finance landscape can do to strengthen their commitment to sustainable policies.
Environmental, social and governance (ESG) policies have become increasingly important since 2015, when the United Nations announced the 17 Sustainable Development Goals (SGDs) to be adopted and implemented by member countries by 2030. These goals build on previous initiatives and highlight the need to address climate change, as well as incorporate diversity, inclusion and corporate governance goals.
Since then, the importance of the ESG aspect of corporate policies has grown steadily as a result of the conviction of the companies themselves and their need to respond to the wishes of increasingly aware consumers. As a result, companies are redefining their strategic priorities and adapting their corporate responsibility policies. The ultimate goal is to guarantee the balance between economic growth, care for the environment and social welfare.
At the same time, investors are also incorporating ESG criteria into their investment models. This reflects the increasing awareness that responsible environmental management may result in positive financial impacts and thus in opportunities to generate value, whether through access to more possibilities for finance or by an improved valuation of equity in the medium and/or long term.
The Covid-19 crisis has simply accelerated this trend. The potential disruption of supply chains and consequent greater rigor in selecting suppliers, the increasing digitalisation that eliminates unsustainable practices, and the strong boost in the short and medium term to social policies addressing the economic consequences of the pandemic, have all clearly strengthened the commitment to more sustainable policies.
The role of trade finance in the ESG environment
In this context, what can trade finance’s contribution be to the achievement of these sustainable goals? Conceptually, trade finance is a mechanism for financing and facilitating trade around the world, mitigating the risks inherent to cross-border operations, particularly in specific countries and with certain client segments (above all SMEs). By financing the different phases of the supply chain of goods and services, financiers can play a decisive role in the transparency and traceability required from their clients and thus contribute to the achievement of the UN SDGs.
There is a very broad range of instruments that may be sustainable within the area of trade finance, including trade loans, factoring, letters of credit and guarantees. For these instruments to be categorised as sustainable they must comply with the requirements set by the financing bank, which may be related to the goods or services of the specific transaction; or with the level of the commitment to sustainability of the clients themselves or their suppliers. All this must be measured with specific indicators and certified by an independent advisor.
One of the key instruments in this respect would be the supply chain financing. As well as incorporating all the benefits of this product as an element of finance, it includes the additional benefit of providing incentives and rewards for sustainable behaviour across the supply chain. The purchaser chooses its suppliers according to their sustainability strategy, which means distinguishing between standards suppliers and sustainable suppliers that potentially could have access to better conditions in terms of price or tenor. Of course, to be considered sustainable, suppliers must be certified as such according to the standards of each industry. Thus the programme rewards best practices and forces suppliers to align with their clients’ sustainability strategy.
A good example of this could be the world of soft commodities, such as cocoa or coffee, or the textile industry, with suppliers typically located in emerging countries, where a clear sustainability strategy may contribute to more sustainable and less polluting production, the promotion of decent jobs and the prevention of collateral effects such as the impact on deforestation of tropical forests in the case of the production of palm oil. Clearly, there is an opportunity for international trade finance to back the most sustainable companies and practices, as well as the businesses and suppliers that are making the transition to more sustainable practices.
BBVA has been a pioneer in adopting the ESG principles. Since 2018 the bank has had its own strategy to fight climate change and drive sustainable development in the form of its Pledge 2025, which is based on three pillars: mobilisation of €100bn in sustainable finance through 2025, of which €40bn has already been used; management of the environmental and social risks that are inherent to minimising possible direct and indirect negative impact; and, finally, the commitment to involve all the stakeholders in boosting the contribution of the finance sector to sustainable development.
However, our experience from a purely transactional point of view is that the volume of finance is distributed somewhat unevenly. In general, those receiving finance are large companies or very specific projects: day-to-day finance, particularly for SMEs, is the significant issue that still needs to be addressed.
That is why, in order to support companies not just in one-off projects but also in their daily activity, in 2019 BBVA announced its framework for sustainable transaction banking. The framework has been reviewed and endorsed by a favourable opinion from Vigeo Eiris. It allows transactions whose finance is geared to projects directly linked to the UN SDGs to be classified as social, green or sustainable. This plan also includes clients and sectors that may not have projects directly linked to the SDGs, but which establish strategies to stop climate change and boost sustainable development with new products linked to sustainability. The ultimate goal is also to support the transition to more sustainable businesses.
The framework thus encompasses the complete spectrum of trade and working capital products (factoring, guarantees, letters of credit, working capital lines), including green deposits and supply chain finance transactions. Currently, a total of 23 trade finance and working capital transactions have been certified under this framework for a cumulative total of €1.563bn.
The integration of ESG policies in transaction banking activity
Despite the pioneering initiatives such as this sustainable transaction banking framework implemented by BBVA, major challenges remain in terms of adopting ESG policies in trade finance and in general in corporate transaction banking. Many of them are inherent to the very nature of this business.
One of the most important is the fragmentation of the market, with multiple agents that do not necessarily have the same interests. A robust methodology is needed that can identify sustainable projects and goods, together with an adequate and trustworthy end-to-end monitoring of the whole supply chain, in particular for SMEs.
It also does not help that there is no public information or any clear benchmark indices as there are for other products (such as the Green Bonds Principles or Green Loan Principles). These would enhance transparency in the market and allow the harmonisation of metrics and also a sustainable performance comparison of the different actors involved, including financial intermediaries and the companies themselves. Without this, it is difficult to ensure the scalability of ESG activity in trade finance operations.
Despite this, we have to recognise the efforts of numerous bodies (the UN, WTO and ICC) and regulators working to establish a single classification and standardisation of the taxonomy of sustainable finance. The use of technologies that allow greater traceability and transparency, such as blockchain or smart contracts, could also be a way of encouraging the general adoption of these criteria, but they are still very far from being a solution in the short term.
Finally, one of the biggest challenges, applicable not only to trade finance but to all sustainable products, is to create incentives for ESG operations through measures such as a reduction of capital consumption for some sustainable assets. This would mean analysing what factors within the taxonomy identified by each regulator involve a lower financial risk, and thus a lower credit risk, so that a capital consumption mitigation factor could be applied to those that meet these criteria.
BBVA has been working for some time with a number of bodies and regulators to provide solutions to all these challenges and to encourage the different agents involved in the financial market to adopt the best ESG policies. We are convinced that sustainability will take its place with technological and digital disruption as the most important strategic challenge for our clients in the coming years. That is why we are determined to take the lead in offering them our advice and support during this transition.