Trade Finance: Tackling Sustainability One Company at a Time
Trade Finance: Tackling Sustainability One Company at a Time
Director and US Head Global Trade
Isabela Mendes is Director and US Head Global Trade within Bank of Montreal’s Chicago Global Trade sales group where she leads a team of sales profe…
Director, Trade & Supply Chain Finance Product Treasury & Payment Solutions
Sunil has 25 years of banking experience spanning various areas including, trade finance product development, project management, technology & business transfor…
Isabela Mendes is Director and US Head Global Trade within Bank of Montreal’s Chicago Global Trade sales group where she leads a team of sales profe…
VIEW FULL PROFILESunil has 25 years of banking experience spanning various areas including, trade finance product development, project management, technology & business transfor…
VIEW FULL PROFILE-
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The wave of sustainability sweeping the planet is becoming top of mind for one of the world’s oldest industries, trade finance, rewarding companies with the best environmental, social and governance (ESG) practices and challenging those still lagging to quickly change their ways.
Until quite recently ESG and sustainability standards may have been viewed as an extra; however, they are now a ‘must have’ for any business that wants to remain relevant. Companies that feed into the massive global supply chain are no exception, where banks are keen to provide incentives for the best players with more favorable financing terms.
“Clients are increasingly coming to us to talk about ESG to ask us to support their efforts,” says Isabela Mendes, Director and U.S. Head of Global Trade at BMO Capital Markets. “Today companies are starting to expect that their suppliers have some form of ESG compliance. At a later stage companies will want the ability to verify that their suppliers are actually adhering to those ESG principles.”
The trend is relatively new, but a rapidly growing one in trade and supply chain finance, a more than $7 trillion industry that continues to grow and which in some form or another has been around for centuries, ever since ancient civilizations wrote invoices (promissory notes back then) on clay tablets.
Sustainable Supply Chain Finance (SSCF) is designed to align and integrate ESG performance criteria into buyer-led supply chain finance programs, allowing global buyers to reward and provide tangible benefits (e.g., better discount rates) to suppliers with strong sustainability performance.
In a world where supply chains account for 90 percent of a company’s overall greenhouse gas emissions, according to the US Environmental Protection Agency, sustainability credentials are also beginning to separate the wheat from the chafe, and those who don’t take it seriously will be negatively affected.
“Companies are realizing that paying attention to stakeholder perceptions and to the social and environmental consequences of their products is really good for business and for the planet,” says Mendes, noting as well that combining ESG with trade finance makes a lot of sense as sustainability becomes a legal imperative that is driven by shareholder demands and financial incentives.
Benefits All Around
By bringing ESG and supply chain finance together, both buyers and suppliers’ benefit – the former gets a more sustainable supply chain, while the latter receives more of the money earlier. BSR, a sustainable business network and consultancy, has estimated that the ESG-linked supply chain finance market represents a $660 billion opportunity, says Mendes,
“Buyers want more transparency on the supply chain and by meeting their own ESG goals they can also help the whole supply chain become more sustainable,” she adds, noting how ESG issues have become front and center for companies as a way to mitigate risks, and also because more businesses care about doing good. “Sustainable supply chain finance puts a value on the sustainability efforts of suppliers and provides them with an internal business case to make improvements.”
According to PwC, 83% of consumers say companies should be actively shaping ESG best practices, while 91% of business leaders think their company has a responsibility to act on ESG issues.
ESG-linked supply chain finance works the same as traditional supply chain finance in that suppliers have the option to sell their invoice at a discount to a bank before the buyer has to pay. For instance, if a buyer’s terms say 180 days for payment, but the supplier needs money earlier, they could get the buyer’s bank to buy the invoice at a discount. At 180 days, the buyer pays the bank for the full amount. With ESG-linked finance, the amount of the discount would vary depending on the sustainability of the supplier, says Mendes.
If a company, for instance, is fully compliant, they can potentially save on average 25 basis points - with no break in the fee if ESG measures are not considered. Indeed, on average ESG underlying programs achieved a spread reduction of 25% compared to comparable non-ESG financing products. While 25 basis points may not seem like much, many of these suppliers are owed millions of dollars, so every bit of savings adds up. “Depending on the volume, that could translate into significant savings for the supplier,” says Sunil Gupta, Director Trade & Supply Chain Finance Product – Treasury & Payment Solutions.
Easier Said Than Done
The fact that you cannot be a successful business these days without taking ESG issues into account has never been clearer but putting sustainability measures into place in the vast global supply chain is easier said than done, as it involves multiple companies across numerous geographies and regions.
Currently, there are no global standards that define what makes a company ESG compliant, which makes it difficult for banks to apply the same metrics to every business. In most cases, the bank bases its discounts on a third party’s assessment of the suppliers’ ESG performance.
“You don’t have a common yardstick from a bank perspective, which means a lot of the ESG programs being rolled out are dependent on the buyer driving the criteria for how to accomplish those extra savings,” says Gupta. “It’s very consultative and very individualistic towards particular scenarios and particular buyers and suppliers. So, from a portfolio and bank perspective, we’re supporting clients as per their individual requirements.”
Still, there are some uniform metrics that should be followed as part of a sustainable supply chain. These might include an absence of child labor on, say, farms or in factories; an annual reduction in carbon emissions – potentially getting to net zero; anti-corruption policies; providing clean water to workers; achieving gender balance at the leadership or staffing levels, and more.
“Carbon emissions, for instance, is something that’s measurable, and that every company contributes to. That’s something we can help correct,” says Mendes.
Driving Change
Buyers can also determine whether businesses are meeting targets by employing third-party companies that can assess the ESG for each supplier. In many cases, these companies will visit the suppliers’ operations and ensure they are indeed taking steps to improve their ESG practices. If they can get 20 suppliers to reduce their carbon footprint – a key area of focus for buyers – and if other buyers can do the same, then the business community could make a serious dent in supply chain-related emissions.
Many buyers are also working with banks to develop their own platforms. Mendes tells of one large agricultural company, for instance, that developed a platform that actively manages and reports on key sustainability areas from supplier (farmer) to end buyer to help determine how sustainable the products being produced are; only suppliers meeting certain environmental and social thresholds are included in the platform.
“Over the long term the farmer is going to have improved production,” she says. “All these points in the platform are measurable and auditable and influence the purchase and the sale of that commodity.”
While ESG-linked financing helps suppliers become more ESG compliant, it also allows buyers to pick better companies to work with. There are so many suppliers out there for buyers and their banks to enlist that they can reward the ones with the best behaviors, says Gupta. At the same time, the suppliers that lose out on business will have more incentive to either evolve or risk becoming redundant.
“If a buyer has 20 suppliers, then it’s up to them to set the standard and say if you reach this certain level of, say, Co2 emissions, then you get preferential pricing, you can go one step ahead,” he says. “That's what's driving a lot of these suppliers to make change.”
Just the Start
Becoming ESG compliant is now a matter of survival for companies. They’re facing increasing pressure from shareholders who see non-compliance as a business and legal risk; regulators are now asking companies to report sustainability metrics, while banks increasingly want to leverage financing to encourage ESG adoption.
However, this is just the start, says Mendes. So far, Europe is leading the way in ESG-linked supply chain finance, but North America will catch up. BMO Capital Markets is having frequent conversations with clients about how to offer ESG-focused financing to their suppliers, for instance. The more companies provide this arrangement, the sooner all supply chains can become sustainable.
The significance of these changes in trade finance cannot be understated. Supply chain, or trade finance, quite literally, touches all aspects of life and business, from food, consumer, and retail, to mining and manufacturing and everything in between. It is critical to the global economy, as witnessed as the pandemic drove supply chain bottlenecks that have helped propel inflation to the highest in decades.
“It has to start somewhere, and this is just the beginning,” says Mendes. “It’s very important to have the necessary funding to build stronger and more sustainable companies, while the collaborative relationship between buyers and suppliers in terms of one helping the other drive value is critical.”
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