Updated: Aug 24, 2021
Environment and Social Governance, or ESG, have become integral to corporations and consumers across all manner of business sectors, affecting most industries and their supply chains. This is leading to forever increasing commitments to ethical decision making within trade and finance. Banks and corporates are at the heart of trade finance and as they have transitioned their processes to meet the new ethical demands of ESG, progress has, undoubtedly, spread to the wider business community. Why has this trend gathered such momentum?
The reason for ESG’s ubiquity in trade finance lies within the nature of what ESG is in and of itself. Essentially, it deals with sustainability. Sustainability, in its purest definition, can be described as maintaining or preserving. Even viewed in these simple terms, it becomes immediately obvious to any business-orientated brain that this can only be a good thing: Preservable business is good business.
The Environmental Pillar
In the last decade or so, society has become far more awake – if not aware – to the impending hazards seen in climate change and the degradation of the environment. As science has made new and ever more alarming discoveries, companies operating in the trade finance arena have become increasingly subject to scrutiny and it is within this backdrop that ESG has gained a footing and then a following. An organisation, under the environmental auspices of ESG, can be subject to a number of criteria through which its attractiveness to customers or investors might be judged. Degree of pollution, waste disposal, energy use, natural resource allocation and conservation, or even its treatment of animals, can now have a major impact on how consumers, clients, investors, or even governments, view a business. Obviously, if a business is cast in a poor light, its very viability in the long-term might eventually become threatened.
Figure 1: Overview example of aspects of ESG.
The Social Pillar
The social aspect of ESG is concerned with a company’s relationships. In a way, this can be thought of as a company’s appreciation of its surroundings. In its operations, does a business take into consideration the needs of all of its stakeholders? Or an organisation might claim to hold a set of values but be in business with groups that have no such codes of conduct. The philanthropy of a company can be hugely attractive to customers or investors since it speaks to having a corporate conscience. This might also be measured in how a business treats its employees (health and safety), or whether a company encourages its employees to volunteer in the local community. In essence, a company should understand where it sits in the business universe, but also be self-aware and be able to discern how it is perceived.
The Governance Pillar
Governance in ESG relates to the internal mechanics of a business. In the first and most apparent instance, a potential customer, investor, or indeed government, would be interested in whether a company is doing anything illegal. This might cover any number of areas such as illicit trade practices, bribery, corruption, varying species of fraud, or perhaps money laundering (to name a few). Less overt aspects of governance might deal with opaque accounting methods, or business operations that take place outside of stockholder oversight. Even such things as conflicts of interest can fall within the governance remit. For nearly ten years, the embedding of ESG metrics into trade finance has been thrown back and forth in discussion and debate.
It was around the mid-2010s that initial pilot projects were established and these largely included dedicated finance programmes for supply chains, and sustainable letters of credit. But what of now?
The Current Climate
The concept of sustainability has taken on a far more profound meaning in recent times. There is no aspect of business that hasn’t been affected by the emergence and legacy of COVID-19. Where ESG was picking up momentum previously, one might argue it has become critical going forward, and especially so within trade finance. The recent HSBC Navigator report has emphasised how organisations who assigned greater import to sustainable business practices, perceived themselves to be better placed to combat the current global crisis. Significant given the increasing environmental risks the global community is being exposed to. According to Surath Sengupta, Managing Director & Global Head – FIG, Portfolio Distribution, Trade Finance of HSBC at a round-table discussion recently, and reported on in the Global Trade Review, the agenda of the discussion of ESG in trade finance itself has been largely set by the buyer in the past. Thanks to the global pandemic, more minor actors – such as suppliers – are required to learn how to transition their businesses in the new dawn: they are being pressured to bring their businesses to the ESG table. Indeed, the changes in the measure of achievement of a business reflect the changes occurring more broadly in society. Where once it was uniquely profit, it then evolved to shareholder success. Now, corporates must also echo the values that drive society.
Figure 2: An example of growing sustainable practices - a wind farm (courtesy of the BBC).
It is important to note however, regardless of the impetus that ESG has gained in the trade finance ecosystem generally, commitment to it remains uneven. Ways and means to monitor the trade finance sector are problematic: there is a general scarcity of data since there is no available public information. Moreover, approaches to business practices are not standardised. These issues have given rise to a knowledge gap in the industry as well as few useful performance indicators. The trade finance sector itself is somewhat unique compared to others and it is this uniqueness – in part – that has hindered the broadscale uptake of ESG. As stated in Euromoney, even by the end of 2020, wider adoption of sustainable business practices has proven fitful. Typically, trade finance itself is about larger volumes at smaller values. This is incongruous with current sustainable finance transactions since they tend to deal with high value low volume products.
Supplemental to the issues outlined above is the question of consistency. According to the International Finance Corporation’s report titled Trade Finance and the Compliance Challenge produced in 2019, up to 80% of trade is financed through credit or credit insurance instruments. The availability of these provisions is, however, skewed in favour of developed economies. Furthermore, since the last financial crisis (and evidently only up to before the current one) somewhere around 200,000 correspondent banking relationships have disappeared. The most affected regions are Africa, the Caribbean, Central and Eastern Europe, and the Pacific Islands. Flows of trade finance have been detrimentally affected. Ultimately, those regions in the world where emerging economies reside tend to be associated with high financial risk. And yet, as indicated in the IFC’s report, many of these areas have low default rates. In this regard, it seems perception alone is inhibiting trade finance and its related ESG. The inevitable question arises: how can ESG uptake occur across the entire spectrum of trade finance when trade finance itself is not accessible in some locations in the world?
Fundamentally, trade finance entities supply parallel services that make global trade possible. They provide guidance and financial support. The arrival of the COVID-19 reality has made sustainable business an imperative. Therefore, the trade finance ecosystem must be extended to everywhere and for everyone. With it will come progress and opportunity. It would then only be a matter of time before ESG followed in the footsteps of the trade finance community.