Green Light for Green Trade Finance

Published: July 26, 2021

Green trade finance transactions require a trade finance instrument to support an underlying green project. But with no market standards yet supporting their use, accusations of ‘greenwash’ threaten their integrity. TMI spoke to the Head of Trade Finance at one of the few global banks currently offering this option about how this view is being challenged and overcome.

When it comes to green opportunities, the world of trade is huge, from sourcing and production to shipping and sales. It follows that funding this space also has enormous potential, both in terms of the good it can do, and the commercial opportunity it presents for bank and client alike.

The World Trade Organization (WTO) has suggested that each year some 80 to 90% of trade is supported by trade finance. Solid statistics are scarce, but approximate valuations place this in the region of US$15tr. in bank-intermediated trade finance. And while the overall supply chain finance market is estimated by McKinsey to be a potential revenue pool of US$20bn, it is often reported that there is a US$1.5tr. gap in trade finance.

With such an opportunity matched by the current enthusiasm (and necessity) for the greening of trade activities, it is surely time for green trade finance to make a stand. Of course, consumer demand and regulatory pressure will be the final arbiter of uptake across the board, just as technology will likely be the key facilitator. But in every case, the action has to be real and credible.

Indeed, proof of ‘greenness’ is essential for the credibility of all involved here, and on the technology side, fintechs such as Halotrade are using irrefutable blockchain data to track and trace goods from origin to consumer. In doing so, it is helping responsible sourcing to be reported as such, and potentially opening up access to more green trade funding on both sides of the deal.

Certainly green trade instruments exist. Back in 2014, the University of Cambridge announced that it was working with the International Finance Corporation (IFC) in partnership with the Banking Environment Initiative (BEI), to launch the Sustainable Shipment Letter of Credit (LC).

The aim here has been to incentivise the trade of sustainably produced commodities (prioritised to the palm oil, soya, beef, and pulp and paper supply chains), with the IFC exploring price incentives for certain commodities under the Global Trade Finance Program (GTFP) and transported with a Sustainable Shipment LC.

However, the other major stakeholders in this movement are the and they have to clearly demonstrate their commitment to make an impact. To date, few tier-one players have a live offering in place. Without their concerted effort and involvement, the current lack of standards in green trade finance will persist. This means open interpretation and those inevitable accusations of greenwash.

Taking a stand

Currently, capital markets participants can operate under International Capital Market Association (ICMA) Green Bond Principles, and those in the debt markets have Loan Market Association (LMA) Green Loan Principles to guide them. For one bank at least, Société Générale (SocGen), the lack of a focused approach detracts from potential progress.

With this very much in mind, it has taken unilateral action, establishing a framework contract and eligibility criteria for green trade finance transactions, based on the EU taxonomy and contributing to some of the United Nations Sustainable Development Goals. These may be considered the gold standard, for now. It also uses the first two standards already existing for the bond and the loan markets as well as – if applicable – a number of very specific elements to SocGen, given its experience and track records

In 2019, the bank started to implement a solution. It places traditional trade finance instruments –trade guarantees, letters of credit, standby letters of credit – associated with an underlying project meeting very strict guidelines. The project also has to be within one of five selected sectors, currently renewable energy, clean transport, waste management, hydrogen, and water management.

Its first green trade finance contract guarantee was issued end of 2019 for Siemens Gamesa Renewable Energy (SGRE), a provider of turbines to wind farms, for €230m. The product did not even exist prior to this landmark transaction.

Building from scratch

Whereas traditional trade finance instruments are usually independent of an underlying project in terms of legal obligation, green trade finance necessarily rings the changes. To be certain that the instrument in place is supporting a qualified green project, it is important to run a detailed and in-depth due diligence on the underlying project, such as project purpose, location, stakeholders and impact on the environment.

To define the due diligence procedure leading to label a green guarantee, the SocGen trade team worked with the environmentalist team within the bank to design the appropriate checks to be performed. Every green trade finance facility it offers must therefore be linked to an underlying transaction – a specific green project – with very objective and demonstrable positive impact goals that can be precisely defined and measured with pre-defined key performance indicators (KPIs).

At a contractual level, this required some deliberation. “Eventually we took existing contracts from the loan and bond markets and worked with our environmentalist teams to see how we could apply these to trade finance,” explains, Marie-Laure Gastellu, Head of Trade Finance, SocGen.

Only with clear definition can proof of greenness be established. From the outset, the bank felt that by grounding its approach to green trade finance with the EU taxonomy it could achieve appropriate credibility, at least until shared definition and standards would be available among the industry. And by initially limiting the offer to the five sectors referred to above, the bank also felt it would be better able to maintain an objective view of greenness, the projects being funded having an obvious positive societal impact.

However, for projects in this space where guarantees can last several years, the bank had to ensure that the green status of each project be maintained throughout its life. To this end, the bank works with the client and its counterparty from the outset to identify precise and analysable green KPIs for each contract, and the client must agree to and at least match these for the duration.

Before a contract is negotiated, the bank ensures that there is commitment by the client to the agreed KPIs that follow, in the form of a Green Declaration. In addition to the green guarantee facility being directly linked to an appropriate project, the client must – at a global/corporate level – demonstrate prior strong engagement with sustainable activities through a well-defined and enacted corporate social responsibility (CSR) policy.

Of course, companies exhibit different levels of green maturity. The most mature will have sustainable practices embedded across their organisation. Gastellu says SGRE made a natural candidate for green trade finance simply because it was “very mature and fully engaged in its ESG journey” and has made significant headway already.

For a business that is natively active in renewable energy or clean transport, for example, demonstrating green credentials is easier as it is part of “the DNA of the company” to define KPIs demonstrating its positive impact on climate change. More traditional corporates with, for example, a history of fossil-fuel use and which now commits to embark on a journey towards more sustainable practices (renewable energy for instance), can also be assisted with green trade finance on specific projects that meet the bank’s requirements, but this requires more attention and commitment.  

Due diligence

It takes time to arrange a green trade finance facility for the first time. The initial SGRE green trade finance deal took SocGen and its partners almost a year to structure, with a significant amount of due diligence required. Indeed, assessment of both client and counterparty for each deal are inspected through a green filter. The underlying goods have to be considered, the project for which the goods are used has to pass the test, but also elements such as country of use are scrutinised.

“We have to make sure that there is nothing in the deal that could be detrimental in any way to the green approach,” states Gastellu. “The deal becomes a very important asset for the reputation of both the corporate and the bank, so we must maintain that fully.”

Ongoing assessment of a green trade finance deal is also essential, to ensure adherence to the KPIs. The bank considered using third-party specialist agencies, but concluded that in most cases it would undertake this aspect internally.

The reason for this harks back to the lack of standards in this space, with agencies (and banks) using their own proprietary approach to conduct their green evaluations. With SocGen adhering to the EU taxonomy, it feels it has the right approach for now. Indeed, notes Gastellu, “we have not faced a situation yet where a client requires us to bring in a third-party opinion”.

Now the framework has been formalised, the process for setting up a deal is considerably quicker and easier. However, it might be expected that green finance products, especially in the relatively unexplored area of trade finance, attract a premium, given the extra work entailed. But this is not true, and there is in fact no need to do this, says Gastellu.

The market is moving in this direction and will see more trade guarantees that will be green-labelled because corporates are increasingly engaging in ambitious and demanding CSR journeys, making commitments to progress their positive impact, she explains. As an early mover in green trade finance, she knows SocGen is afforded “a very strong point of differentiation” for corporate clients, and that this alone could drive increased business.

Opening up the market

With green trade finance guarantees already live, and LCs also now possible, the bank is considering how it can move to the broader trade finance space and is tentatively looking at how it can develop a solution for open account trading.

In this space, the need to define green becomes the most vital hurdle to overcome, notes Gastellu, because open account trading steps away from the clear boundaries of a project and into the general flow of commerce. Understanding and monitoring origin and destination of goods, the nature of the sellers and resellers, and of the buyers and end-users, even the form of transportation of the goods, makes this a complex matter.

There is no open account solution yet, but not so long ago green trade finance guarantees didn’t exist either, and these now have a healthy uptake. Indeed, having started in Europe, Gastellu now reports interest in Asia and the Middle East.

Believing green trade finance will become mainstream “in the next few years”, she says SocGen is developing a framework for “positive impact trade finance facilities”. This will use sustainability-linked instruments to help corporates create and work towards specific sustainable targets. The movement is gathering pace, and banks, with an eye on the huge opportunities ahead – both from a societal and a commercial perspective –are finally beginning to deliver.