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Growing supply chain focus prompts interest in nascent form of ESG finance

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Growing supply chain focus prompts interest in nascent form of ESG finance

As the coronavirus pandemic exposed the fragility of global supply chains, it prompted a renewed focus among brands and corporations on how to rebuild them in a more resilient and sustainable way. As a result, banks are now seeing a growing interest in what is still a nascent funding tool: sustainable supply chain finance.

CDP, an environmental disclosure organization, has recorded a 24% jump in the number of companies asking their suppliers to report environmental data this year. The pandemic and its economic fallout had shown the importance of building resilience into supply chains, the group said May 20, with corporations such as Nike Inc., Airbus SE and Ørsted A/S now asking suppliers to disclose data related to climate change, deforestation and water security issues to use in supplier engagement strategies.

Banks are increasingly being pulled into companies' environmental, social and governance strategies. Since the outbreak of the pandemic, HSBC Holdings PLC, one of the world's largest trade finance banks, has seen "an acceleration" in the number of clients getting in touch to discuss sustainable supply chain finance solutions as well as other ways the bank can help to improve their supply chains, said Burcu Senel, HSBC's head of sustainability in trade.

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"The number of conversations that we're having, the interest and number of clients pro-actively reaching out to us have increased substantially," she said in an interview.

A supply chain finance program is commonly set up by a corporate buyer with a bank or alternative provider to allow suppliers to get paid early for an invoice. This form of trade finance has been consistently growing since the financial crisis of 2008 and has proved particularly resilient during the pandemic, despite global disruptions to trade.

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Sustainable supply chain finance typically involves incorporating ESG criteria into the funding conditions. Essentially, suppliers are rewarded if they perform well against certain ESG goals, such as through better rates or access to the financing program in the first place — a "carrot" approach that incentivizes partners to do better.

While this is not a completely new form of ESG finance, the market is still nascent. American clothing manufacturer Levi Strauss & Co. launched one of the world's first sustainable supply chain finance programs in 2014, but the number of corporate buyers that have publicly followed with similar schemes is small. In fact, the market is limited to only "a handful buyers," according to an estimate last year by Charlotte Bancilhon, manager at BSR, a sustainability consultancy.

Yet the opportunity is remarkable. BRS in 2018 predicted that in time the sustainable supply chain finance market will reach $660 billion, representing a $6 billion opportunity in revenue for financial service providers. The research was based on interviews with executives at the likes of Bank of America Corp., Deutsche Bank AG and JPMorgan Chase & Co.

HSBC has in place two sustainable supply chain finance programs, with German sportswear company PUMA SE and U.S. retail giant Walmart Inc. The scheme with Walmart, set up in 2019, pegs a supplier's financing rate to its sustainability credentials, including progress on cutting carbon emissions.

Senel expects that HSBC will launch more sustainable supply chain programs in light of the pandemic, although typically they take a minimum of three to four months to set up, so the growing client interest may take time to materialize into specific deals.

'ESG risk multiplier'

The Asian Development Bank, too, has seen a growing number of parties reach out to the bank amid the crisis to talk about solutions linked to sustainable supply chains, and the bank is "now pro-actively discussing" such offerings with clients, said Roberto Leva, an investment specialist for trade and supply chain finance at the bank, speaking on a webinar July 16.

Clients come to the development bank with various ESG concerns driven by the pandemic, he said. On the social side, workers' health in light of staff being infected by the virus in unsafe work conditions is one such example. On the environmental side, he said, COVID-19 has been a reminder of the importance of sustainable and resilient food production and supply.

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The pandemic has proved to be an "ESG risk multiplier," according to Sustainalytics, which tracks company activities that generate undesirable ESG effects and which works with banks on their sustainable finance programs.

Up to the end of June, Sustainalytics processed 1,270 COVID-19 incidents. Close to a third of these related to occupational health and safety, such as companies facing criticism for failing to provide adequate protective gear to workers and breaching social distancing rules. Other cases included lawsuits filed by families of employees who died after contracting the disease, regulator involvement and safety probes, Sustainalytics said in a July 20 report.

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Sustainable supply chain finance programs do not necessarily look alike but address sustainability goals specific to the corporate buyer. As a result, HSBC is seeing increased interest not only in the programs it already offers, but also in building new, bespoke solutions, Senel said.

The 'S' in ESG – social – is becoming more important, she added. Clients that have previously worked with HSBC on environmental issues now come to the bank to discuss concerns around social equality, diversity and workers' rights in their supply chains.

This trend is similar to what is observed within the bond space, with more and more "social bonds" emerging to address the demands of consumers and communities that are increasingly aware of current social issues, said S&P Global Ratings in a June 22 report.

Going digital

Implementing sustainability measures in supply chain finance has faced some barriers, including a lack of standards and limited awareness of such solutions.

Another challenge is that the trade finance industry is still largely paper-based, giving little transparency over supply chains while also making it easy to forge documentation linked to a lending program.

But this could be changing in wake of the pandemic as disruptions to transport and carrier services have forced banks and buyers to accelerate the adoption of digital solutions for their trade and supply chain finance services.

"I have not seen so much movement as now within the banking trade finance community to really push forward the digitalization projects," said Maria Mogilnaya, product lead for green trade finance at the European Bank for Reconstruction and Development, in an interview.

Once trade finance is made digital, it will be easier for banks and buyers to see what is going on in their supply chains, influence suppliers and prevent information from being tampered with, she added, expecting that digitalization will be a driver for growth in sustainable trade and supply chain finance products.

In a pilot last year, players such as BNP Paribas SA, Barclays PLC, Rabobank, Standard Chartered PLC, J Sainsbury PLC and The Unilever Group were testing how blockchain technology can be used to collect and record ESG data on suppliers as part of a sustainable supply chain finance program.

Shona Tatchell, founder of halotrade Ltd., whose supply chain platform was used for the trial, told S&P Global Market Intelligence that while she saw increasing interest from banks in her technology before the pandemic, the number of conversations she is having with potential partners is only intensifying now.