The Role of ESG in Trade Finance

By Daria Loi - December 13, 2022

What if the world of finance was changing and you didn't even know it?

ESG is doing more than playing a role in the finance world as a whole, and specifically in Trade Finance. According to McKinsey, the combined volumes of sustainability-rated debt instruments (not specific to trade finance) have grown approximately 80 percent per year, increasing from roughly $155 billion in 2017 to more than $1.6 trillion in 2021. It is clear Trade Finance investments will follow in the same direction. Mckinsey also estimates that revenue from sustainable Trade Finance and cash management products will grow by 15 to 20 % annually to total combined revenues of $28 billion to $35 billion in 2025, with market penetration reaching approximately 25% in Trade Finance products.

Despite this, many involved don't understand the exact role that ESG plays in Trade Finance. Without that knowledge, these individuals and businesses will fall hopelessly behind.

Want to stay on top of evolving matters of ESG and trade finance? Keep reading to learn everything you need to know!

ESG: Understanding the Big Picture

ESG refers to "environmental, social, and governance" matters regarding investments. An increase in focus on sustainability when making financial decisions has been evident for some years now. What began with consumers pressuring businesses to offer ethically and sustainably sourced products quickly turned into corporate social responsibility (CSR) commitments that span industries and supply chains. Ultimately, this has led businesses and individuals to consider incorporating ESG factors into their trade and investment decisions.

That's because ESG lets lenders put tighter controls on who they lend money to. For example, a business may not qualify for a needed loan because the company produces too many emissions per year.

With ESG, lenders try to do their part to create a better and more sustainable world. But it does mean that individual traders, borrowers, lenders, and businesses need to know more about this delicate topic to navigate a changing world.

The Big Picture of Trade Finance

What is trade finance? Generally speaking, trade finance exists to solve trade cash flow gaps by advancing payments and covering costs associated with sales and POs. When businesses need additional capital to fulfill a large order (because they won't get paid by their customer for 60, 90 or even 120 days after receiving the goods), they often rely on trade financing to cover the difference.

Trade finance is growing in prominence by the year. In fact, as of 2021, it has grown to account for a $5.2 trillion trade ecosystem spanning the entire globe!

Who relies on trade finance? A whopping 80-90% of world trade relies on trade finance! Both enterprises and small to medium-sized businesses (SMBs) rely on this financing to effectively unlock working capital from their current receivables. In this way, these businesses keep things running and give themselves room to grow.

Why ESG Works So Well With Trade Finance

ESG plays a role in many different industries, but especially in this one. The importance of trade finance as a means to achieve Sustainable Development Goals (SDGs) is recognised in the UN Declaration on Financing for Development, as it is uniquely positioned to mobilize capital at a scale necessary to drive meaningful change.

For one thing, trade finance can help reduce poverty by funding SMBs in emerging countries, allowing them to make a part of and compete in the global trade landscape. A reduction in poverty aligns perfectly with ESG goals, allowing ESG lenders to help make a better world, one investment at a time.

Furthermore, ESG lending is often tied to very specific metrics, such as percentage of a company's CO2 emissions. About 30% of global CO2 emissions are estimated to be associated with international trade, and shipping alone accounts for about 3% of the world’s emissions. ESG trade financing helps focus on reducing emissions in an industry where this is of utmost importance.

Finally, there are many small businesses in emerging countries that traditional lenders (banks) are hesitant to finance. This provides alternative lenders with an unprecedented opportunity to grow their own businesses even as they use the principles of ESG to create a more sustainable planet.

Challenges of ESG in Trade Finance

ESG and trade finance are a very natural fit. However, there are still some important challenges to overcome.

Risk of widening existing trade gap: At its core, ESG focuses on restricting financing to companies that meet certain sustainability metrics. These lenders must develop an "ESG" score for each company they consider doing business with. And they may not finance a business due to a low ESG score.Unfortunately, this has the potential to widen the existing trade gap, which works against actual ESG goals.

Lack of industry standards: There are other issues when it comes to ESG and trade finance, including having no set definition for what constitutes a legitimate ESG trade finance investment. A lack of industry standards and governing entities lead to confusion and greenwashing.

All of this adds up to a very fragmented market. While that market is still full of major opportunities, there are still challenges that everyone involved must navigate.

How Fishtail Approaches Trade Finance Sustainability

Here at Fishtail, we are devoted to using trade finance to create sustainability. However, we know very well what the current challenges facing ESG and trade finance are. How, then, does Fishtail approach trade finance sustainability?

First, we live up to our motto: "trade finance for the rest of us." Our in-depth data analytics coupled with our advanced technology allow us to specialize in financing the traditionally unfinanceable: small and midsize businesses in emerging countries.

We also use cutting-edge technology to predict CO2 emissions for everything that moves. From there, we can tie CO2 emissions for shipments to the rates that we charge. Thus, borrowers have a strong business incentive to lower their own emissions. The way we see it, we reward good behavior instead of punishing the bad ones.

And Fishtail will soon be launching the Sustainable Supply Chain Leaders Association. The SSCLA is an organization that will offer better working definitions for ESG in trade finance. Furthermore, the SSCLA will push for better and more widespread collaboration between different players in the ecosystem: tech providers, cargo owners, freight forwarders, data aggregators, etc.

In short, Fishtail doesn't just want a better world. We're doing our part to help make that better world into a reality, one day at a time. Just stay tuned for more green from us very soon!

Interested in making an ESG investment in trade finance? Contact us today!