Sustainable Trade: why trade finance can help regulators avoid greenwash
By 2022 climate-related disclosure by large corporates will be mandatory in the UK; the EU will require sustainability disclosure from March 2021 1 and President Biden has come to power on a promise to integrate sustainability into every area of government policy, inclduing the tariff regime. New Zealand already has sustainability financial reporting requirements.2 Some 78% of European businesses alone are argued to be below acceptable disclosure standards on the climate risk they pose3 and regulatory changes are much-needed step towards, literally, cleaning up the balance sheets of large corporates.
There are two main issues with the policies so far, however. The first is this: sustainability is not just about climate change. This is an important and necessary part of sustainability of course, but the Sustainable Development Goals cover society and human condititions as well. “Green” issues and impact are arguably easier to measure, and the argument would run that we have to start somewhere – ease of measurement makes regulation easier too so there is no harm in current approach.
However, if we are really going to make a difference and create sustainable trade in every sense of the word, then decent work, access to healthcare, protection against fraud and crime, educational and work opportunities and the right to housing and clean water also need to be included in sustainability targets. In short, while the regulations are welcome, they do not go far enough to ensure that sustainability in all its senses is captured by any new regulations. Post Covid, the issues of inequality, inclusion and economic sustainability are also vital to include in financial reporting requirements. While these are much harder to track, especially through Tier 2 and Tier 3 supply chains, they are essential if we are to make a difference to the sustainability stance of business, large and small alike.
Second, regulatory requirements as they are currently framed put the onus on business to report. Unless banks also have strong compliance measures associated with, say, preferential credit terms, there is a danger that the financial disclosure regime creates perverse incentives for “greenwashing.” In other words, unless there is a pull from the financial sector as well as a regulatory push, the exercise may just become one of neat accounting rather than substantive change.
The issue for trade finance is manifested itself most clearly in the compliance function. If a company is not complying with reporting standards, that is easy to measure and monitor. However, if the banking sector is to do this properly, then there is far more that needs to be done. For example, the sustainability standards and benchmarks need to be agreed consistently across the world so that banks can manage their own and their clients’ legal and regulatory risks and maintain their license to operate. There is no way of understating the magnitude of the compliance challenge (and expense) this poses.
What is clear, however, is that banks are beginning to align around the complexity of this agenda. There is an understanding that this cannot be undertaken by one bank alone: if preferential credit terms are to be applied to clients that comply with a more complex definition of sustainability, then every bank needs to have a shared definition both of sustainability and of what can be usefully measured within that definition. In short, the sector needs to decide what, from a trade finance perspective a “compliant client”, “compliant correspondent bank” and “compliant originator” is.
This goes beyond existing KYC and AML considerations to a broader concept of sustainability “kite marks” that are comprehensive and accepted by all. An equivalent on the consumer side is the “Fair Trade” mark allocated to businesses for compliance to a code of sustainability criteria. Applying a sustainability kite-mark from a credit assurance process would require collaboration, measurement and tracking on a colossal scale using the methodologies of “spatial finance.”4 This framework would ensure that the process of allocating accrediation would be outside of sensitive transactional or commercial frameworks between banks and their clients and therefore independent and replicable.
This is not a trivial task but there are realistic approaches and technologies out there to do it. In effect, banks will need to take the responsibility, not just as global sustainability champions, but also as the global foot soldiers ensuring that changes in regulations are implemented and for helping their clients to become compliant. This will take time, pragmatism and collaboration to achieve, but the important thing is to make sure it is done.
Given the fact that a bank’s license to operate may come under threat anyway if their clients are found to be non-compliant, the question is not, “can we afford to do this?”, but rather, “can we afford not to do this if we are to avoid greenwash.”
1 https://www.bakermckenzie.com/en/insight/publications/2020/11/eu-sustainable-finance-disclosure-regulation 2 https://news.bloomberglaw.com/environment-and-energy/eu-will-drive-climate-disclosure-regulation-much-like-gdpr 3 https://www.cdsb.net/eu-non-financial-reporting-directive/1047/78-europe%E2%80%99s-largest-companies-falling-short-adequately 4 https://www.wwf.org.uk/sites/default/files/2020-12/Spatial%20Finance_%20Challenges%20and%20Opportunities_Final.pdf