The recent International Trade and Forfaiting Association (ITFA) Report on making trade sustainable explores how trade and trade finance can enable a more sustainable world, but also warns of the negative effects of the current regulatory structures on sustainability reporting. The report is based on interviews and a survey with members of the ITFA, an association of trade finance professionals.
The report argues that trade finance can help achieve the UN’s Sustainable Development Goals by providing lending to businesses that are transitioning to more environmentally and socially responsible models. However, this requires common standards of reporting, consistent data, and a more inclusive dialogue with regulators that balances the environmental and social aspects of sustainability.
The report identifies a “regulatory paradox” that creates perverse incentives for banks and hinders the transition to more sustainable trade. The paradox consists of six points:
- There is no favourable regulatory capital for green deals compared to brown financing, which disincentivises lending to the transition.
- The risk-based approach to sustainability is backward-looking and does not account for transition risk on reasonable time frames for climate change.
- The focus on green financing widens the trade finance gap in emerging markets and for smaller businesses in supply chains, where social factors are more important.
- The minimum regulatory reporting becomes the norm, and modest targets are set to avoid accusations of green-washing, which replaces green-washing with green-hushing.
- The social aspect of ESG is under-incentivised because it is intangible and hard to measure compared to the environmental aspect.
- The emphasis on environmental criteria creates a barrier to the development of appropriate frameworks based on social criteria in emerging markets and Africa in particular.
The report also makes the following points regarding ESG:
- ESG is a top priority for most organisations, but there is confusion over what and how to measure it.
- ESG strategies are driven by client-facing objectives, such as helping the planet, creating business opportunities, and engaging with clients differently.
- The EU taxonomy, the EU’s Sustainable Finance Disclosures Regulation, and the global International Sustainability Standards Board are the most important regulatory frameworks for ESG reporting.
- Trade finance is a special case within ESG reporting, as it requires transaction-level measurements and deals with sectors and geographies that are not well understood by regulators or ESG communities.
- Credit insurance can support trade finance by providing appropriate risk assessment tools, common measurements, and common sustainability definitions.
- Technology can help trade finance provide transition support to their clients by automating ESG risk assessments and providing systematic and consistent data. However, the lack of common audit standards limits the role of Fintechs.
The report concludes with three recommendations based on the feedback they encountered:
- To establish an Audit Council that represents the trade finance industry to regulators and sets common standards for ESG reporting.
- To establish a common data pool to share experience and data on scenario modelling and climate-related financial risk for ESG reporting.
- To include credit insurance, African and emerging market and smaller trade finance providers in the Audit Council and data modelling to preserve the trade finance ecosystem and account for different socio-economic and sectoral conditions.
In Summary
The report shows that trade and trade finance have the potential to enable a more sustainable world, but also face the challenges of the current regulatory structures that govern sustainability reporting. The report identifies a “regulatory paradox” that creates perverse incentives for banks and hinders the transition to more sustainable trade. The report proposes three recommendations to address this problem: establishing an Audit Council, a common data pool, and a more inclusive approach to ESG reporting. The report urges the trade finance industry to act quickly and pragmatically to avoid reputational damage and failure of trade to support sustainable global trade through its financial products.
