# Trade Finance: The Small Brush to Paint the Big Picture Author: Pal Sinha, Barnali Author URL: https://financedigest.com/author/pal-sinha-barnali Published: 2022-05-16 Category: FINANCE Category URL: https://financedigest.com/category/finance Meta Title: ESG Accountability and Trade Finance: Building a Meta Description: Learn how the private sector is driving the ESG movement with sustainable finance instruments, ensuring accountability across goods and commodities. URL: https://financedigest.com/trade-finance-the-small-brush-to-paint-the-big-picturehtml ![undefined](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/istock-1304066178-1736815719926-compressed.jpg) _![](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/018-1736815719935-compressed.jpg)_ _By **Marc Naidoo**, finance partner in international law firm, McGuireWoods’_ Ignorance is sometimes bliss, especially in the context of being an end consumer. A verification here, a badge there, and suddenly a product can have the affect of allaying the need to be, and be seen, as environmentally and socially conscious. In no way is this intended to be a slight on those consumers who are trying to do the right thing, but rather a platform to ensure that those good intentions are being channelled into a more accountability driven goods and commodities ecosystem. As with any structure, accountability starts and is driven from the foundation. In this instance, I would regard capital (debt or equity) and use thereof as a suitable foundational point on which to build a framework for ESG accountability. Private [sector financiers](https://www.financedigest.com/how-big-data-is-sending-shockwaves-through-the-financial-services-sector.html "How big data is sending shockwaves through the financial services sector") are relentlessly driving the ESG movement through the use of sustainable finance instruments. The task has been made somewhat easier (or challenging depending on how one looks at it) due to more robust credit evaluation criteria as well as internal and external stakeholder pressure. Pleasantly surprising, is the increase in number of social and governance linked instruments, which shows a maturity in the market as market participants migrate to other issues besides environmental concerns which has been dominant in the sustainable [finance landscape](https://www.financedigest.com/what-needs-to-happen-to-improve-the-landscape-for-smes-trying-to-access-finance-options-in-the-uk.html "What needs to happen to improve the landscape for SMEs trying to access finance options in the UK"). The ever-present conundrum is the approach to [finance where there is an element of unsustainability in the underlying product or business](https://www.financedigest.com/1-in-3-uk-businesses-looking-for-finance-are-finding-it-harder-to-get-a-loan.html "1 in 3 UK businesses looking for finance are finding it harder to get a loan"). My view is that by mitigating harmful actions across a structure, the less desirable ESG outcomes of a business’ operations may be mitigated as well. [ESG must](https://www.financedigest.com/occupational-health-and-safety-must-be-brought-back-to-the-forefront-of-esg.html "Occupational Health and Safety must be brought back to the forefront of ESG") be looked at within the context of an ecosystem, and not ring fenced with a purist view that would either shun existing businesses, or drive those businesses to financiers where there is less accountability. The flexibility around mitigating the negative impacts [across a business’ operations can be fully realized through trade finance](https://www.financedigest.com/700000-employees-across-the-uk-have-access-to-fair-finance-will-reach-one-million-employees-in-2017.html "700,000 Employees Across The UK Have Access to Fair Finance, Will Reach One Million Employees in 2017") instruments. The principle extends to both hard and soft commodities, as an analysis needs to follow the journey of the goods from source to end consumer. Similarly, and possibly controversially, the principle also extends to “dirty” goods, such as coal and oil, as there is merit in using [trade finance](https://www.financedigest.com/ing-toughens-oil-and-gas-policy-to-include-trade-finance-midstream.html "ING toughens oil and gas policy to include trade finance, midstream") instruments to enhance accountability. Just because a product or resource is not strictly ESG compliant, [doesn’t mean](https://www.financedigest.com/making-sure-that-finservs-digital-transformation-doesnt-mean-digital-exclusion.html "Making sure that FinServ’s digital transformation doesn’t mean digital exclusion") that the entire supply chain relating to that product or resource can’t be. That is the first issue with the current approach to trade finance. Market participants are too quick to write-off businesses that deal with goods that previously formed the backbone of the [trade finance economy](https://www.financedigest.com/at-chinas-largest-trade-fair-exporters-worry-about-world-economy.html "At China’s largest trade fair, exporters worry about world economy"), an approach which is short sighted and self-defeating through virtue. The extraction of these resources provide employment for much of the developing world. Separately and equally as important, these resources (for example coal) are needed in the developing [world to allow those economies](https://www.financedigest.com/biggest-economy-in-the-world.html "Biggest Economy in the World") to grow and provide a better standard of life for the people therein. Trade [finance is a method of working with these businesses to create value across a supply chain](https://www.financedigest.com/5-steps-to-successful-supply-chain-finance.html "5 Steps to successful supply chain finance") as well as accountability. By introducing ESG financing terms and technology into the supply chain, [businesses](https://www.financedigest.com/6-ways-to-spring-clean-your-business-finances.html "6 ways to Spring clean your business finances") are incentivised to “clean up” their respective supply chains which would mitigate ESG concerns on the entire structure, as opposed to a ring-fenced solution which isolates one component of a supply chain and disregards the rest. This is the [way where true ESG value can be realised by an end](https://www.financedigest.com/5-common-ways-people-end-up-in-debt-without-realising.html "5 Common Ways People End Up In Debt Without Realising") consumer. The benefit of sustainable finance is that [financiers and trading](https://www.financedigest.com/data-centres-and-the-changing-financial-trading-landscape.html "Data centres and the changing financial trading landscape") houses have the flexibility and freedom to agree on trade finance terms, which can be as boring or creative as the parties desire. Here are a few terms that may be worth noting, which show the importance of trade finance commercial terms in providing true value to the end consumer. The inclusion of [technology related terms within financial instruments is becoming more popular as the world](https://www.financedigest.com/is-wearable-technology-ushering-in-a-brave-new-healthy-world.html "Is wearable technology ushering in a brave new healthy world?") moves to a digitised method of information validation and recording, especially through blockchain technology. Financiers are including undertakings relating to these types of [technologies](https://www.financedigest.com/how-financial-services-companies-can-successfully-utilise-low-code-and-no-code-technologies.html "How financial services companies can successfully utilise low-code and no-code technologies") in financial instruments, although we have not seen this concept migrating to a lowering in pricing terms, yet. Trade finance instruments, some would argue, are the perfect platform to expand on these concepts as well as create new information undertakings that could impact the entire [supply chain](https://www.financedigest.com/how-to-bring-immediacy-back-to-the-supply-chain-with-faster-payments.html "How to Bring Immediacy Back to the Supply Chain With Faster Payments") as opposed to just the business operations of the borrower. For instance, whilst a company may deal in a resource such as coal, they could ensure that the process of the goods to end consumer is sustainable enough to mitigate some of the harmful consequences of the coal itself (as mentioned earlier some economies still require coal as a source of power). Blockchain technology can be used to digitise the supply chain and bills of lading, ensuring that at each point in a commodity’s journey there is a set of criteria that need to be met (whether signed off by collateral managers or port officials). The criteria could include [carbon footprint](https://www.financedigest.com/ecb-can-cut-carbon-footprint-by-shedding-bonds-of-biggest-polluters.html "ECB can cut carbon footprint by shedding bonds of biggest polluters") on transport, labour practices in extracting the commodity, labour practices in transporting the commodity or even grading levels depending on what is being transported. The information would be [tracked on the goods or commodities](https://www.financedigest.com/sp-global-acquires-firm-to-bolster-capability-to-track-commodity-shipments.html "S&P Global acquires firm to bolster capability to track commodity shipments") in question throughout the supply chain, thus creating a clearer representation on the sustainability of the item as a whole, as opposed to a snap call at extraction stage. The requirement to use this kind of technology can be built in trade finance instruments, both as an undertaking and a repeating representation. Better information on supply chains can also help in setting pricing ratchets which incentivise the borrower to continue to monitor the supply chain. Another possible solution would be to include more robust due diligence measures within a trade [finance instrument as they relate to the borrower’s business](https://www.financedigest.com/5-ways-to-improve-your-business-finances.html "5 Ways to Improve Your Business Finances") and counterparties. The enhanced due diligence can be set as an over-arching requirement in a trade finance instrument, which allows lenders to have a look through right on the fundamental operations of the borrower. This would represent a more accurate gauge on the sustainability of business operations, given that the focus would not be exclusively on environmental concerns, but would focus more on social and governance issues. For instance, measuring local procurement, board and ownership composition, review of labour practices and on-site visits to ensure that basic worker needs are met. These are components of a business operation that need to be measured, and which sometimes fall through the cracks given the superficial nature in which some ESG transactions are measured. By moving away from pure environmental concerns, an analysis of the supply chain as a whole can depict the true cost to the World of a product. Trade finance is uniquely positioned to allow that analysis. Possibly the most novel [way to use trade finance](https://www.financedigest.com/3-key-ways-you-can-transition-from-finance-to-fintech.html "3 key ways you can transition from finance to fintech") to facilitate sustainability, is to allow borrowers to do the right thing while still conducting business in less fashionable sectors. I will re-iterate that there is a need to [change the way](https://www.financedigest.com/10-ways-automation-has-changed-the-role-of-the-cfo.html "10 ways automation has changed the role of the CFO") that the World relies on hydrocarbons, unfortunately that change needs to be measured and with a view to protecting those on the planet who can’t be left in the dark, both literally and figuratively. In this regard, if a corporate must engage in extraction of [fossil fuels](https://www.financedigest.com/bank-finance-for-cleaner-energy-grows-but-still-lags-fossil-fuels-report.html "Bank finance for cleaner energy grows, but still lags fossil fuels – report"), or trading in the same, they should be allowed to address other areas of the ESG spectrum to mitigate for this. ESG is not binary, and doing the perceived “wrong” thing should not preclude one from also doing the “right” thing. Addressing these other ESG concerns is already prevalent in sustainable finance transactions. Borrowers contribute to community upliftment, mitigation the damage of their operations as well as adhere to local procurement rules. These usually are covenanted in the finance documents, but may also link to margin ratchets. The beauty of this approach is that there is a large amount of creativity afforded in setting these KPIs, which in turn ensures that the actual needs that [need to be addressed](https://www.financedigest.com/if-the-nation-backs-fintech-we-need-to-address-a-few-things.html "If the nation backs FinTech, we need to address a few things") are addressed. In this regard, trade [finance instruments offer borrowers and lenders the ability to set these KPIs across the entire supply chain](https://www.financedigest.com/g7-finance-leaders-pledge-financial-stability-supply-chain-diversity.html "G7 finance leaders pledge financial stability, supply chain diversity"). The possibilities are endless, with a few examples being: worker upliftment on transport routes, sustainability awareness training for affected communities and streamlining shipping routes. These can all be linked to ratchets, or could also be simple covenants. The value of trade finance is that a greenfield solution can be provided across an entire supply chain, which in my view is the only [sector within finance](https://www.financedigest.com/finance-is-the-next-big-sector-to-be-ubered.html "Finance is the next big sector to be Uber’ed") that can implement this. There is a [role for all financing](https://www.financedigest.com/theres-nothing-artificial-about-the-role-of-ai-and-data-in-the-finance-industry.html "There’s nothing artificial about the role of AI and data in the finance industry ") in making the World a more sustainable place. However, [ring fencing](https://www.financedigest.com/uk-energy-regulator-drops-plan-to-ring-fence-customers-cash.html "UK energy regulator drops plan to ring fence customers’ cash") sectors and processes within commerce will only partially achieve this. For the average consumer of goods and services, an emphasis on sustainability should look at the big picture, which in turns requires an analysis on the finer details. True [value can be realised](https://www.financedigest.com/2021-predictions-realising-the-value-of-payments-transformation.html "2021 Predictions: Realising the Value of Payments Transformation") where there is an understanding of micro and macro economic factors as well as an appreciation of all aspects of ESG. Trade finance in my view is the perfect [landscape to create](https://www.financedigest.com/how-to-create-an-edible-landscape-your-neighbors-will-love.html "How to Create an Edible Landscape Your Neighbors Will Love") this value and understanding, as no other sector within finance offers more exposure to a supply chain and the nuts and bolts of how end consumers interact with goods. With trade finance instruments acting as the lens under which the finer details can be monitored and mitigated, it allows the sustainability landscape to start painting the bigger picture. **_About Author:_** _Marc Naidoo is a finance partner in [international law firm](https://www.financedigest.com/international-law-firm-calls-in-viato-connect-uk-and-us-offices.html "INTERNATIONAL LAW FIRM CALLS IN VIATO CONNECT UK AND US OFFICES"), McGuireWoods’ London office.  His practice focuses on emerging markets, with a particular emphasis on Africa and sustainable finance.  Marc can be contacted at mnaidoo@mcguirewoods.com_ --- This blog is powered by Superblog. Visit https://superblog.ai to know more. ---