As the financial engine of the global economy, banks have a crucial role to play in helping business customers to become more sustainable and socially inclusive. Focusing on clients at a group level, however, can fail to provide the actionable data and targeted incentives needed to make a difference. A more effective approach would look at specific activities across supply chains. How could you apply this approach within your bank? How could it support your overall environmental, social and governance (ESG) agenda?
ESG has become one of the defining challenges and opportunities of our age. As your bank looks at how to bring your influence to bear, trade finance and supply chain finance are important focal points.
By linking the availability and pricing of finance, you can encourage clients to develop more sustainable and socially inclusive products, sourcing and distribution. You can also apply your risk data and sector insights to help develop and promote best practices.
The results would not only be beneficial for society, but also boost clients’ commercial prospects and, ultimately, yours. This includes helping to make their products and services more marketable to today’s increasingly ESG-conscious customers. Tackling social and environmental issues at source could also help to reduce clients’ risks in areas such as carbon tax, regulatory intervention, reputational damage or reliance on sourcing and operations that could eventually become redundant.
However, few banks have been able to make successful headway on aligning ESG and trade and supply chain finance. To support sustainable practices, you need the right customer data. But this remains relatively scarce. One of the main problems is that most of the available data is at the group level. While entity level ESG scoring is important, it doesn’t provide enough information at the critical activity level. A client’s carbon footprint may be going down overall, for example, but this group score may mask problems in particular areas of sourcing or production.
Supply chain impact
Our analysis also highlights the extent to which assessments of individual companies can often miss the ESG credentials of the supply chain as a whole. The impact can be significant. Positive developments might include consolidating shipments or encouraging more local sourcing. Larger companies can also help smaller and local producers to invest in initiatives such as improving health and safety for employees or reducing water and energy consumption.
Too late to incentivise
The other big drawback of group data is that it is a lag indicator, rather than providing lead insights into current aims and strategies. This backward-looking view means that you would only incentivise companies that have materially transitioned to more sustainable and socially inclusive operations. This misses the opportunity to fund and advise companies who want to make the transition.
SMEs are a bank blind spot
Company-specific evaluation is especially problematic when dealing with SMEs. Data is often hard to come by. Yet these companies don’t tend to have ESG strategies or capabilities and hence pose a significant sustainability risk. In turn, this increases the risk for your bank.
Five ways to get on track
What’s the way forward? From our experience of working with both banks and their clients, five priorities stand out:
1. Enrich data sourcing and evaluation
Broadening the focus of data sourcing and evaluation to include specific activities and wider supply chains would improve your ability to evaluate and incentivise clients’ ESG strategies. It would also enable you to evaluate ESG performance in real-time and respond to ‘lead’ rather than ‘lag’ indicators.
Comparable approaches are already being successfully applied within procurement management. This includes tendering criteria in areas such as environmental and labour practices. Social and environmental auditing and certification can also provide reassurance in sensitive areas such as working conditions or sourcing of contentious materials like palm oil.
ESG evaluation at a supply chain as well as company level is still at a nascent stage. But some specialist providers are coming on stream. In some cases, evaluations are explicitly linked to the sourcing of green finance. The next frontier will be moving this kind of scoring to an activity level.
2. Regear incentives
Lead data would improve your ability to offer activity-focused incentives for changing strategies .
The green bond scheme to finance responsible soy production in Brazil shows how incentives might work at an activity level. You could also offer finance and favourable terms to larger companies planning to support SMEs within their network.
Using available certification could provide a starting point for evaluation. You could also draw on your sustainability and supply chain risk data to develop specific incentive criteria for different sectors.
3. Make the most of data from across your bank
Harnessing data and altering processes from other parts of your bank would improve your ability to identify and address sustainability risks across supply chains. A case in point is the potential to use new standards, such as those enabled through ISO 20022 to carry sustainability data.
4. Create a central repository of data
Providing activity level and supply chain information could prove onerous for some companies, especially SMEs. To ease the burden, the banking industry could come together with market data providers to create a central global repository for key information such as certification so clients would only need to provide this once. This repository could be linked to onboarding utilities such as the KYC registry.
5. Communicate the impact
As part of your ESG evaluation and communications, it’s important to be able to gauge the difference your new activity and supply chain focus is making. Examples include improvements in pay and safety at work or quantifying the reduction in energy usage and emissions.
The result would be a virtuous circle in which you are helping clients to change their social and environmental practices and this is in turn moving your ESG strategy forward in a material and quantifiable way.
Using the power in your hands
Society is looking to you and other banks to make a real difference in tackling climate change and strengthening social inclusion. An activity and supply chain focus would enable you to identify social and environmental issues at source and provide incentives for addressing them. It would also provide a tangible demonstration of how you are using your influence as a force for good.
If you would like to find out more about how we can help with your sustainability journey, please email Stuart Williams or Ian Clarke.