Closing the Trade Finance Sustainability Gap
Developing environmentally sustainable global trade means taking a closer look at how we pay for it.
Topics
Leading Sustainable Organizations
Most major financial institutions are making significant progress in identifying and assessing the environmental and social risks of their business transactions. But for the majority, trade finance remains a gap in their environmental and social risk management systems.
Trade finance is one of the most fascinating business areas in the financial sector. Millions of small transactions make global trade possible every day. Consequently, there is also a very direct link to our society at large. First and foremost, trade finance is an important enabler of economic growth, and therefore a key contributor to global prosperity. But might it, in some instances, also be an enabler of controversial businesses — businesses that cause detrimental environmental and social impacts?
Let’s start by answering the question, What is trade finance? and looking at how can it expose banks and insurers to environmental and social risks.1
Trade finance is an important cog in the global economy. The World Trade Organization (WTO) estimates that 80–90% of world trade relies on trade finance. Trade finance is conducted primarily by commercial banks and insurers, which support importers and exporters, as well as traders, in a number of ways: by issuing letters of credit or other guarantees such as performance bonds, and through short-term lending to cover transaction costs, such as when commodities are being shipped from sellers to buyers. Depending on the type of trade finance transaction, reputational risks and (less likely, but not impossible) liability risks exist at several levels. These levels include the good itself (e.g., asbestos fibers, which are banned in many countries), the conditions under which the good has been produced (e.g., palm oil from non-certified sources), the means of transport (e.g., crude oil spills that result from ship, rail or truck accidents during shipping), and the purpose for which the good is to be used (e.g., equipment used in controversial projects). Even when there is no good involved, risk may still be present — for example, with a performance bond related to the construction of a controversial project.
Because of the significance of this business for both buyers and sellers, banks and insurers can be seen as important enablers of global trade.
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1. Note that this article discusses the trade finance business related to the global trade in services and the physical delivery of goods, and does not cover trading in commodities on financial markets and the corresponding controversies.