Can changing how world trade is financed actually change the world?
Andrew Voysey Director, Finance Sector
8 June 2015
We were excited to learn that the Financial Times has shortlisted the Banking Environment Initiative’s (BEI) trade finance product development work for this year’s ‘Transformational Business Award’. The winner will be announced later this week.
The work in question is the BEI’s ‘Sustainable Shipment Letter of Credit’, which aims to pave the way for banks to promote and incentivise the trade of sustainably produced agricultural (or ‘soft’) commodities such as palm oil, soy, timber and beef.
But how can banks hope to make a difference to such complex global supply chains when they are merely facilitators of international trade?
is not a widely understood banking service and, even to many clients, its rules, practices and language can appear a little arcane. A Letter of Credit, for example, is a bank guarantee that underpins large transactions between importers and exporters that may not know or trust each other very well. The bank promises to pay the exporter on the importer’s behalf, providing the shipment’s documentation matches the conditions stated by the buyer. The importer then pays the bank rather than the exporter directly, making the transaction between the two parties more secure.
In 2013, the University of Cambridge Institute for Sustainability Leadership (CISL) embarked on a journey with BEI Member banks to help them and their commodity trading customers examine the processes through which banks were funding large-scale trade in soft commodities. The aim was to see whether it was possible to develop commercial opportunities for banks to reward trade in sustainable commodities.
The journey started with palm oil and the Letter of Credit. Our practitioner-led research discovered that it is possible to link the supply chain tracing system used by the Roundtable for Sustainable Palm Oil (RSPO) to the documentation used by banks to extend credit lines to individual commodity shipments via Letters of Credit. This meant that, for the first time, the sustainability of individual commodity shipments could be verified by the banks funding them.
By bringing together industry leaders as a group, we were then able to secure preferential terms from the International Finance Corporation (which underwrites trade finance risk for banks) for such shipments, meaning that once identified, these trades would be cheaper for banks.
What difference does this make? We are witnessing the biggest global shift of our time in how we buy and produce agricultural commodities, as growers, companies and consumers recognise that new models of increasing agricultural production are required. These models need to reconcile growing demand for food and the need to improve farmers’ livelihoods with maintenance of essential stocks of soil, water and biodiversity. The Consumer Goods Forum (CGF), a body representing 400 of the world’s biggest companies including Unilever, Nestlé and Coca-Cola, is spearheading this change in outlook: it has committed to achieving zero net deforestation in its key supply chains by 2020.
Yet this shift is messy and complicated. Producers and the traders that dominate so many commodity supply chains quickly point to the fact that demand for sustainability is not yet uniform across all major import markets, especially in China and India. Meanwhile, those emerging market importers may perceive the premium prices often associated with sustainably produced commodities as a barrier to their involvement while the transition is still in its early days.
The BEI’s Sustainable Shipment Letter of Credit will never be a ‘silver bullet’ but it is significant because its key impact is to reduce the cost of importing sustainably produced palm oil to emerging markets. Early signs are promising, with this new approach already being applied to other means of financing trade. Indeed, one BEI Member bank has reported nearly $50 million of new ‘sustainable shipment’ business in the six months from July to December 2014 using ‘Documentary Collections’.
For banks, the benefits extend beyond innovating to support their clients address one of their biggest challenges. As these shifts in market norms accelerate and give rise to increased risks to market access for producers that are not keeping pace with changing buyer requirements, it will also pay for banks – as intermediaries – to be one step ahead of these shifting risk dynamics.
To build on this early work, the BEI will shortly launch a Sustainable Trade Finance Council to expand its application to other trade finance products and other commodities. With interest being expressed from around the world, including in China, in better understanding its full potential, we have high hopes that this is only the beginning.