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  1. Opinion
April 6, 2022

From EVs to rhinos: Let’s welcome finance innovation

Since the near collapse of the global banking system in the late 2000s, governments have sought to temper capitalism’s worst excesses. This shouldn’t change, but as we seek solutions to solving climate change, we must nurture the sector’s more creative instincts: no more so than in the area of trade finance.

By Daniel Flatt

finance innovation
Getting our heads together: all aspects of banking needs to innovate if we are to achieve our ESG aims. (Photo Freder via iStock)

Finance innovation is not a term everyone associates with fond memories. Remember CDO-squared structures, those marvels of banking engineering concealing all manner of mortgage risk? Shortly after they emerged, the capital markets froze, triggering a global economic downturn still felt today.

Of course, the 2008 crash was not down to one toxic product alone. But you know you are at the sharp end of a financial market when your inbox is full of news updates from banks claiming to have concluded a world-first deal.

This should come as little surprise to those covering sustainable finance. The surge in capital directed towards environmental or social endeavours is sitting at record highs; even the more developed segments, such as green bonds, are not by any definition mature.

But, as we set our sights on solving some of the most challenging social and environmental issues ever faced, finance innovation and risk-taking has never been more essential.

The rhino bond

The World Bank’s $150m Wildlife Conservation Bond is a prime example. Priced in March, a fascinating feature of the deal is that investors have agreed not to receive any coupons during its five-year life; all the capital will go to supporting two wildlife parks in South Africa.

With the help of Credit Suisse and Citi, a handful of institutional and private bank clients were convinced to buy the debt at a discounted issue price, receiving a guaranteed return when the principal is repaid, and the prospect of a “conservation success payment” at maturity – essentially a variable payment dependent on agreed metrics being hit.

And here’s the kicker: the success is predicated on the percentage population growth of the critically endangered black rhino. The more these beautiful creatures get jiggy, the more investors get paid .

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How replicable such a remarkable deal is remains to be seen, but it is vital that such innovations make it to pricing day; the market needs to know what investors are willing to back.

This is also the case in the world of trade and supply chain finance. Underpinning world trade, the $7trn market, not famed for its nimbleness – it is an area of banking still heavily reliant on paper documentation – has seen a handful of innovations of its own lately.

Green trade finance

On 9 March, Standard Chartered announced its role – alongside Citi, Nordea and ING – in executing a syndicated €350m green trade finance facility to Swedish electric car manufacturer Polestar Performance, a market first. In short, finance has been made available to support working capital needs on receipt of invoices tied to the import of electric vehicles to Europe and North America.

While the financial structure itself is not especially novel – although it is rare to see syndicated trade finance outside of the commodity sector – it’s the story behind the deal that’s important; it highlights the heavy lifting required to get such trades off the ground.

Speaking to Pradeep Nair, global head of structured solutions at Standard Chartered, about the deal makes clear the challenges that trade finance banks face in accommodating fresh processes to mitigate risks such as greenwashing and escalating transaction costs (trade finance operates on thin margins).  

Firstly, for it to be considered green, the facility needs to align with the bank’s public green sustainable trade finance framework. Namely, does it fit at least one of the following criteria: the specific economic activity has a sustainable end use, is tied to sustainable goods and services (certification required), there are proven sustainable suppliers, has a carbon transition story.

The activity must also fit under terminology outlined by the EU Taxonomy of sustainable activities, says Nair.

What’s more, the framework also outlines the checks and balances the bank must undergo to ensure the authenticity of the trade. Incorporating proof of “greenness” requires additional work for both the bank and the company in question, usually in terms of documentation. Polestar is, for instance, obligated to publish an annual impact report outlining the outcome of its green activities.

“[Trade finance] is not rocket science,” says Nair, “But you’ve got to follow the process, and people are loath to change.”

Infrastructure for finance innovation

This sentiment also applies to the industry more generally. At present, there are no formal green or social trade and supply chain finance standards.

In the absence of one, Citi chose to adopt the green loan standards as set by the Loan Market Association for the Polestar deal, says Tarun Khosla, a regional head of trade and working capital at the US bank. Tailored for long-term debt, this template is not ideal but is an example of the market applying a practical solution where a made-to-fit one does not yet exist. 

But the markets, as ever, are evolving. Since revealing its position paper in the fourth quarter of last year, the influential International Chamber of Commerce (ICC) plans to publish its ICC Sustainable Trade Framework very shortly. This will be the first of many iterations.

The ICC’s work may prove not only important in streamlining green trade and supply chain finance processes, but, in turn, could pave the way for number crunchers to assess accurately any risks hidden within them. Payment risk in trade finance is well understood; greenwashing is not.

Well, if it isn’t cheaper…

A better handle on the latter should lead to cheaper, more competitive pricing of trade and supply chain finance – assuming regulators are willing to reduce capital charges for this type of balance sheet activity. Despite the EU raising this as a possibility a few years back, the lack of infrastructure to assess the risk implications has kept the notion on ice. The world of trade finance spins slowly, but time is not on our side.

For now, incentivising companies to adopt green trade facilities comes down partly to liquidity – it’s easier to get your hands on funding as banks increasingly redirect capital to sustainable activities – and partly to public relations and branding as cynical as the latter may be.

In trade finance, scale is everything – without it you don’t have a viable business. If we are really committed to moving to a more sustainable world, we must ensure that the infrastructure is there to support this dusty, bookish yet vital corner of the banking world.

Finance innovation is our friend. For now.

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