Supply chain financing has traditionally been important in optimizing the working capital for buyers by extending payment terms without negatively impacting the suppliers’ cash flow. In recent years, banks have increased the geographical availability and scope of sustainable supply chain financing. This could be because this is an important area for environmental, social and governance (“ESG”) efforts and financial institutions profit from the discount or fee charged for providing early payment and managing the transaction. 

What is sustainable supply chain financing increasingly popular product and could it support the management of indirect emissions from the supply chain (“Scope 3 Emissions”)?

With sustainable supply chain financing, the financier makes early payments to the business' suppliers on terms that take into account the sustainability performance of the supplier or the ESG rating of the supplier. 

Businesses can use sustainable supply chain finance as a proactive strategy to enhance the sustainability of their supply chain. Suppliers with strong sustainability performance or ESG ratings benefit from gaining access to working capital financing.

Sounds good? Think again, the application is not without some obstacles. For financiers offering sustainable supply chain finance, the lack of industry standards creates concerns around greenwashing. The Green, Social, Sustainability and Sustainability-Linked Bond Principles (the “Principles”) do not lend themselves for easy application to supply chain financing. For example, the Green Bond and Social Bond Principles focus on (1) use of proceeds, (2) project evaluation and selection (3) management of proceeds and (4) reporting. These requirements are built around the purpose of the financing, but do not lend themselves well to assessing the business' of suppliers, the goods supplied or the mode of transportation. On 22 June 2023, the International Capital Market Association (ICMA) announced the 2023 editions which include the climate transition finance handbook (“CTFH”) and updates to the core recommendations for impact reporting metrics for energy efficiency & renewable energy. How this will impact sustainable supply chain financing is yet to be seen.

There are some cross industry efforts to provide solutions in this area, the ICC Standards for Sustainable Trade and Sustainable Trade Finance (STFD) launched a pilot in November 2022 with banks, corporates and technology players to test its Wave 1 framework in real world transactions. The Wave 1 framework was created to reach an agreed common definition of sustainable trade and sustainable trade finance.

The results of this pilot were published on 6 June 2023 and have raised valuable insights, including:

• the Scope of the Wave 1 framework was for short term flow trade products, but participants saw value in extending the framework to the full suite of both trade and supply chain finance products so that no trade division in a creditor / financier role would have to apply multiple methodologies; and
• sustainability scores based on quantitative measures are becoming more commonplace and can be more easily combined with automations in trade finance.

Sustainable supply chain financing could definitely help reduce Scope 3 Emissions, however there are some obstacles that need to be addressed before this can be an effective tool to tackle climate change.