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Key challenges of sustainable trade finance in Hong Kong – Episode 1: Sustainable trade finance on the rise, but what is it?

  • Hong Kong
  • ESG - Sustainable Finance

04-11-2022

Why should I read this?

Sustainable trade finance (“STF”) is becoming a growing interest within the financial sector and we are seeing new developments arise in Hong Kong. This is in part born from the accelerated focus on environmental, social and governance (ESG) issues across borders and businesses.

While a number of related standards for sustainable goods and services and financial products are gradually getting in shape for the Asian and conventional loan market, none are readily adapted to robustly define and demarcate sustainable trade. Therefore, it is crucial for the parties to stay current with the latest development in STF.

What is sustainable trade finance?

For conventional loan markets, sustainable finance is always in the form of loan instruments to borrower and distinctively, a loan is always a “proceeds” product. Green/social/blue loans refer to loan instruments made available exclusively to finance or refinance green/social/blue projects. Distinguishably, sustainability-linked loans (“SLLs”) focus on predetermined sustainability performance targets measured by predefined key performance indicators (“KPIs”) comprising an ESG component.

STF is definitely way beyond loans to borrowers. Trade finance covers conventional “proceeds” products such as import/export loans and receivables finance, unfunded commitment covering letters of credit, demand guarantee and standby letter of credit issuance, and also hybrid financing products like financing an exporter by way of discounting a third party’s payment undertaking - negotiation of a letter of credit is essentially the negotiating/financing bank’s purchase of issuing bank’s payment undertaking. Given the great variety of trade products, the relatively well-established green/social/blue loans or SLLs may not be able to be squarely applied to STF. As such, market players are looking for guidance in this respect.

Positioning Paper from ICC

International Chamber of Commerce (“ICC”) published a positioning paper on Standards for Sustainable Trade & Sustainable Trade Finance (“ICC’s Positioning Paper”) in late 2021, outlining a roadmap for stakeholders in the trade finance community to align definition of sustainable trade and STF and to establish a standardised framework for assessing the sustainability of a given trade transaction or trade finance portfolio.

The following areas have been settled by ICC:

  • No penalty: The proposed sustainable definitions and standards are not designed to unnecessarily increase the overhead for businesses and financial institutions in complying with such sustainability standards or penalise non-compliances, but to promote and encourage sustainable trade.

  • Holistic assessment: As opposed to individual assessment on a particular component of a trade transaction (akin to the project based assessment for green/blue/social loans), a holistic sustainability assessment framework will be adopted to address all three dimensions of “ESG” across various components of a trade transaction or trade profile.

  • Sector based assessment: The sustainability standards are expected to be adjusted by sector, considering the different levels of maturity regarding sustainability exposure, data availability and transparency exhibited by different industries.

  • Mode of sustainable trade finance: STF involves the financing or facilitation of sustainable trade by using recognised trade finance instruments.

What’s next?

That said, what has not been settled?

ICC has yet to formulate uniform guidelines and practices for the financing aspect of sustainable trade, in the absence of which, trade finance banks or practitioners are required to “play around” their existing products offering to cater for STF.

The trade finance banks/practitioner would probably have to consider issues like whether they should have a brand-new product offering for STF? Is it necessary to segregate the trade finance products from other general banking and finance facilities? Is it necessary to monitor the use of proceeds? Will they allow borrower’s self-assessment? What is the consequence of sustainable breach? Will they need a separate set of STF documents? To find an answer to these questions, it is necessary to take into account the product design, system compatibility, cost implication and legal documentation infrastructure.

We will discuss the product aspect for STF in the next episode “The product structure of sustainable trade finance”.

Further reading

An Introduction to China’s First ESG Disclosure Standards (es-notifications.com)

The Sustainable Finance Package: Commission amends MiFID,- Publications - Eversheds Sutherland (eversheds-sutherland.com)

 

For further information on ESG and sustainable trade finance in Hong Kong, please contact: