Exploring “green” finance offerings, part 2

In this four-part blog series, we’re exploring some of the key “green” financial offerings emerging in today’s banking market and why banks should pay attention to them. Part one explored the inner workings of green financing and green bonds. In part two, we’ll cover sustainability-linked loans and sustainable supply chain finance (SSCF).

What is a sustainability-linked loan?

According to the Sustainability Linked Loan Principles, released in July 2021, a sustainability-linked loan covers “loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivize the borrower’s achievement of predetermined sustainability performance objectives.”

In effect, a sustainability-linked loan links the terms of a loan—often the pricing—to the borrower’s performance against specific sustainability targets. These targets are typically negotiated and agreed upon between the borrower and lender group for each transaction.

Contrary to a green loan, a sustainability-linked loan can have “non-green” purposes, such as the financing of general corporate objectives. Further, a loan can be structured as either type of loan at the same time.

The rise of sustainable supply chain finance

According to the Business for Social Responsibility, SSCF is defined as supply chain finance (SCF) practices that integrate environmental, social and/or governance (ESG) considerations with a view toward driving sustainable behaviors in global supply chains.

Essentially, SSCF rewards suppliers for being sustainable. Those rewards can take different forms. For example, a supplier with good ESG performance could receive better finance rates or terms than other suppliers, or even gain access to an exclusive supply chain program.

Such programs are typically led by corporate buyers and implemented to build and incentivize a more sustainable supply chain.

SSCF advantages and drawbacks

Since 2014, several leading global brands, such as Walmart, Puma and Levi Strauss, have implemented sizable SSCF programs, and most major banks tout the success of their SSCF programs. However, there are some notable SSCF obstacles, including difficulties in monitoring suppliers’ sustainability-related activities, reporting variations due to a lack of common standards, or even fraud.

Mechanisms to maximize SSCF benefits

The BSR report highlighted above shares promising SCF mechanisms to incentivize and fund SSCF, including sustainable payables finance and smart contract solutions. The report notes these mechanisms have the potential to offer tangible commercial and sustainability benefits to global buyers, finance providers and suppliers.

Sustainable payables finance solutions involve integrating ESG performance criteria into buyer-led SCF programs, allowing global buyers to provide tangible benefits (e.g., better discount rates) to select suppliers (e.g., those meeting defined sustainability targets). This solution applies to global companies that have or are setting up SCF programs and want to offer a direct incentive to their own suppliers.

Smart contract solutions are self-executing contracts in which the contract terms between the buyer and seller are computerized, often within a distributed and decentralized blockchain network. Smart contracts enable transactions to be traceable, transparent and irreversible, which are the basic tenets of a traditional SCF program.

The role of companies in SSCF

A good example of a smart contract solution is the partnership between Walmart and HSBC to develop an SSCF program that gives Walmart suppliers preferential pricing for progress in meeting sustainability standards. Suppliers’ progress is measured based on Walmart’s Project Gigaton and the company’s Sustainability Index Program. Project Gigaton is an initiative the company launched to eliminate one billion metric tons (a gigaton) of greenhouse gases from its global value chain by 2030.

The role of banks in SSCF

Businesses operating across supply chains represent the most important opportunity for driving sustainability. According to a variety of researchers, businesses are the source of most of the greenhouse gas emissions in the world today. As a result, the role that international banks can play in encouraging companies to become more sustainable is paramount to increasing sustainability.

Barriers to SSCF adoption

While the interest in SSCF is growing, the uptake is still marginal. Current barriers to adoption are largely due to low awareness of SSCF, as well as limited access to supply chain data to support such programs. However, given the current trajectory of market forces today, from growing government regulations to meet climate pledges to consumers (and employees) choosing institutions with sustainable business practices, we can see adoption taking place more rapidly when the following happens:

1. A greater number of banks and corporations gain more awareness
2. More data providers rush into this niche area of finance to provide data management, data analytics and other forms of support

Conclusion

Sustainability-linked loans and SSCF programs can be powerful tools for driving sustainable behaviors across global supply chains. Providing additional education, support and awareness will go far in making each more readily accessible.

Join us for part three of this blog series in which we’ll discuss what happens when you blend green financing with emerging technologies.

If you would like more information on this topic feel free to contact nancy.amert@cgi.com or andy.schmidt@cgi.com.