Opinion Sustainability Green supply chain finance is the sector’s next step Lenders need to become sufficiently familiar with the operation of their client supply chains By Victor Penna November 2, 2023, 11:13 AM Pexels/Yogendra Singh Partnering with polluting suppliers can cause massive brand damage. Financing linked to ESG goals can help partnerships with greener companies Across the world, markets and regulators are challenging businesses to look beyond profit margins and to adopt environmental, social and governance (ESG) practices. The Middle East is no different. But what companies often overlook is that this extends beyond managing their own impact on the environment and society, to that of their suppliers. Today, entire sectors are being scrutinised and held accountable for supplier behaviour and ethics. Neglecting ESG risks not only jeopardising business reputation and investor trust, but has legislative ramifications. Mubadala’s first-ever green bond order book hits $6bn Explained: Green bonds and how they work UAE entities explore green finance prospects The European Union’s new Corporate Sustainability Reporting Directive, which takes effect next year, will require EU companies – in effect, anyone dealing with European companies or their Tier 1 (first-level) suppliers – to report on their value chain. So suppliers will receive increased requests for information on their sustainability credentials to meet disclosure requirements. Such information is likely to include environmental footprint measurements and details on ethical sourcing of products, fair labour standards and sustainable production. The legislation has implications for the Middle East, a region entwined in a complex web of supply chains that feeds the global economy. The banking sector can help here, by creating specific financial incentives designed to encourage suppliers to embrace sustainability. Green bonds and loans have served as the foundation of green finance, but ESG-linked supply chain finance is the next step in the sector’s evolution. Discounts for sustainable action Green finance – including bonds, loans, sukuks and other instruments – aims to align financial interests with environmentally conscious practices. But, until recently, its impact on supply chain participants has been more limited. Instances of companies partnering with environmentally hazardous suppliers have sparked public outrage and brand damage, emphasising the need for comprehensive supply chain reform. ESG-linked supply chain finance is a response to such pressures. At its core – and there are other ways in which it could evolve – it involves banks offering early payment on supplier invoices at a lower cost of finance to the supplier, by relying on the better credit ratings of the buyer. In an ESG-linked programme, the discount is linked to the achievement of ESG metrics agreed between the business and its supplier base. These can be tailored to specific outcomes, with suppliers that bring the most positive impacts receiving the most cost-effective arrangements. ESG measures that could be integrated into a supply chain finance model include labour practices, environmental impact and promoting critical needs like financial inclusion. The programmes can be highly customisable – the key is for the parties to agree on the targets, support and educate suppliers and set up systems to measure attainment, either through an internal team or third-party provider. Broadening take-up While green supply chain finance programmes are relatively new in the region, several banks have already launched initiatives, indicating the sector’s potential for future growth. Lenders need to ensure they become sufficiently familiar with the operation of their client supply chains, ESG objectives and how these link to the financing structures devised. I believe there is scope for further innovation in green supply chain finance, enabling the banking industry to more closely align the financial offer with positive sustainability outcomes. For example, there is a promising opportunity to develop better scoring systems to measure specific ESG objectives. This would enable more accurate assessment and monitoring of suppliers’ sustainability practices, and help the parties identify areas for improvement and where more targeted strategies might be necessary. Certainly, green supply chain finance deals extend beyond offering discounts to suppliers. Transition finance is another area where banks could play a significant role. For instance, they could provide financing to suppliers to upgrade their manufacturing processes, invest in energy-efficient infrastructure or acquire a fleet of fuel-efficient vehicles. By supporting such initiatives, banks contribute to the overall green transformation of the supply chain. Hopefully this area of finance will continue to grow and mature. Victor Penna is co-head of global transaction banking at UAE bank Mashreq