Blissful ignorance is no longer an option. From January 2026, large corporates with operations in Europe will need to have full oversight of the environmental, social and governance (ESG) standards in their supply chains, under the terms of the EU’s Corporate Sustainability Reporting Directive (CSRD). And from January 2027, the rules tighten up even further, to include smaller firms.
Given that large companies often have tens of thousands of suppliers around the world – and many tiers of suppliers – that won’t be easy. But help may be at hand.
Big corporates routinely use trade banks to provide supply chain finance (SCF). That’s to say, they ask their bank to extend credit to a supplier on better terms than the small firm could command on its own. It’s a form of receivables finance, and it can be used to encourage certain behaviours.
Walmart, for example, works with HSBC to source cheaper finance for suppliers that have better sustainability ratings, as part of its global Sustainable Supply Chain Finance programme. The smaller firms benefit from pricing that is linked to Walmart’s credit rating.
The idea now is that SCF could be used as a carrot to encourage better flows of data around ESG compliance – and ultimately higher ESG standards.
Why sustainable supply chains matter more than ever
This already seems to be a growing trend. “The number of conversations we are having with clients on embedding sustainability into their supply chains has increased significantly over the last 12 months,” says Vasilka Shishkova, solutions structuring director for global trade and receivables finance at HSBC. She explains that the demand is largely down to the new disclosure and reporting requirements.
The CSRD does not mandate any specific penalties for non-compliance, but the expectation is that no one will want to be the skunk at the ESG picnic. That would mean higher costs of finance and reputational problems.
The current guidelines may also be just the start. Research by HSBC and the Boston Consulting Group in 2021 shows that global supply chains account for up to 80% of the world’s total carbon emissions. If supply chains can’t be made greener, more socially responsible and reflective of good governance practices, the planet has a serious problem.
So, could a combination of reporting guidelines like the CSRD and incentivised ‘self-regulation’ via SCF be the solution? Or does there always need to be a regulator making companies toe the line?
Can supply chain finance help to enforce ESG?
It’s a question made all the more important by a rising awareness of the various issues in global supply chains, from hidden child labour to the destruction of rainforests and toxic oil spills. But as Angela Francis, director of policy solutions at WWF-UK, explains, supply chains can undoubtedly be a force for good. “Trade is an enormous driver of innovation,” she says. “We have got to use it to drive net zero.”
Some corporates are already rejigging their supply chains to do just that. “The rules of engagement are changing,” says Shishkova. “Previously the goal was producing the best quality at the lowest price. Now, increasingly, conversations are about transitioning manufacturing processes to embed ESG.” That sometimes includes dropping suppliers which can’t meet ESG standards or reporting requirements, she adds.
Of course, that kind of decision won’t always be an easy call. “One problem is that smaller companies – both buyers and sellers – don’t necessarily have the required data, especially when you get down to the deep tiers,” says Rebecca Harding, an international trade consultant who created the world’s first automated sustainability scoring system for trade finance.
Still, based on the sums involved alone, the idea of using SCF to drive good ESG standards does look convincing. According to HSBC’s research, up to half of the $100tn (£79tn) investment needed to achieve net zero by 2050 has to be directed towards SMEs. SCF could be a useful conduit for that.
Then there’s the global reach that trade finance offers. Shishkova argues that SCF could ultimately achieve a far greater impact than legislation or other conventional forms of ESG regulation, on the grounds that supply chains connect millions of companies around the world.
But hitting the mark is still a work in progress. “Most banks would say that if you can get targeted money to businesses in supply chains, that can help both the supply chain and the bank to be more sustainable,” says Harding. “The problem is that it’s hard to know what, say, ‘green’ really means.”
There are other practical issues too, Harding adds. “Supply chain finance tends to move quite quickly – within 30 days. Getting the right data, at the right time, can be both expensive and unwieldy.”
Why the banking world needs to swap value for values
A further challenge – for SCF providers and regulators alike – is that dealing with ESG is a moving target. What needs to be done will change as the climate transition proceeds and the planet warms. What’s more, many problems – such as the loss of biodiversity – are currently so-called ‘externalities’ not priced into business models.
“Regulators want to know about the ESG-related risk exposures of banks because regulators are tasked with overseeing financial stability. But this looks backward and not forward to the ESG transition that needs to take place,” says Harding. That could, she says, lead to more ‘green-hushing’, where firms focus on toeing the current regulatory line and keep quiet about what’s needed for the future.
Harding suggests that SCF providers and their clients should approach regulators to discuss what rules, standards and data would help the banks to really incentivise more sustainable supply chains. “So, for example, the regulations could be changed to allow different capital ratios [at banks] for more sustainable assets,” she says.
After all, the banks are just part of a much bigger – and highly politicised – space, Harding explains. “Trade is being weaponised and the sustainability agenda is being weaponised, and banks are the foot soldiers in this space, being told to go over the top. They’re damned if they do and damned if they don’t.”
Fundamentally, in Harding’s view, the need for good ESG standards in supply chains means banks are being asked to shift from a value-based model to one that prioritises values. But a banking and funding model not built on market prices is a radical departure.
“A new values-based economic system requires a public discussion,” Harding says. “For example, should the rich north try to impose its values on the global south?” That’s hardly the sort of question a bank can be expected to answer alone.