As the region prepares to host COP28, the Gulf’s banks are well positioned to take the lead on sustainable supply-chain financing (SCF) programmes for corporate clients, encouraging them to address their indirect environmental footprint in a more cost-effective way.
The logic is simple: eight supply chains (food, construction, fashion, fast-moving consumer goods, electronics, autos, services and other freight) are responsible for 50% of global emissions.
These industries have several abatement levers – from switching to renewable power and recycling waste to adopting carbon capture – to cut emissions along the supply chain.
Banks want to price in the environmental and social externalities in a way that could incentivise small and medium-sized enterprises to improve their environmental, social and governance credentials.
But it is difficult for banks to reach any kind of scale with such a programme because of important roadblocks in the early stages of development, including with raw data collection and diverging ESG priorities.
Good opportunity
Positioned as it is at the centre of some of the world’s most important trade routes, the Middle East’s desire to become a global logistics hub comes at a time when it is looking to diversify revenues away from oil. Its vast capacity for infrastructure investment can make these ambitions a reality.
“There is a significant need in the market for someone to orchestrate this change, and there are huge diversification opportunities for oil-exporting countries to invest in logistics and green supply chains,” points out Emrah Durusut, senior partner at ESG consultancy firm Xynteo.
It’s the SMEs that need funding, and we don’t mind funding them, but we also have to consider the credit risk that they can represent
Banks in the region are eager to integrate ESG best practice in their supply-chain finance businesses.
“We’ve come a long way in terms of raising awareness in the market on the relevance of building sustainable supply chains,” says Anirudha Panse, head of trade finance product innovation, global transaction banking at First Abu Dhabi Bank (FAB).
The bank first launched a fully automated sustainable supply-chain financing solution in Egypt back in 2021 and is now rolling out its trade products in Saudi Arabia, including supply-chain financing as well as receivables finance solutions.
For Panse, the focus on the Middle East, thanks to Egypt and the UAE hosting COP27 and COP28, means that the corporate landscape could catch up quickly.
“It’s accelerating the journey and creating awareness of the topic and the business opportunity,” he says. "It's mandating companies to look at their own business practices and where they should be."
Expectations that the UAE’s role as a UN climate conference host will boost this momentum even further are high.
“I would characterise the Middle East as being at a tipping point, with COP28 on the agenda and the introduction of new government initiatives in the region. It will be on everybody’s radar,” says Victor Penna, executive vice-president, co-head, global transaction banking at Mashreq Bank.
Mapping exercise
Corporates in the region are also facing pressure to look at their indirect emissions to meet global reporting standards, driven by investor demand for disclosure.
But it is difficult for them to take the lead on this, usually because they have little visibility on their own supplier ecosystem.
“Before we start implementing any ESG performance standard, we need to make sure that we have visibility,” says Durusut. “Some of our clients mention that they have done as much as possible to optimise their operations; anything more requires collaboration with other companies in the value chain that they might not have worked with before.”
What we’re seeing in the local market is that there is some progress on ESG data reporting and sharing but we are a long way from scale
A 2022 survey by McKinsey found that 45% of respondents either had no visibility into their upstream supply chain or can see only as far as their first-tier suppliers.
This lack of visibility means that SCF programmes must be tailored to each client and that a considerable part of the initial work is in listing the suppliers relevant to that client. Right now, there is no way for banks to have a one-size-fits-all product available across sectors, so the actual number of successful sustainable SCF programmes is limited.
Only once the suppliers have been identified can the corporates and their banking partners start establishing an ESG performance baseline.
Finding the information
Then comes the issue of data reporting.
“What we’re seeing in the local market is that there is some progress on ESG data reporting and sharing but we are a long way from scale,” one senior trade finance banker tells Euromoney. “There’s intention, but lack of clarity in the regulatory process is holding us back.”
There has been some progress on standard setting recently. Last January, the Exchanges Committee of the Gulf Cooperation Council (GCC) published a set of unified indicators for voluntary ESG disclosures by listed companies in the region. These include 29 indicators aligned with the World Federation of Exchanges and Sustainable Stock Exchanges Initiative.
Others are more optimistic and think the Gulf region can also capitalise on the already existing and very efficient data-provider industry to make up the data gap at a much faster pace.
“It’s not like there isn’t data available already,” says Penna. "ESG reporting firms now measure a whole range of different ESG criteria at scale, and they are doing it for millions of suppliers."
For him, the bigger challenge for banks is that companies may not all be concerned with the same sustainability issues.
ESG is a moving target, and while corporates are already struggling to keep carbon out of their supply chains, the market is already expecting progress on other ESG criteria such as biodiversity loss or gender parity.
A successful SCF programme should start with the process of determining how the clients’ objectives are relevant to its own business line.
“What matters is how to influence their behaviour,” Penna says. “Not everyone attributes the same strategic importance to the supply chain, or to the ESG considerations within it.”
Working capital
The ones that consider the supply chain to be of strategic importance usually do so because it is responsible for the bulk of their production costs. So, if banks want to get a sustainable SCF off the ground, it’ll be much easier if the ESG benefits are associated with pure and simple cost reduction.
“If we can deliver a programme that does this, we can structure it in a way that rewards the suppliers who are doing the right thing,” says Penna.
It makes sense for financial partners to lower the cost of capital for the suppliers of those corporates and make abatement worth their while.
“New financing solutions are needed for the SMEs because it’s not credible to think that they can bear the costs of transition,” adds Durusut.
The discussion starts with sustainability-linked objectives, but it ends up about the financial benefits. They should be treated as two different things
At the end of 2022, SMEs accounted for 63.5% of non-oil GDP, according to data from the UAE government, which explains why today, most SCF programmes are launched with larger corporate clients who can demonstrate a level of maturity on certain ESG topics.
“It works better when you target a large company because of the awareness level,” says Sivakumar Kuriyakkattil, head of open account product solutions, global transaction banking at FAB. "The anchor buyer can motivate the SMEs to join the programme and get the SMEs to engage on the ESG aspects."
FAB had some success with government initiatives during Covid, when the bank launched a $1.6billion sustainable SCF programme with the ministry of finance in Abu Dhabi and national health insurance company Daman to speed up payments of SMEs’ receivables and reduce the cost of working capital to SMEs in the market.
“We wanted to address the disruptions in supply of medical care equipment and medicines,” explains Kuriyakkattil. "Everyone was suddenly looking for supplies, and there was a backlog of claims that hospitals or clinics were waiting for, a lot of funds getting locked up."
It was also a way for the Emirati lender to mitigate some of the risks that come with SME lending and focus on helping multiple tiers of the economy to get liquidity access.
“We realise that SMEs in tiers 7 or 8 need the cash the most, and not necessarily as much as those in tiers 2 or 3,” he says. "So how do we make sure that the dollar that is dispersed to principal contractor reaches tier 7 or 8? We are looking at how to do that.
“At the end of the day, it’s the SMEs that need funding, and we don’t mind funding them, but we also have to consider the credit risk that they can represent,” he adds.
And if banks can offer a better cost of working capital to suppliers based on ESG performance, it will encourage data flows around ESG compliance and incentivise regulators to set the right standards for it.
Incentive solutions
Understanding how the corporate views its supply chain can also help banks chose the right incentive mechanisms to get suppliers on board.
According to HSBC’s UAE Supply Chains – Networks of Tomorrow report, the preferred methods for corporates encouraging suppliers to adopt sustainability policies are: requiring new suppliers to conform as part of the onboarding; mandating compliance with their own sustainability policies in order to transact; and providing a timetable/end date for them to align.
But for the banks suggesting SCF programmes, adapting pricing from one tier to the next is a more common type of financial incentive that focuses on transition.
If, for example, the company is operating in a relatively constrained supply chain with fewer suppliers able to provide a particular product, it may be more inclined to adopt a programme that rewards suppliers on the progress they are making rather than a punitive one that excludes those who score below a certain threshold.
“If there is less choice in the supplier ecosystem, the client might work harder to get them to improve on their ESG performance because they won’t have the option to pick a competitor,” says Penna.
Supply-chain financing often finds itself in a debate over what it means to be truly sustainable and if lenders should reward those who are performing well on ESG matters, or those who are doing the most to improve.
This means that more needs to be done to ensure that the suppliers who are asked to improve are also given the support to progress.
“The most successful programmes are ones where, in addition to measuring and rewarding the right behaviours, there is an educational element to help suppliers understand how to make the necessary changes in their ESG-related behaviours,” Penna adds.
Technical assistance also goes a long way.
At FAB, Panse argues that the bank has a role to play in raising awareness with its clients about the relevance of addressing ESG issues such as the emissions intensity of their production lines.
“The discussion starts with sustainability-linked objectives, but it always ends up with a conversation about the financial benefits,” he says. "In my view, they should be treated as two different things."
One way of doing that is providing tech solutions that can make sustainability data available and digestible.
“We partnered with a company called Coriolis [now TradeSun] to help assess the ESG ratings of certain companies and their suppliers,” Panse says. "It allows us to support our clients in understanding where they stand."
If data providers follow global taxonomies to drive the adoption of a single measurement system by large corporates, that can reverberate down the supply chains.
In such complex operational systems, suppliers gravitate towards efficiency. This efficiency and a narrow focus are essential for such programmes to work.
“SMEs tend to follow their larger customers,” says Penna. "Those who have the buying power will dictate the ESG criteria that matter most to them, and suppliers will report on what the major buyers consider to be most important."
