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The trade finance industry has long strived for inclusivity. It recognises the importance of embracing an overarching vision that fundamentally reimagines its practices. To fully realise this vision, it is imperative to actively engage African voices in trade finance discussions.
Creating avenues for African voices to be heard in the trade finance space can lead to the identification of effective trade finance strategies that genuinely reflect the aspirations of the African economies. Through an inclusive approach, trade finance can empower African countries to fully participate and benefit from global trade.
Given the inherent complexity of sustainability and ESG in trade finance, and with the current focus of the international sustainability standards on addressing developed markets, the distinctive requirements of the African economy have yet to be acknowledged and integrated.
To gain a comprehensive understanding of the African trade finance ecosystem and the obstacles hindering the continent from implementing the existing sustainability and ESG principles, Trade Finance Global’s (TFG) Deepesh Patel spoke with George Wilson, Head of Institutional Trade Finance at Investec.
The importance of trade finance in the African economy
With trading activities contributing to up to 40% of GDP growth in some African economies, it is evident that trade finance is the most direct pathway to sustainable development in Africa, embodying the principle of ‘trade, not aid.’ At the heart of the African economy are its Micro, Small, and Medium Enterprises (MSMEs), which employ 85% of the continent’s workforce.
As Wilson stated, “These employees ultimately become consumers, contribute to tax revenue, and fuel self-sustaining development”, further reinforcing the role of trade finance in creating a self-perpetuating cycle of growth and prosperity.
The transformative power of trade finance can be seen in success stories like China and India. Over the past three decades, these nations have successfully traded their way out of poverty, leading to a remarkable reduction in global poverty concentration rates, from 40% to 10%.
Unfortunately, the remaining 10% of the world’s impoverished population is still concentrated in Africa. A reality that underscores the importance of trade finance as a vital tool in combating poverty and driving sustainable development across the African continent.
Understanding the root causes of the African ‘Trade Gap’
Africa’s trade finance gap has widened over the years and remains susceptible to global supply chain disruptions and geopolitical events.
According to Wilson, the African ‘Trade Gap’ primarily stems from the international regulations on investment banking capital and the limited liquidity available for trade financing within the continent.
The implementation of international compliance regulations, such as the Basel reforms and AML policies, originally intended for international investment banks following the global financial crisis, has had unintended negative consequences on African transactional banking. To adhere to these regulations, international financiers had to de-risk their trade finance transactions in Africa, limiting access to credit facilities for African traders. As a result, their only option to access credit facilities is through local African banks.
Nonetheless, local African banks face their own set of challenges in profitably financing merchant trade activities. They struggle with high regulatory costs and pressure from regulators to comply with Basel regulations. In addition, compliance regulations continue to incentivise local African banks to prioritise purchasing government bonds over providing trade finance to traders.
Wilson accentuated the dilemma by stating, “The African banks had a choice. They could either use their scarce capital and liquidity to offer loss-making trade finance facilities to their merchant clients, or they could buy government bonds, fulfil all their regulatory ratio requirements, and have zero risk-weighted assets (RWAs) with a 15% return.”
ESG sustainable trade finance in Africa: The challenges
The challenges of implementing ESG sustainable trade finance in Africa are multifaceted.
Following the COP27 summit, ESG sustainable finance was anticipated to be a catalyst for positive change in addressing sustainability issues within the trade finance sector. However, as highlighted by Wilson, it has yet to meet expectations, particularly regarding its impact on Africa.
A lack of consensus on standards and definitions, along with ineffective initiative launches, has posed significant hurdles to the integration of the ESG industry into sustainable trade finance. Additionally, ESG sustainable finance does not fundamentally align with Africa’s unique landscape and realities, considering the continent’s economic conditions.
ITFA’s latest positioning paper on ‘Sustainable Trade Finance and African Trade’ sheds light on a key factor contributing to this disconnect: the lack of involvement of African trade practitioners in shaping the global ESG frameworks. This is partly due to the decision-making and drafting process being predominantly driven by first-world policymakers.
Therefore, it is crucial to recognise the key differences between trade finance in developing countries, like Africa, and trade finance in developed countries, to ensure contextually relevant sustainable finance practices. African trade finance involves products with a specialised approach, unlike the ESG frameworks built on debt and project finance models. Similarly, designing sustainable finance models for Africa must consider market conditions such as limited access to digital infrastructure and electricity.
Moreover, subjective interpretations and conflicting priorities also contribute to the obstacles facing African sustainable finance. The initial development of ESG frameworks without African input has led to Western perspectives shaping the interpretation of the UN Sustainable Development Goals (SDGs) into ESG regulations.
Subjectivity becomes apparent when examining ESG ratings, as they can vary across different ESG rating agencies despite using the same inputs. Resolving dialectically conflicting components of trade, which is often encountered in African trade finance, requires subjective resolutions on prioritisation due to the varying sustainability aspects and environmental impacts. These subjective interpretations may not align with Africa’s economic development priorities.
Evidently, Africa needs its own sustainable trade finance framework that echoes its own specific approach and priorities in establishing ESG credentials.
Empowering African trade financiers: Collaborative solutions for Africa’s success
In response to the challenges surrounding sustainable trade finance in Africa, concerted efforts have been made to develop practical solutions through collaboration.
BAFT and ITFA have established global working groups with dedicated African sub-working groups focused on ESG. The proposed approach acknowledges the subjectivity and difficulties of capturing all data within the current ESG frameworks. It suggests that African trade financiers can make sustainable trade finance designations on the ground, similar to the Know Your Customer (KYC) process conducted by African banks.
By amplifying African voices and promoting indigenous solutions, there is an opportunity to attract capital back into African trade finance, narrowing the gap between sustainability goals and practical implementation.
With a dedicated commitment to collaboration and a keen focus on addressing Africa’s actual needs, a promising future for African sustainable trade is undoubtedly within reach.
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