Focusing on the E in Export Finance

Nick Tostivin, Head of Finance and Global Head of Trade & Export Finance, Pinsent Masons

Camilla Ash, Associate, Pinsent Masons

Madiha Aslam, Director, Structured Finance, Innovo Group

Export Credit Agencies (ECAs) play a crucial role in facilitating international trade by providing financial support and insurance to domestic companies exporting goods and services.

Their broad function is to (a) mitigate the risks associated with exporting to foreign markets by providing loans, loan guarantees and insurance to support domestic companies, (b) provide financial support to exporters, ensuring they have the necessary funds to complete international transactions and (c) facilitate market expansion by enabling companies to explore and enter new markets, thus supporting national economic growth and international trade.

ECAs are increasingly integrating sustainability into their operations in a number of ways. The proliferation of sustainability standards and guidelines have crept into export credit transactions (partly due to fact that, under the UNFCC Paris Agreement, national governments now have a legal requirement to align with net zero goals and are mandating ECAs to align with their own commitments under UNFCC required Nationally Determined Contributions) just as ECAs are increasing their efforts and focus on projects that promote sustainable outcomes such as renewable energy and sustainable infrastructure, and are aligning their strategies with global net-zero targets, helping businesses transition to low-carbon operations. One example is UK Export Finance which has introduced a sustainability strategy (2024-2029) with an explicit £10bn target of providing “clean growth” for supporting sustainable projects in developing countries. Many ECAs are also part of international alliances aimed at promoting sustainable trade and investment. For example, The Berne Union is an international association of ECAs that promotes best practices in sustainable finance and trade, and the OECD Guidelines often form the backbone of the ECAs’ sustainable lending deals, ensuring that their financial support aligns with international sustainability standards.

In export finance, parties have a wide range of environmental guidance materials and practices to consider. How are these (successfully) navigated on transactions?

Navigating the wide range of environmental guidance materials and practices in export finance can be complex, but there are established frameworks and best practices that help ensure successful transactions.

Environmental due diligence is a key area on which ECAs, engineering, procurement, and construction (EPC) contractors, lenders and borrowers alike spend a lot of time on in the beginning phases of a transaction. Whilst an essential element of any sustainable finance deal, this takes time and costs money, which for some market participants can act as a deterrent.

Adherence to recognised international standards such as the IFC Standards, Equator Principles and the OECD Guidelines also help the underlying project to align with ECAs’ and lenders’ sustainability standards, demonstrating sustainability credentials, and support the associated “bankability” of a project.

Typically, the first assessment of the E&S requirements on a project is guided by an initial high-level review of the location and scope of the proposed project by the ECA and bank at the point that the transaction is initially brought to the financiers. At this stage a few items are key:

To have a client and / or EPC with an E&S team who have experience of managing internationally financed projects and have knowledge of compliance requirements pertaining to IFC standards and Equator Principles. This enables all parties to have an initial realistic discussion on potential risk implications and categorization of the project.
It is helpful if initial E&S studies up to national regulatory E&S standards are in place at this point, to help financiers make a more informed decision on the key risks to be mitigated. Typically, these may be included as part of the initial feasibility review the client might have conducted on the project.
It is important that an initial scoping review of the project is then completed through a consultative process between the Client, EPC, ECA and lead Bank to ensure that all parties focus and agree on the core risks around the project under consideration and identify risks that can be considered secondary in nature (unless otherwise flagged in a subsequent report). This allows the identification of a “fit-for-purpose” scope of work for engagement of E&S consultants to conduct an impact assessment, leading to more efficient use of time and resources.

More broadly, Inter-agency collaboration also helps to further the objective of aligning sustainable finance practices. ECAs will often collaborate with other financial institutions and international bodies to share best practices and ensure consistent application of sustainability standards. For example, SACE (the Italian export agency) revealed its ESG Strategy at COP28. The primary goal of their strategy is to contribute to the community well-being and overall prosperity. After unveiling its strategy, SACE hosted a round table involving companies, financial institutions, and other stakeholders to explore solutions supporting the “ESG revolution”1. This example shows the increasingly collaborative approach ECAs are taking in market engagement, to develop good practice.

Finally, ongoing monitoring and reporting is an essential part of demonstrating the impact and outcomes of export finance (more on this below). This is something which is increasingly factored into the early stages of a transaction and then during the life of the project to measure positive sustainability impacts and ensure robust control measures are in place to mitigate any adverse sustainability impacts.

Increasingly, in practice, these impacts are considered during due diligence, and then legal mechanisms are integrated into the project financing documentation. This supports ongoing project monitoring, oftentimes using a formal Environmental and Social Action Plan, and includes the use of legal conditions (i.e. conditions precedent and/or subsequent), which need to be met by project contractors and/or operators often to the satisfaction of an independent sustainability expert.

1. SACE - Press Releases Detail ESG RE-EVOLUTION IN SACE

Do these measures help move the milestones or distract parties from achieving real impact?

There are challenges in integrating these measures, however it is crucial that all project finance parties are aligned in terms of understanding both the sustainability risks, and positive outcomes on any specific financing opportunity.

Whilst the benefits of incorporating sustainability practices into export finance transactions may be clear, there can be difficulties in achieving real world impact. To focus on the positives, stakeholders should seek to understand:

alignment of interest in sustainable practices amongst borrowers, export credit agencies and lenders, which can lead to long-term environmental and social benefits;
sustainable finance frameworks used by transaction parties, including ECAs, to help mobilise “sustainable finance” and “sustainability-labelled” capital, define use of proceeds for sustainable outcomes, measure and disclosure impact; and
identification and mitigation of environmental and social risks to protect investment value and enhance project outcomes.

However, there are some drawbacks of sustainability in export finance, such as:

Complexity, costs and lack of consensus – The volume of inconsistent market standards and guidelines gives rise, on occasion, to a lack of understanding or consensus amongst stakeholders. This can result in poorly defined due diligence and a creep in technical advisors adding complexity, delay and ultimately cost to due diligence exercise. The lack of consensus is illustrated when lenders other than just the leading bank in a syndicated loan arrangement have different due diligence requirements or standards for credit decisions.
Potential for greenwashing – Some market participants are reluctant to be trailblazers in their sustainability agenda due to the increasing regulatory security in ‘greenwashing’. In the context of the introduction of more stringent regulation – such as the new anti-greenwashing rule that took effect in UK financial services on 31 May this year – and enforcement, institutions are naturally tending to take a cautious approach to the way they manage sustainability risks and the associated claims about the sustainability credentials of the projects they finance. Institutions are also at increased risk of litigation and/or potentially damaging public relations campaigning from shareholders and activists. It is in this context that some institutions have been electing not to overtly publicise their support for, or make claims about, ‘green’ projects they invest in – a trend that has been colloquially referred to as ‘greenhushing’.
Inconsistencies – The lack of universal standards for sustainability compliance can lead to inconsistencies as to how these goals are applied and measured.

These drawbacks at times result in inefficient execution of transactions, wherein agencies and financiers struggle to appropriately assess the project specific risks associated with each project in the context of covering gaps as a result of inconsistent views. Oftentimes it leads to agencies and financiers requesting for additional reports and confirmations from external due diligence agencies in order to substantiate their decisions, leading to scope creep, additional costs and project delays. The prevalence of these delays in recent times across the ECA industry has also resulted in borrowers and buyers becoming wary of tapping ECA financing as a liquidity source for high-priority time-sensitive projects.

For efficient navigation across all these aspects, it is key for agencies and financiers to have fully functional collaborative ESG teams with the ability to assess risks based on the specifics of each project being considered, knowledge of flexibility required in implementing solutions across developing and emerging markets, and commercial acumen to understand the realities on ground to allow equitable implementation of standards.

What measures are being seen in the wider industry to enable equitable transition to a green economy?

The OECD has long been involved in setting standards relating to export credit and last year agreed to adapt terms and conditions that many export credit agencies apply globally, to better support the transition to a green economy.

The Equator Principles – a voluntary set of standards for determining, assessing, and managing social and environmental risk in project finance – were first launched in 2003. Development of the principles, which have subsequently been revised, reflected the desire of many institutions to meet external calls to place ethical considerations towards the forefront of financing decisions – by channelling loans and other forms of finance to projects that could demonstrate their compliance to minimum social or environmental standards. However, the anti-trust movement in the USA has seen firms de-listing from the Equator Principles in recent months and this sustainability backlash adds yet more doubt and uncertainty to the strength of these global standards.

This agenda has evolved in the years since, with new frameworks emerging to seek to encourage sustainable finance in response to today’s climate emergency and broader concerns about the impact of business operations and financing arrangements on people and the environment.

One of the frameworks now commonly used is the LMA’s ‘green loan’ principles and supplementary standards, designed to reflect the wider policy and regulatory agenda on sustainability that continues to evolve internationally – as well as the increasing demand on the finance industry in respect of sustainability from shareholders, customers, and activists.

At the moment, sustainability standards are often lifted and dropped from model provisions like the LMA principles into export finance contracts for projects. The thinking behind this is that it provides institutions with comfort that they are behaving according to industry standards on sustainability. However, this is a rigid approach that can effectively ‘gold-plate’ sustainability risk management requirements and may go beyond what is expected for individual projects.

A rigid application of the LMA principles and standards is not envisaged by the LMA itself. They are designed to be applied flexibly, giving financiers scope to apply some pragmatism and commercial sense when subjecting EPC contractors and borrowers to sustainability requirements. To do so will require upskilling and a more holistic and collaborative approach to sustainability risk management. The LMA is also working on a “Transition Finance” framework which will be a welcome addition to the sustainable market especially in hard to abate sectors in which there is potential for large emission reductions.

The International Chamber of Commerce has tried to address the lack of uniform standards and consensus on what constitutes sustainable trade or sustainable trade finance by publishing “Wave 2” of its Principles for Sustainable Trade. The ICC Secretary-General has recognised the growing interest in sustainability, which brings hope for change, but also a greater demand for precision and clarity. Their “Wave 1” framework sets the standards for sustainable trade mainly in the textiles industry and enables banks, businesses, governments, NGOs and regulators to assess transactions in a standardised way and to determine how transactions meet those standards. “Wave 2” is an enhanced set of principles, expanding to other industries like the agriculture, energy and automotive sectors, bringing together learnings from the pilot to increase its breadth and depth, as well as ensuring it is scalable to be applied to global trade transactions.

It will: (i) refocus the core assessment towards “Use of Proceeds” to increase alignment with existing sustainable finance frameworks, (ii) add a standardised means to assess the sustainability of how goods are transported; (iii) implement a “graded score” so that one can articulate and compare the extent to which a trade transaction is sustainable; (iv) enable the use of approved taxonomies and third party sustainability scores to assess transactions; and (v) remove the need for any subjective judgement to increase the robustness of the framework and enable its automation going forward.

The reporting of environmental data is an increasingly strenuous task. In export finance, where the borrower and buyer can be different entities, how is the reporting requirement dealt with?

Typically the reporting requirements on each transaction are agreed with the buyer, borrower and EPC during the finalisation of loan documentation and post review of the environmental and social due diligence conducted on the project by export credit agencies and the financiers.

Each export finance transaction is bespoke and reporting requirements are not standardised. To increase efficiency and bring down cost, there needs to be consistency in the market on reporting, so that financial institutions, ECAs, EPC contractors, borrowers and professional advisors can enter into sustainable transactions knowing what will be required in terms of environmental due diligence and reporting from the outset.

At times borrowers also question the rationale of default-related provisions in the loan documentation as a result of non-compliance with environmental reporting deliverables, where the latter in reality sit under the purview of the buyer. A more standardised methodology (with some scope of making it project-specific) would help borrowers understand basic requirements around monitoring.

As a standard, for sovereign financings, the borrower should ensure reporting requirements are met by the buyer as part of the covenants agreed in the loan documentation. In practice, the reporting deliverables and prepared and submitted to the buyer by the underlying EPC contracted on each project, who has direct visibility of ESG deliverables on ground. In this case therefore it is important to engage EPCs who employ teams with knowledge of international ESG standards, and have the ability to monitor and report on these requirements on a timely basis. In parallel, it is equally important to have buyers with systems that ensure efficient delivery of information to the EPCs for completion of monitoring reports where necessary.

A useful option is to have project implementation units (PIUs) in place at the buyer / regulatory authority level for development projects, with clear roles and responsibilities identified. In order to have efficient implementation of these PIUs, it is necessary that agencies and financiers invest time and resources towards conducting workshops at buyer-level (vs. only interacting with the borrowers) and engage in capacity building exercises for the sustainable upskilling of human capital and project implementation.

Further, there is a need for export credit agencies and financiers to develop an understanding of availability of local information on various ESG deliverables in order to determine and implement monitoring requirements that are achievable in the context of local data (as opposed to using boilerplate requirements from developed markets and trying to implement those in developing and emerging markets in the name of improving ESG standards).

Conclusion – To cover what actions you would like to see the market take moving forward to maximise sustainability impact

There is merit in developing a robust, certified new sustainability labelling system, such as FAST Infra Label, as it could offer institutions a simpler way of satisfying themselves as to the sustainability risks in a project while being cross-cutting of the different standards in operation. Labelling could especially help unlock capital in the context of transition finance, where there is an urgent need to accelerate investment in clean energy and other carbon-reduction projects to meet international climate targets.

More broadly, however, export financiers need to be willing to work in partnership with EPCs to recognise the fact that projects are run differently in developing or emerging markets relative to the developed world. The differences between a sustainability-linked transaction in the developed world compared to in the developing world or hard-to-abate sectors means that the application of standards cannot be uniform. In the developing world especially, there is a pressing need for new transport, health and sanitation projects – potentially life-changing infrastructure. There is a balance to be struck between meeting sustainability standards from a climate protection perspective, whilst at the same time not adding delay to, and pushing up the cost of, delivering such projects by imposing overly burdensome sustainability requirements, particularly in countries where the swift development and conclusion of these projects is needed the most.