• Trade finance, Sustainable finance

    Sustainability and supply chains

14 April 2021

While ESG principles and alignment start at home, they must carry through to supply chains, explain Deutsche Bank’s Anil Walia and Bjoern Goedecke in BCR’s World Supply Chain Finance Report 2021

Speaking at the 2020 SCF Forum Global, environmental documentary filmmaker Huw Cordey noted that “there is nowhere more important when considering the challenges of climate change than supply chains.”1

His claim is based on solid ground. In May 2020, the Overseas Development Institute (ODI) estimated that the share of global emissions linked to trade could be as high as 38%2 – demonstrating the sizeable role that the industry could play in supporting the sustainability agenda. Much of the power – and therefore much of the responsibility – to drive mass change towards more sustainable global business practices lies in the hands of large international corporates.

The sticking point is that while general awareness of the issue is widespread, few businesses are aware of the extent of their responsibility. This runs well beyond integrating sustainable practices into their own activities to encompass the behaviour of their suppliers as well. For the biggest companies, the carbon footprint of their procurement and supply chain is massive and far beyond their local carbon footprint. While they may be honest and sincere in their intentions, their actions are limited because they do not understand the full scope of their responsibility and the impact their activities can have.  

We need to move beyond this. There is a real onus on these companies to drive the change that is needed. As buyers, they are in a unique position to drive real, meaningful global change. Here progressive supply chain management can play a huge role.

Yet awareness among treasury teams, even within large corporations, remains limited – a knowledge gap that represents one of the major barriers to progressing the sustainability agenda. It underlines the importance on installing sustainability in supply chains, as well as how companies can begin playing their part.

A moral imperative that makes business sense

Speakers at a United Nations’ General Assembly High-Level Meeting in 2019 warned that time is running out to prevent irreversible damage from climate change. With only 11 years remaining to avert catastrophe3 the current pace of change is too sluggish to save the planet.

Furthermore, at the FT Future Forum in October 2020, Dr Matthew Bell, Asia-Pacific climate change and sustainability services leader for EY, described the current situation as “the greatest economic transformation in our lifetime, because it impacts on every single industry sector. Nobody’s immune”.4

Furthering the ESG cause has not just become a business or a regulatory responsibility; it is a moral obligation. And it goes beyond climate change to other areas, such as decent conditions for workers. In 2013, a poorly constructed and crowded garment factory in Dhaka, Bangladesh serving several major Western retailers collapsed – leading to 1,134 deaths.5 Although this is an extreme example of the kind of issues at stake, it provides a powerful message to buyers and acts as a reminder of the responsibility they hold for what goes on along their supply chains.

Sustainable practices also make sense from a business perspective. Integrating ESG considerations into the business helps with stakeholder rebalancing. As a new breed of environmentally and socially conscious customer comes to the fore, strong ESG credentials are now required to secure buy-in to a company brand. For younger generations, this has become personal – it threatens to affect their lives directly as well as those of their children in turn.

Demonstrating a commitment to ESG can also help secure buy-in from investors, who are increasingly aware that ESG factors represent material risks that must be managed.6 A strong ESG story will help companies meet and exceed investors’ expectations while improving access to finance in the capital markets.

It also looks likely that ESG standards will soon be backed by some degree of regulatory enforcement. For instance, an EU Action Plan to shape sustainable global supply chains – promoting human rights, social and environmental due diligence standards and transparency – was approved in December 2020.7

Finally, a particularly pertinent consideration in the current pandemic is the importance of supply chain resilience. With the crisis triggering sharp shocks to supply chains across the globe, corporates recognise the importance of shifting from cost-focused to resilience-focused practices in their supply chains. ESG principles typically dovetail with this goal, with moves such as on-shoring, as well as simplifying or shortening supply chains to be nearer to end markets; all helping drive greater resilience and foster long-term success.

How companies can integrate ESG into their supply chains

So, how can companies make a sustainable supply-chain programme workable and impactful?

They begin by actively managing the practices of their suppliers, identifying how sustainable they are and determining where sustainability can be improved. A supermarket, for instance, will want to ensure its fish suppliers source their produce in a responsible way – capping their hauls at a sustainable level to maintain stocks over the long term. A manufacturer of electronic goods should check that its factory workers benefit from proper working conditions.

Encouraging suppliers to change their behaviour, of course, can be a challenge. Small or medium-sized suppliers in emerging markets may have other more immediate issues to deal with and may object to the extra effort required for an environmental or social benefit they neither understand nor value. The key is to set achievable, yet impactful, ESG standards for suppliers to meet – and, at the same time, help those who fall below requirements to improve. Companies can even set minimum standards below which they will not work with a supplier.

As filmmaker Cordey put it later in his interview at the 2020 SCF Forum Global, “Just asking suppliers to make changes without capital and liquidity is a fool’s errand.”8 Accordingly, the right mixture of support and incentives is essential and will likely vary from company to company and case to case. Compelling propositions include offering “approved supplier” status to those meeting the highest standards, which can be used as an impactful marketing tool for their business.

ESG-linked SCF programmes will play an increasing role in supporting corporations looking to strengthen relationships with their suppliers while at the same time incentivising sustainable behaviour across the supply chain. One option involves encouraging sustainable behaviour by offering a more favourable price for the sale of approved payables under an SCF programme to those suppliers who meet sustainable performance standards as compared to those who fall short.

This can be achieved through various means, such as highly individualised sustainability targets for an individual seller or standardised sustainability performance metrics for a group of suppliers. Another option could be to ring-fence green and sustainable transactions by committing 100% of the underlying exports/imports to a specified purpose. These can then be financed at favourable rates, provided the purpose clearly meets sustainability criteria outlined in internationally recognised taxonomies, such as the EU Taxonomy for Sustainable Activities, the Green Bond and the Green Loan Standard by the Loan Markets Associations (LMA).9

These sustainable SCF programmes are set to change the paradigm for how business and trade are conducted and funded. They already help to drive the sustainability agenda and will continue to do so as we emerge from the pandemic.

“Sustainable supply chain finance programmes are set to change the paradigm for how business and trade are conducted and funded”

Time and money constraints

Many corporates understandably point to the time-intensive nature of the process, as well as the fact that it is fundamentally complex and difficult to manage. Often, the problems begin as early as agreeing on an interpretation of “sustainability”. Issues around standards, taxonomies and key performance indicators (KPI) remain. How do you determine the right KPIs to measure a financing programme? And how do you take those measurements? These questions can confound any business lacking the relevant in-house expertise. Yet, an industry has sprung up to help address these challenges. Today, businesses can outsource much of the process to external agencies, providing structure, experience and rigour to the process – albeit at a cost.

This leads to another common barrier. Many businesses worry the process is too expensive. Organisations may be unwilling to commit to costs that do not necessarily yield an immediate benefit to their business. Here it is important to remember the hidden cost of ESG risk. Poor ESG practices will levy their own toll on the business – not necessarily now, but certainly in the future.

Reasons for optimism

The recent past bears examples of supply chain finance programmes that have proven both achievable and impactful. In 2014, Levi Strauss & Co. established a well-documented partnership with the IFC to provide cheaper working capital funding to emerging-market suppliers that perform well against certain ethical, environmental and safety criteria.10 Puma joined the same IFC programme two years later, adopting a financing structure with tiered pricing for short-term working capital, offering progressively lower costs for suppliers achieving high scores in its supplier rating system.11

Notable names continued to launch projects in 2020, despite the widespread economic disruption. Spanish infrastructure and renewable energy firm Acciona launched a sustainable SCF programme streamlining payments to 25 suppliers working on the construction of a new power plant for converting waste into electrical energy.12

As we move forward, the industry will take steps to continue breaking down the barriers that hamper others looking to follow suit. There is scope in the near future for regulators to provide incentives for sustainable behaviour. Central banks, for instance, could provide regulatory capital advantages or cheaper funding for commercial bank lending to sustainable companies or supporting sustainable transactions.

While the onus is principally on large corporates to keep their houses in order, providers of financial services share the responsibility to support them as they drive real improvement right across their supply chains.

This article was first published in BCR’s World Supply Chain Finance Report 2021 in February 2021. It can be downloaded here


Sources

1 See https://bit.ly/327yvuS at scfacademy.org
2 See https://bit.ly/3uNn7R6 at odi.org
3 See https://bit.ly/3mFttPO at.un.org
4 See https://on.ft.com/3ddQSVx at ft.com
5 See https://bbc.in/3sdygsV at bbc.com
6 See https://bit.ly/2QiBH4b at home.kpmg
7 See https://bit.ly/32axgep at consilium.europa.eu
8 See https://bit.ly/2OKWPQj at scfacademy.org
9 See Supply chain finance at corporates.db.com
10 See https://bit.ly/3mM0kma at ifc.org
11 See https://bit.ly/3dWjaCZ at supplychaindigital.com
12 See https://bit.ly/3a3FqJW at scfacademy.org

Anil Walia

EMEA Head of Supply Chain Finance – Payables at Deutsche Bank

Bjoern Goedecke

EMEA Supply Chain Finance – Payables Sales at Deutsche Bank

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