Published: April 19, 2023
Despite the ‘green’ epithet, the ESG space is often more of a ‘grey area’. Standardisation is lacking around the regulation and measurement of sustainable activities. Monitoring Scope 3 emissions and obtaining ESG data from supply chain partners are additional challenges. What’s more, greenwashing is a growing source of reputational risk. Nevertheless, progress is being made by industry bodies, regulators, banks, and corporates, to address these concerns. Treasurers are also playing their part in moving ESG forward, through mechanisms such as sustainable SCF.
Climate change. The Covid-19 pandemic. Russia’s invasion of Ukraine. These three events have arguably led to the most intense focus on supply chains in recent history, with the just-in-time model coming under fire and gaps in supply chain information becoming glaringly obvious.
This intense scrutiny of global supply chains, and international trade practices as a whole, has also flicked the spotlight onto ESG within value chains. Stakeholders, ranging from investors to regulators, banks, customers, and employees, are increasingly focused on areas such as greenhouse gas (GHG) emissions, biodiversity loss, human rights, and modern slavery.
For Amparo Pérez, Head of Trade and Working Capital Product Management, Europe, Barclays Corporate, the growing desire, and need, for transparency and accountability within supply chains has never been clearer. “We are all measured against ESG targets and performance, so the sooner we embed ESG into our operational processes and reporting tools, the better. Ultimately, ESG will be a driver of success going forward,” she notes.
One yardstick of that success will be a company’s ability to comply with the ESG regulations and disclosure requirements coming down the line. The seriousness of this issue is highlighted by the results of the 2022 TMI and Barclays European Treasury Survey, now in its third year, with the top regulatory concern for respondents (29%) emerging as sustainability/ESG reporting.
Pérez continues: “We are starting to see more governments across the globe issuing new laws and regulations around GHG emissions, environmental damage, and social concerns. Many of these measures also impose obligations that cover supply chains.” Take the German Supply Chain Due Diligence Act, for example, which came into effect on 1 January 2023 for organisations with more than 3,000 employees[1]. The Act aims to make supply chains more transparent, while also bolstering human rights and environmental protection – by placing the onus on businesses, and their directors, to take responsibility for the actions of all their supply chain partners.
Furthermore, the penalties for non-compliance are significant. Buyers that are made aware of ESG violations in their supply chain but take no action to address them could be required to pay up to €50,000, together with an administrative fine of up to 2% of the organisation’s annual revenue (if it exceeds €400m). In addition to fines, companies not complying with the Act can also be excluded from being awarded public procurement contracts for up to three years[2].
While Germany’s efforts arguably represent the forefront of ESG regulation in the European supply chain sphere, having country-specific rules is not always helpful to the wider goal of harmonising ESG standards. Thankfully, however, there are both worldwide and pan-European projects underway to help deliver harmonisation.
Here, Pérez highlights the work of the World Bank and the Organisation for Economic Co-operation and Development (OECD) to provide guidance on the development and alignment of green taxonomies. Indeed, one of the key findings at the 8th OECD Forum on Green Finance and Investment in 2021 was that “current ESG and taxonomy [efforts] are a sign for a shift in the right direction, but are generally neither forward-looking nor well-aligned among each other”.[3] Work is ongoing in this area to reduce fragmentation.
In the trade arena, additional standardisation steps are being taken by the International Chamber of Commerce (ICC). As well as encouraging green trade through the publication of The Standards Toolkit for Cross-border Paperless Trade and authoring a paper on ESG export finance, the ICC has developed the first industry guidance on what constitutes a sustainable trade finance transaction. Created together with a number of banks and corporates, the finalised Standards for Sustainable Trade and Sustainable Trade Finance were announced at the COP27 conference[4] and will once again assist with harmonisation.
Meanwhile, in Europe, a proposal for a Directive on Corporate Sustainability Due Diligence was adopted by the European Commission (EC) in February 2022. According to the EC, “the aim of this Directive is to foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance. The new rules will ensure that businesses address adverse impacts of their actions, including in their value chains inside and outside Europe”.[5] (See fig. 1 below for an overview of the companies covered by the new Directive).
Large EU limited liability companies:
Non–EU companies: +/- 2,600 companies in Group 1 and +/- 1,400 in Group 2
Third country companies active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU.
SMEs
Micro companies and SMEs are not covered by the proposed rules. However, the proposal provides supporting measures for SMEs, which could be indirectly affected.
As Pérez notes, the proposed Directive identifies a number of risks to be tackled around the labour market, health and safety at work, and GHG emissions, to name a few. There is also a requirement for companies to build a business plan outlining their contribution to limiting global warming to 1.5°C above pre-industrial levels, as per the 2015 Paris Agreement.
GHG emissions, in particular carbon dioxide (CO2) are a major source of global warming. To keep global warming to no more than 1.5°C – as called for in the Paris Agreement – GHG emissions need to be reduced by 45% by 2030 and the transition to net zero must be completed by 2050[6]. This goal has placed a major focus on the reporting of GHG emissions by companies across the globe.
The most widely used framework for GHG reporting, the GHG Protocol, is categorised into three areas, Scope 1, Scope 2, and Scope 3 emissions (see fig. 2). Value chain emissions, or Scope 3 emissions, account for the majority of a company’s carbon footprint – anywhere between 70%[7] and 90%[8] according to estimates – and these originate in an organisation’s supply chain (see figure 2).
Source: GHG Protocol
One of the major challenges with Scope 3 supply chain emissions, says Howard Hughes, Head of Sustainable Product Group, Barclays Europe, is that they can be difficult to measure, as the company is dependent on the availability of good quality, reliable, and comparable data in relation to each of their suppliers. “Often, this leads to a fundamental lack of information and transparency around Scope 3 emissions. As such, it is easy to understand why organisations have until now tended to focus only on Scope 1 and 2.”
Pérez agrees, adding that it will take significant time and effort for a corporate to understand the emissions of all its suppliers. The fact that suppliers across the value chain are likely distributed across different countries around the globe is a big hurdle, she believes. Furthermore, a corporate’s supplier base is not static – it is constantly evolving and will change from one year to the next. “This makes it tough to identify all suppliers and to extract reliable data across the chain.”
But Hughes goes a step further, saying that obtaining ESG data is, in fact, one of the most significant challenges for organisations, “as clearly baseline data is critical to both understanding the current position and informing future target-setting and reporting”. The issues here are numerous.
“Sometimes, companies aren’t sure what ESG data to seek from suppliers as there is no global standard on sustainability performance targets,” says Hughes. This can make it tough to develop an effective ESG strategy if it is based on untargeted information.
And even if a business is sure what ESG data it wants to gather, this can vary significantly from company to company. Pérez notes: “Some may want to pursue very specific targets, such as reducing CO2 emissions by a certain percentage, while others may prefer different KPIs for themselves, but also for their suppliers.” Again, this can lead to fragmentation in approaches to ESG data and makes the sharing of relevant supplier information among industry verticals challenging. “There is still work to be done on industry collaboration. Business within the same industry, such as automotives, could – with the correct permissions and within the right confines – potentially share data and information on their suppliers. This would help to lower the ESG burden on individual organisations.
Furthermore, inadequate internal systems can mean that ESG data is hard to access. In addition, the mechanisms to provide ESG-related information at the supplier level are still evolving. As Pérez observes: “Some suppliers, especially SMEs and/or those located in developing countries, might not have the necessary tools to measure their GHG emissions or other ESG metrics. Moreover, they may well have urgent issues to deal at this point in time. And they might not have the necessary internal and external stakeholder support to focus scarce resources onto ESG – yet.”
As such, any data sourced under these conditions could be inconsistent and potentially untrustworthy. “If you don’t trust the data, you certainly don’t want to use it to set your ESG strategy,” Hughes cautions. “And if the quality of your ESG data is poor, there is a significant risk that the company will be unable to maximise the value of its ESG strategy. At this point, ESG risks turning into a simple compliance or box-ticking exercise. But done right, it can be a catalyst for the creation of tangible, direct value to the business.”
According to Howard Hughes, Head of Sustainable Product Group, Barclays Europe, regulators see climate change as a systemic risk to the global financial system, and most central banks are taking steps to protect against it. Meanwhile, for commercial banks, the risk imperative to evaluate climate change in financing decision making is clear. Key risks include:
Physical risk
There is potential for destruction of property, loss of asset value, and loss of economic activity as a result of climate change, explains Hughes. As a result, lenders are working to closely understand their direct exposure and assess the physical risk involved in their positions. This is not an easy risk to quantify, however.
Transition risk
While the transition to a low-carbon economy presents enormous opportunities for positive change, and new operating models, there are significant challenges to consider. For example, policy changes, technological developments, or public opinion could leave lenders exposed to asset devaluation and even defunct business models. Transition risk can develop from existing assets or business models subsequently impacted by transition change, or new assets/models which ultimately do not become part of the transition ‘solution’.
Reputational risk
For lenders in the public sphere, the risk of reputational damage from not ‘doing ESG right’ is increasing. Both external (investors, pressure groups, governments, regulators, media, and customers) and internal stakeholders are driving focus in this area, confirms Hughes, and no lender (or corporate) wants to find itself on the wrong side of greenwashing claims or regulatory action. While caution should be exercised, it could be that the risk of inadvertently supporting greenwashing becomes a real barrier to ESG progress and innovation in the future. A careful balance therefore needs to be struck.
Regulatory risk
As outlined above, the vast spread of regulatory initiatives relating to ESG, and the fact that regulations are continually evolving, can make it challenging for corporates to stay on the right side of legislation. The risk of fines, or other penalties, for transgressions is increasingly real, especially where greenwashing is concerned. Hughes notes that in the UK, for example, the Competition and Markets Authority (CMA) has opened an investigation into three fashion brands and their environmental claims. This is a clear statement of intent and highlights the need to ensure corporate ESG claims are accurate and correct.
Resource risk
Implementing a new corporate plan of any type can place significant strain on a company, and enacting an ESG strategy is no different. There are also upfront and ongoing direct costs associated with sustainability efforts. So, while wider financial (and non-financial) benefits can be derived from a clear ESG strategy, it can be expensive to develop and implement a sustainable approach to doing business. What’s more, the need for a cross-functional team to tackle ESG, involving multiple departments such as legal, the C-suite, finance and treasury, procurement and sales, as well as the sustainability function (if one exists in the organisation), can present additional challenges from a resource perspective.
These risks by no means outweigh the potential benefits of ESG for banks or corporates, which have been widely discussed in the industry press. But it is important to undertake sustainable endeavours with a full understanding of both the advantages and the considerations.
Among those organisations that have succeeded in defining a clear ESG strategy, one solution leveraged to help support the reduction of Scope 3 emissions is sustainable SCF. And according to the aforementioned 2022 TMI and Barclays European Treasury Survey, 29% of respondents are keen to use sustainable SCF (and trade) solutions in the year ahead.
At their heart, sustainable SCF programmes look to incentivise desirable behaviours or characteristics within supplier organisations. As Pérez explains: “A sustainable SCF programme could involve environmental and climate targets, such reducing GHG emissions and decarbonisation, as well as encouraging appropriate land use and preserving biodiversity. But increasingly, we see corporates incorporating social elements into their SCF programmes, such as ensuring human rights are protected, or encouraging more diversity and inclusion.”
There are various ways to incentivise these desired behaviours and/or characteristics from suppliers. Some corporates might want to achieve their goals through differentiated pricing, while others may prefer non-pricing incentivisation mechanisms. Ultimately, the corporate’s specific goals will dictate the type of programme and the type of certification, monitoring, and control required, explains Pérez.
In brief, pricing mechanisms consist of setting up pricing models that apply depending on the sustainability KPIs set by the corporates. An SCF programme could provide preferential pricing to suppliers with a better ESG rating, for example, and this is one way to incentivise suppliers to improve their ESG plans.
The available range of incentivisation mechanisms within the sustainable SCF space is broad, and continually evolving as the market matures. As such, flexibility is required around the best approach on a business-by-business basis.
Differentiated pricing can be achieved in a number of ways:
Non-pricing incentivisation mechanisms could include:
Despite the range of options available, Pérez suggests that these methods will typically work better for corporates rolling out their first SCF programme, and can be more challenging for large corporates with many different existing SCF programmes in place and multiple parties involved.
Alongside the right incentives to make sustainable SCF effective for all involved, appropriate governance is fundamental. This, of course, covers the ‘G’ pillar of ESG, but it is not about box-ticking; it is about ensuring the programme truly works and delivers the benefits it originally set out to do. At a time when the risk of greenwashing, and associated action from regulators, is only increasing, this governance aspect has never been more critical. “Transparency and rigorous regulation are absolutely key here,” confirms Pérez.
Ideally, best practice governance will include supply chain policies, risk assessments, and due diligence ensuring the correct objectives are being financed. Independent evaluation of sustainable SCF programmes, by firms specialising in this area, is also vital.
Hopefully, as the ESG sphere matures, and regulation develops to be clearer, the paths towards best practice will also become more evident. Pérez comments: “We encourage the continued global harmonisation of initiatives to develop and implement ESG taxonomies, supported by improved data availability and company disclosures. Regulatory harmonisation is fundamental to the widespread adoption of ESG activities, especially throughout supply chains.”
New technologies also have a role to play here in promoting compliance with all regulatory and stakeholder expectations. AI, for example, could be leveraged to support ESG data extraction, analysis, modelling, and reporting. Nevertheless, cautions Pérez, the cost of such technology can be high. “Greater industry collaboration is therefore required to spread the risk and financial burden, as well as making access to ESG technologies equitable.”
Elsewhere, education is an important component to best practice. “Awareness around the subject is key to establishing achievable and impactful ESG KPIs for all parties across the value chain,” believes Pérez. “The focus should also be on how to support companies that struggle a bit more with the requirements and help them to identify paths to improvement.”
Perhaps the most important aspect of best practice, however, is understanding that sustainability is not merely a concept or even an ideology. Rather, confirms Hughes, “ESG must be a well-considered, clearly stated process or course of action, created in advance to achieve a specific goal – ideally underpinned by science. Those are the key ingredients to ESG success.”
Barclays Bank Ireland PLC is registered in Ireland. Registered Office: One Molesworth Street, Dublin 2, Ireland D02 RF29. Registered Number: 396330. A list of names and personal details of every director of the company is available for inspection to the public at the company’s registered office for a nominal fee. Barclays Bank Ireland PLC is regulated by the Central Bank of Ireland. This article is intended only for an audience in Europe. Where readers are present in the UK it is only intended for persons who have professional experience in matters relating to investments, and any investment or investment activity to referred to within it are available only to such person
Treasurers are increasingly looking to support their business goals by exploring the growing range of ESG-related financial instruments. During a recent podcast, TMI Editor, Eleanor Hill, spoke with three experts from Treasury4Good Award-winners Societe Generale, to see how the bank is responding to this demand. Corporate treasurers are keener than ever to find new ways […]
Since the start of the Covid-19 pandemic, there has been huge disruption to established supply chains. Treasurers must now consider everything from increased commodity risk to new FX requirements and growing ESG expectations. NatWest’s Mirka Skrzypczak, Head of Working Capital & Trade Products, and Rowan Austin, Head of Trade Origination and Advisory, outline six steps […]
BNP Paribas scales new heights, winning seven TMI Awards in tandem with its clients As corporate branding goes, BNP Paribas’ trademark green could not be more appropriate – the bank is leading the pack in terms of its sustainability commitments and solutions, and is TMI’s 2021 Global Bank of the Year for ESG. Bank Awards […]
To say it has been a challenging year for businesses is an understatement. Many companies have struggled to survive, while others have grappled with rapid shifts in operational models. As we head towards 2021, with the prospect of Covid-19 vaccines providing a ray of hope, how should treasurers prepare? Peter Cunningham, EMEA Sales Head, Corporate […]
