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    INTERNATIONAL CORPORATE BANKING | SOLVING SUSTAINABLE

    Clean, Lean and Green

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    Contributors: Amparo Pérez & Howard Hughes

    19 Apr 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.

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    Contributors: Amparo Pérez & Howard Hughes

    19 Apr 2023

    Clean, Lean and Green
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    Taking ESG to New Levels in Trade and Supply Chain Finance

    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.

    Reporting on progress

    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 employees1. 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 years2.

    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 conference4 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).

    Companies falling under the new EU rules

    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.

    Addressing climate change

    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 20506. 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).

    Overview of GHG Protocol scopes and emissions across the value chain

    Source: GHG Protocol

    Scope 3 complications

    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.

    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.”

    Enter sustainable supply chain finance (SCF)

    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.

    Embracing best practice

    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.

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    About the analysts

    Amparo Pérez

    Head of Trade and Working Capital Product Management, Europe, Barclays Corporate Banking

    Howard Hughes

    Head of Sustainable Product Group, Barclays Europe

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