ESG in the context of supply chain finance
Excerpt of an original article by Mark Douglas in Primerevenue : original article link is available below
For some businesses, ESG is now a matter of compliance. Higher expectations from electorates and international agreements such as the Paris Climate Accord are propelling bold regulation to meet ESG commitments, particularly relating to emissions. Closer to home relating to the supply chain, the EU has put a spotlight on unfair trading practices, forcing companies to rethink how they pay vendors for goods and services. In other cases, most notably in the U.S., social pressure is driving significant momentum. In 2020, we saw companies prioritise workplace diversity and inclusion to enact measures for meaningful change, and a recent report by the Governance and Accountability Institute found that 90 per cent of S&P 500 companies publish sustainability reports.
In the wake of the “Green Finance Revolution,” the financial services industry is building a marketplace for investors to put green money to work in a material way. The Green Bond market has gone through USD$1 trillion issuance since its launch in 2007, with USD$305 billion in 2020 alone. As expected, there was a slight slowdown for the first three quarters of 2020 compared to the previous year; however, Bloomberg reported a dramatic surge in green bonds during the month of September that maintained momentum through Q4.
Establishing an ESG Framework in the Context of Supply Chain Finance
Currently, there is no industry standard around ESG and supply chain finance, also known as supplier finance or reverse factoring. Different ESG ratings agencies and governmental bodies have outlines for the scope of ESG, but the Greenhouse Gas Protocol (GHG Protocol) uses an emissions scope framework that can most closely be translated to ESG in the context of supply chain finance. Using this framework, PrimeRevenue segments ESG into three scopes: direct impact, upstream indirect impact, and downstream indirect impact.
Direct impact relates to a company’s own ESG impact. What policies and initiatives are being implemented to drive social and sustainability objectives directly within the business?
Upstream indirect impact focuses on the supply chain and how businesses can influence their suppliers’ behavior related to ESG. How can they encourage and support suppliers to adopt socially and environmentally friendly business practices? And how can they help suppliers take corrective action when needed? This presents an opportunity for businesses to utilise sustainability-linked funding within their suppliers, which is the relevant investment class for this type of initiative.
Downstream indirect impact explores how a business can encourage and influence customers to improve their ESG impact.
Expanding the Scope of Supplier Finance Beyond DPO
As companies think about sustainability and social responsibility more holistically, they are reframing how they think about supply chain finance. Organisations have traditionally viewed supply chain finance primarily as a tool to improve days payable outstanding (DPO) while simultaneously helping suppliers adjust to longer standard payment terms. Other considerations, such as the very real benefits of a more robust supply chain or more liquid suppliers, have traditionally come second. The global pandemic has changed that thinking. The vast majority of PrimeRevenue’s supplier expansion projects over the past 12 months have been driven by a desire to bolster supply chain liquidity, and buyers are beginning to understand the opportunities ESG provides to expand the driver of supply chain finance beyond working capital.all without meeting a certain ESG threshold.
A supply chain finance programme is also a powerful way for businesses to have upstream influence (scope 2) on suppliers of all sizes. By providing flexibility to get paid early, buyers can encourage their suppliers to adopt better business practices or take corrective action. The most intuitive opportunity is access to early payment, which unlocks cash that can be used to invest in ESG-related activities to improve the supplier’s rating. Alternatively, buyers can offer suppliers perks for meeting ESG criteria. Examples include access to green funding or priority spend as a preferred supplier.