Sustainability is a word frequently thrown about in boardrooms across the globe as corporates become more aware of the need to better manage environmental, social and governance (ESG) risks in their supply chains.
While having a clear ESG strategy is now the expected norm among many international firms, few of them have ever considered using supplier finance techniques as a way of encouraging better sustainability standards throughout their supply chain.
This is a missed opportunity, Charlotte Bancilhon, associate director at Paris-based non-profit organisation BSR tells SCF Briefing. She is urging businesses – and their banks – to re-think how they drive up ESG standards in their supplier networks.
“We found that there is an opportunity by integrating ESG into supply chain finance to create tangible rewards for suppliers to commit and improve on their sustainability performance,” she says, referring to research conducted by BSR last year.
“When you talk to leading buyers that have already set up sustainable SCF programmes, they see this as the only way they have to incentivise suppliers, as the other ways – such as compliance – are more of a ‘stick’ [approach],” she says.
“The only way to incentivise with cash incentives is for global buyers to integrate sustainability performance of suppliers into their supply chain finance programmes,” she said.
The more commonly-used ‘stick’ approach often refers to ESG policies that revolve around buyers imposing audits and compliance on suppliers – pushing them to improve rather than encouraging them to raise their standards.
In contrast, sustainable SCF could offer suppliers financial incentives to improve their standards – whether that is using more renewable energy sources or improving worker conditions – by offering a more attractive range of discounts on early payments of invoices under a supply chain finance programme. The rate of discount would be dependent on how suppliers perform against a sustainability metric.
There are currently only a “handful” of publicised examples of global buyers and their banks setting up these kind of sustainable SCF programmes, Bancilhon says. Most of these rely on multilaterals to step in and share some of the risk with the banks.
In 2016, sports clothing brand Puma set up a programme with French bank BNP Paribas and the multilateral IFC. The scheme offered a tiered approach offering better short-term financing rates to suppliers that achieved a higher sustainability score – based on Puma’s own internal rating system.
The involvement of the IFC enabled higher risk suppliers in countries such as Bangladesh, Vietnam and Pakistan to be included in the programme. BNP Paribas provided financing to suppliers in developed markets. In the first year, Puma extended $100 million worth of financing to suppliers and covered 15 percent of its supplier base.
Clothing brands Nike and Levi Strauss have also been some of the first to pioneer the use of sustainable SCF programmes.
Yet one barrier preventing the wider uptake of sustainable SCF is how to measure sustainability performance among suppliers. “That is a million-dollar question right now,” says Bancilhon.
There is still no uniform standardized approach, she says, and different industries often assess themselves against different metrics. This makes for a complicated process when a buyer tries to assess a supplier’s level of compliance.
There are currently three ways to measure sustainability, she explains.
Buyers and banks could use an external third-party auditor to assess suppliers or they could use third-party rating systems – such as rating platforms offered by EcoVadis.
Or, in the case with Puma – large global buyers can develop their own internal supplier rating system against which they rank their suppliers.
There is still a lot of work to do to make the use of data easier to gather and compare between industries, Bancilhon argues.
“Supplier sustainability data is improving and becoming more readily available. But it is true that the lack of consistency and uniformity of the data is a key hurdle – especially for companies that will have supply chains across industries such as retail – that is a key question that warrants further research,” she says.
A general lack of awareness about sustainable SCF programmes has further hindered uptake, and this is an issue BSR is keen to address.
“One of the bigger challenges we found was not a lack of solutions, but a lack of dialogue between key stakeholders even within the businesses themselves,” said Bancilhon.
“We talk to sustainability teams and procurement teams but rarely do companies’ sustainability teams talk to finance. We do an annual survey of our 250 plus members and the question we asked was how many of you have engaged your finance department, and only 13 percent said yes. So, it is about getting people in the room and around the table so that sustainability, procurement and treasury teams define shared goals. This is what we would like to see,” she says.
Ensuring smaller suppliers are able to be integrated into schemes is yet another obstacle facing buyers and their financial partners. A bank told BSR last year that the costs of on-boarding such as KYC often outweigh the benefits for suppliers if their receivables are less than $350,000.
Bancilhon urges banks to consider how they could step up to the challenge and support these smaller suppliers.
“The multilaterals are going to provide the financing to those suppliers that global banks can’t reach. Maybe it is about doing the right collaborations and I would put it up to the banks to find innovative ways to provide the capital where it is needed,” she says.
Recent wider criticism of supply chain finance programmes also has the potential to derail BSR’s efforts to encourage the use of sustainable SCF.
Following high-profile bankruptcies of companies using SCF, some media reports and business groups have argued that the use of supplier finance has been misused to allow large buyers to squeeze small suppliers and push out their payment terms to beyond industry norms.
Bancilhon warns buyers looking to set up sustainable finance programmes to avoid changing payment terms once suppliers are on-board.
“It is easier to bring ESG data into a new SCF programme than an existing one. If you already have a programme – it is hard to apply a tiered system with sustainability and you would need to re-negotiate terms – which might not be easy,” Bancilhon adds.
Despite the obstacles, Bancilhon insists the long-term benefits of improving sustainability standards will be good for businesses’ bottom line as well as vital for the environment.
“There are benefits for all parties beyond image-building for banks and lenders,” she says.
“In time this is a way to reduce risk for lenders and banks. We found research that suggests a strong link between good ESG performance and better credit risk. So, in time it is also going to reduce risk.”
BSR will be speaking at the 3rd annual SCF Forum Asia on 23rd May at the Shaw Foundation Alumni House, National University of Singapore. SCF Briefing readers can benefit from a 10% discount on the standard ticket price by using this link or entering the code SCFB10 at checkout. For more information, visit www.scfforumasia.com.