Addressing ESG Through Working Capital
There has been a growing awareness in the corporate community that environmental, social and governance (ESG) investing can no longer be brushed off. But for companies to truly make a meaningful ESG impact, they need to include their supply chain in the process. Implementing better working capital management solutions may prove to be the answer companies are looking for.
ESG and Supply Chain Finance
When many organizations first began prioritizing ESG, they did so mostly for compliance reasons. However, from about mid-2020 onward, there has been a considerable shift at many companies. Anthony DeCandido, partner and financial services senior analyst at RSM, told Thomson Reuters that ESG efforts are now being driven by alignment with corporate values. Boards are prioritizing ESG because they understand that it can enhance risk management, which ultimately translates to better financial and nonfinancial performance.
And the efforts are growing. Research by BCG in late 2021 found that 80% of companies planned to increase their investments in sustainability. RSM’s 2022 ESG Report found that 70% of midsize companies have implemented formal ESG plans or strategies, up from 66% in 2021. Additionally, 88% of those middle-market companies provide external reporting on their ESG performance, and 69% now have a dedicated senior executive charged with establishing and executing and ESG vision.
Still, there is always room for improvement. For most organizations, commitment to addressing environmental concerns (the “E” in “ESG”) generally means that they are assessing their direct impact, or carbon emission scopes 1 and 2. But a company scrutinizing its own impact only goes so far. Only a handful of companies are assessing the carbon emissions of their suppliers. That matters, because for banks and corporates, over 70% of their ESG impact is through their supply chains.
Assessing the ESG impact of multiple suppliers is certainly no easy task. First, an organization needs to accurately assess itself (i.e., scopes 1 and 2) so that it can come up with criteria to then measure its suppliers against.
That’s a tall order if you’re truly being thorough. For example, a major corporate client of Kyriba’s has three data sets that it works off of. Each set has three total indicators, with each indicator having five sub-indicators. So that’s 45 data points in total that this company needs to measure itself against. But most of the company’s suppliers don’t use nearly that many data points when measuring themselves. So, what should be done?
Determining an ESG Rating
Some companies have taken this issue to rating agencies, who will then present suppliers with questionnaires. These questionnaires help the agencies determine ESG ratings for the suppliers.
But again, this is much easier said than done, especially for large companies. S&P 500 companies and food retailers, for example, can have tens of thousands of suppliers, and the cost for getting ratings on every single one can be challenging.
Alternatively, companies can establish their own set of KPIs and collect them from their suppliers. It may ultimately be cheaper and faster to implement.
But collecting that data is only addressing part of the issue. The bigger question then is how to prompt those suppliers to make ESG investments. Integrating ESG within working capital was discussed in depth at the recent Working Capital Forum Europe 2022 in Amsterdam, with the current rising interest rate environment being a major concern. With rates rising rapidly, there will have to be major incentives to convince suppliers to extend payment terms and join SCF programs.
That’s where working capital solutions like Kyriba’s Supplier Sustainability program come in. Many suppliers are small and medium-sized enterprises (SMEs) with very costly or limited access to funding. Through these supply chain finance programs and leveraging on buyer’s risk, smaller companies can often receive funding at a lower cost than they would typically be able to obtain on their own.
Kyriba offers a Supply Chain Finance platform directly to buyers and indirectly to suppliers, as well as via a white-label formula from banks directly to their customers, which include both sides of the supply chain. While the platform allows users to connect with ESG providers, categorize programs and offers pricing based on ESG scores, currently not all programs include an ESG notion. Both corporates and banks, as well as technology platforms, still have a lot of work to do to include and embed ESG into working capital programs.
While many ESG programs have struggled to get off the ground, one reason they might start to pick up quickly is because the problem has become more observable as temperatures rise and weather conditions worsen. The environmental impacts of not making changes are being felt more and more every day. Companies are therefore feeling more pressure to accelerate their transition into a more ESG-friendly model.
One way to make an immediate ESG impact is through working capital. Working capital programs that persuade suppliers to make invest in sustainability can have a positive effect across many industries. However, those programs must evolve over time; the ESG goals of today won’t be the same in five years. Companies as a whole need to understand that making a true commitment to ESG is an ongoing effort and they will need to be supported by the right technology to track and follow up those changes.
Learn more about how Kyriba is committed to making a positive impact through its ESG program.