FOR many corporates, environmental, social and governance (ESG) factors are becoming part of supply chain management strategies.

 

ESG factors serve as a guideline for environmentally friendly and socially acceptable supply chain activities. This spans procurement, sourcing and supplier relationship-related actions. Companies are realizing that adhering to these standards and employing the proper strategies for implementing them are the way forward.

 

In last year’s sustainability survey by Asset Benchmark Research (ABR), results show that 73% of Asian companies verify that all parties along their supply chain adhere to internally-acceptable environmental standards. That was up from 68% a year earlier.

 

ESG issues are also on the board’s agenda. Environmental issues are coming into sharper focus in boardrooms as regulators and stakeholders demand greater adherence to ESG standards.

 

Four in five Asian-listed companies (84%) say their board of directors have a clearly defined oversight over the impact of the company on the environment.

 

The Paris Climate Accord (2016) has intensified the pressure on corporates to embrace sustainability in their operations. Furniture retailer Ikea Group uses 1% of the world’s commercial wood supply (17.8 million cubic yards). It has bought forests in areas such as Alabama to make its supply of wood sustainable. Tire maker Michelin invested in rubber plantations in Indonesia, partnering with petrochemical company Barito Pacific to produce eco-friendly natural rubber.

 

Governments including China are pushing for sustainability in businesses. Prime Minister Li Keqiang said in March 2017 that China will continue to develop green finance.

 

ESG in supply chain finance
Businesses are becoming responsible for ensuring that their supply chains are managed well. These companies are also in a strong position to influence their suppliers.

 

Many companies are evaluating the viability of contracts with suppliers based on ESG compliance. They are also becoming more creative in commanding ESG adherence from suppliers.

 

French retailer Pimkie, which handles E230 million in purchasing yearly, established a supplier finance programme that enabled suppliers to get paid earlier, contingent on adherance to sustainability standards. The initial idea was to remove inefficiencies arising from using letters of credit with the company’s Asian suppliers. Similarly it was an attempt by the company to curb some of its ESG risks.

 

It introduced a reverse factoring platform that covers 60 of Pimkie’s suppliers, representing 85% of the company’s purchases. Each of the 60 suppliers represents an annual contract of at least E0.5 million. The company runs a semi-annual external audit of factories producing products for Pimkie and ascribes an internal score.

 

The programme provided its suppliers an incentive for developing a corporate social responsibility programme. The company rates its suppliers based on their progress on socially responsible activities.

 

Suppliers with a score of less than 40 out of 100 will be given the “wood” rating, while those with a score of over 85 are “platinum”.

 

“Most of our suppliers are silver. We want platinum to be exclusive,” says Gregory Ambrosio, Pimkie’s group treasury manager. “Our criteria will get tighter.”

 

Suppliers labelled wood cannot take part in the supplier finance programme. High-scoring suppliers can get paid up to 14 days earlier. Pimkie foresees a E12-15 million boost in its working capital yearly once the supplier finance programme is fully up and running. Suppliers are paid earlier via relevant banks. “We want to strengthen our supplier relationships and bolster working capital. Due to the solution we changed our payment terms from 60 days to 90 days,” adds Ambrosio.

 

Pimkie is not alone in the use of financing to push the green agenda. Sports retailer Puma established a supplier finance programme with funding from the International Finance Corporation (IFC), to reward its 300-plus suppliers in emerging markets that improve environmental, health, safety and social standards. China’s Ball Planet was one of the first suppliers to join the programme. 

 

“We are keen to start using this finance facility since access to affordable financing is a challenge,” an executive at Ball Planet said. 

 

Green loans
Lenders are also finding creative ways to promote sustainability in businesses. ING said it is looking to offer more green loans to Asian commodity producers. Unlike regular loans, green loans are linked to a borrower’s sustainability performance. In 2017 the bank offered a US$150 million facility to commodity company Wilmar International (Singapore).

 

“We recently helped a client launch what we believe to be the first sustainable loan in Asia based on sustainable performance improvement. It is important that we use our innovation not only to help ourselves, but to further other areas including sustainability which is something we feel strongly about,” says Isabel Fernandez, member of the management board and global head of wholesale banking at ING. Evaluated by second opinion provider Sustainalytics, the loan’s interest rate will be cut subject to Wilmar meeting sustainability milestones.

 

Early this year agri-business Olam announced that it had secured a three-year sustainability-linked revolving credit facility aggregating US$500 million. This is Asia’s first sustainability-linked club loan that gives benefits for hitting sustainability targets.

 

From supply chain management to green loans and ESG investing, the drive to make the financial system a force for good is apparent in the face of climate change and social unrest.

 

Strong ESG performance  has become one of the crucial criteria for evaluating the strength of a company. Companies that adhere to high ESG standards are those investors consider to have business models that are superior and sustainable. Investing companies use ESG factors to gain insight into the quality of a company’s management, culture, and risk profile.

 

“I have always been asked about governance because there is this understanding among clients that governance is an important part of long-term investing in emerging markets. Ideally, you have a good alignment of interest between management and minority shareholders,” says Ross Teverson, head of strategy, emerging markets, Jupiter Asset Management, which has US$71.5 billion in assets under management. Teverson was speaker at an investor dialogue organized by The Asset in London.

 

Teverson is of the view that governance in Asia’s emerging markets has improved a lot over the past two decades. One of the easiest ways to prove that is to look at the proportion of companies paying a dividend. “When I started investing in emerging markets in the late 1990s, at the time 40% of companies paid some sort of dividend. Now, that is closer to 90%. Cash coming back to us is the single best measure or evidence that there is some alignment between management and us as minority shareholders.”