ESG and technology in the supply chain
December 2023 | TALKINGPOINT | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
December 2023 Issue
FW discusses ESG in the supply chain with Joost Vreeswijk, Michelle Davies, Alenka Turnsek and Jon Scott at EY.
FW: Could you explain why it has become important for companies to consider environmental, social and governance (ESG) issues throughout their supply chain? Given the importance of ESG, what are the top three issues to consider?
Vreeswijk: Regulators, business and the investment community find themselves in a conundrum around what encompasses sustainability, especially standards and regulations, and how to trust progress reports and action plans. But the direction of travel is set. Supply chains keep the world moving, and are therefore a fundamental part of any sustainability and resilience journey. There is significant potential value available and risk for those not pushing ahead. Consider the top three issues with sector dynamics in mind. First, the baseline. Can a company confidently measure and report on climate and social aspects – including reporting scope 3 emissions, labour, generative aspects and ‘fairness’ of its tax arrangements – in its extended supply chain? Second, the landscape. Does a company have a clear view on tax and regulatory changes – including margin-eroding carbon taxes, circularity directives and incentives to accelerate green capital allocation – impacting its supply chain today and tomorrow? Third, the roadmap. Has a company created a transition roadmap? This could involve teaming with its supplier base to reformulate products, and fundamental questions such as types of energy usage. It should also include reviewing and overhauling legal and contractual frameworks, as well as aligning expectations across the supply chain.
Davies: From a legal perspective, there are several environmental, social and governance (ESG) areas to consider. Are contractual provisions sufficient and clear and well drafted to protect the business interest? Are these provisions sufficiently robust, so if sued, the outcome will be as expected? And are compensation and remedies adequate to enable the wronged party to enforce and recover full loss?
Scott: The ability for organisations to measure and manage ESG metrics impacts multiple areas of the business, from customer demand and pressures, to exposure to environmental taxes, to the ability to attract investment analyst ratings, to talent retention. It is vital to have the correct data and processes in place to measure ESG metrics through the supply chain. Effective technology enablement is essential. With clear visibility and measurement in place, it is easier to identify where in the supply chain improvements can be made to generate value, both to the organisation and its stakeholders. Last but not least, businesses need to be equipped with the right data-led tools to respond effectively to increasing ESG regulatory and compliance needs. Notable examples include the EU Carbon Border Adjustment Mechanism (CBAM), where the first reporting obligations hit in January 2024, and plastic packaging taxes, which require a wide range of disparate data from multiple sources.
Turnsek: We collectively have the task of adapting our economies to the Earth’s carrying capacity. We need to start addressing the six transgressed planetary boundaries, including climate, to help prevent abrupt, irreversible, large-scale environmental changes, and to preserve social and political stability. One is regulatory requirements and demands. Non-compliance brings financial implications, but may lead to an inability to access materials, products and services. Compliance is only the baseline activity, and it typically reacts to pressures rather than anticipates and prevents emerging trends. Another issue is planning for supply chain resilience to economic and physical risks, such as weather and climate extremes. By incorporating environmental and social aspects into strategies and planning, companies can proactively analyse risks and plan for contingency to reduce disruption to business-as-usual supply chains and on the demand side. Also a consideration is value creation. This includes opportunities to not only adapt but to lead in improving supply chain resilience and addressing growing consumption and its challenges.
“There is a lot of focus on environmental metrics, however social and governance metrics are areas where organisations can drive significant value.”
FW: What specific aspects of the supply chain are obvious candidates for ESG improvement?
Vreeswijk: If I had to single out a few aspects, the following could be considered among the ‘low-hanging fruit’. First, energy usage. This could be switching to renewables or other alternative fuels. Second, material choices and product design. Organisations could consider redesigning products to use less emission-intensive sources. Third, circularity concepts. This may include organisations increasing the amount of recyclable content they work with. Lastly, labour conditions. Organisations have the option of scoring tier 1 suppliers for working conditions and certain sustainable practices. It goes without saying, but with every business change – whether it is to products, processes or people – there is a tax consequence. Our advice is to bring the tax team to the table at the start of the planning process.
Davies: Of course, there are many aspects of the supply chain, but prioritising is a difficult and arguably the most critical starting point. Businesses should consider those items which can be easily verified and pass rigorous due diligence checks. This will depend hugely on the sector the business operates in, too. What is more challenging is where it is almost impossible to obtain a secure due diligence process. How then does a customer protect its position and manage the resulting risk? It is an overwhelming concept, so start where it makes the most sense and take it from there.
Scott: In the short term, businesses could choose to focus on those areas where they have a high degree of control and influence. There is a lot of focus on environmental metrics, however social and governance metrics are areas where organisations can drive significant value. For example, the social element includes gender diversity and inclusiveness. The right data and analysis can shed light on pay imbalances and inequities that need to be addressed.
Turnsek: It is worth noting supply chain aspects differ between industries. The agriculture and food industry are some of the most critical industries for our wellbeing, and the most resource-demanding – in terms of water and biodiversity – and polluting industries, such as greenhouse gas (GHG) emissions and nutrients pollution, with high incidents of human rights infringements. Shifting from intensive farming methods and monocultures to regenerative agriculture and agroecology, for example, in the upstream, and reducing plastic packaging pollution and food waste in downstream value chains, are critical actions. For industrial manufacturing sectors, the main aspect is to engage in sustainable product design and introduce circular economy principles in manufacturing processes and business models, which contribute to reduced lifecycle carbon footprint, resource use and pollution. For industries such as pharmaceuticals, cosmetics and homecare goods, environmental aspects are focused on addressing water use and effluents, nature and carbon-intensive raw materials and processes from the upstream perspective, and the impact on water quality and plastic packaging pollution in downstream value chains.
FW: What types of technology are typically leveraged to trace the journey of a product or raw material from start to finish, and ensure that ethical, sustainable practices are maintained throughout?
Vreeswijk: Currently, only selected sectors, such as food and medicine, have invested in traceability of input materials. Many applications are relatively narrow in scope and often based on closed loop systems. Next year’s EU Digital Product Passport (DPP) regulation will require businesses to share product information – including material extraction and recycling – across the value chain. The challenge is the lack of standards and protocols which all value chain players are willing and able to sign up to, in addition to privacy concerns. This often leaves the dominant player in an ecosystem of forcing standards on smaller players. Blockchain solutions are gradually emerging with the premise of more data security, compatibility and certainty. Combining blockchain solutions with large-scale enterprise resource planning (ERP), and customs and logistics platforms, is slowly shaping a traceability ecosystem. Data quality assurance concerns remain, such as from third or fourth tier remote suppliers. As technology infrastructure matures, contractual and legal frameworks will require significant attention.
Davies: From a legal perspective, the question is more around how to ensure that the supply contract contains terms which are robust, enforceable and provide adequate remedies if the technology fails to deliver, is not implemented correctly or at all, or if the resulting sustainable practices do not materialise.
Scott: Currently, there is not a standard for organisations to adopt. In practice, not all countries and suppliers are willing to share traceability information. However, there are case studies where organisations have worked with suppliers to achieve traceability of raw material and the labour used across the supply chain. We can see blockchain becoming more prevalent in this area, and mega ERP providers will develop their products to support traceability.
Turnsek: Technology is being used in many ways, but there is no uniform approach. There are emerging business reasons and regulatory requirements for companies to physically track products from originating plots of land and mine to landfills, including the EU Digital Product Passport (DPP), the EU Battery Regulation, the European Critical Raw Materials Act and the EU Deforestation Regulation. Blockchain is predominantly used by large multinationals, governments and commodities ecosystems to physically track products and vital information about ingredients, while qualitative information and certification is increasingly being required by regulators and consumers. Where origin and authenticity are paramount there is more use, such as with pharmaceuticals, and food and high-end goods. So far, the update has been limited due to costs, complexity, regulations and deployment to effort. Quick response (QR) codes and radio frequency identification (RFID) tags are more widely used for identifying and tracking information. RFID tags, in particular, are used to track the movement, location and status of goods moving through the supply chain and facilities, quality and safety, and preventing theft.
“Everyone in the business – from employees to executives – must understand ESG ambition in connection with the company’s purpose.”
FW: What practical steps can companies take to tie ESG performance into their supply chain? What essential advice would you offer to companies on integrating sustainability and corporate responsibility into the heart of their operations to achieve ESG goals?
Vreeswijk: Sustainability officers are a great start. To achieve step-change, the tone needs to be consistently set from the top. Sustainability key performance indicators (KPIs) should be embedded into balanced scorecards of the leadership team, including product and supply functions. To truly move the needle in functional domains, companies should consider a number of steps. First, setting cross-functional sustainability performance challenges. This includes bringing together and empowering multiple functional owners around single ESG performance challenges, such as when re-engineering products around regenerative and less harmful materials, and bringing together design, sourcing, logistics, customs and tax, and manufacturing functions. Second, challenging business leaders on circularity and lifecycle management. Growing awareness that investment into circularity principles like modularity, repairability, recyclable content and durability will reap benefits, creating a more loyal customer base, reducing green taxes owed, and moving toward a more effective use of resources, eventually driving longevity and economic sustainability for companies. Lastly, integral category impact thinking. Placing specific ownership on categories such as water, biodiversity or labour will require concerted change and encourage collaboration with other local players.
Davies: From a regulatory perspective, companies should develop a due diligence protocol and process, which focuses beyond compliance on additional risk and value areas. They should build a contracting framework, including precedent provisions which protect against risk and allow access to value. And they should develop a dispute management system to ensure smooth enforcement of contracts. Importantly, sustainability needs to be infused across the entire organisation and not necessarily housed within a limited group of people or functions. It needs to become a point of reference for every individual and needs to be embodied not only across functions, but actions too.
Scott: The most important step is to embed ESG metrics into enterprise performance management (EPM) processes, with KPIs clearly assigned to roles. A technology-enabled approach needs to support the business by measuring current status, running scenario analyses to test alternative options, with a connected view across environmental and social metrics, setting targets for the future, monitoring actual performance against targets, and defining potential actions to achieve improvements.
Turnsek: Companies should reflect their intent and commitment to sustainability in their purpose statement. Translating the purpose into strategic and operational plans will ensure that sustainability is covered in every aspect of internal and external activities. Weaving sustainability into product design, operations, and internal and external interactions requires cross-functional collaboration on a new level. Changes to governance forums and processes, and new roles and functions, are required to capture and embed an entirely new discipline into a company’s activities and impacts. Everyone in the business – from employees to executives – must understand ESG ambition in connection with the company’s purpose. Sponsorship and ongoing communication need to be set from the top. ESG should be embedded into KPIs, linked to executive remuneration, and integrated into every business decision. Employees need to understand how they can contribute value and improve ESG performance. This requires time and investment in talent upskilling and educating employees on how ESG fits into their everyday role and into the bigger picture.
FW: How should companies work with their business partners throughout the supply chain, from suppliers to manufacturers, distributors and retailers, to hold them accountable for adhering to ESG standards?
Vreeswijk: Engagement, collaboration and enforcement are key when working with business partners. The level of partnering needed is unlike anything we have seen before, but so is the challenge we are collectively facing. My top five areas to focus on would be supplier communities and collaboration, going beyond tier 1 suppliers to capture more scope, integrating the supplier and customer base into product design with circularity options and material choices, working from a common value agenda, and using scope 3 reporting requirements to help shape priorities.
Davies: Three key ways in which companies can work with their business partners is, firstly, to develop robust due diligence and contracting protocols and frameworks, secondly, to include enforceable provisions in contracts, and thirdly, to engage with stakeholders before implementing due diligence and enforceable provisions, so there is clarity around expectations, alignment of process and value-driven agendas.
Turnsek: Collaboration, not competition, is essential. While many recognise this, the reality is that the level of collaboration is lagging during this transitional period, where there is no real precedent for the level of ecosystem collaboration and partnering needed. Mostly, the interaction between supply chain actors is still driven by economic performance and often leans toward short term and tactical relationships. Features of future business relationships across product ecosystems include supply chain visibility throughout all tiers, clarity of multi-ESG purchase criteria, risk-sharing, purchase terms with longer commitments to suppliers, and co-investment in products and infrastructure. Governments are asking companies for more accountability and transparency of their own and their business partners’ performance and impact, as reflected in reporting overseen by the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD)). Standards 1 and 2 issued by the International Sustainability Standards Board (ISSB) alone require companies to know and work with their partners to improve collective performance.
“Technology can assist with more valuable due diligence and data gathering outcomes, including utilising compliance data for uses beyond compliance.”
FW: What role can technology play in supporting ESG initiatives?
Vreeswijk: There is no sustainability without technology, and there are some great use cases. For chief financial officers, the big question is how to fund innovative, groundbreaking new technology in this space. The good news is that there is a vast array of financing and funding opportunities available, whether this takes the form of cash grants, tax incentives, loans or guarantees. Companies need to ask themselves several questions. Will new technology deliver a reduction in water use? Will new processes or technology deliver a reduction in waste or increase the ability to recycle materials? Will new processes or technology deliver a reduction in emissions? Will new processes or technology support renewable energy deployment? Will new processes or technology contribute to greater circularity? If the answer is yes, it is well worth exploring potential financing and funding opportunities available at the national, EU and private level. Tax teams are advised to consider research and development (R&D) activities – past, current and planned – and determine a way to systematically monitor potential funding opportunities and assess eligibility.
Davies: Technology can support ESG initiatives in three particular ways. First, generative artificial intelligence (GenAI) can show the potential impact of different approaches on cost, risk and value. Second, scenario planning against different identified risks can help to shape strategies to secure desired outcomes. And third, technology can assist with more valuable due diligence and data gathering outcomes, including utilising compliance data for uses beyond compliance to reduce additional risk and access value.
Scott: As well as technology, there is also the question of data. This is key to most ESG initiatives in order to understand the current state, scenario model options, monitor improvements and ultimately record a level of assurance over the ESG metrics reported externally.
Turnsek: Technology will bring transparency, efficiency and efficacy. It is a critical enabler to make our way of life more sustainable, and to address and maintain global economic activities within the nine planetary boundaries. We are and will increasingly use technology in the following ways. First, to enable management to identify, anticipate and plan for complex operational landscapes, by including ESG inputs into scenario modelling to inform decision making. Second, to monitor complex global supply chains for business reasons and to comply with transparency regulations requiring accountability of companies’ impact of end-to-end operations. Third, to embed circular economy principles into product design, operations and business models, including customer interaction, to transform use and preserve materials across the lifecycle of products. Fourth, to improve the operational aspects of production and reduce production waste and effluents, tailoring products to reduce waste, especially food waste. Lastly, to educate and advise consumers about environmental and functional performance of products and services, to enable comparison and informed choices that address needs and wellbeing.
FW: Looking ahead, can we expect ESG to become one of the primary factors in supply chain management? Will we see a concerted drive toward proactivity and transparency?
Vreeswijk: Sustainability and resilience, fuelled by data and technology, are becoming clear extra dimensions next to the historic foundations of cost, working capital and differentiated service levels. Trade-offs are getting more complex, and include emerging taxes – including sugar, plastics, carbon and waste – that are often hard to understand and quantify. Supply chain leaders will also need to factor in potential grants, incentives and other funding vehicles available to accelerate the transition. Supply chain leaders share in the collective ownership to protect their company’s brand and reputation by correctly embedding sustainability and circularity principles. While legal frameworks are an essential part of enforcing compliance, supply chain leaders with thousands of suppliers and hundreds of factories are looking at managing significant risks through an updated ‘supply chain risk and control’ framework. In our view, many businesses have only recently started to grasp these risks, with most risk control frameworks limited to supply disruption only.
Davies: Regulation is pushing greater transparency, but what really has the potential to shift the dial is the potential for disputes and litigation arising from a failure to be truly transparent. Litigation costs, but also potential reputational damage, particularly if a company’s customers move en masse to a different brand, will mount up.
Scott: We can see two key pressures concerning ESG as a factor in supply chain management. The first is from regulation and compliance, such as the CBAM, which can have a significant cost implication for organisations impacted. The second is from consumers who are demanding more transparency into the environmental impacts in the production of their goods and services. A vision for the future is to see more focus on social and governance metrics through the supply chain.
Turnsek: ESG will become one of the primary factors in value chain management. Already, we see the short-termism economics perspective dissipating, giving way to more long-term thinking. Transparency should be viewed as a competitive advantage, not just meeting regulatory needs. Transparency means companies will take on more responsibility for their and their partners’ performance and impact. Transparency and authenticity of disclosures – such as no greenwashing – are increasingly demanded by customers, especially younger consumers. Business relationships will be different: long-term partnering versus short-term transactional relationships, factoring economic, environmental and social aspects into longer-term ways of working. Companies embracing new, collaborative ways of working will be more resilient to shocks and more prosperous in the medium and long term. On the financial side, increasing taxes and levies on negative externalities – including carbon pricing, plastic packaging taxes and levies, and lifestyle taxes – will begin to hurt margins and sales. On the flipside, there is also an increased availability of public and private funding and grants for sustainable products and activities.
“In our view, many businesses have only recently started to grasp these risks, with most risk control frameworks limited to supply disruption only.”
FW: What is the direction of travel from a tax and regulatory policy perspective? What should businesses have on their radar?
Vreeswijk: As a practical example, supply chain leaders will need to keep abreast of policy and regulatory change that may disrupt their businesses faster than their own transition plans. The impact of the CBAM on supply chains in certain sectors is likely to be punitive on margins, to a degree that certain ‘source, make, move’ lanes become uneconomical faster than anticipated. Supply chain leaders need to proactively model scenarios to guide their business through supply chain changes, as well as responsibly dealing with stranded manufacturing assets, local labour pools and suppliers that may be caught up sooner than anticipated in the negative economic realities. This, too, is part of a much more complex supply trade-off.
Davies: From a regulatory perspective, there are three key areas for businesses to have on their radar. First, a move toward net zero through transition plan regulation. Businesses should be monitoring regulatory activity across their entire footprint. Second, a greater focus on greenwashing claims and increased regulation around the consequences of misleading sustainability positions and misinformation. And third, an alignment of regulation globally. A convergence of approach may bring simplification in many areas, but it is important to consider that there may always be some degree of country customisation.
Scott: The direction of travel is set. If companies look at the European Green Deal (EGD), there are emissions targets to be met, some as soon as 2030, in addition to packaging and waste targets. A big component of the EGD is the EU’s Circular Economy Action Plan, which lays out a lot of change, especially for key sectors like electronics, batteries and textiles, which will mean big or small value chain transformation. Then there is the reporting side – the CSRD and CSDDD should be firmly on the radar of businesses across Europe and beyond. While there is a lot of regulation, and in many cases taxes, on the horizon, there is the other side of the coin: financing and funding opportunities, and R&D incentives. Companies that get their approach to ESG data and technology in shape can articulate and build a solid business case for investment.
Turnsek: Overall, the number and complexity of sustainability-related regulations is increasing worldwide as seen in our EY Green Tax Tracker. The key is to monitor the regulatory landscape and help business translate the regulation into operational and strategic implications. The EGD is arguably the most comprehensive policy framework, including climate, energy, biodiversity, pollution, circular economy, water, buildings, transport and sustainable food systems. All sectors are covered, although impact per policy varies. The package includes extensive transparency reporting requirements. EGD uses the most diverse mix of policy instruments: regulations to set targets and minimum standards, taxes and levies to discourage activities causing negative externalities, and substantial grants and incentives to enable sustainable transformation. The EGD gained international attention with its extraterritorial measures – including the CBAM and the Deforestation Regulation – and its value chain-based reporting requirements, such as CSRD and CSDDD. The latter have spurred international action, notably by the ISSB and the Securities and Exchange Commission. The US also introduced the Inflation Reduction Act, providing $370bn of ESG-related funding. Asia-Pacific countries are also moving and having a major impact.
Joost Vreeswijk is the EY global sustainability tax services leader and also leads supply chain transformation in Europe, Middle East, India and Africa (EMEIA). He has over 25 years of experience specialising in supply chain management, tax aligned operating model design and implementation. Today, he spends most of his time helping companies transform toward more sustainable operating models, delivering purpose, strategy and value amid a complex tax, legal and regulatory landscape. He can be contacted on +41 79 959 3813 or by email: joost.vreeswijk@ch.ey.com.
Michelle Davies is the EY global sustainability legal services leader. She specialises in energy transition, sustainability and decarbonised solutions and ESG. She and her team have advised on many of the sector’s most innovative and complex mandates in the climate and sustainability space, helping organisations across various forms of renewable and clean energy (onshore and offshore wind, solar, clean hydrogen, biofuels, biomass and energy from waste). She can be contacted on +44 (0)20 7806 0417 or by email: michelle.t.davies@uk.ey.com.
Alenka Turnsek leads the tax sustainability policy offering across EMEIA at EY. In her role, she briefs businesses on policy trends and legislative developments related to sustainability, covering regulations, taxes and incentives. She helps companies to identify regulatory trends and developments that may impact their business, assess the potential impact and build a plan to respond effectively. She can be contacted on +44 (0)20 7951 1383 or by email: alenka.turnsek@uk.ey.com.
Jon Scott leads thinking around technology-enabled approaches to sustainability tax and legal issues across EMEIA at EY. He has a particular focus on enterprise performance management (EPM) covering forecasting, planning and analysis processes. He helps organisations create, design and build connected EPM solutions that address sustainability reporting and performance management needs, delivering a connected view across financial, social and environmental metrics. He can be contacted on +44 (0)20 7951 3657 or by email: jon.scott@uk.ey.com.
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