Corporate Social Responsibility: Supply chain finance programs provide a pathway for buyers to encourage CSR compliance by supplier.
CSR guidelines, also known as Environmental and Social Governance (ESG), are seen as an effective means to strengthen an organization's reputation and support growth objectives. Such guidelines cover the practices of supply chain partners, who represent a major source of sustainability risks related to climate, labor conditions, and human rights. Beyond protecting brand reputation, adherence to CSR best practices is critical to ensure the resilience of strategic procurements. In short, supplier compliance can help avoid devastating supply chain disruptions caused by a supplier who faces an environmental or social issue. Clear guidelines are also a tool for evaluating suppliers who are slow to adopt CSR best practices.
Setting the Bar for Industry Best BehaviorsIn this heightened environment - where consumers, regulators, lenders and investors are watching closely - most companies have put in place a code of conduct that their suppliers must abide by in order to make sure they run their businesses in a responsible and ethical manner. Often, those supplier conduct principles are modeled on public ESG standards (e.g. United Nations principles) and industry best behaviors.
To ensure compliance, many companies conduct ESG audits of their suppliers.
However, this raises critical questions as to the most efficient and cost effective way to implement supplier codes of conduct.
It is generally accepted that differentiating purchase price according to CSR performance for each supplier (e.g. paying a better price to the most responsible suppliers) is simply not workable. The most common commercial lever with non-compliant suppliers is to terminate business (or threaten to do so). Of course, this option is not always optimal from a production stand point. Either the relationship is terminated, causing a disruption to operations, or the supplier is under a constant cloud of reputational risk.
Promoting a Responsible Supply ChainCorporate Treasury has an opportunity to play an increasingly vital role in promoting a responsible supply chain. Employing sustainable financing solutions at the treasury level can be an effective means of encouraging and rewarding improved environmental, safety and labor practices from suppliers.
Bank provided supply chain finance has already proven to be an effective means for buyers to optimize their working capital requirements, allowing suppliers to leverage the buyer's credit rating to monetize receivables. In this way, suppliers get their hands on cash faster, while buyers benefit by enjoying longer credit terms on supplies.
Taking this a step further, without undermining any benefit from a traditional program, treasury can use innovative supply chain finance approaches to encourage suppliers to adhere to their corporate's supplier code of conduct. In a traditional supplier finance program, all suppliers have their invoices purchased by the discounting bank at the same discounting rate based on the buyer's credit rating. In the case of a sustainable supplier financing program, a discounting rate is established using a sliding grid which creates a correlation between each supplier's compliance with set CSR standards and the discounting rate they can access. To that end, a scorecard can be used to attribute a CSR rating to each supplier.
Those who receive a good rating can subsequently be rewarded with better rates provided by the discounting bank. In practice, the rate corresponding to the median CSR rating would typically be the rate of a traditional program. The best rated suppliers benefit from lower discount rates (with a "reward" measured in basis points deducted from the median rate), while the supplier with a below-average CSR rating would pay a higher discount rate (with a "penalty" added to the median rate) to participate in the program. While this provides incentives to those suppliers with the highest rating on the CSR grid, it does so without dissuading other suppliers from wanting to participate.
The Financial Carrot Can be Better than the Punitive Stick with SuppliersEncouraging supplier compliance with a company's CSR policies is often best accomplished using a carrot, rather than the harsher approach of a punitive stick. Sanctioning suppliers over inadequacies in their health, safety and sustainability procedures tends not to be as persuasive as financial incentives.
As was expressed by Franck Wachter, Senior Head of Treasury and Insurance at Puma, "the audits create an 'in or out' mentality. Too often the results were either a supplier complied and got our business, or they didn't. There was no real incentive for them to improve further."
Moreover, resorting to sustainable supply chain finance can be an effective way to externalize the reward/punitive tool outside of the perimeter of the corporate's commercial activity. The buyer stays out of the loop, as the discounting bank is in charge of implementing the incentives through the receivables discounting pricing.
Additionally, a sustainable supplier financing program is a flexible structure that can be tailor-made to the needs of each corporate. For example, the discount rate grid can be designed in such a way that the "penalties" cover the "rewards", so that the sustainability element of the program is at zero-cost for the buyer.
Nevertheless, it is conceivable that a corporate would elect to bear all or part of the "rewards",
"The audits create an 'in or out' mentality. Too often the results were either a supplier complied and got our business, or they didn't. There was no real incentive for them to improve further 1 "Franck Wachter, Senior Head of Treasury and Insurance at Puma
Lastly, common sense may suggest that encouraging responsibility through supply chain finance makes sense mainly for corporates with suppliers in emerging markets. But this would be short-sighted. Such programs can be used for procurement originating from developed countries - in particular to encourage suppliers engaged in the renewable energy transition and environmental protection practices.
Steps Treasury Can Take to Transform Supply ChainsIf a treasurer can be a powerful force in transforming supply chains into paragons of social responsibility, what then are the key steps he/she can take in concert with supply chain partners?
A first step would be to develop cross-functional partnerships across the organization involving treasury, procurement, supply chain, sustainability, corporate affairs and finance to ensure alignment with broader CSR goals and KPIs.
In parallel, the treasurer may start a dialogue with a bank which displays a strong CSR engagement and has a proven track record in supply chain finance, as well as in sustainable supply chain finance.
The preliminary work should focus on - in cooperation with the company's CSR and procurement teams - (i) the identification of the suppliers for whom a sustainable supply chain finance program would be the most beneficial, (ii) unless already in place, the development of a supplier scorecard that measures and tracks each supplier's commercial performance and sustainability attributes, as well as the organization of auditing and rating processes (with or without the support of an external CSR audit firm).
When suppliers are given a CSR rating, the partnering bank and treasury will conduct a thorough supplier's portfolio analysis in order to determine the appropriate pricing grid, and ultimately the cost, or absence of cost (when "penalties" cover "rewards"), of the program. Then, the corporate can decide to set-up either a program that will accommodate a limited list of suppliers who need to improve their sustainability performance or to implement a more global program, or even adjust an existing program.
Influencing Practices to Meet CSR GoalsNowadays, consumers are frequently holding large corporations responsible and accountable for the ethical behavior of their suppliers. Having laudable goals, policies, guidelines and resources are no longer enough. As discussed earlier, a vast majority of corporates have already implemented a sound procurement-related code of conduct and effective processes to verify if suppliers are complying with such codes. The real challenge is ensuring that trade partners are fully adhering to ESG requirements.
Since commercial sanctions that threaten suppliers who fail to comply is simply not realistic or effective, supply chain finance solutions stand as a far more effective tool for influencing the practices of suppliers, keeping them in line with CSR goals.
There clearly can be a healthy marriage between corporate social responsibility and supply chain finance. Treasury's vital part in the success of this marriage cannot be underestimated.
This article has primarily focused on the "supply side" of manufacturing companies. However, supply chain financing programs can be leveraged on the "sales side" to promote the marketing of natural resources or manufactured goods that contribute directly to energy transition and sustainable growth. Sustainable receivables financing is an effective way to achieve this goal.
 "How It's Made Is As Important As The Brand", BNP Paribas CIB website