The coronavirus crisis has prompted a renewed focus among brands and businesses on how to rebuild in a more sustainable, resilient way. But building up greater resilience to tomorrow’s pandemics – and similar existential crises – should lead businesses to look beyond their own front gates and towards the entire value chain, writes Rowan Austin, Head of Trade Origination & Advisory at NatWest Group.
Whether from shareholders, regulators, customers or the media, business and finance leaders felt rising pressure to become more sustainable before the pandemic. But the need to build corporate resilience to environmental, social and governance (ESG) risks has clearly become much more acute over the past year. Managing social risks, for instance – chief among them the health and safety of workers and communities – has gained renewed urgency in a world still reeling from a pandemic and ever more likely to face others in the future.
Yet the Covid crisis also underscores just how quickly ESG risks can propagate across the entire global economy. Over the past year, pandemic-induced lockdowns led almost immediately to supply and demand shocks that exposed vulnerabilities in firms everywhere. Temporary trade restrictions, border closures and shortages of supplies – particularly medical and pharmaceutical products needed to combat a once-in-a-generation public health catastrophe – amplified those weaknesses.
All of this underscores the need for businesses to take a much deeper, cross-value chain approach to reliability and sustainability if they are to remain resilient in the face of emerging systemic risks.
ESG is like building a home: start with the foundation and build from there
ESG risks are broadly impactful and deeply interconnected – which means they require ecosystem-wide responses. But that can make it challenging to find a suitable starting point.
Developing a deeper sense of corporate purpose that goes beyond profit and strives to make a positive impact on society is a useful platform upon which to build more specific sustainability goals. Our purpose at NatWest, for example, is to champion potential and help people, families and businesses thrive. This includes commitments to removing barriers to enterprise, increasing financial capability, and helping the transition to a low carbon economy – where we’ve made considerable progress. This year, we achieved net zero emissions for our own operations and delivered £12bn of funding and financing for climate and sustainable finance, allowing us to bring forward our £20bn target from 2022 to 2021 (which we expect to exceed).
Using purpose as a starting point – or being ‘purpose-led’ as it has come to be known – can help to distil higher-level objectives which can then be transformed into a framework for tangible action, whether improving the health and wellbeing of employees and communities or reducing the carbon footprint of operations and office buildings.
End-to-end supply chain resilience is key
But in moving from purpose to action, many businesses risk falling into the trap of focusing solely on what lies directly in front of them. For example, supply chains create on average up to four times the greenhouse gas (GHG) emissions of a company’s direct operations, with further impact on air, water, biodiversity and resources.
The severity of the pandemic’s impact has shown that businesses need to map and understand their end-to-end supply chains, and then focus on how sustainability and resilience issues can be addressed.
Global value chains developed with the primary focus on driving down costs in the supply chain. However, the pandemic has highlighted that supply chain resilience is hugely important – and in addition to this, both climate change and increasing public awareness of environmental and social issues has heightened awareness of supply chains – pushing risk management to the top of the agenda for corporate decision makers. At the same time, customers, regulators, investors and the public increasingly expect businesses and their suppliers to adhere to social responsibility principles.
Businesses must contend with a wide range of ESG risks affecting supply chains:
- Policy & legal risk: climate policies to reduce GHG emissions or to halt land degradation can require rigorous measures, to which every supply chain member will have to comply and act upon, or can result in additional costs (including taxes) along the entire supply chain. At the same time, multinational companies are exposed to country-specific regulations in the regions where their suppliers are located.
- Climate change risks: these can have a huge effect on the resilience, quality and costs of supply chains, impacting the availability of raw material and energy supply to a company and its suppliers, or leading to acute physical risk through extreme weather events.
- Global health risks: it may seem obvious in a post-Covid world, but global health risks can be hugely disruptive. Lockdowns can force suppliers to cease production, disrupt logistics providers and prompt ad-hoc border closers.
- Market risks: changing customer and investor preferences can result in large shifts in demand for products and/or investment demand. Investors or lenders may start to demand a higher coupon or even turn away from companies if they can’t show that their supply chains are ESG-compliant.
- Reputational risks: these can arise when suppliers do not comply with a company’s sustainability principles, or when companies don’t “practice what they preach”.
Creating and maintaining a sustainable supply chain can require significant investment and time – from drawing up initial sustainability frameworks for the entire supply chain to continuously engaging with suppliers on an ongoing basis.
Successful companies tend to follow a similar four-point process: (1) establish a vision for sustainability and define expectations for suppliers; (2) determine the scope of efforts by identifying the greatest actual and potential risks in the supply chain; (3) work directly with suppliers to improve their sustainability performance, or source new responsible suppliers that fit the bill; and (4) track performance against agreed goals.
Innovation in financing products is playing a growing role
Financial markets are constantly innovating to help companies align their funding and sustainability objectives. In the debt capital markets, green bonds – where proceeds are used to finance environmentally beneficial initiatives like energy efficiency or eco-friendly waste management projects – have dominated the corporate agenda in recent years. Similarly, banks (including NatWest) have rapidly grown their green lending activities, helping borrowers refine their sustainability frameworks while structuring loans and other targeted funding facilities to help them meet ESG objectives.
More recently, forward-looking businesses and lenders have turned to sustainability-linked debt structures to help align their financing and sustainability ambitions, both in the debt capital markets and loan markets. These structures allow borrowers to directly link sustainability-related KPIs, like company-wide emissions targets, to the cost of borrowing, allowing companies to benefit from lower loan pricing or bond coupon payments if those targets are met (and crucially, face higher payments if they are not). These structures allow businesses to put their money where their mouth is, keeping them accountable for their sustainability commitments.
Supply chain finance has an important role to play here, too, both in rewarding greater end-to-end sustainability and providing tangible incentives for corporate behaviour change. Structures that offer suppliers financial advantages such as lower pricing, improved access to credit or reduced working capital needs in exchange for prioritising ESG (which can be evidenced through ESG ratings and reporting) could have a significant positive impact on value chains globally, making both buyers and suppliers more resilient to tomorrow’s major shocks – and creating accountability across the entire supply chain.
Rebuilding with ESG resilience in mind
After a year like no other in recent memory, many of us are now familiar with the ways in which global public health emergencies can precipitate disastrous economic and social consequences.
But the pandemic served as a proof-point for sustainability in other ways, too. According to data from BlackRock, 88% of its sustainable funds – which include green or ESG-linked bonds and stocks issued by companies with a high ESG rating – outperformed their non-sustainable counterparts from January until the end of April 2020, when the pandemic was at its height. Strong demand from global capital allocators and banks for companies actively seeking to improve their resilience is a trend long in the making, but the crisis has served as an opportunity to test their mettle versus the status quo and amplify that demand.
There are tangible steps businesses can take to build resilience to ESG risks and help reduce the likelihood of future crises in the process, but it will require action across the entire value chain. It takes time, and investment – but if this past year has taught us anything, it’s that inaction or a lack of preparedness can be far more costly.