Treasurer’s top of mind: Navigating the ESG landscape

In a world that’s increasingly conscious of environmental, social, and governance (ESG) issues, companies are finding themselves at the forefront of a transformation towards sustainability. ESG initiatives are no longer just buzzwords; they are becoming integral to a company’s success and reputation. In this blog, we’ll delve into the world of ESG, from its foundational principles to the future of ESG and treasury.

ESG initiatives: The starting point

ESG programs often begin with Sustainable Key Performance Indicators (KPIs). These KPIs drive ESG progress and are instrumental in guiding a company’s sustainability journey. In most companies, determining these KPIs and leading ESG transformations typically fall under the purview of the procurement division.

Leading ESG initiatives can often be challenging for treasurers, as they are often one step removed from the core business operations. Instead of direct involvement, a best practice is for treasurers to focus on developing financial structures that enable their companies to meet ESG KPI metrics.

The modern treasurer has several tools at their disposal to analyze and structure metrics. Focusing on success criteria is critical, given meeting defined metrics can lead to benefits while missing targets can often result in penalties. Various financing options are available to support ESG goals, including Supply Chain Finance (SCF), green bonds, ESG-linked securities, and ESG KPI-linked credit facilities.

However, a major concern in the ESG landscape is “greenwashing,” where financing is linked to ESG KPIs without substantial environmental impact. A best practice is to focus on clear, objective KPIs and to avoid overleveraging the same KPIs across multiple facilities.

Scope three emissions, which encompass emissions not produced by the company itself and are not the result of activities from assets owned or controlled by the company, pose a unique challenge. Often, they are difficult to quantify and verify, making third-party assessments or external audits essential for monitoring progress in this area.

Different stages of the ESG journey

Companies vary in ESG progress, with many still not having defined KPIs to those who have already implemented ESG-linked financing and bonds. However, for many companies, the journey to ESG success looks similar. The company will start with planning and assigning responsibilities, then will define its corporate KPIs, once these have been established, the final stages usually include ESG-linked financial instruments.

These financial instruments are often tied to scope one and two emissions (direct emissions), which the company has more control over; however, there is a growing focus on scope three emissions serviced by ESG-linked early payments. Every company will have unique ESG goals, ranging from eliminating coal exposure to promoting sustainable aviation fuels and reducing energy consumption, and the financial instrument chosen to support the initiative will have to align with the goals.

ESG pricing structures: Aligning incentives

ESG pricing structures are designed to incentivize positive ESG actions by connecting financial rewards to improvements in predefined KPIs and penalizing the opposite. These initiatives can attract funding from new investors, as seen with ESG bonds. However, the willingness of investors is often influenced by market conditions, and market volatility sometimes overshadows ESG considerations.

For supply chain pricing structures, programs often involve raising fees for non-compliant suppliers, lowering fees for compliant suppliers, maintaining lists of compliant and non-compliant supplier categories, and exploring joint ESG marketing opportunities with compliant suppliers. These mechanisms are essential for fostering ESG compliance throughout the supply chain but can be extremely labor-intensive without adequate technology solutions.

Targeting the right partners

For most companies, the majority of ESG improvement opportunities lie in their downstream supply chains. Decisions about which segment of suppliers to target for ESG improvements are central to a company’s ESG strategy. These segments may include suppliers impacting sustainability, such as those contributing to carbon emissions, or those focused on diversity, equity, and inclusion (DE&I).

However, supplier segmentation poses challenges in terms of identifying relevant suppliers and effectively allocating resources to track and reward smaller suppliers for ESG compliance – crucial elements for holistic sustainability. Pinpointing which suppliers are most pertinent requires a nuanced evaluation of factors like operational impact and alignment with ESG goals.

Resource allocation must strike a balance, ensuring sustainability initiatives reach both larger and smaller suppliers. Tracking compliance, especially for smaller suppliers, demands transparent reporting systems, while incentivizing adherence is key to fostering positive change.

To address these challenges, companies can implement advanced data analytics for supplier assessment, establish clear communication channels for reporting, and create incentive programs, such as preferential treatment or long-term partnerships, to reward and encourage ESG compliance across the supply chain.

Future of ESG and treasury

The current market sentiment strongly suggests that ESG and green transactions will become the norm. Companies that do not incorporate ESG requirements into their goals risk exclusion from partnerships with ESG-focused organizations. We increasingly expect banks and treasury teams to demand ESG compliance for most future business dealings.

ESG-linked financing solutions will soon be expected components of standard financing or structured financing offerings. Technology will play a vital role in tracking and monitoring ESG KPIs, particularly for sustainable supply chain finance, where thousands of suppliers need to be managed and reputable third-party rankings linked to companies.

ESG initiatives are no longer optional but necessary for companies aiming to thrive in an evolving business landscape. Understanding ESG principles, aligning incentives, and forging partnerships with the right suppliers are all critical steps on the path to sustainability and success. The future is ESG-focused, and companies must adapt to remain competitive and responsible global citizens.