Treasury Today Country Profiles in association with Citi

SCF: rewarding good behaviour

Three small white presents

Treasurers might think there is little they can do to improve the environmental, labour and safety standards of their suppliers. A new initiative by The World Bank and supplier finance platform GT Nexus suggests otherwise.

Just over a year and a half ago, the eight-storey Rana Plaza building near Dhaka, Bangladesh collapsed, tragically taking the lives of more than 1,100 people, most of whom were workers employed by several garment factories accommodated in the building.

In the immediate aftermath of the tragedy investigators found, littered amongst the rubble and the bodies of the victims, labels from various well-known Western clothing brands. What proved to be one of the worst industrial disasters in history also ended up serving as a wake-up call for large retailers on the reputational risks lurking in their supply chains.

Shortly after the disaster, new initiatives were announced by many US and European retailers, designed to ensure that nothing like this could happen again. Although most of these initiatives involved the inspection and monitoring of factories, some also began to look at ways to incentivise improvements. For instance, the International Finance Corporation (IFC), the private sector arm of the World Bank, began offering low interest loans to factories in Bangladesh, agreeing to improve safety conditions.

A new initiative launched by Levi Strauss and Co (LS & Co) earlier this month, aims to take the idea of using financial incentives a step further. The San Francisco jeans maker, working with the IFC and its cloud-based supply chain finance platform (SCF) GT Nexus, has developed a scheme which rewards suppliers in developing markets boasting good environmental, labour and safety standards.

It operates on a sliding scale, based upon LS & Co’s Terms of Engagement (TOE) assessment. The more suppliers improve on the variables set out in the TOE, they receive progressively lower interest rates – and fees – on working capital loans, delivered through the GT Nexus platform.

An incentive to improve

The idea came about by chance. Whenever the IFC makes investments, it must ensure that the recipients are in compliance with a set of performance standards, covering everything from environmental issues to labour standards. Of course, when launching its Global Trade Supplier Finance (GTSF) programme, the organisation quickly realised that it would be impractical to visit and assess every business in a buyer’s supply chain. Instead, it decided to focus on companies that already had supplier compliance systems in place meeting the World Bank’s standards.

Suppliers simply provided the IFC with copies of audits demonstrating that they met the set standards for financing. In some cases, of course, suppliers were found to be lacking on either labour or environmental standards when their audits were examined. IFC initially imagined this would deter some suppliers from participating in the scheme. In fact, as it turned out, they couldn’t have been more wrong.

“What we found, to our surprise, was that many came back to us later with verified audits which showed they had improved their level of compliance,” says Farzin Mirmotahari, Senior Operations Manager at IFC. The willingness of suppliers to review and improve on labour and environmental practices made the company wonder whether an SCF could be applied in such a way that it did more than simply mitigate the risk of credit failures in the supply chain. “We really thought that this would be an obstacle, but it turned out that suppliers were prepared to improve. That got us thinking: is this something buyers might be interested in?”

Indeed, they were. To market leaders like LS & Co, it had become apparent that merely policing the supply chain was not enough. In order to secure real and lasting improvements in its supplier base, the company decided it wanted to reward suppliers that invested in safer factories and introduced environmental safeguards. The IFC’s GTSF programme seemed an ideal way for them to achieve that.

“Normally companies deal with social compliance issues in a negative way,” says Kurt Cavano, Chief Strategy Officer at GT Nexus. “Suppliers are told they need to have their factories inspected as a pre-condition for doing business. But if you can use cheap credit as an incentive to improve standards, that really does have the power to change behaviours.”

Focusing all sides

But why are suppliers who fall short of the required standards proving so willing to make the substantial investments necessary in order to improve their TOE score and get on board?

Cheap financing is obviously a big factor. After all, most – if not all – of the suppliers targeted by the scheme are based in developing economies where financing is often expensive or perhaps not available at all. “The difference between the rates the IFC are offering companies and the prevailing market rates in some of these countries leads to real incentives for the factories,” says Cavano. In some cases, the cost of financing might be three or four times lower than what they would typically receive on a loan from their bank. Considered in this context, the solution means that any investment made by the supplier to meet its buyer’s requirements almost pays for itself.

But it seems to be about more than just the ability to access cheap finance. There are even a few larger, reasonably well-financed suppliers based in relatively advanced economies – Taiwan and South Korea – that have also worked on their labour and environmental performance after joining the scheme. Mirmotahari believes LS & Co.’s TOE might, in itself, be helping to drive change. The TOE, he says, focuses senior management and all the various departments within the company on the fact they have a certain rating – and then encourages them to explore why that is.

“What we have also found is that there is a compliance team in the supplier company focused on these issues, but the production and finance teams are much less aware of what needs to be done,” he says. “This helps to break down those silos and focuses all sides on what needs to be done.”

Leading the way

Given the enormous success the initiative has had, Cavano does not expect LS & Co. to be the last to use SCF in this way. “Since we’ve announced this programme we’ve had a huge number of customers – and even some non-customers asking us how they can get involved in a programme like this. Because bringing the whole thing together, balancing financial and reputational risk – and doing it in an electronic environment so it can be done easily and simply makes total sense when you step back and look at it,” he says.

Mirmotahari is similarly upbeat when asked whether the initiative could be rolled out to other buyers. “We have been doing the GTSF programme for about four or five years now without the E&S (environment and social) pricing,” he says. “But ever since this news came out the reaction has been tremendous. So we are looking at getting a few more buyers involved now; companies, like Levi, that have already invested in a supplier compliance programme.”