Scope 3 emissions are typically the biggest part of a corporate’s carbon footprint and the hardest to unravel and measure. But companies can’t get to net zero if they don’t get to grips with emissions in their supply chain. Corporates, banks and ratings agencies discuss their progress.
Earlier this year, the treasury department at French utility EDF structured and sold the energy company’s first social bonds to investors. The proceeds have gone to finance capex purchases from EDF’s SME suppliers supporting generation and production activities at its nuclear fleet and electricity network, particularly targeting small businesses in areas of high unemployment.
In another endeavour linked to EDF’s promise to support its suppliers reduce their own carbon emissions and promised in the company’s sweeping Mission Statement, it introduced a reverse factoring programme last year. It offers preferrable discounting rates to its suppliers when they reach a certain level of ESG integration in their own business. So far, supplier uptake of the ESG-linked supply chain credit has been slow, due in part to cheap, government-sponsored bank financing to SMEs, but Bernard Descreux, EDF’s Head of Treasury believes it will pick up going forward.
Both treasury initiatives have been driven by EDF’s ambition to reduce its Scope 3 emissions, the carbon footprint of the components in a company’s product and of those products once in use. Scope 3 emissions are typically the biggest part of a corporate’s carbon footprint and the hardest to unravel and measure. They also reveal an important granularity: a coal mining company won’t produce huge emissions in its mining processes (Scope 1), but use of its product (Scope 3) has a profound impact on global emissions; Tesla’s production processes score poorly in ESG ratings because manufacturing the electric car is a carbon intensive process, but the product has minimal downstream emissions.
At EDF, Scope 3 emissions comprise the burning of gas sold to end customers as well as purchased electricity the company sells; emissions from the firm’s minority generation assets plus all purchased goods and services, explains Matthew Reed, Head of Sustainable Finance Development, part of EDF’s finance team tasked with finding, measuring and financing the reduction of EDF’s total carbon footprint. “We reduced our Scope 3 carbon emissions by 11% last year, part of a targeted 28% reduction by 2030,” he says.
Both Descreux and Reed link progress to the company’s overarching climate strategy for carbon neutrality across all emission scopes by 2050 where the focus is on decarbonisation rather than offsetting emissions. The group’s commitment to next zero resulted in EDF’s finance and treasury teams drawing up a Sustainable Finance Strategy to fund the company’s transition. Social bonds and ESG-linked supply chain credit are the latest tools in an armoury that includes an €8.7bn green bond programme to date used to finance the bulk of EDF’s renewable and hydro-electricity investment. “You need a clear-eyed carbon strategy,” advises Reed. “Before pulling the levers, you need to be clear of the goals.”
Basis points
Banks are offering a growing array of financial products to support companies getting to grips with their Scope 3. Citi offers corporate clients a sustainable supply chain finance product that incentivises their counterparties to improve their sustainability by offering preferable rates of financing and services. Like the overlay it applied to its existing supply chain offering for German chemical and consumer goods company Henkel, seeking to nurture resilience and incentivise sustainability across its supplier base. “We created two universes,” explains Parvaiz Dalal, Global Head Payables Finance at Citi in London. “Henkel’s most sustainable suppliers received favourable pricing with a certification process while Henkel’s traditional suppliers remained on our basic product offering.”
Citi uses a certification agency to check and rate the sustainability of all companies in the buyer’s supply chain, segregating them into green, amber and red. Different sleeves within the programme allow suppliers to move up the ladder and tap preferential financing and services if their sustainability improves. “We find that suppliers in the programme categorised as ‘red’ typically strive to improve their sustainability and reach ‘green’ accessing the ensuing rewards for helping Henkel deliver on its sustainability goals,” says Dalal, who links the burst in client demand to the pandemic. “Since COVD, companies are looking with much more detail at their counter parties; how things are sold and where and how they source.”
The ability to move up the ranks is crucial to the programme’s success and embodies the proverbial ‘journey’ inherent in ESG integration. “It is not a one-time exercise,” says Dalal. In Citi’s traditional supply chain finance programme, corporate clients’ suppliers are onboarded through a light KYC process and not treated as the bank’s clients. In contrast, under its Sustainable Supplier Finance programme, Citi reviews its clients’ suppliers’ certification and ESG status every year to allow ‘red’ suppliers to improve to tap the benefits and keep already ‘green’ suppliers on their toes. Buyers typically concentrate on their biggest emitters in the first year; in the second year they dig deeper and in the third year look at their long tail suppliers.
Getting started
Colour coding belies the complexity of tackling Scope 3 emissions. For many treasury teams, the biggest challenge is simply working out how to measure emissions in their supply chain. Rather than an industry standard or universally consistent metrics, the measurement landscape is populated by different ratings providers fighting for market dominance. “It is not an established market place,” says Mark Douglas, Managing Director, Strategic Accounts at supply chain finance platform PrimeRevenue, who adds that buyers and suppliers often use different rating agencies making it even more difficult to compare data.
Deciding what to measure is equally boggling. Companies can make the same product but with different carbon components depending on the buyer, while treasury teams struggle to feed data into their ERP systems. Finding the required data is certainly onerous. Suppliers need to detail and provide evidence of every potential sustainability credit or black mark from the source of their energy to the diversity of their workforce. It’s created a mixed level of enthusiasm. Tier 1 suppliers are quick to onboard, but Tier 1 suppliers’ suppliers are notably less willing. “This is where the conversation tends to get tougher – they don’t want to be dictated to,” says Douglas. Still, motivated by the belief it will help them win business, he notes that more companies are accepting that it is an imperfect system and taking the plunge.
Henkel’s most sustainable suppliers received favourable pricing with a certification process while Henkel’s traditional suppliers remained on our basic product offering.
Parvaiz Dalal, Global Head Payables Finance, Citi
Onboarding requires engagement and patience. Descreux hopes EDF’s social bond programme will become an important source of knowledge transfer, helping suppliers grasp and benefit from their role in supporting the utility’s sustainability targets. “Accessing this finance involves deep discussions on how suppliers can contribute to our goals,” he says. “Sustainable finance is something that is still very odd to many people within a company and within a treasury. It’s important to help people understand what it means.”
At Tesco, which became the first UK retailer to offer a sustainability linked supply chain finance scheme to its supplier base last year via a platform developed in partnership with Santander, the priority has been balancing a fair and credible scoring system with a process that is not too time consuming and complex for small suppliers. The company has tailored the methodology for SMEs so that the data ask is less onerous, explains Alex Ashby, Head of Treasury Markets for the retailer, where Scope 3 emissions make up more than 90% of the company’s total emissions footprint and where treasury came up with the supply chain concept in 2019.
Ratings agencies have an essential role in creating confidence in the grading system and preventing greenwashing. At French ratings agency EcoVadis, suppliers are rated and certified annually taking into account their policy, actions and results, explains Sandy Gray, Private Equity Sustainability Solutions, North America at the company. She also stresses the importance of rating agencies verifying the information they receive from suppliers to instil market confidence. “Rating providers should only utilise self-assessment questionnaires if they are accompanied with polling of that company’s policies, actions, results and verification of the information. Suppliers have to realise someone is watching them and that a rating is not a free ticket.”
She also notes that progress on Scope 3 reporting is still slow, partly because of the detail of information and data required. Only 15% of the 90,000 odd companies EcoVadis rates can successfully report on their Scope 1, 2 and 3 emissions. “Companies can only begin to harness the emissions in their supply chain when they have a firm handle on how to calculate and report on emissions,” she says.
Benefits
A Scope 3 strategy brings recognition and rewards from investors. Speaking during a recent webinar hosted by FCLTGlobal, the not-for profit that aims to focus capital on the long-term to support a sustainable economy, Jim Fitterling, Chairman and CEO of Dow highlighted growing investor pressure on companies to get to grips with their Scope 3 emissions – and the rewards of action. Fitterling urged large corporates to “get on board” with Scope 3 and help SMEs in their supply chain reduce emissions. “We are working on our Scope 3 emissions with our suppliers, building it into our supplier partnerships with a clear line of sight,” he said. The company is also reducing Scope 3 in its products, many of which increase energy efficiency in buildings in line with emerging building codes and government policy.
Companies not taking action increasingly feel investor heat. Groups like Climate Action 100+, a group of global investors striving to ensure the world’s largest corporate emitters act on limiting their carbon footprint, have utilities in their sights. Like renowned laggard South Korea’s Korean Electricity Production Company, (KEPCO), monopoly owner of the majority of South Korea’s 50-odd coal-fired power plants. Climate Action 100+ investors are ratcheting up the pressure on the company to limit and exit coal and fossil fuel extraction to fuel its energy production with the threat of divestment.
In one encouraging trend, integrating Scope 3 is resulting in more private companies cutting their emissions. The argument goes that private companies, out of the public spotlight and free from looming regulation like mandatory climate-related financial disclosures for listed companies, are slower to cut emissions. But Gray points out that around 70% of EcoVadis’s 90,000 corporates are SMEs, the bulk of which are private. “We have developed a methodology that can work equally in public and private companies, across countries, industries and enterprise size,” she says.
Companies the world over have pledged carbon neutrality by 2050 but unless they get to grips with emissions in their supply chain, they’ll never meet their commitments. “You can’t be net zero as a company if your Scope 3 emissions are heading to net zero. They have to try and influence it,” concludes Prime Revenue’s Douglas.
