Transcript | Understanding ESG Traceability in the Supply Chain – with Doug Johnson-Poensgen and Debjani Mallick Listen A fast-growing ESG topic in boardrooms and C-suites is ESG traceability – achieving transparency into the complete supply chain of goods and services. Organisations – and more importantly, their customers and clients – are seeking more transparent, secure and responsible supply chains. This is about far more than one supplier or manufacturer meeting the organisation’s ESG standards. It’s about understanding the origin and path of all goods and materials across increasingly complex and global supply chains. This episode of Board Perspectives features our conversation with Doug Johnson-Poensgen and Debjani Mallick about ESG traceability. They share their guidance for directors and C-suite leaders on how to navigate this often-complex challenge. Listen Kevin Donahue: A fast-growing ESG topic in boardrooms and C-suites is ESG traceability — achieving transparency into the complete supply chain of goods and services. Organisations and, more importantly, their customers and clients are seeking more transparent, secure and responsible supply chains. This is about far more than one supplier or manufacturer meeting the organisation’s ESG standards. It’s about understanding the origin and path of all goods and materials across increasingly complex and global supply chains. This is Kevin Donahue, a senior director with Protiviti, welcoming you to a new edition of Board Perspectives. For this episode, I had the pleasure of speaking with Doug Johnson-Poensgen and Debjani Mallick about ESG traceability. They share their guidance for directors and C-suite leaders on how to navigate this often-complex challenge. Doug is founder and CEO of Circulor, which provides a leading solution to industrial-complex supply chain traceability based on AI and blockchain technology. Doug has 25 years of international experience as an executive and non-executive director operating in the financial services, IT and management consultancy sectors. Debjani is a senior manager within the ESG and Supply Chain practice areas of Protiviti’s Business Performance Improvement practice. Her primary focus is to develop the firm’s sustainable operations business solution. Debjani has 10 years of engineering and business experience helping organisations to meet their operational and sustainability goals. Debjani, thanks for joining me today. Doug Johnson: Thanks for having me, Kevin. Kevin Donahue: And Doug, it is great to speak with you as well. Doug Johnson: Yes. Thank you. I appreciate the opportunity to talk with you today. Kevin Donahue: So, Doug, let me ask you our first question: The world has changed rapidly even since the start of this year, 2022. Businesses and their boards are facing unprecedented demands, from rising inflation to ongoing challenges to find qualified talent. How do all these global issues such as war, recession, climate change, aftershocks of the pandemic and others impact thinking around ESG commitments and goals today? Doug Johnson: We’re recording this now in the latter half of the year. I don’t think any of us would’ve imagined it would have been quite as eventful as it has been so far. The challenge for organisations is recognising that sustainability, for example, is increasingly perceived to be a driver of good business — quite apart from the fact that ESG performance is increasingly affecting cost of capital, cost of debt, cost of equity for organisations, for the financial industry. Obviously, there is an enormous variability in the quality of ESG data, which is why regulators are looking at starting to define what it is that should be reported in order that one can start to compare claims across organisations. The SEC has, obviously, picked up on this theme as well. And then, more broadly, beyond ESG, you have the challenge of corporations both in Europe and the U.S. starting to be made responsible for what goes on within their supply chains, whether that is rules of origin because of sanctions or because of things like tax credits coming in through the Inflation Reduction Act in the U.S. or the German and Swiss and Norwegian supply chain laws. Increasingly, organisations need to understand what it is that they are inheriting, whether that is inherited Scope 3 emissions — very relevant to things like the water industry, where 80% of the total emissions and manufacturing EV come from supply chain. And of course, nobody wants to see things like child labor within their supply chain, but for most folks, understanding what happens in their supply chains beyond Tier 1 is pretty hazy. Kevin Donahue: That’s great, Doug. Thank you. Debjani, let me ask you a bit about this issue of supply chain traceability. What is this, exactly, and why is it becoming a hot topic, particularly at the board level? Doug Johnson: Supply chain traceability is a shift in mentality around how we look at our organisational boundaries and where our responsibility starts and ends for the goods and services that we offer to the market. This has become elevated as a strategy consideration for several reasons. There’s certainly a growing market demand for more transparent, secure and responsible industrial supply chains. Consumers and investors are demanding ethical and socially responsible sourcing. And life cycle management for the goods and services that consumers are purchasing is a major consideration, as well as for the companies that they would like to support. Some of the shift in mindset is also driven by the regulatory landscape. ESG reporting requirements are only becoming more stringent. Supply chain traceability initiatives establish a foundation of data availability and transparency that enables an organisation to accurately report its environmental footprint, social impact, and compliance with laws and regulations. As Doug mentioned, related to some of the macroeconomic developments in our world today, supply chain traceability has only growing importance in uncertain times, such as the volatile environment that we’ve been operating in for the last few years. In times of recession, supply chain traceability serves as a vehicle through which you can basically tap opportunities through your relationships in your value chain. You can uncover opportunities for greater efficiency, reducing costs — logistics and transportation being just one example of where this has relevance. So, holistically, organisations are having an increase in awareness of the scope of impact that they have on our planet. Supply chain traceability enables them to ultimately collect the data that they need in order to effectively manage this impact and to be fully accountable for those outcomes. Kevin Donahue: Doug, let me follow up with this question for you. In your experience, what are the most notable business outcomes and impacts resulting from implementing supplier traceability initiatives — the ones that Debjani just described — within an organisation? Doug Johnson: Two broad themes: One is about reducing risk. That’s around greater transparency, supply chain resilience. The second theme is around predominantly evidencing ESG performance to improve, for example, sustainability. If you look at the C-suite — the CEO and the board, chief procurement officer, chief supply chain officer, CFO and then general counsel — they will all have slightly different perspectives. If you are the CEO, you’re clearly interested in the reputation of the organisation. You’re clearly interested in how sustainability performance, for example, can drive top-line growth. Obviously, you do not want to fall behind your basket of competitors in terms of your ESG performance. In many industries, given that certainly in any form of manufacturing, obviously, you answer to regulators, you answer to consumers and, of course, your shareholders, they increasingly want to see you doing something about it. Most of the problems you’ve got probably are inherited from your supply chain. Think aerospace, automotive, construction, textiles, food, all complex global supply chains with, usually, the brand selling to the customer, having a fairly limited view what’s going on in the deeper tiers of the supply chain. Yet those are the risks they carry. If you are the chief procurement officer, chief supply chain officer, clearly, you need to try and somehow marry price, availability and quality now with questions of sustainability. You cannot manage something you cannot measure. Starting to understand who the suppliers are within your supply chain and what you inherit from and whether that’s risk around deforestation or carbon emissions, it is increasingly a core part of the world. Most of our customers are, for example, the likes of automotive, who now see this as core business. Regulators, of course, are driving some of this too. In Europe, we will shortly have battery regulation, which would require the issue of a battery passport — essentially, a product passport for an EV battery. Not just, where do the materials come from, but also what is the carbon footprint per battery? Flip across the Atlantic to the United States, obviously, an EV text credit will rely on demonstrating that the raw materials, the physical rock, came from the right countries and that the majority of the work, the majority of the value-added, was done within the United States. That’s impossible without traceability. If you’re the general counsel, you’re clearly interested in managing risks around things like responsible sourcing. The CFO, particularly if he or she is contemplating a green bond, is now going to be worrying about how to demonstrate that they’re actually meeting the commitments that underpin that green bond. Right now, the likes of Shell and KLM and others are facing class actions from investors in those green bonds saying, “You’re not doing enough. You’re not doing what you said you were going to do.” So, there’s a whole range of different perspectives here where demonstrating what you’re doing in your supply chain or what you’re trying to do to influence that ecosystem or suppliers that you rely on is increasingly core business. Now, that’s today. Look forward 15, 20 years for a second. Over the last 25 years, we have implemented ERP platforms within our organisations to include efficiency within the processes not just in our organisation but also with our Tier 1 suppliers and then outbound logistics. We are in the early stages of digitising deeper tiers of supply chains. Of course, as we all know, the digitising processes help create efficiencies. Think about the horrific inefficiency of post-trade paperwork currently necessary to move stuff around the world and the amount of time it takes to get paid. Well, that equals a reasonable amount of working capital tied up in this relative inefficiency, which is a significant value-creation opportunity for everybody without cost engineering suppliers. What we’re talking about here with traceability is in fact digitising business processes between organisations in supply chains. That creates efficiency opportunities as it becomes more ubiquitous. Kevin Donahue: That is fascinating, Doug. A quick follow-up: I know the answer, but I want our audience to hear this. You know that the brands are carrying this risk of the products that they’re selling and the ESG footprints in their supply chain. I’m guessing that lack of awareness — just saying, “I don’t know” — is not going to hold water with their clients, customers, stakeholders. Doug Johnson: There are in place, obviously, requirements for reporting around conflict minerals. Conflict minerals, for those that don’t know, are gold, tin, tungsten and tantalum, but the approach that was taken to that was around trying to cascade questionnaires through suppliers that you buy from in an attempt to understand your risk profile. If you look at the conflict-minerals report that comes from most public companies, it’s usually very long and very comprehensive, but you could summarise it in the end by saying, “We don’t really know.” The spreadsheet and the questionnaire is the old way of doing it. Now, of course, we’ve started to apply digital technologies like distributed ledgers or blockchain and machine learning to the data about the flow of materials within supply chains — essentially, creating a digital thread that follows that flow of materials. You can start to see who touches what where. You gain far greater insight into these kind of risks in a way that, frankly, wasn’t previously possible. Amnesty International has had a jolly good go a number of times against large consumer-electronics companies and auto manufacturers — for example, in the responsible sourcing of cobalt. Sixty percent of the world’s cobalt comes from the Democratic Republic of Congo. A reasonable proportion of that is dug up by miners with concerns around not only funding armed groups but also child labor and very unsafe working practices. Clearly, nobody wants that in their supply chain, but discovering where you’re sourcing things from and being confident that it is a responsible source is not a trivial activity. The mandraulic approach to doing this, the human-effort approach, has been blanket auditing and all manner of standards and certification methods, but none of those achieve more than point-in-time visibility. It’s not the same as having live surveillance across your supply chain that follows the physical materials that eventually find their way into your product. Kevin Donahue: Thanks, Chris. Jonathan, I’d like to hear your perspective on this as well, particularly from the EU perspective. Are you seeing a rise in voluntary reporting? Doug Johnson: We are. Many organisations are making some level of disclosure. We see quite a lot of organisations making disclosures which are more related to their goals and targets and their aspirations than necessarily the progress they are making. You’ll start to see, “We aim to be carbon neutral by 2030 or 2045” or “We aim to reduce our carbon footprint by 15% or 20%.” I was reading a cement company’s one yesterday — 35% within 10 years. Those types of more aspirational goals, with indications of the types of things the organisation is doing to achieve those goals and less in terms of fair reporting always on the progress that has been made to date. There are a number of reasons as to why that’s happening. This is going to accelerate rapidly. There have been a lot of targets set by governments fairly recently, and the easiest way for many of those governments to achieve their targets is to pass that problem on to the organisations that work within their jurisdiction and to then enforce it on their supply chain. And through that, it becomes something that’s quite rapid and quite accelerating, and one of the things that we are starting to see is — and maybe the stakeholder was slightly understated in some of the comments that Chris made, although he did reference it — those elements of supply chain. We are starting to see demands from our customers to provide quite specific information about elements such as diversity and diversity inclusion metrics being an important factor, but we’re starting to see the ones around climate — our impact on climate companies showing demands that have been very specific about providing a clear view as to how we will achieve certain goals by certain dates, and wanting measures and metrics. As that starts to get enforced on us, we then have to pass that onto our supply chain, because our carbon footprint is usually impacted by our supply chain. As we start to select the organisations that we work with, we have to start passing on those demands. And in order to make the judgments and to make the assessments, we need some form of reporting that we can fall back on and that we feel that we can trust. You can start to see how this can accelerate very rapidly, and that is starting to happen. Climate is a very hot topic in the EU, and as a result of the goals, the demands, that have been set, I do see an awful lot of change in that space. The nature and extent of reporting does vary significantly, and typically, at least one of the factors that determines this is how closely aligned elements of ESG and, particularly, climate are with business strategy. I referenced the cement industry in an earlier comment — maybe in oil and gas. If you’re in some of those industries that are very close, you would typically see very extensive reporting, and that’s been coming for a number of years. Whereas, if you’re engaged with an organisation that is less directly in a pipe, you’ll likely see a lot less information being provided voluntarily, but it is changing and the pressure to the supply chain is going to accelerate this very fast. Kevin Donahue: That’s the perfect segue way to my next question for you, Debjani. Transparency — it’s a highly valued characteristic for organisations, especially today, with a client and customer base highly attuned to social media chatter, market reviews and other channels that significantly impact an organisation’s reputation positively or negatively. What are ways to practice and implement transparency in your ESG strategies, and why is it so important to stay transparent in these areas? Doug Johnson: Tracking the physical flow of a material as it’s changing state is challenging and complex. It’s essential that you understand your supply chain: Who are the key players? What risks are inherent to the geographies in which you and your supply chain partners operate? What are the product certifications that are relevant to your manufacturing? It’s about understanding what those requirements are and then ensuring that you have a methodology for compliance against those requirements. Additionally, it becomes important to consider what the role of technology is in implementing your strategy. Some topics that come to mind include a digital strategy that could leverage IoT or digital fingerprinting technology — Doug had touched on that previously — to track the movement of goods and services. What information would you be able to make visible to your supply chain partners and customers to establish that trust and uncover inefficiencies? Take Doug’s example of blockchain technology: Blockchain technology establishes a shared system of record and enhances data reconciliation across organisations. It helps us to overcome the challenges of integration between partners in increasingly complex supply chains. One of the benefits is, you’re able to build trust and confidence of customers while establishing compliance with laws and regulations. Also, with your own supply chain partners, you’re laying the groundwork for innovation to identify and tap into supply chain inefficiencies. There’s a clear play here from both the revenue and the cost perspective. Kevin Donahue: Debjani, just to circle back for a moment to the perspective of the board of directors, it sounds like these are questions they should be asking their CFO or their procurement officer: “Are we implementing blockchain?” “Do we have the ability to do digital tracking?” — those sorts of questions. Doug Johnson: Absolutely. Ultimately, with the ESG strategy, we’re seeing more of a focus on the CFO being the person who is ultimately accountable, but at the end of the day, whatever strategy that we come up with needs to be operationalised. It is important to also engage a VP of operations or supply chain. Kevin Donahue: Doug, another key area of focus among stakeholders is greenwashing — creating a veneer of being ESG-friendly, but without the policies and practices to generate meaningful impact and results. At the board level, what steps can directors take to ensure that management avoids this? What do directors need to look for in terms of red flags or warning signs? Doug Johnson: There’s obviously a proliferation and further evolution of reporting standards — multiples of them — plus regulations in different geographies. There’s a dearth of good primary data and an awful lot of snake-oil salesmen promising wonderful presentation of ESG metrics. So, as a board, it can clearly be quite confusing to understand what to do. Obviously, this is a long-term game. If you’re looking at something like, for example, decarbonising your enterprise, it’s something you’re going to measure in decades — clearly defining mission, vision and values in the organisation, and how things like decarbonisation play within that, and establishing clear, measurable goals on that journey. And things like TCFT, for example, require that in the U.K. and some other countries — we now have legislation that requires boards to put forward a decarbonisation plan together with measurable targets that their financial auditors will start to measure against as well. I see something similar coming across other countries. Then, how do you make sure that you’re focusing on things with meaningful impact? An approach that we’ve seen work successfully in some organisations is the creation of emission-abatement curves that show what the opportunity for, for example, admissions reduction are on the relative cost for different parts of the organisation or different products that are being manufactured. Then, focusing energy, going deep into the most polluting or the most high-risk. When I say “going deep,” that’s the opportunities for traceability. That’s where you need to gain greater visibility in order that you could make a difference. Obviously, taking meaningful action ultimately is about building trust and confidence in what you’re doing. We are at the point where we’re moving from the war of the glossy brochure — and most large organisations have them — to one where stakeholders increasingly expect evidence of performance, not just plans. As a board, looking at where we actually make a difference, how can we demonstrate that we’re making progress? I want to illustrate this one — a very good example: An EV car manufacturer last year published a life cycle assessment for the manufacture of a car as a baseline. It was the first car manufacturer to do so. This year, it redid it in order to demonstrate an improvement. In their latest report, they reported a 6% reduction in carbon emissions per vehicle produced, and were able to evidence it. Holding yourself to account by publishing your baseline and showing how you’re making progress and evidencing how you’re doing it is a best practice. Kevin Donahue: That’s great information. Thanks, Doug. I want to define one acronym you tossed out there for our audience. The TCFT is the Task Force on Climate-Related Financial Disclosures. A great resource — I will post a link to their website in our show notes. Doug Johnson: Debjani, for organisations just starting to come to grips with their supply chains as well as their ESG challenges, because there are a lot of organisations that aren’t advanced in these areas — they may just be talking about blockchain, digital technology, etc. — what does the future look like, and how should they prepare, or even start preparing? Kevin Donahue: There are three Rs that come to mind: regulation, risk reduction and resilience. From a regulation perspective, the time to act is now. Global regulations are coming into effect as early as mid-2024. At that point, all activity in your supply chain is going to be your responsibility. From a risk-reduction perspective, the global environment in which we are operating is rife with instability — Doug talked to that to great extent. Risks to businesses are up, with only more uncertainty on the horizon. Establishing a supply chain traceability mindset is going to be critical to protecting your business from reputational damage, legal action and supply chain risks. Leaders in the market are getting grips on their supply chains and, ultimately, taking more of a resiliency mindset. Your competitive advantage lies in your ability and willingness to do the same. What you need to do to put this into action is decide what transparency means for your company. Develop a materiality assessment that captures the most relevant considerations in devising your ESG strategy. Consider what types of products and services you deliver and what the relevant supply chain risks are. Evaluate your organisation’s mission, vision and values, and ensure alignment with your strategy. Review the geographies that you operate in — understand what geographic ESG considerations are relevant. Despite troubling times, ESG strategy development remains a priority at the board level across organisations. It’s only expected to increase in importance from this pattern of once-in-a-generation supply chain disruptions that we have been experiencing. Employees and customers already have made, and will continue to make, decisions about which brands and companies that they support and want to work for based on the ESG values of those organisations. Organisations should invest the time and effort upfront to define what their ESG and sustainability story is going to be. Doug Johnson: So, as we close out our conversation, what one piece of advice do you have for a board member looking to better understand supply chain traceability and the overall ESG landscape in which their organisation is running its business? Kevin Donahue: This is a scenario where success is going to lie in partnership. Establishing full data visibility across your value chain can understandably seem overwhelming. The truth is that it is a significant undertaking. So, have an open dialogue. Leverage your supply chain partners. Uncover the risks that are most relevant, and work toward solutions around monitoring and managing those risks. This will only help you to get to your goal, which is, ultimately, to establish trust in a way that we do business. Doug Johnson: I love Debjani’s answer — it’s a really good point. You can’t do it all at once. If you are a complex manufacturer, you might have 20,000 or more parts going into your products. The question is, where are your most significant responsible sourcing risks, and where are your greatest sustainability impacts, your most polluting supply chains? Start there first? Respondent: My thanks to Doug and Debjani for joining me in sharing their insights on ESG traceability. One of the more notable takeaways is, boards and leaders cannot turn a blind eye toward this concern. Full supply chain visibility and transparency are paramount. For more information on this and other ESG topics, visit Protiviti.com/esg. 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