by Nick Picone, Trust Your Supplier VP of Advisory Practice
In my last post, I shared my thoughts on the coming regulatory headwinds and potential financial implications that all companies that lack efficient and effective supplier management capabilities will eventually face.
Today, I want to share insights from conversations I’ve had with leaders across the supply chain, procurement, and compliance officers at the various conferences I’ve attended with my team over the last three months.
Risk is Increasing
Nearly every discussion I had involved an extraordinary level of intellectual curiosity about what my company TYS does and what I saw in my day-to-day role as we partner with companies across the globe on their risk and compliance transformation initiatives.
I explained that nearly everyone understands they lack the comprehensive visibility across their supplier base to effectively manage risk and compliance at scale. I also shared a reasonably bold opinion that many companies I am meeting with face the increased risk of a supply chain extinction-level event due to a perfect storm across their small and middle-tier suppliers.
Some people challenged my position – which you expect – or mentioned that the level of risk I was referring to did not apply to their company which I was also willing to debate. The good news is that nearly all were interested in understanding why I thought the way I did and what I was looking at or seeing that shaped my view.
I explained that small and medium-tier suppliers are most at risk from this “perfect storm” we all face. It is especially important to recognize that these small and medium-tier suppliers could also be strategic and to understand the risk most companies face today by only focusing on their top-tier suppliers due to cost and complexity issues. In other words, companies generally have very little clarity into the situation beyond the first-tier suppliers until it’s too late.
Pre-COVID Survival
Before the pandemic and the world-changing events of the past few years, many small to medium-sized companies were practically on life support, and continued to exist because of favorable lending standards and the abnormally low cost of capital over the previous fourteen-year period. These historically low rates and easier access to credit provided a lifeline to businesses, particularly small and middle-tier suppliers who barely made it and primarily relied on regional banks to provide access to capital.
The Perfect Storm
Today, the problems we face as a society are well known. We find ourselves in a new environment; the optimal operating conditions of the past have quickly eroded and created the previously alluded to perfect storm characterized by exploding interest rates, tightening lending standards (especially across regional banks), inflation, geopolitical risk, and shortages across the supply chain. These events, taking place concurrently, are creating the most challenging financial climate – and operating environment for business – in at least fifty years. As a result, there is a dramatic increase in the risk of a significant shock to the global financial system that begins with regional banks and will ultimately impact companies and consumers.
Supporting Data
It may seem bold to suggest that many – okay, a significant portion of a company’s supply base may not be in business in 18 months. I realize that it is impossible to predict the future. Still, it is possible to see around corners, especially when you have complete visibility over your supplier base and access to instant real-time intelligence.
For example, let me share several “sobering” present-day statistics that will illustrate just how much stress your small and middle-tier suppliers are under – particularly diverse suppliers.
A record number of small businesses folded during the pandemic, and African American businesses were unfortunately “the hardest hit” with a drop of 41%, followed by a 32% decline in Latino-owned businesses.” As a point of comparison, the decrease in white-owned businesses was 17%.
Those numbers are hard to accept for some, which is understandable because they surprise many.
The Opposite of Cynical – Clarity
I understand technically, the opposite of cynicism is optimism. However, for anyone to become optimistic – which I am, by the way – I believe you need a clear line of sight to understand your current reality – where you are, where you want to go, and what you must overcome to get there.
However, you can only achieve your goals with a solid and stable supply base that includes your small and medium-tier suppliers.
The two questions you now must ask – and be able to answer, how stable and resilient is your value chain beyond your tier-one suppliers? How do you really know?
by Nick Picone, Trust Your Supplier VP of Advisory Practice
“Regulatory fines and penalties for non-compliance are steep. In 2018, non-compliant firms were subject to $3.945 billion in penalties and another $794 million in judgments related to SEC investigations and complaints, while FINRA imposed $61 million in fines.” – What’s the True Overall Cost of Non-Compliance?, complysci (2019)
As illustrated by the above excerpt from a 2019 article, compliance challenges were an issue even before the pandemic hit. But when you learn that there were $3.945 billion in penalties – which is a significant number, in my opinion, what does it really represent? Is it a call to action or such an incomprehensibly large figure that makes you think, “wow,” and move on to pressing “right in front of you” demands?
Let’s face it, with the pandemic, war in Ukraine, persistent inflation, and a myriad of other “challenges” that we are facing, if it doesn’t affect you directly, $3.945 billion is someone else’s problem.
Even when you break down the numbers and demonstrate how non-compliance costs firms “nearly three times the cost of being compliant,” it does little to create a sense of urgency beyond passing awareness. By the way, the actual dollar figure for non-compliance in fiscal 2017 was $14.82 million. Conversely, the estimated cost to ensure your organization was compliant with existing regulations at that time was $5.47 million.
The Lens of Inertia
Like high blood pressure, inflation, and the fact that Netflix seems to cancel great series for no apparent reason, we all know compliance is “important,” but we can’t do anything about it, can we? There are so many other, more granular things to worry about from a collective and personal standpoint.
For example, at one of the many conferences I have attended over the past two months, it was alarming to see firsthand how many people had name badges that said “former” or “looking for work.
“My point in all this is that we have to, first of all, recognize the realities of the general mindset in our industry. How can you expect a procurement team to worry about carbon footprint and conflict minerals when there is so much economic uncertainty? Even in good times, there is a long history of “risk recognition and inaction.” A McKinsey 2006 survey provides compelling evidence of how risk avoidance was more a state of mind than an actual event.
While not as acute, the challenges we faced in 2006 are no different from those we face today regarding compliance. The question is this: why will our response be different this time?
One reason I think it will be different this time is that the cost of non-compliance increased by 2,650% from 2017-2019, which is the definition of exponential growth.
Ideal Conditions For A Speed Trap
“A hidden scaffolding of financial incentives underpins the policing of motorists in the United States, encouraging some communities to essentially repurpose armed officers as revenue agents searching for infractions largely unrelated to public safety.” – New York Times (2021)
According to one report, the average police officer writes 100 to 150 tickets each month. While that number can vary from city to city, town to town, it is safe to say that when it comes to moving violations such as speeding tickets, there is a noticeable police presence, e.g., speed traps at the end of the month. Yes, this is an anecdotal observation, more than a scientific conclusion. But does that make it any less accurate?
Here is the reality. During tough economic times, government deficits increase. There are primarily two ways to plug deficits. The first is to cut spending and the direct and indirect taxation of people and businesses. This approach rarely happens.
When you look at the size of fiscal deficits and all the fines that businesses across the globe will eventually face, you can see how governments understand that they have a unique speed trap set from an enforcement perspective, as companies have no good way to effectively and efficiently manage their large and extended supply networks from a compliance perspective.
To be clear, this is not an anti-government rant. It is a reality.
If you disagree with me, google the term “sin tax.”
According to one of many definitions, “sin taxes are usually placed on the sale of cigarettes, liquor, tobacco and other goods that are considered dangerous to individuals or society.”
There is a clear parallel here when you think about conflict minerals, global warming, modern slavery, data privacy, etc.; these are also societal issues that negatively affect us all.
Stay tuned for Part 2: How To Avoid The Non-Compliance Speed Trap (What’s The Opposite of Cynical?)
Recently, I was on a panel at Wake Forest University, School of Law, NC on this subject, and it triggered my interest in digging deeper into this space. Chainyard has been involved in ESG via its SaaS platform, Trust Your Supplier, since 2020. I occasionally participate in the Hyperledger SIG on Climate Change where many different topics are discussed. The goal of this article is to share my thoughts as I continue to expand upon that knowledge in the coming months.
What is ESG?
ESG expands to Environment, Social, and Governance. There have been many subsets of it in the past, but the current incarnation is a result of concerns about the climate, environment, and social justice. ESG is complemented by DEI which looks at diversity, equity, and inclusion in society and at the workplace.
Businesses have an impact on our Earth. It includes human and machine activity, and the use of natural resources including water, fossil fuels, raw materials, and minerals. These can result in greenhouse gas emissions like CO2, pollution of the air we breathe or water we drink, deplete natural resources, generating vast amounts of waste, etc. The ESG framework measures the degree to which a corporation adheres to sustainable and environmentally responsible practices.
Organizations have relationships with customers, partners, people, and communities. ESG measures the social impact on people both internal to the company and customers and supply chain partners. Many questions arise such as how workers are treated, do they get living wages and good healthcare, are the labor practices acceptable, are the communities they serve benefitting, etc.
Governance refers to a corporation’s management practices related to ethics, regulatory and legal compliance, and transparency in reporting. Companies have to establish policies, procedures, guidelines, and measurement frameworks to achieve these goals. “DEI” or diversity at the workplace, equity in opportunities and wages, and inclusion are all part of governance activities.
According to Moody’s, a 2022 survey of their customers found among other insights,
“Customers also indicated that rising customer expectations, environmental, social, and governance (ESG), and future of work, are the trends expected to affect their business the most”
Saving the Planet
Fixing the damages caused to the environment by human activity requires a multi-pronged approach. Though it is generally accepted that the main contributor to the climate crisis is CO2 emissions, the environment has been seriously injured by many factors; key among them being the disposal of plastics, which is now the major cause of ocean pollution and the extinction of many species.
To address the crisis, there are several projects put in motion by NGOs, governments, and global institutions. Some of them are voluntary and others are imposed by regulation. These projects fall under several categories such as:
Emission Reduction
Carbon Farming and Sequestering
Migration to electrical energy
Transition from Fossil Fuels to Renewable sources
Carbon Offsets and Credits to compensate for emissions
Carbon Insetting through corporate self-improvement initiatives
Plastics Management
Plastic Waste collection, sorting, recycling, and disposal
Discontinue single-use plastic items.
Measuring the impact of micro-plastic pollution
Land and Water Management
Forest management (re-forestation, conservation, and afforestation)
Restoration and protection of coastal wetlands and marine life
Carbon-Friendly Agriculture
Waste Management
Efficient and effective collection, sorting, and recycling of industrial and household waste.
Reprocessing electronic waste to extract valuable metals and reduce the discharge of toxic chemicals into the environment.
Excess inventory sharing by enterprises with others.
Manufacturing products using sustainable processes and raw materials.
We are all familiar with how our government is pushing for a rapid transition to Electric Vehicles (EVs) and renewable energy from wind and solar power.
Carbon Offsetting, Credits, and Insetting
We need to understand what strategies corporations are using to achieve net-zero goals. Corporations make commitments to the industry or the government about becoming carbon neutral or reducing their emissions. In order to meet those targets, they invest in projects that address in part or full those commitments. These projects can be internally triggered, or the corporation can fund third-party projects.
A generic approach followed in the industry
It is generally agreed that 1 offset or credit is equal to 1 metric ton of carbon dioxide emission (CO2e). A typical tree planted in a reforestation program takes about 40 years to sequester 1 metric ton of carbon. The same amount is roughly emitted by an automobile in about 3 to 12 weeks.
Carbon Offsetting
Carbon offsetting is a mechanism by which a company that has been emitting CO2 and is not yet ready to fix its process, technology, and operations, funds offsetting projects in the voluntary carbon market (VCM). For example, ACME Corp. which has been emitting 100 metric tons of CO2 could invest in the MOSS Project which supports the preservation of the Amazon rain forests to offset its emissions. For a novice, offsetting works as shown.
Carbon Offsetting – High-Level Flow
Some typical projects include:
Forest conservation
Wind farms, hydropower projects, solar power plants
Other renewable energy projects such as fusion
Landfill gas capture and management
Providing energy-efficient appliances to local communities such as the recent push in NY To ban gas stoves.
Farm power, methane capture, and biogas production, something very common in Asia and Africa
Waste management
Carbon Credits
These are regulated credits also referred to as Cap-n-Trade. The Government or the Regulatory Body sets caps on carbon emissions which translate into “Emission Allowances”. These allowances are available for purchase as “Carbon Credits. Business entitiespurchase “Carbon Credits based on assigned emission allowances. These allowances are gradually reduced over time to realize tangible emission reductions.
Carbon Credits Model
Carbon Insetting
Insetting refers to a Business Entity reducing its own emissions through the adoption of new technology, optimizing supply-chain processes and practices, and improving efficiency. Insetting is more important as it enables a company to take ownership and responsibility for its emissions.
Insetting
Actions a company may take include deriving more of its energy from renewable sources, management of resources such as water and raw materials, and enforcing ESG across their upstream and downstream partners.
Key issues in the Measurement and Reporting of ESG initiatives
Currently, there are many projects by various organizations in the voluntary carbon market. There is no consistent way to verify if these projects are genuine and truly deliver the benefits they promise. Some of the issues are:
Consistency in the application of policies and regulations
No single or integrated verifiable and trusted project registry
Too much focus on CO2 emissions though the environment is harmed by various other activities.
Potential Double Spend problem (accounting of credits and offsets)
Traceability of Offsets & Credits throughout their lifecycle from issuance to retirement
Transparency of project status and benefits
Consistent and verifiable (regulatory) reporting
Why Blockchain?
Blockchains have a bad reputation for being energy-intensive, and thus not climate or carbon friendly. Well, that comes from Bitcoin mining and other public blockchains that supported the proof-of-work (PoW) consensus protocol. PoW is very CPU intensive and consumes a lot of energy to solve a mathematical challenge essential for block verification and earning crypto. However, most other blockchains support better protocols such as proof-of-stake, BFT, or proof-of-authority which are much more energy friendly.
A blockchain is a valuable tool that can help address many issues. It extends enterprise solutions and can work cohesively with IOT and AI/ML technologies.
An immutable record of data enables “track and trace” of projects, the provenance of lifecycle events, and transparency. All this depends on stakeholders including applications and things recording data into the ledgers.
Smart Contracts can help with governance, enforcing policies and business rules, and managing tokens issued as offsets, credits, and incentives.
Decentralized Identity is a relatively new concept and can be applied to projects, people, organizations, and things. Every project can be assigned a DID and tagged with verifiable credentials by bodies such as Carbon Action Reserve, Verra, and the like. DIDs are cryptographically verifiable, universally resolvable, and enable Proof-of-Existence and Proof-of-Verification
Consensus protocols such as Proof-of-Stake allow validators to verify transactions and maintain consistency and integrity of the ledger
Privacy and Anonymity are very important for organizations. Using encryption and secrets, organizations can be transparent about their commitments and actions, yet implement privacy and confidentiality to avoid exposing their business secrets and intellectual property.
Three use case patterns where blockchain can augment ESG initiatives are:
Provenance, and Track & Trace of ESG Projects
Facilitating the trading and trustable record-keeping of Carbon offsets and credits (tokens)
Supporting risk, audit, and compliance reporting
These patterns cut across many domains such as supply chain, health care, real estate, and energy,
Organizations and Bodies involved with Sustainability Initiatives
It was enlightening to see the number of organizations and companies involved with climate initiatives and ESG.
Some of the notable ones are:
Verra is one of the most recognized and trusted providers of standards and guidelines for sustainable development. The Verra registry is a repository of certified and verified projects.
Climate Action Reserve is approved to serve as an Offset Project Registry (OPR) for the Compliance Offset Program under California’s Cap-and-Trade Program. They also maintain project registries and support various carbon offset programs.
GHG Protocol According to their website they provide standards, guidance, tools, and training for businesses and governments to measure and manage climate-warming emissions. One can download worksheets and tools to measure and record carbon emissions footprint.
The Gold Standard is another reputed and recognized organization that provides standards, verifies and certifies carbon projects, and maintains project registries.
Other organizations include
American Carbon Registry
CSA Group Registries
Climate, Community & Biodiversity (CCB) Standards: Certification to the Climate, Community & Biodiversity (CCB) Standards demonstrates that a project simultaneously addresses climate change, supports local communities and smallholders, and conserves biodiversity
Task Force on Climate-related Financial Disclosures (TCFD) – Increased reporting of climate-related financial information.
Verra – SD-VISta The Sustainable Development Verified Impact Standard (SD VISta) – Premier standard for certifying the real-world benefits of social and environmental projects, from gender equity and economic development to affordable clean energy and restoration of wildlife.
The United Nations’ Sustainable Development Goal 7 (SDG 7) focuses on reliable and clean energy modern energy services, as defined in its Target 7.1
Paris Accord on Scope 1/2/3 reporting
United States – Environmental Protection Agency
European Commission (2020) Circular Economy Action Plan
Open Earth Foundation
Hyperledger Foundation – Climate SIG
Many projects support ESG such as the MOSS Project, Toucan, Plastic Bank, Save The Planet, Klim DAO, and Greenly. The notable ones that need mentioning are:
Trust Your Supplier – Chainyard is a SaaS blockchain network focused on supplier risk and qualification. Workflows help customers capture supplier ESG initiatives and actions and get them verified through third-party verifiers who provide ESG rating scores.
TYS Captured ESG Information
TYS has standardized the information capture to gather ESG information that can be used by organizations to support Scope 1 & 2 reporting today, and a goal of Scope 3 in the future.
Title Chain – Borsetta is an evolving network that enables asset track and tracing of energy micro-grids, helps secure their title, and tokenizes the grid and energy production among other functions. Though it is not directly related to ESG, it mainly targets microgrids that support renewable energy ecosystems, including the energy they produce and the excess quantity sold to the national grid. Microgrids serve campuses and are seen as the future of community-driven energy production.
Digital Credentials for Carbon Accounting is an initiative by the British Columbia government in Canada. The initiative known as “Traction” set up under the Energy & Mines Digital Trust supports the BC Government’s requirement for certified annual sustainability reporting. The solution is built on a blockchain platform based on Hyperledger Aries and Indy and leverages the Decentralized Identity (DID) standards protocol. The mining companies collect data for sustainability reporting, which is verified by organizations such as PWC resulting in the issuance of a Verifiable Credential that can be shared with the government.
ESG and Blockchain (A conceptual architecture)
Earlier in this article, we discussed how a blockchain complements ESG solutions. Can blockchain add value beyond Carbon Offsets and Credits? Yes, there are many reasons.
The Blockchain can serve as an ESG BUS providing access to various services such as project verification and tokenization
Many institutions maintain verifiable registries of carbon projects, some enabled by blockchains, and others provide APIs. A decentralized identifier can be assigned to every project. Decentralized identifiers are a W3C-enabled standard and specification to define the structure, attributes, and architecture of DID and its constituents. DIDs are universally resolvable to “DID DOCS” which are JSON documents present authentication schemes, digital signatures, and service endpoints to access various aspects and details about the project.
The blockchain can record hashes (aka digital fingerprints) of data received from IoT sensors that track emissions or watch human activity, thus providing immutable tamper-evident proofs for later audit.
Carbon offsets and credits are offered by various organizations. A unified solution can act as an interface for enterprise blockchain to have access to those marketplaces and exchanges.
Enterprises having insetting programs can record the lifecycle of their projects against commitments, thus offering transparency into their programs. Solutions such as TYS capture and/or process such information in their risk assessment workflows. Blockchain “Oracles” assist in making those connections and ensuring the reliability of the source and the received data.
AI ML algorithms and third-party rating providers can calculate ESG scores. which can be recorded with proofs and signatures. Today many companies such as Bloomberg, Ecovadis, CDP, Moody’s, D&B, S&P Global, and other analytics firms provide the service and can secure their ratings on a trusted decentralized ledger.
Lastly, both enterprise and public blockchains have a role to play.
Summary
Governments across the world and global conferences such as the World Economic Forum-Davos, United Nations Climate Conferences held in Kyoto and Paris, and UN Climate Action i.e. COP27 are focused on actions to address climate change. The “E” in ESG is not just limited to carbon emissions but includes plastic waste and other human and industrial waste, non-carbon pollutants. and management of our forests, coastal and marine life. While Carbon offsets have been used as a tool by individuals and industries, it does not make them responsible for their actions. The impact of offset projects has been difficult to measure and report. Insetting as a goal puts more responsibility and accountability on corporations to improve their process and technology. Blockchains can help bring more trust, transparency, accountability, and compliance to ESG management. Also, it is unclear, how much of the geo-political events and industrial disasters are taken into account such as the war in Ukraine, the Norfolk Southern toxic spill in Ohio, or the dairy explosion that occurred in Texas.
About Chainyard
Chainyard is a boutique blockchain consulting and advisory firm based in Morrisville, NC. As the first Hyperledger Certified Service Provider, it has executed over 50+ projects. Chainyard’s Trust Your Supplier enables supplier risk assessment and qualification including ESG-related risks. To learn more, please send me an email or visit our website.
A favorite character in the James Bond series (other than James himself) is Q. Q always has these amazing hi-tech gadgets that save James from a certain demise at just the right time. Explosive alarm clocks, the Knife Shoe, exploding pens, a submarine Lotus Esprit, and of course the attacking sofa. He also has little patience for James and his laissez-faire attitude. Q is cool.
For your suppliers, what’s not cool is the “Q” word: Questionnaires.
Suppliers receive and return countless questionnaires containing dozens to hundreds of questions from each customer. Many of these questions are similar from customer to customer with slight variations and various formats. Just google “supplier questionnaires” and you’ll be overwhelmed with many template options and suggestions of what to include in your questionnaires.
So as a procurement organization, what should you include in your questionnaires? And how do you keep them up to date? Key global risks, evolving market conditions, geopolitical issues, and new compliance mandates require revisions to your questionnaires to collect crucial pieces of information from your suppliers. This is necessary to mitigate any risk to your organization.
Each time a company sends out a questionnaire or sends an updated questionnaire, the supplier must respond to each customer separately. The queue for having your specific questionnaire updated and returned can be quite lengthy, therefore creating a lag in the transfer of information. This lag leads to stale data and a lack of visibility to manage your company’s risk in current market conditions.
So, what’s the solution? The “S” word: Standardization. Trust Your Supplier (TYS) has pulled together a conglomerate of major buying organizations to develop a set of questionnaires that are standardized. These questionnaires cover industry, location, and buyer-specific issues that allow each organization to assign the relevant questionnaires to their suppliers. And these questionnaires are kept updated to reflect new requirements and regulations.
Here’s an example of how it works:
A set of questionnaires can be assigned to a supplier by a customer. Once those questionnaires have been completed and published by the supplier, the procurement team can review the answers. But there’s more! Suppliers can then share the same completed questionnaires with other customers…with just a click of a button. So instead of sending the same 200 answers separately to each customer, the supplier now just needs to focus on any unique questions a customer may have. This dramatically reduces the supplier’s administrative burden as well as the onboarding time and keeps their information current and accurate.
Let’s suppose this supplier has added a new product and now they are working with conflict minerals. No problem. The supplier can update the Conflict Minerals questionnaire and once published, the system will automatically notify every connected customer. The supplier’s new motto is now: “Do Once, Share with Many.”
These standardized questionnaires offer additional benefits to buyer teams. The TYS approvals workflow can be customized and automated with each questionnaire. Each answer can be “scored” based on your internal risk threshold. Any answer that does not align with your company’s preferred score will then be directed to the appropriate team role for further review and approval. This allows your team to focus on undesirable answers rather than spending time reviewing all answers.
Another TYS feature that softens the blow of the Q word is Questionnaire Groups. Depending on the supplier segmentation strategy, buyer organizations can use a targeted approach to send relevant questionnaires to a configured group of suppliers. These groups are customized by the buyer team and then assigned as a group to suppliers that fit into that category (i.e., location). This simplifies the questionnaire assignment process for the buyer team.
And the newest TYS feature is Predictive Questionnaires. Buyer teams can create a set of rules that will predict which questionnaires should be assigned to a particular supplier. This is tremendously valuable as new compliance regulations and laws come into play throughout the world, and provides the opportunity to reach more of your supplier base without further manual outreach.
Ultimately, standardization and automation result in benefits for both supplier and buyer organizations. The reduction in the onboarding cycle time allows transactions to occur faster and there is reduced administrative effort on both sides. Buyer organizations can also then benefit from having full visibility into their supplier base for strategic decision-making and risk management.
Check out a real example of how quickly suppliers can complete their profiles and questionnaires on the TYS system.
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These standardized questionnaires offer additional benefits to buyer teams. The TYS approvals workflow can be customized and automated with each questionnaire. Each answer can be “scored” based on your internal risk threshold. Any answer that does not align with your company’s preferred score will then be directed to the appropriate team role for further review and approval. This allows your team to focus on 