Is Blockchain the Key to a More ESG-Compliant Supply Chain?
January 26, 2022
Is Blockchain the Key to a More ESG-Compliant Supply Chain?
The retail industry will need to overcome unprecedented challenges if it wants to mitigate ESG risks and improve visibility into its supply chains. Fortunately, help may be on the way.
The information age continues to dominate the business landscape, bringing with it the expectation of greater corporate transparency. The extent to which an organization’s business practices, operations, and culture are open and accountable is a differentiator for consumers — and investors.
Today’s consumers and investors demand corporate transparency, monitoring corporate actions to ensure they align with their own values. Businesses are listening, and many companies recognize the need to put “purpose” on a par with profits. As a result, leaders are beginning to prioritize environmental, social and governance (ESG) policies in their business operations.
ESG issues in the supply chain
With the requirement to integrate ESG policies into business activities, implementation presents challenges as businesses try to adapt. The retail industry, in particular, is facing unique and broad challenges.
Consumers are focused on the retail supply chain due to frequent negative news about the manufacturing and sourcing of materials. It is difficult for retailers to identify and mitigate these issues because of the global distribution of vendors and suppliers. Often, tier 3 and 4 suppliers do not comply with agreed-upon standards.
Governmental and regulatory bodies recognize this issue and are forcing action to reduce ESG-related issues throughout the supply chain. The European Green Deal, for instance, provides due-diligence guidance on forced labor. Similarly, Germany recently passed a law mandating “corporate due diligence in supply chains.”
The Sustainability Accounting Standards Board (SASB) identifies supply chain risks as material to a company’s financial performance, recommending retail companies audit tier 1 suppliers for wastewater discharge, environmental assessments, labor code of conduct, and third-party certified raw materials. SASB also suggests that companies require their tier 1 suppliers to perform similar audits with their vendors1.
The bottom line is that without full, consistent visibility into their suppliers’ operations, organizations struggle to monitor, mitigate, and comply. Fortunately, the retail industry and others are deploying a technology-driven solution to improve supply chain operations: blockchain.
The benefits of blockchain, including greater security, accuracy, and cost efficiency, are making significant improvements to supply chain management. Spending on blockchain is predicted to grow from $253 million in 2020 to more than $3 billion by 2026 as companies now use blockchain to track and trace materials and products throughout the entire supply chain.
Pharmaceutical companies leverage blockchain to prevent counterfeit or stolen products from reaching consumers. Similarly, food companies utilize blockchain to track their food supply, providing traceability and helping monitor and control the spread of foodborne illness.
Blockchain can also be used to track raw materials from the farms through manufacturing, verifying that those raw materials were sourced from sustainable locations and trusted suppliers. Blockchain has also helped companies focus on ESG on reducing carbon footprints, ESG disclosures, and sustainability tracking because of improved visibility into all tiers of the supply chain.
So, what’s keeping some companies from making the investment? For one, there is the skepticism that comes with adopting a new technology and the seemingly imponderable nature of blockchain. Some managers may be under the impression that adoption will cost millions of dollars of R&D budget. Others may believe that blockchain will replace all their systems, resulting in the need to build everything from the bottom up.
The barriers to entry are far lower than most would suspect.
Let’s start with cost savings. One of the most innovative components of blockchain technology is the “smart contract.” Essentially, this is an algorithm that runs a “if X, then Y” sequence. When companies can implement an application that automatically reacts to variables along the supply chain and inform a contract, both money and time are saved.
Then there’s security. Because blockchain is decentralized, it’s virtually secure from hacking, making blockchain all the more attractive. This comes at a time when cybersecurity costs are set to grow in the next four years to nearly $190 billion.
Finally, there’s the accuracy and trustworthiness of the data because the data is not corruptible and is verifiable and allows all parties to have visibility into the information contained on the blockchain.
Blockchain is not the be-all, cure-all to issues such as labor exploitation or other human rights violations, but it’s a step forward for companies who must comply with growing regulatory expectations and ethical questions asked by the public.
Legal considerations around blockchain
While blockchain technology certainly has the potential to bolster supply chain operations, there are several legal and regulatory considerations that must be taken into account. Here are a few key factors to consider:
- Enforceability, performance assurance and liability: Consider a blockchain-based smart contract. While it is often used to automate and protect the supply-chain process, it does not eliminate the need for a robust legal framework. Whether it be unintended programming errors, reliance on traditional legal documents or the need for human oversight, all of these challenges must be addressed through traditional means (ie, contracts, court rooms).
- Data security and privacy: New regulations and guidelines are emerging, raising questions about whether blockchain may disclose sensitive and confidential data. Prudent companies should carefully consider what data is put on-chain and add customized blockchain-related data protection and privacy provisions to their commercial agreements, as well as imposing obligations upon counterparties to comply with such regulations.
- Governance, consensus and documentation: Blockchains being used to oversee supply chains will require a certain degree of permissioned functionality given the technical concerns regarding transaction processing time, data privacy, AML, KYC and other regulatory issues. This means limiting platform access to known participants and restricting the rights of those participants on the platform.
Certainly, having transparency, accountability, and visibility into every aspect of your supply chain is critical for supply chain management. It has become crucial, in fact, for businesses trying to provide accurate information to all their stakeholders. Whether companies are looking to improve ESG-related issues, better manage suppliers and vendors, or create a true business differentiator, blockchain represents a dynamic tool for today’s business leaders.
This article was drafted in collaboration with DLA Piper. Authors from DLA Piper include:
Partner, DLA Piper
Co-Chair, Blockchain and Digital Assets Group
Attorney, DLA Piper
1: Sustainability Accounting Standards Board (SASB), Apparel, Accessories & Footwear: Sustainability Accounting Standard (October 2018).
© Copyright 2022. The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals.
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January 26, 2022
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