Commodities and the Sustainability Transition

This perspective was originally published by Marsh here

The need for developing a sustainable supply chain — in line with environmental, social, and governance (ESG) values — has become a prominent topic for commodity traders in discussions with their banks, funders, and insurers. These stakeholders are increasingly seeking insight into clients’ ESG strategy and implementation.

As a result, commodity traders, who play an integral part in the supply chain as originators and sellers of raw materials, are implementing ESG measures to respond to the evolving contract and regulatory landscape, and paying more attention to the ESG credentials of their supply chain partners.

In order to examine the impact of embedding ESG in trading operations, as well as the challenges this creates, Marsh held a seminar — Commodities and the Sustainability Transition  Moving the Needle to the New Normal — at the end of November, chaired by Marsh’s head of climate and sustainability strategy, Amy Barnes.

At the roundtable, speakers suggested the sustainable transition of commodities trading requires interdisciplinary action, unlocking of finance for smaller players and transitional projects and, at times, a flexible and pragmatic approach.

The view that sustainability could be a great catalyst for innovation and present significant commercial opportunity was also highlighted by panelists. As well as providing countries in the global south with a “once in a generation” opportunity to convert their natural wealth into a vector for development, the measures could foster innovation and help future proof the industry.

Here is a summary of some of the key factors put forward to enable commodities trading to move to a more sustainable future.

Need for an interdisciplinary approach

At the moment, there is no standard definition of ESG terms, nor of what “good” looks like, although there are moves to create a standard taxonomy.

There is, however, alignment that environmental, social, and governance aspects need to be addressed coherently across the three topics, rather than separately. The issues are interdependent and a single-minded focus in one area could have negative effects in another.

“ESG is interconnected. Sometimes, there is a danger of thinking they are distinct components,” said Suzanne Scatliffe, global sustainability director at AXA XL. “If we think about climate change, which is probably the most prolific ‘E’ topic, actually that’s a social one as well.” Climate change, for example, can have negative impacts on health and food security and interrupt education.

Financing the supply chain

Unlocking capital for small and medium-sized enterprises (SMEs) is going to be key in the transition. Finance needs to be made available to all layers of the value chain — and not just the larger players. The World Bank estimates that formal SMEs contribute up to 40% of national income (GDP) in emerging economies.

According to the Carbon Disclosure Project (CDP), Scope 3 upstream carbon emissions (which result from activities of assets not owned or controlled by the reporting organization) are on average 11.4 times higher in the supply chain than in operations themselves. Therefore, companies can reduce their carbon footprint significantly by focusing on their supply chains.

Access to finance will determine how fast physical supply chains can transform, especially if new technologies are needed during the transition process, according to N. L. N. Swaroop, director of alternate and ESG distribution at HSBC. “This is not just about trading patterns and human behavior — it’s a fundamental change in the way goods are manufactured, the way they are consumed, and how businesses trade goods and services.”

Technology has a big role to play and innovation needs to be supported by finance. There is a lot of existing technology that currently cannot be commercialized or scaled, and investment is needed to make that technology scalable. In addition, technology in the form of digitalization can drive transparency and measurement, ultimately helping SMEs access finance.

Partnership and collaboration

More mature companies are helping the supply chain transform, rather than making simple statements with no action.

Trafigura, said the company’s head of corporate responsibility, James Nicholson, is investing in people on the ground, who are from local communities. “We need people to understand how we are going to navigate this transition, without seriously negatively impacting producer nations,” he said. “We need the finance sector, we need insurers, and we need downstream receivers to actually roll up their sleeves.”

It is a worry, he continued, that some financiers and receivers are saying they are going to rule out particular developing countries from their supply chain due to social and environmental concerns. At the moment, some 20% of the world’s metals and minerals were coming from artisanal mining, while the artisanal mining community represented 90% of the world’s miners, he said. To focus solely on the environment element and ignore how changes would impact these communities would have substantial social consequences.

However, there is a need for data and greater transparency. As service companies, commodity providers need to provide information and assurances regarding their ESG credentials when required, whether it be by off-takers, end-users, financial institutions or regulators. This is not only necessary to meet environmental targets but also to ensure the long-term sustainability of the supply chain.

Time for practical actions

Change needs to proceed in a progressive manner that supports countries in the global south, panelists put forward. “There needs to be a fine balance, so we do not get into another crisis while solving for one,” Swaroop added. “There needs to be a balance between the credit risk approach and the climate risk approach.”

Rewarding good ESG behavior could be an effective strategy. For example, more nuanced restrictions on underwriting for carbon intensive industries could be appropriate to support companies who are making headway on their ESG transition. There could also be a place for philanthropy to act as a bridge to longer term financial solutions, while policies and regulations were deemed necessary.

The greatest challenge undoubtedly will lie with the commercial world, as it continues to supply global financial needs, said Nick Robson, Marsh’s global head of Credit Specialties. And it was now incumbent on the financial sector to transform “great discussions into practical actions,” he said.

For more information on commodity trading risk, please contact your Marsh advisor.