How Distributed Ledger and Blockchain Technology can help monitor and enhance ESG compliance in supply chains
As supply chains have become more expansive, complex and global in their outreach, it has become more and more important to ensure that appropriate mechanisms are in place to monitor and control environmental, social and governance (ESG) risks and vulnerabilities across the chain.
At a time when stakeholders, customers, regulators and investors are placing increased emphasis on the ESG impact of a company’s processes and operations, a breach by any entity within a company’s supply chain, however remote, has the potential to create a domino effect, causing disruption and reputational damage as well as financial loss and regulatory penalties for other entities within the chain. For example, recent news reports about alleged employment practices of certain factories and sub-contractors reportedly used by fashion retailers Boohoo and Quiz underscore the potential damage that can arise if ESG risks and vulnerabilities are not addressed.
Beyond the reputational and cost impacts, the introduction of legislation (such as the Modern Slavery Act 2015 and the Bribery Act 2010 in the UK) places legal transparency and disclosure obligations on companies in respect of their supply chains. Such scrutiny places obligations on companies to investigate and challenge the legitimacy and impact of their supply chains, which in some cases can be cumbersome and administratively burdensome.
The role of technology
Some companies are turning to technology enablers to help improve data flows and to provide an auditable trail of compliance across the whole supply chain. Technologies being considered include blockchain and distributed ledger technology (DLT) platforms, artificial intelligence, smart contracts and internet of things platforms and processes.
Projects addressing ESG risk and vulnerabilities are more likely to be effective where it is easy to prove a direct correlation between physical reality and digital records (commonly known as a “trust boundary”). Even in areas where it is necessary to use a third party to certify the correlation (such as certification or inspections), a number of companies, governments and NGOs are looking to technology solutions to improve processes to bridge the trust boundary - for example, through the use of drone technology for remote inspections or projects or the use of artificial intelligence and big data analytics to monitor and verify human rights breaches.
In this briefing we focus on some of the blockchain and DLT use cases currently under review by businesses hoping to address such problems. (Later briefings will focus on some of the other technologies under review, such as the internet of things and artificial intelligence, and the role that they can play in this process.)
What is DLT and blockchain?
Blockchain is a form of distributed ledger technology. A distributed ledger is a digital database of the assets held, and the transactions entered into, by members of a DLT network, copies of which are then distributed to the members of the DLT network. Transactions are recorded on the distributed ledger in accordance with rules that have been pre-agreed by the members of the DLT network and, once recorded, each party receives a record of that updated ledger.
The result is that each party has a secure, traceable and immutable record of every transaction entered into on that ledger.
For more information on blockchain, see Unlocking the Blockchain: A Global Legal and Regulatory Guide.
How can DLT and blockchain help improve data flows within a supply chain?
A number of DLT and blockchain characteristics are designed to address concerns specifically about transparency and record keeping, which is why a number of companies are looking to harness their potential with their supply chain processes.
Key characteristics of DLT and blockchain
• Transparent and auditable: Each member of a DLT network has a secure, time-stamped record of each transaction at every stage in a supply chain. Some platforms are looking to create a “digital twin” (a digital replica of a physical asset) whose movement can be traced on the ledger to verify and authenticate its provenance - for example, by attaching a barcode, a QR code, a RFID tag or forensic dyes to a product, which are then scanned or identified at each stage of its journey.
• Decentralised: An updated copy of the ledger is held by all members of the DLT network. As such, it is not reliant on a single entity (or multiple different entities at various stages in the supply chain) to oversee the accuracy of information or to reconcile data from multiple sources. This helps to reduce the risk of error, bias and security breaches and helps to streamline administrative processes.
• Reduced costs and time: Parties are able to verify supply chain data in real time, potentially shortening transaction times and streamlining compliance functions with resulting efficiencies and cost benefits.
• Immutable and irrevocable: On current computing power, it is nearly impossible to alter existing data on DLT or blockchain platforms without detection. This increases regulator, stakeholder and consumer confidence in the information provided, as well as reducing the potential for fraud.
• Reduced reliance on third parties, agents and intermediaries: DLT and blockchain platforms can function on a peer-to-peer basis. This improves visibility across complex supply chains and reduces the potential for human error.
• Compatible with other technologies: DLT and blockchain platforms have the ability to be used in conjunction with other technologies used across supply chains, such as smart contracting, artificial intelligence and the internet of things - for example, by uploading data received from IoT sensors onto a blockchain in order to enhance shipment tracking
The role of DLT and blockchain to monitor ESG in supply chains
One of the main concerns of companies looking to improve ESG monitoring processes within their supply chains relates to the robustness and transparency of information flows and record keeping.
Large-scale global supply chains can be complex and costly to monitor, with numerous suppliers and agents (who may be subject to multiple legal regimes), which can make end-to-end visibility and auditing more cumbersome. DLT and blockchain processes are designed to help improve transparency and robustness of information and record keeping.
A number of companies are looking to harness these technologies to improve data flows within their supply chains:
• Provenance is a platform that uses blockchain technology to trace supply chains across diverse sectors, including coffee, beauty, food and fashion. In 2016, Provenance is reported to have partnered with fishermen in Indonesia, using blockchain to track fish from “catch to consumer” in order to monitor responsible sourcing. This enables a premium to be charged for sustainable fish, which can in turn be passed on to the fishermen themselves.
• Tracr is a blockchain platform being developed in partnership with De Beers to track diamonds from mine to jeweller, providing an auditable trail of provenance across the supply chain.
• Accenture is reported to have has partnered with companies including Amazon Web Services, Everledger and Mercy Corps to create a “circular supply chain.” Reports say that, by using technologies including blockchain, Accenture has created a system whereby consumers can trace a supply chain by scanning a tag on a product and directly “tip” the producer of the source product, thereby rewarding and incentivising sustainable practices.
As the demands of stakeholders and regulators to ensure compliance with ESG standards and processes increase, so too has the importance of robustness and transparency in data flows and record keeping.
Innovative DLT and blockchain platforms can address such problems. Manual processes to address them are costly and subject to human error and the risk of fraud. As the business imperative for digitisation continues, we can expect to see wider adoption of such technologies by companies keen to navigate the complex area of supply chain compliance.