Climate and change: Decarbonizing procurement contracts

This is a contributed op-ed written by Ashley Norton, director of the Analytics Production Group at Seal Software, a contract analytics solutions provider.

The fight against climate change has captured the attention of the business world as companies look to confront what is perhaps the most enormous challenge of our time. In 2018, carbon emissions levels rose 2.7%, and the United Nations called upon leaders in business and government to bring the levels down 55% by 2030 to avoid a climate catastrophe.

A report published in May by CDP, an organization that helps disclose the environmental impact of major corporations, reveals 215 of the world’s biggest companies view climate change as a likely threat to the bottom line within the next five years.

Three-quarters of the companies participating in the CDP study report actively integrating climate risk into their business strategy.

According to CDP, supply chains account for between 50% and 70% of total corporate emissions. Consider that BASF Group says approximately 85% of its emissions originate in the supply chain, and Mondelez International, spun out of Kraft Foods in 2012, estimates that certain emissions represent over 90% of its overall greenhouse footprint.

Recognizing the environmental impact fo their operations, major firms are taking action. Amazon has revealed plans to attain carbon neutral operations by 2040, and Coca-Cola and Mars have joined the Climate-Resilient Value Chains Leaders Platform, which is meant to help them mitigate climate-change threats through more resilient supply chains.

Contracts are a link in the climate solution

Using contracts as leverage over partner and supplier behavior, procurement and legal departments can be a link in the bridge toward sustainability, particularly because multinationals and their supply chain relationships often extend to jurisdictions under weak environmental regulations.

Often considered a blunt instrument for motivating responsible corporate action, regulations are not the only tool available to corporations.

Alignment with transnational public-private initiatives, as well as industrial and corporate codes of conduct, is often embedded in agreements. This extends to M&A due diligence, compliance with voluntary standards and corporate social responsibility provisions, and risk management around sales exposure and obligations. Non-compliance risks contractual breach, as well as reputational damage and capital flight by environmentally responsible investors.

A poll of publicly available corporate contracts held by the U.S. Securities and Exchange Commission found that half of them incorporate some kind of environmental requirements, representing about 80% of the total sales in their respective markets.

In a study by Pace University and the Institute of International Commercial Law, nearly 80% of companies now require climate-aware contracts with partners, and close to 70% deem inclusion of sustainability clauses in contracts highly or very important.

The CDP’s system for reporting that uses the Greenhouse Gas Protocol (GHG Protocol), is becoming more pervasive as a contractual element. The protocol includes the Corporate Value Chain (Scope 3) Accounting and Reporting Standard (GHG Scope 3 Standard) for emissions and reporting, and CDP instituted a voluntary Supply Chain Program that now includes many of the world’s biggest companies and their suppliers.​

In the public sphere, the European Union has adopted policy frameworks and regulations that address decarbonization such as energy efficiency and renewable energy directives, and is in the process of implementing rules for calculating the environmental footprint of products and organizations.

In the U.S., California aims to accelerate a reduction in CO2 emissions with ambitious automotive and building standards, and laws which require the state to procure all electricity from carbon-free sources by 2045.

The International Organization for Standardization has defined ISO 26000 as a framework for corporate responsibility, and an obligation to adopt its guidelines is often written into “contractual provisions or incentives as the first example of exercising influence over companies’ business partners.” 

Similarly, the OECD Guidelines for Multinational Enterprises, which states that “enterprises can also influence suppliers through contractual arrangements,” is often embedded in contractual text.

In one compelling example, BT Group Plc. has instituted its own GS20 Climate Change Procurement Standard, which requires that contracted suppliers have a policy to address climate change. They must also actively measure and report carbon and other greenhouse emissions, and are required to set carbon-cutting targets and report on progress.

Decarbonizing contracts with artificial intelligence

It remains a struggle for negotiators to parse through thousands of contracts, work that is typically done manually by lawyers and specially trained experts in the finance or procurement suite. Technical jargon contained in contracts varies significantly from one document to the next, and the sheer number and diversity of contracts means that sales teams are often overlooking or misunderstanding pivotal decarbonization details buried in text.

While software for legal document review is nothing new, its use has typically been focused on organizing and storing legal agreements.

Artificial intelligence raises the bar, and can be deployed across an entire contract group to identify relevant contractual texts dealing with CO2 and other greenhouse emissions. This may involve identifying contracts with clauses and terms that are missing or require updated climate change provisions, or finding and analyzing those that already include private or public regulatory obligations to determine if they are in scope.

Contract analytics can also make certain predictions which have crucial implications for due diligence and M&A because AI can efficiently sort through a large volume of contracts and flag those requiring further human inspection. Having information about climate-change provisions, or the lack thereof, will allow companies to update contracts more regularly to align with their CSR priorities and initiatives.

Moving ahead with contract analytics

Extraction and identification of key data points in contractual documents can help firms proactively take steps to mitigate their carbon footprint – both in their own contracts and in partner and vendor papers. Managing variations in these documents with artificial intelligence has already proven to make it far easier to identify noncompliance and ensure favorable provisions.

Extending current contract analytics use cases to deal with climate change is certainly not a big leap, and in fact the technology and expertise is already in place to do this. It is exactly this type of adaptive thinking that is needed as the private sector looks to avoid the heavy hand of regulators, while also filling the moral void left by governmental inaction.

Identifying contract clauses and terms that are suboptimal, not just for the company but also for humanity, cannot solve the climate crisis on its own. However, it is a step in the right direction and one that is within our grasp.