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Christine Chow, Director – Engagement, Hermes Investment Management, looks at applications of blockchain technology for responsible supply chain management.

Following the launch of Bitcoin futures on 10 December 2017, it seems an opportune time to look into the technology that has enabled its ascent and applications in many sectors.

Bitcoin’s birth originates from a nine-page paper by Satoshi Nakamoto-san, titled Bitcoin: A Peer-to-Peer Electronic Cash System. In the paper, the author focuses on the underlying standardised, decentralised ledger or registration process where each transaction is time-stamped at each interaction point by the associated transaction parties. These interaction points are commonly referred to as ‘nodes’.

In this peer-to-peer network, the open registration process serves as an ongoing cryptographic proof-of-work, providing transparency in the value chain of the items being exchanged. However, the decentralised registration system is not without its weaknesses. For example, a certain percentage of fraud is expected. In its nascent form, registrations by nodes are on a best effort basis; and nodes can leave and rejoin the network at will.

As the application of blockchain technologies expands, we have seen increasing practical applications. For example, two Australian banks are now using blockchain for bank guarantee for commercial property leasing. It eliminates the need for physical document management through multiple transactions. The technology is also increasingly being used in supply chain management – from seafood to tea, and from farm produce to diamonds.

Blockchain and supply chain management

Starting January 2018, the Seafood Import Monitoring Programme requires specific data related to seafood imports to be provided electronically to US Customs and Border Protection. Origin data of seafood is recorded alongside the global tracking system. An example from the global fish trade gives us a glimpse of the importance of this development. An article in the Financial Times (‘The fight against food fraud’ published 24 March 2016) reported that when fish from off the coast of Scotland, Norway and Russia are caught and cleaned, they are sent to China to get filleted before being shipped to larger freezers in South Korea for global retailer buyers to make bulk purchases. Without a transparent process of monitoring the global peregrinations of our food, we are exposed to significant food safety issues without knowing the source of potential contamination during the multiple stages of preparation processes, let alone knowing whether any child or slave labour has been involved.

An article by Thomson Reuters Foundation (‘Can blockchain ensure Unilever’s tea farmers produce a fairer brew?’ published 14 December 2017) reported that a group of food and retail companies, including Nestle, Unilever, and Tyson Foods joined an IBM project in August 2017 to study how blockchain systems can help track food supply chains and improve safety. With improved data, small-scale farmers are able to get bank loans with more favourable terms, improving their productivity and quality of life. Blockchain is also used in ensuring the authenticity of organic certification.

In November 2017, Hermes Investment Management had the opportunity to participate in the International Council on Mining and Metals (ICMM) roundtable on blockchain technology applications in the supply chain. As the only investor representative at the event, we were keen to communicate the message that global investors expect companies to find reliable, transparent and cost-effective ways to certify that their supply chains are sustainable and free from slavery and corruption. Everledger, a London-based company, shared its experience in monitoring the diamond supply chain. Knowing the origin of a diamond helps to reduce counterfeiting, insurance fraud and smuggling from conflict regions because digital certificates are difficult to forge being in a decentralised system, providing a better alternative to paper certificates.

The implications for the cobalt supply chain

At the ICMM meeting, we discussed whether the same control rigour through technology could be applied to the cobalt supply chain. This recommendation can be traced back to a blog we published in March 2017 – ‘Beyond tin, tungsten, tantalum and gold: cobalt mining in the Democratic Republic of Congo (DRC)’. In the blog, we highlighted the challenges of monitoring the cobalt supply chain, and began engagement along the chain to understand the root causes of issues related to human rights violations. We advocated a collaborative platform that facilitates the sharing of costs and expertise, with access to a wide range of companies. We wanted companies to consider using blockchain technology to identify human rights issues and to improve current supply chain management practices.

Since then, cobalt prices have risen from US$52 per tonne to US$75 per tonne (December 2017), according to the London Metals Exchange. Whilst companies are working on substituting cobalt with other minerals, the rapidly increasing demand for electric vehicles mean that there is inevitably going to be a demand gap. In the interim period, the demand for cobalt continues to rise.

Many of the companies that we engaged with have done well in improving their cobalt supply chain. Apple has expanded its responsible sourcing efforts to beyond 3TG covering cobalt. Samsung SDI, a key battery manufacturer for Apple and Samsung Electronics, published a supply chain responsibility report, following the OECD Due Diligence Guidelines for Responsible Supply Chain. Together with other members of the Responsible Cobalt initiative, established by the Chamber of Commerce of Metals, Minerals and Chemicals Importers and Exporters, the two companies led a collaborative academic study seeking ways to create sustainable societal impact in local communities.

The Chinese cobalt smelter and refinery, Huayou Cobalt, which was heavily criticised by Amnesty International for allowing child labour in its mines, conducted a detailed presentation at the OECD responsible supply chain conference in Paris in May 2017. The presentation provided an update on the local community’s engagement, training and health and safety improvements that the company has made in its operations in the DRC. We are pleased to see such progress, however, the application of technology still lagged our expectations. Fortunately, at the ICMM meeting, RCS Global, the responsible sourcing advisory and audit group that has worked with many of the aforementioned companies on this issue, presented a potential solution. It has mapped out a 12-step blockchain-based Chain of Custody system for the minerals supply chain. There are a number of similarities and differences in applying blockchain to minerals when compared to other supply chains. In terms of similarities, key players in the upstream production, such as the miners, must agree a set of input data to define the data features of cobalt. At this point there is little difference to the 40 features, including colour and clarity, to create a unique diamond’s identification, or using a batch tracking method to ensure the authenticity of organic food produce, except that cobalt, which is a by-product of copper, will have a different set of identification features. These may include, for example, a mineral fingerprint that analyses content of impurities.

In terms of challenges, there are a number of them. Firstly, tea or bacon do not transform in the same way as cobalt from plantation or farm to shop shelf. The manufacturing process that produces smartphone and car batteries as end products requires the use of numerous types of materials; cobalt is only one component. During the multiple stages of transformation and aggregation, there needs to be a clear approach in authenticating that all the materials used are child and slave labour free. Secondly, there has to be an overall alignment of the responsible production processes to standardise ‘registration by nodes’ at each aggregation point. For example, the current paper certificates system will have to be replaced by a more digitally enhanced method. Thirdly, independent traders of cobalt play a crucial role in the supply chain. They mix cobalt from different sources to suit the demands of the market. Downstream buyers should agree common production and material stewardship standards and associated purchase terms promoting best practices. In all likelihood these will arise from existing or developing industry platforms.

One key challenge remains – the business case for adoption for miners. Currently the pressure is from the downstream companies to provide more transparency, but without any corresponding reward – either financially or reputationally.

The journey ahead

All of the above require industry collaborative efforts, covering the industries of miners, smelters, refiners, battery manufacturers and ultimately, the consumer electronics and auto companies. With improved traceability and transparency, companies can improve quality management and use of recycled materials, enhancing the circular economy. We are probably at the beginning of this journey, although I am confident that given the progress in many sectors that we have witnessed this year on applying blockchain for good, we are closer to our goals than ever before.

Christine Chow
Director – Engagement
Hermes Investment Management

The Hermes Investment Management blog ‘Beyond tin, tungsten, tantalum and gold: cobalt mining in the DRC’ is available online at: www.hermes-investment.com/ukw/blog/eos/beyond-3ts-gold-cobalt-mining-drc. The academic study into creating sustainable societal impact in local communities mentioned in the article is available online at: https://escholarship.org/uc/item/17m9g4wm.

The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.

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