Managing ESG risks in supply chains

The delay to the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) does not mean that environmental and human rights due diligence in supply chains is no longer an issue. Supply chain risk continues to be a huge topic for risk managers, and ESG considerations are an important element of that. Data is crucial but capturing ESG data across supply chains is no easy feat, and will require new technologies and digital tools, as well as contractual solutions and supplier relationship management. ESG issues are fast-evolving material risks for many companies, especially those with complex global supply chains, says Sophie Tuson, senior associate at RPC and environment and climate change practice lead. She explains that on the environmental front, these risks include physical climate risks such as increased extreme weather events impacting core suppliers, or biodiversity risks such as the depletion of natural resources on which a business relies like water, cotton or agricultural products. She says ESG risks in supply chains also encompass various social risks like forced labour, child labour and the unlawful treatment of local communities including Indigenous peoples, and notes that these ESG risks are increasingly being called out explicitly in legislation as lawmakers seek to make corporates accountable for their social and environmental impact. Tuson also notes that ESG risks in supply chains also encompass legal and reputational risks where companies breach their legal obligations or are found to be ‘greenwashing’ or ‘social washing’. “Companies face a rising tide of litigation and other forms of legal challenge from NGOs, shareholders and regulators who are increasingly concerned about companies’ social and environmental impact. These legal challenges can be costly, reputationally damaging and any negative legal judgments can have a significant impact on business models,” she says. ESG data Capturing ESG data across supply chains and pulling out meaningful insights will be a big logistical challenge for many businesses, according to Tuson, and companies will need to harness an intelligent mix of technical and contractual solutions and supplier relationship management to ensure they can gather the ESG data they need to fulfil their new legal obligations. “As a starting point, companies should map out the relevant legal requirements to narrow down which will impact them and what the specific legal requirements are. Navigating the new legal requirements can be complex and fiddly so companies should seek support from internal and external counsel with this process. Next comes scoping – companies will need to scope out exactly what data is needed and from which suppliers. Having a good bird’s eye view of the supply chain will be fundamental for this,” she says. Tuson notes that for each data point, companies will need to make a strategic decision about whether to rely on primary data from suppliers or use secondary data as a proxy in the short term, but in each case, companies will need to be able to justify the approach they have taken. “If a company relies on primary data, it will need to clearly define the specific data ask for suppliers (e.g. what type, format and graduality of data it needs) and ensure that its supplier contracts contain the necessary provisions and enforcement mechanisms to ensure a reliable flow of data from suppliers going forward, and to enable it to ultimately walk away from a supplier if problems do arise,” says Tuson. She adds: “Sensitive and pragmatic management of supplier relationships will be crucial in helping unlock the ESG data that companies need. Suppliers are likely to be bombarded by data requests from multiple customers. Defining clear data ‘asks’ for suppliers and collaborating across the supply chain to support smaller businesses will be key.” Olivia Dakeyne, associate director of insight at Themis, a financial crime intelligence provider, says that in terms of internal measures, companies should ask suppliers to answer questions as part of a rigorous risk assessment and submit certain documentation/information, as well as conducting their own enhanced due diligence – for example, screening suppliers and third parties for financial crime risks. This could involve engaging an external financial crime investigator provider if you don’t have internal resources, and using AI platforms for mapping and visualising financial crime and human rights exposure through supply chains. As for external measures, Dakeyne says companies should use new technologies and digital tools that allow for more effective tracking and understanding of supply chains and exposure to financial crime risks – for example, geospatial data and geospatial mapping and satellite photos to understand source of origin on products and monitor transportation in real time. She says companies can also secure QR codes on shipments to create electronic transferable records to track and verify shipments with more security, and use blockchain as a digital ledger to verify chain of custody, and machine learning and satellite imagery to map and monitor offshore infrastructure and large vessel traffic. An important element in all this is getting supply chains to co-operate. Dakeyne believes this is best done through a carrot-and-stick approach: “Engage as a first step, talk to them about the issues and see if they are willing to work on them. Provide incentives for suppliers and third parties for them to co-operate (e.g. special/prioritised access to procurement platforms/tender opportunities, the ability to secure longer-term projects or apply for projects that aren’t open to all). And then if necessary, as a stick, use the threat of divestment/withdrawal from relationship, and the threat of adverse media.” Risk mitigation measures Once companies have obtained the right data on their supply chains, it is then about identifying risks and mitigation of those risks. Dakeyne points to enhanced due diligence and ongoing screening/monitoring (especially of adverse media). “Ultimately, you need to know who you’re dealing with/your supplier if you want to avoid reputation risk. It is important to screen for any potential links to products or companies operating in high-risk regions due to human right restrictions/violations. Educate your staff and foster a strong anti-financial crime, ESG and sustainability culture so it really permeates the business. And ensure senior management and leadership is actively engaged in fostering ESG commitments.” She says companies can also look to set themselves apart from their competitors, helping to gain a loyal customer base by offering accountability and transparency in ESG practices and commitments. RPC’s Tuson says risk mitigation measures include looking for any particularly high risk suppliers when mapping the supply chain and putting additional processes in place to monitor them, through additional audits or informational requirements in supplier contracts. She also says that ensuring supplier tender and onboarding processes are sufficiently robust to identify and weed out any high-risk suppliers is key. Finally, she adds: “Developing supply chain resilience and weaving this into contractual agreements will also be crucial to enable companies to walk away from a supplier, and find a replacement at short notice, if needed.” ---------------------------------------------------------------------------------------------------------------- Table: ESG risks in supply chains Human rights (social) risks – involvement of modern slavery, forced labour and human trafficking in many supply chains (especially construction, hospitality, agriculture, domestic work, mining, electronics and textiles/fashion factories etc); issues with infringement on/violence and human rights abuses towards Indigenous peoples and local communities from agricultural production and mining in many areas of the world and also murder of environmental defenders and journalists; links between conflict financing and supply chain risks such as illicit mining, which leads to violence and other human rights abuses in vulnerable populations, especially among children. Environmental risks – Risks of environmental crime such as illegal deforestation, illicit mining, waste trafficking and also environmental destruction and degradation from legal deforestation and mining or those activities that take place in a legal/illegal grey area and which can converge with other financial and serious crimes (high risk of this in commodity supply chains including palm oil, soy, cattle, coffee, cocoa, rubber, timber, wood pulp and paper, oil, gas, minerals). Monoculture associated with agricultural commodities also destroys biodiversity and soil integrity. Financial crime risks – Risk of financial crimes in supply chains, such as sanctions evasion, corruption and bribery, money laundering, tax evasion. Reputational risk – Risk of adverse media and resultant impact on share value, customer demand or protest, public protest/boycotts, accusations of greenwashing and pressure from shareholders or investor groups if lack of ESG oversight found. Regulatory/legislative risk – Risk of non-compliance, fines, convictions, as well as the risk of sanctions under human rights sanctions programmes. Physical/supply chain risk – Most businesses and commercial services depend on natural capital/resources either directly or through their supply chains. Aggressive consumption of local resources reduces their availability in the long term, undermining sustainable development and creating economic instability. Source: Themis _________________________________________________________________ The inaugural ESG Insight and Intelligence Conference will take place in London on 26 June. This event will examine the European regulatory demands associated with ESG, look at the impact on the corporate risk profile and consider how these risks can be managed more effectively. It will also drill down on the increasing demands and disclosures requirements placed upon insurance buyers by insurance carriers. For more information, please visit https://events.commercialriskonline.com/ESG-24

Managing ESG risks in supply chains

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