Creating an ESG-compliant supply chain framework

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ESG & Supply Chain Risk

Creating an ESG-compliant supply chain framework Ethical BoardroomBy Andrew Henderson, Director of Due Diligence Proposition, Refinitiv

 

 

 

Following on from the 2021 United Nations Climate Change Conference (COP26), environment and sustainability is firmly at the top of the agenda for corporates around the world. When it comes to discussions about corporate obligations in respect of carbon emissions and wider environmental responsibility, it’s important that business leaders think about how they will convert their ambitions into concrete initiatives and the practical steps they will need to follow.  

Involve the right stakeholders

The job of ensuring an organisation understands and meets its regulatory and legal obligations is generally seen as the role of the compliance function. In practice however, building a compliance programme incorporating environmental, social and governance (ESG) factors, is not that straightforward. It’s been estimated that more than 80 per cent of a business’s emissions and environmental impact are found in its supply chain. As a first step, any compliance programme that aims to support emissions or sustainability obligations must start with that part of the business, which means the compliance function must work with a wider group of colleagues, including those in procurement and supply chain management.

Creating an ESG-compliant supply chain framework Ethical Boardroom

Currently, people in these teams tend to talk about climate and other measures as part of the broader ESG category, which covers a myriad of issues. In the environmental space, people consider how a business performs as a steward of our natural environment, looking at waste and pollution, resource depletion, deforestation as well as the sustainability and greenhouse gas and climate change concerns. Social covers how a business treats people, including legal issues such as health and safety, human rights, child labour and slavery, as well as more recently emerging areas such as diversity and equality. Lastly, topics in the governance group consider how a company manages and conducts itself.

Understand the business imperative

Before embarking on building an ESG compliance programme, it is worth thinking through what objectives are driving the decision. The most obvious is that it’s the right thing to do; the impact of humans on the natural environment and the role business has in mitigating that impact is enough for many CEOs to sign up to ESG policies. But, it’s unlikely to be the only motivation. Other reasons for implementing ESG programmes may include legislation, positive business reasons or, more recently, a desire to appeal to investors.

Choosing an appropriate framework

Once the drivers are understood, the teams tasked with building programmes to manage the obligations should consider what model or framework to use. There are many compliance frameworks that could be used, including generic ones like ISO19600 or ISAE 3000, which can be modified to cover almost any topic, and should fit with what a company is already using in other areas. Alternatively, specific frameworks could be applied for each topic (such as the Green House Gas Protocol Corporate Accounting and Reporting Standard) which are more tailored to a particular obligation but may require more work internally to understand and apply to a particular business

.“It’s been estimated that more than 80 per cent of a business’s emissions and environmental impact are found in its supply chain”

There is no shortage of laws and regulations relating to most aspects of ESG. Some require diligence and statutory reporting, while others, such as like the new German supply chain laws, impose significant fines (up to two per cent of global turnover) and bans from public contracts, which tend to focus the minds of business leaders. 

Positive improvements to the business can come in many forms. These may include innovation that produces better products, the competitive advantages from showing sustainability, meeting the expectations of a more aware and discerning customer base, reduction in costs due to waste, or better staff recruitment and retention if your business can show it shares the ethical beliefs of those it needs to hire.

The link between ESG and future investment

Increasingly, it is investors who are leading the charge to ESG compliance through a desire to invest in businesses that have a long-term sustainable future as well as complying with their own legal disclosure requirements. There has been an enormous increase in investment funds with ESG mandates, leading to significant pools of funds that are becoming inaccessible to companies without a strong ESG message. This move towards ESG compliance as a result of external investor factors has also led to a significant change in how stakeholders view the programmes. As a consequence, business functions like procurement and supply chain management are moving away from being entirely focussed on supply quality and cost. These groups are now seen by executives and finance leaders as a crucial link to the future funding of the business.

Creating an ESG-compliant supply chain framework Ethical Boardroom

Reporting requirements

If you chose a general framework, it’s important to remember that, given the interest from investors, it’s vital that your programme not only helps to meet the obligations, but it’s also able to report out publicly in a format that is commonly understood by the investor community. This again requires consideration of both general descriptions of what your business is, possibly using the EU taxonomy for sustainable activities, or more detailed tools like the FTSE Russell Green Revenues Classification System (GRCS). Additionally, for specific topics such as carbon reporting, there are several options to choose from, such as those provided by the Carbon Disclosure Project (CDP), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), Sustainability Accounting Standards Board (SASB) or one of many more.

“Dealing with ESG topics is much like complying with other topics that have been addressed in the past, such as corruption, sanctions, or money laundering” 

No matter which model is chosen, the steps taken to understand the risks in your supply chain generally take the same path, starting with a risk assessment, then some level of due diligence, whether using a passive method like screening or actively seeking information. After the effort involved in building such a process it’s useful to think more broadly than just ESG and to consider some of the many other risks that might be in your supply chain. Examples of these include the core procurement concerns around quality as well as bankruptcy, cybersecurity and fraud or general reputational concerns – all of which can cause an impact to your business.

Setting clear priorities

With so many obligations to comply with from both within the ESG world and outside, the key to managing them all is to prioritise. To achieve this, first understand your drivers, then use those, plus your knowledge of your own business to prioritise the obligations, based on how your business actually operates around the world. Once you have a clear set of priorities, draft and communicate policies that set out what you intend to do to manage them, which should be informed by the resources that will be committed to achieve them. 

In many aspects, dealing with ESG topics is much like complying with other topics that have been addressed in the past, such as corruption, sanctions, or money laundering. The key difference is that well-designed ESG programmes will not only meet the obligations, but they can also make a direct link to the investor community, which is a clear benefit to the business as a whole.

 

About The Author:

Andrew Henderson is the director of the Due Diligence Proposition at Refinitiv. In his previous roles, Andrew has assessed, designed, implemented and managed compliance programmes for multinational organisations across a wide range of industries. He has been involved in the design and development of data products, services and workflow platforms, and retains a key interest in using technology to support compliance. Andrew has degrees in law and information technology.