Supply-chain shortages are the focal point of 2021, advancing the era of ESG on a global stage. The supply-chain squeeze has spanned multiple industries, causing temporary high inflation as the Federal Reserve projected. What is overlooked in the big picture, however, is that ESG will be here to stay and reshape the supply-chain landscape over the long run. As ESG goes mainstream, a few breakthrough developments are under way.
The market calls for a global mandatory sustainability standard With successful experience in developing a global accounting standard, and implementing it in more than 140 jurisdictions, IFRS joined the force of promoting sustainability by launching the International Sustainability Standards Board (ISSB) at the COP26 climate summit held in Glasgow, UK, in November this year. A global baseline sustainability disclosure standard spearheaded by ISSB in collaboration with multiple market-led standard-setters will redefine enterprise value.
Notably, the proposed climate-related disclosure prototype identifies 14 industries to disclose supply-chain management practices. Once past the due process, supply-chain management will be deemed as material information on sustainability risks and opportunities. We expect companies will report ESG in the same rigorous manner as financial reporting. In short, ESG reporting will become a new norm.
Ballooning ESG funds fuel shareholder activism to act on supply chains Investors are the driving force behind the ESG revolution, calling out corporations to tackle supply-chain issues using growing stewardship power. With the assets under management of ESG funds surpassing $35 tn in 2020, according to the Global Sustainable Investment Alliance, we see a record high support rate (34 percent) for shareholder resolutions during the 2021 proxy season in the US.
According to Morningstar, this is largely attributed to the substantial support from large asset managers, such as BlackRock and State Street, to name a few. In particular, concerns arising from the supply chain have led to mounting shareholder proposals, and supply-chain human rights shareholder resolutions gained 52 percent support. We anticipate the supply chain issues will continue to be a major focus for investors’ stewardship efforts in the coming years.
Mandatory regulations accelerate sustainable supply-chain management Governments are stepping up to regulate supply-chain issues, spurring more attention to sustainability. Early this year, the EU passed the proposal for the EU Directive on Mandatory Human Rights, Environmental and Good Governance Due Diligence.
Following the EU’s legislation, Germany adopted the Act on Corporate Due Diligence in Supply Chains. Large companies that meet certain thresholds must identify human rights violations and environmental degradation risks at both direct suppliers and indirect suppliers. Compliance failures will lead to fines of up to 2 percent of the average annual revenue for large companies.
The EU and German due diligence laws will significantly impact suppliers because of the highly intertwined global economy. To prevent companies from seeking regulatory arbitrage, other countries will ramp up regulations and increase global collaboration.
Barriers stand in the way of supply-chain progress Despite the heightened regulation and growing attention, addressing ESG issues along the value chain is challenging. The first obstacle is the lack of visibility due to the sheer number of direct suppliers, not to mention indirect suppliers. The second roadblock is that limited data availability impedes assessing suppliers’ ESG performance. ESG Playbook finds that less than 18 percent of the 2020 Forbes Global 2000 firms screened suppliers using environmental and social criteria.
Last but not least, the complexity of quantifying suppliers’ carbon footprint hinders supply-chain decarbonization. McKinsey estimates that for many companies, Scope 3 emissions account for 80 percent of their carbon footprint. Among companies that have set goals according to the Science Based Targets Initiative, however, less than half include Scope 3 emissions. There is a lot of work to be done to improve these numbers.
Plans to understand the opportunities and control risks There is no perfect solution. To comply with the supply-chain regulations and meet stakeholders’ expectations, corporations should start ESG reporting promptly. Introducing an affordable and scalable digital platform to monitor the suppliers is a good starting point. Sending industry-standardized questionnaires to suppliers to streamline ESG data is another step in the right direction.
Furthermore, empowering and incentivizing suppliers facilitates changes in behavior, such as setting goals and recommending easy-to-use carbon calculators. Lastly, identifying hot spots and allocating the resource to the highest-impact area can enhance the return on investment and secure buy-in internally.
To summarize, those that demonstrate leadership in sustainability and in particular in their supply chain will be rewarded with a lower cost of capital, attract top talent and enhance their brand image. ESG Playbook offers a one-stop solution to help companies streamline the ESG data collection and comply with regulations with prebuilt worksheets, supplier dashboard and carbon calculators, and so on. For more information, please visit the ESG Playbook website.
