A focus on environmental, social & governance risks puts procurement and supply front and centre of investment decisions, says GREG CHANT-HALL
Over the last 20 years, the investment community has taken an increasing interest in environmental, social & governance (ESG) issues in the companies in which they invest. Now, the investment community is realising that many of these issues and risks sit within the supply chain. While these issues used to be considered ‘non-financial risks’, they are beginning to be seen more as non-direct financial risks. This is putting procurement and supply chain front and centre of investment decisions.
A recent report by the UN-supported Principles for Responsible Investment (PRI) and assisted by CIPS, highlighted why ESG risks in the supply chain are worth taking into account to protect investments. It advises investors to ask companies detailed questions about supply chain complexity, how ESG issues are embedded into contracts, and how people are trained in managing specific ESG risks. It also advises investors to engage with procurement decision-makers to find answers to technical supply chain management questions.
This is significant. The PRI’s signatories represent more than $70 trillion invested in a wide range of companies and assets around the globe. With ESG risks – from corruption to human rights abuses – firmly on investors’ radars, investee companies can expect to be asked searching questions about how they manage those risks. Procurement professionals need to respond and demonstrate how such risks are identified and managed throughout multiple supply-chain tiers. Once a company chair or CEO is put on the spot by a challenging investor question, pressure will filter down to procurement and supply chain leaders to ensure that next time, the firm has a more satisfactory answer.
PRI member Adam Heltzer of investor Partners Group explains: “Landing on ‘not enough information to assess’ is an insufficient due diligence conclusion. The conclusion should be that significant ESG risks may exist [in the supply chain] and that the deal team will assess in more depth immediately post-acquisition.”
ESG supply chain risks vary depending on the sector, nature and scale of the company. A recent Trucost/GreenBiz report suggests that in construction, around 75% of environmental impacts lies within the supply chain, whereas for the utilities sector it can be less than 10%.
Approaches to supply chain engagement on these issues also vary widely, and some sectors have little meaningful engagement, influence, or even knowledge beyond tier one suppliers. In construction, each new sizable project often establishes a new supply chain from Tier 1 down, where companies may not have worked together before and may not fully understand the requirements regarding ESG risk management. They may not even know the identity of firms one step removed in the chain.
Investors are becoming more attuned to the benefits of good ESG risk management in supply chains such as: quicker response time to any emerging issues; protecting licence to operate, brand and reputation; and enhanced business continuity.
Cheeringly, excellent developments take place in this arena weekly. Take the work that Guard Global has done to build an online digital ESG reporting tool, combining structured data and blockchain technologies to enable assured reporting of each supply chain tier, through to top tier reporting frameworks such as GRI, CDP and UN Global Compact.
A healthy interest from investors on ESG risks in the supply chain will encourage more proactive steps by companies, in turn improving social and environmental performance, and governance across all supply chain tiers. This will not be achieved at the expense of finance performance, but in tandem. By robustly managing non-financial risks, companies protect their financial returns.
The final word is from the PRI: “Companies are increasingly expected to understand and manage their exposure to supply chain risks. For those with a good understanding of their supply chain, this is a great opportunity. For others, it is getting harder to hide.”
Greg Chant-Hall is director at Square Gain and author of the PRI guide and toolkit on Managing ESG Risk in the Supply Chains of Private Companies and Assets.