Customers, regulators, and shareholders expect companies to effectively manage environmental, social, and governance (ESG) risks, which can test supply chain resilience and even threaten their operations.
In 2022, 27% of Chief Procurement Officers prioritized ESG initiatives and risks, with more expected to prioritize it in 2023. This number should be higher, with Ardent estimating that more than half of a typical enterprise’s ESG footprint can be attributed to its supplier base.
Procurement and supply chain teams must adapt to an evolving legal and regulatory landscape to manage ESG risks, which pose reputational and operational challenges to their company’s value chains. These pressing ESG risks could impact supply chains the most this year.
New ESG Laws and Regulations Take Effect
As ESG risks grow in complexity and severity, governing bodies across the globe continue to pass laws and regulations to ensure that companies mitigate these risks. Two of the toughest laws to recently take effect, the US Uyghur Forced Labor Prevention Act (UFLPA) and the German Supply Chain Due Diligence Act (LkSG), carry severe consequences for non-compliance.
While similar in reporting requirements, the UFLPA and the LkSG differ in scope. Germany’s law, in particular, foreshadows similarly comprehensive ESG legislation that has recently passed in Norway and looms in Canada and the Netherlands. Multinational companies operating in these jurisdictions will have to at least consider their potential compliance requirements, legal obligations, and risks for non-compliance.
While compliance may be difficult to achieve, negligence is even more expensive. Companies fined for compliance failures are assessed significantly higher penalties when they are negligent and have not taken reasonable steps to monitor business practices. For example, a large manufacturer’s fine for an illegal business practice went from $250 million to over $1 billion once it was discovered that an oversight/compliance program was basically non-existent.
In 2023 and beyond, companies will struggle to balance growing compliance requirements with today’s economic realities, their existing technology infrastructure, and competing regulatory priorities. Despite the challenges, an increasing number of companies are seeking to promote integrity in their supply chain not for compliance reasons alone, but to build a sustainable or ethical brand and drive positive change for people and the planet.
For Some Companies, Scope 3 Emissions Reporting Becomes Mandatory
In the next 12 months, regulatory bodies within the US and EU may require some companies to track and disclose their Scope 3 greenhouse gas (GHG) emissions. Unlike Scope-1 or Scope-2 emissions, Scope-3 emissions include indirect emissions produced across the company’s supply chain by its supplier base. They can represent up to 98% of a company’s total carbon footprint. Tracking and reporting Scope-3 emissions is not easy.
In March 2022, the SEC proposed a rule change that would require publicly traded companies in the US that tout Scope 3 GHG emissions reductions to disclose them. The SEC is due to make a final decision in 2023 and may reverse course. Regardless, other governing bodies likely will require Scope 3 emissions reporting. For example:
- The UK government requires companies to report certain Scope 3 emissions and may require other reporting.
- The Science Based Target initiative’s (SBTi) Net Zero standard requires Scope 3 emissions reporting, to which more than 3000 companies belong.
- The International Sustainability Standards Board (ISSB) will require companies to report their Scope 3 emissions, with rules finalized in early 2023.
Child, Forced Labor in our Backyards
Modern slavery is a beast of a problem that traps victims of all ages, from different geographies and in different industries. It’s grown 20% since before the pandemic, with an estimated 50 million people now in some form of slavery – even in our backyards.
In July 2022, reports surfaced alleging that Hyundai subsidiaries employed children as young as 12 in their Alabama plants. Since then, other suppliers to Hyundia and Kia were found to have employed child labor in the US. And in February 2023, media reports uncovered widespread child labor allegations across the US within the apparel, automotive, and consumer packaged goods industries.
Anti-slavery laws, some nearly a century old, don't always prevent slave labor from entering supply chains. Corporate compliance is often not enough. Companies can follow the letter and the spirit of ESG laws and regulations by establishing robust supplier controls and risk management programs and gaining visibility into their products and services’ extended supply chains, which get darker as they get longer. The more collaborative and transparent trading partners are on labor practices, the less cover there is for modern slavery to take root.
Economic Worries Overshadow ESG Risks
Although greater awareness and rising concerns over climate change, environmental impact, and social justice have made ESG a higher business priority, a possible recession in 2023 may jeopardize progress made on these issues. Already, investors have been fleeing ESG-focused businesses as they look to preserve cash and prioritize profitability over sustainability, which carries long-term consequences.
For example, climate change poses serious economic and humanitarian risks. If the world continues to warm as predicted, it will lead to rising sea levels and put at risk seaports, coastal communities, and 410 million people globally. Also, as we’ve seen during the pandemic, social issues, especially modern slavery, worsen when companies retreat to survival mode. Ten million more global citizens fell into slavery during the pandemic – how many more will meet the same fate should the economy fall into a recession?
We must balance our common humanity and ecology with our need for financial stability. They’re not mutually exclusive. Companies now have access to innovative resources that can enable them to not just hold the line on ESG principles but advance the line – even through hard or uncertain economic times. We must not let up on our mitigation efforts – we must double down on them in the coming year.
A Viable Path Forward
Organizations need modern solutions for modern business problems that will become more problematic. To mitigate potential impacts that ESG risks pose this year, procurement and supply chain teams need third-party risk management solutions to operate with agility and scale across their extended enterprise. They need real-time access to multiple risk intelligence data to provide continuous, full spectrum monitoring of their third parties’ risk exposure, which enables proactive risk mitigation and corrective actions. But how do we get there?
The responsible path for most companies regarding building a risk, compliance and sustainability program for your extended enterprise is to Think Big, Start Small and Grow Fast. Think big and design a program accordingly so you don’t end up with several fragmented solutions and lose visibility into your complete risk exposure. Start small because a big bang approach for something as complicated and ever-changing as managing risk and compliance for your supply chain is doomed. Grow fast by incrementally expanding your risk management program to the many areas of compliance. Finally, plan to be agile as regulatory changes are being introduced and updated from over 1200 regulatory entities around the world.