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    ESG risks in your supply chain

    Greater scrutiny of social and environmental risks and their effects, and growing regulatory action, will keep supply chains in the spotlight for many risk professionals.

    ESG has quickly risen up the corporate agenda, and many companies are taking steps to improve their environmental, social, and governance practices. But ESG risk extends into the supply chain, and companies must be aware of these risks in their suppliers and other partners.

    To spot ESG risk, you have to know what forms it can take. Environmental risks include those related to climate change and biodiversity, whereas social risks could be linked to human rights, impacts on communities, customer relations, health and safety, or forced labor. Governance controversies could stem from corruption and fraud, gender discrimination, internal controls, or anti-competitive practices.

    esg infographic artboardRegulation drives better disclosure

    Regulators require improved disclosures from companies on the social and environmental risks and impacts on their supply chains, and are implementing more rules and stepping up enforcement. Many countries have developed or are developing environmental and human rights due diligence legislation – including Germany, France, Luxembourg, Finland, the Netherlands, and Switzerland.

    In February 2022 the EU proposed mandating companies to carry out due diligence on the impact of their operations and supply chain on the environment and human rights. This far-reaching legislative proposal builds on EU due diligence frameworks such as the Deforestation Regulation aiming to tackle global deforestation and forest degradation, and the Conflict Minerals Regulation aimed at stemming the trade in conflict minerals. Elsewhere, Japan recently began developing guidelines on human rights due diligence.

    Analysis from Moody’s ESG Solutions suggests that companies are unprepared for the increased scrutiny of social and environmental risks in their supply chains. Our assessment finds a high incidence of social and environmental supply chain controversies in sectors with complex supply chains. Furthermore, our ESG assessment data shows that the majority of the most exposed sectors have ‘weak’ or ‘limited’ performance (a score of less than 49 out of 100) in implementing labor and environmental supply chains standards, suggesting a lack of capacity to meet the demands that emerging risks pose.
    esg infographic sept 2022

    Social controversies remain prevalent

    Social supply chain controversies spiked during the Covid-19 pandemic. Although cases have reduced since then, they are still above pre-pandemic levels. We expect social supply chain controversies to remain above pre-pandemic levels as forthcoming legislation shines a stronger light on poor practices.
    social supply chain controversies table

    Specialized retail has the most social supply chain controversies globally, totaling 117 cases, followed by food with 58 cases, technology hardware with 37, and automobiles with 35.

    top five sectors for social supply chain controversies
    The controversy topics with the most cases are decent wages and forced labor, with 144 and 139 cases worldwide respectively, suggesting that exposed companies are not doing enough to fix workplace problems. Health and safety, child labor and indigenous people’s rights are the next three ESG topics with the most cases. Specialized retail stands out as a sector with a heavy dependence on human capital. It often operates in parts of the world where labor standards are less stringent, leaving the sector’s workforce less protected.

    top five social supply chain topics

    Biodiversity dominates environmental controversies

    As with social supply chain controversies, food and specialized retail have the most environmental controversies, with 51 and 29 respectively. Automobiles is third, with 23.

    Biodiversity risks and impacts are fast rising up the agenda for private-sector companies: biodiversity is associated with the highest number of environmental controversies, with 117 globally. These controversies may involve links to illegal deforestation in sectors such as food and supermarkets, or the effects on local communities of pollution from poor operational practices.

    Initiatives such as the Taskforce on Nature-related Financial Disclosures aim to provide companies with a framework for managing and disclosing nature-related risks and impacts. The much-awaited second half of COP15, the United Nations’ Biodiversity Conference, will take place in Montreal in December 2022. Government representatives expect to agree a new global treaty to halt and reverse biodiversity losses focused on the implementation of the Post-2020 Global Biodiversity Framework. Both initiatives will raise the profile of biodiversity risks and impacts for companies, investors and governments, providing pathways for better management and greater scrutiny on corporate activity in this area.

    top five sectors for environmental supply chain controversies
    Further scrutiny and growing regulation will likely bring more supply chain controversies to the surface, as will growing attention on higher-priority issues of concern, such as biodiversity.

    Labor standards outpace environmental standards

    Many companies are poorly placed to manage increasing scrutiny of social and environmental risks and impacts. Our assessment finds that management of environmental and labor supply chain standards of listed companies in exposed sectors is largely ‘weak’ (a score of less than 30 out of 100) or ‘limited’ (a score of 30–49).
    environmental labour standards
    Automobiles scores highest, with an average score of 40 out of 100 for environmental standards in the supply chain, followed by food with 35. Supermarkets score an average of 32, industrials 28 and specialized retail 24.

    Average scores for labor standards in the supply chain, though low, were higher than environmental scores. Automobiles achieve 45 out of 100 and supermarkets 39. Specialized retail has the lowest average, at 32.

    Sectors in which supply chains are highly exposed to environmental risks, dependencies and impacts — and which have large workforces, and in many cases impacts on communities to manage and mitigate — have ‘weak’ and ‘limited’ scores. These scores emphasize the challenges for companies unprepared to improve their operational practices and related disclosures on these issues ahead of greater scrutiny. Regulation, sustainability disclosure standards, and other disclosure frameworks will be catalysts for action. However, companies in sectors that perform poorly today will find bridging the gap harder to achieve. They are likely to be exposed to growing risks as scrutiny ramps up.

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