Arguably, no phrase has become more prevalent in business circles over the past year than environmental, social and governance - ESG. As the world continues to crack down on greenhouse gas (GHG) emissions, and more money is being shifted towards businesses with a reputation for “doing the right thing,” hitting the ESG mark is quickly becoming an imperative for organizations across all industries – and particularly in their efforts to build more sustainable and resilient supply chains.
Improving how we manage global supply chains is critical for reducing GHG emissions. According to the Environmental Protection Agency, organizations' supply chains often account for more than 90% of their greenhouse gas (GHG) emissions, when taking into account their overall climate impacts. These emission figures – paired with the heavy reliance on natural resources, chemicals and the waste production associated with making and shipping finished goods – make the supply chain a focal point in the ESG push. However, due to a global supply base and a persistent reliance on outdated technology, organizations are finding it challenging to establish effective ESG compliance strategies within their supply chains.
To resolve this challenge, many enterprises are looking to reduce emissions by changing manufacturing and distribution through broader reshoring efforts, but these efforts often take time. Semiconductors and the products that are reliant on them like automobiles and industrial manufacturing are a classic case. Despite the huge investment made by the Biden administration to increase domestic semiconductor manufacturing, companies investing in new semiconductor-fabrication facilities in the US won’t be in production until at least 2024, thus delaying GHG benefits of wider production around chip-intensive industries.
With that in mind, the following are some key considerations for businesses interested in building ESG-compliant supply chain infrastructures that deliver in the short-, medium- and long-term.
Benchmark Existing ESG-Risk Foundations
Building a successful compliance foundation starts with understanding areas of compliance strength and weakness. Ongoing compliance depends on having a sound base, which then supports the addition of new requirements or the updating of existing requirements. For example, recent legislation includes the German Supply Chain Law, and the EU’s Corporate Sustainability Reporting Directive (CSRD), which entered into force in 2023.
In addition, rules such as climate-related disclosures for investors remain highly significant for U.S. SEC reporting. Businesses that begin their ESG-compliance journeys by skimming over their existing infrastructures and prioritizing only the most pressing regulatory points, unfortunately, leave numerous risks either partially or completely unvetted.
Compliance success hinges on having a robust set of controls that routinely stress test every facet of business operations. Hitting the mark in emissions reporting is one aspect, but what if the oversight of hazardous materials use is lagging? Modern ESG compliance is about being as comprehensive as possible, ensuring that every business function is up to scratch and feeds into the other functions’ goals.
Thus, to build a seamless ESG-compliance strategy that drives business success, organizations need to begin by having a firm grasp of the ESG-related supply chain risks throughout their entire operations. If not, it is likely that their supply strategy will fall apart or the results will be underwhelming.
Solve Data Gaps
For decades, there have been a limited number of ESG-related compliance regulations (e.g., no conflict minerals) and no overarching ESG regulatory framework. But as ESG regulation becomes more sophisticated, where global and regional requirements change, regulators are expecting not only more robust information, but also documentation on business processes that are helping improve their wider ESG efforts. This means companies need to prioritize their data-driven capabilities in concert with business process and the implementation of advanced technologies for improving ESG-focused supply chain risk analysis and reporting.
To do this, organizations need to gain deeper insights into every area of their supply chains, as well as a verifiable assessment of what risks impact their business the most, for example, through materiality assessments. This includes everything from how their operations stand up to labor laws, to the controls they have in place to snuff out bribery or unfair competitive practices in the supplier base. For instance, as outlined by laws such as the California Transparency in Supply Chains Act, a retailer may need to focus on their suppliers and their labor practices in specific regions where child labor has been identified as risk. For an industrial manufacturer, it could come down to the source of a commodity or core component that goes into a bill of material (BOM) due to regulatory restrictions of sourcing from a particular region.
Thanks to advances in modern technology, businesses can now deploy a much more scientific approach to compliance than ever before. For example, organizations can monitor for regulatory shifts in real-time through automation so that they can constantly stay abreast of potential risk areas in their supply chain. Furthermore, they can use artificial intelligence and cloud computing for ongoing oversight of their risk identification, assessment and resolution workflows, enabling them to know exactly who is handling which task and when a given task should be completed.
Regardless of the specific supply chain dynamic, organizations need to build out procedures that digitally document the details of specific supply chain paths and the compliance requirements should regulators audit their company’s processes. This documentation includes the ongoing monitoring of specific supply chain requirements, insights on the exact steps the company should take for assessing ESG risks related to reputation or compliance issues, how and when the organization responds to issues that arise and what best practices the business has put in place to prevent similar issues from happening in the future.
Become More Agile
Once existing gaps have been identified and addressed, companies can begin managing risk in the supply chain. Each business is different, and priorities will inevitably shift over time. Therefore, it is essential that businesses have dynamic solutions in place that will allow them to establish a measurable strategy that can quickly adapt to protect their capital base, earnings and reputation while also allowing them to continue grow and create a competitive advantage. It is no longer good enough for compliance risk strategies to rely on intuition, static information and best guesses.
With a growing number of regulatory requirements, ESG-risk is only going to become a bigger challenge in the years ahead. However, by keeping these few key priorities in mind, organizations can build a new level of ESG performance in their supply chains that ensures compliance while also driving business success.
