Analysis

ESG Insights: Supply Chains

The coronavirus pandemic has placed an unprecedented spotlight on supply chains; they are now a dominating feature on every news page, press release and regulatory announcement. It is easily the most common challenge on which we have been advising our clients for at least the last six months. With the knock-on impacts of Brexit, the Suez Canal blockage and of course COVID-19 persisting, it seems inevitable that risk managers will continue to sweat over supply chain bottlenecks and breakdowns for many months to come.

When scrutinising supply chains through an ESG lens, management teams must look beyond pandemic considerations. While companies continue to respond to COVID-19 using expanded inventories, contract extensions or onshoring, the pressures upon international logistics have masked the growing impact of climate change on supply chain networks.

Weathering disruption

Climate change is already impacting corporate profitability. Extreme weather has cost Europe approximately €500bn over the past 40 years, and last year was a major factor behind the power outages experienced by a whopping c.4% of the world’s population (c.350 million people). This year carries the burdens of increasing agricultural commodity prices and materials shortages due to the sheer magnitude of these events in 2021, the second-most costly year on record for the world’s insurers after “hurricane-riddled” 2017. As the director of the Sustainability Initiative at MIT told Bloomberg last month:

“It’s not the next big supply chain crisis. It’s the next big supply chain crises, plural.”

Supply chain vulnerability to climate change is not new, but greater awareness of the problem is. Last summer, the UK government’s Climate Change Committee concluded in their climate risk assessment that “enhancing supply chain resilience should be a priority for post-COVID recovery planning”, and a recent government report said that “more will be required in the next eighteen months to address this complex risk area”.

Yet complacency on this issue persists. Findings published by AXA Climate in December revealed that 40% of risk managers felt their organisation did not have a climate risk governance mechanism in place. Conclusions from KPMG’s recent report on global manufacturing suggested that, despite 68% of CEOs saying they will ensure their supply chains are resilient, they “may not yet have grasped that the goals of digital transformation and ESG are both consistent and work powerfully together [to] mitigate supply chain risk and enhance sustainability”.

Climate risk visibility

Climate change creates not just greater risk but greater uncertainty. As the on-demand global economy recalibrates to a more robust set of logistical networks, businesses have the opportunity to integrate supply chain climate adaptation. In the past, risk managers have relied on historical data to inform their decision-making. However, we do not know with any precision how severe climate fluctuations will become as the rate of change accelerates; historical observations are less useful for accurately informing future risk. Speaking to Michael Gloor, CEO of climate risk analytics firm Correntics, what is needed is a forward-looking approach:

“Due to the complexity of global supply chains, climate risk transparency requires more and more of a software and data-driven approach… we need to focus on key resilience issues in a company’s value chain and to identify the adaptation measures with the best cost-benefit ratios.”

The recently published annual Carbon Disclosure Project report shed grim light on the state of climate risk adaptability and transparency. For example, approximately 63% of suppliers reported that they continue to source commodities from countries with a high deforestation risk and, despite expectations that the gap between global demand and supplies of fresh water will reach 40% in less than a decade, two thirds of suppliers failed to reduce their water withdrawals from water-stressed areas. The most frequently reported water risks were flooding and increased water scarcity, yet only 13% of suppliers confirmed that they have procedures in place for identifying and assessing water-related risks that fully cover their supply chains.

For business, these risks and uncertainties could have serious consequences. They increase the likelihood of food poverty, drought, wildfires and flooding disrupting supply chains, problems which will likely get worse as climate conditions deteriorate. In financial terms alone, the CDP concluded that environmental supply chain disruption will cost companies $120 billion within the next five years.

Supply change

Environmental issues are interconnected. Social governance objectives for your supply chain better insulate stakeholders from the physical risks posed by disruptive weather. Safe working conditions and longer-term relationships with partners and employees can stimulate sustainable practises that make the sourcing of raw materials less susceptible to extreme events, while improving visibility over the composite parts of your product pipeline.

It’s hard to ignore the irony that supply chains are both the most vulnerable pieces of the corporate jigsaw to the impacts of climate change and the most responsible for causing climate risk thanks to their carbon footprint (i.e. Scope 3 emissions). Whilst corporates are rightly focused on reducing these emissions, Scope 3 tunnel vision must not blind managers to the very real and escalating risks of climate disruption to suppliers, their employees, and the goods and raw materials fundamentally underpinning corporate growth.

As the KPMG report noted, businesses “won’t likely have a healthy supply chain if they don’t focus on ESG, and without a healthy supply chain, they will likely struggle to meet their long-term goals”. Having visibility on what’s happening is crucial to comprehending climate risks, and a company that is aware of its supply chain is better equipped to deal with them.

Recommendations

Focus on adaptability and resilience

Much of the impact of climate change is unpredictable. Avoid trying to calculate risks that are in fact unknowns. Build adaptability and resilience into your business and avoid dependency on risk models which can distort the sustainability of your value chain.

Improve visibility

Where possible, use a data-driven approach to improve visibility across your product pipelines and clearly communicate findings to stakeholders. Be prepared to leverage supplier relationships with those that fall short of the mark on sustainable sourcing. Incorporating AI and blockchain technologies can also help streamline your value chain and reduce your Scope 3 emissions footprint.

Embed ESG into your supply chain

ESG means little if it remains tucked away safely at HQ. A good place to start (or to benchmark against) is ‘’The Sustainable Procurement Pathway’, found on pages 23-27 of this CDP report; this is a comprehensive guide developed by the CDP to help organisations assess and improve the management of supply chain footprints.