The Devil is in the Supply Chain

ESG analysis focuses on a wide range of issues of varying importance to investors. Many of these can be directly assessed from the company’s reports and other direct sources. Perhaps the hardest to assess however is the supply chain. In this area companies are expected to apply sufficient resources to monitor their suppliers and the contractors that they use. Historically, the focus of supply chain and procurement has been on technical quality, cost effectiveness, speed of delivery and reliability, all of which are easily monitored by managers.

Tough to manage

It is not difficult to imagine why some companies struggle with this area of governance. Supply chains can be highly complex. They can be several layers deep and involve many countries. They often encompass developing countries that have looser legal requirements, poor enforcement of regulations and different values. It may not be easy to influence the actions of a particular supplier. The different pieces of supply chains are often highly synchronised. Companies are of course highly switched on to the financial risk of disruption to their supplies. Indeed, the complex series of relationships that comprise the value chain might be impossible to change substantially in the near term.

 What are the benefits?

There are all manner of reasons for companies to be proactive in managing ESG risks in their supply chains:

·         Protecting business continuity by avoiding shutdowns, contract breaches, legal jeopardy

·         Deepening working relationships increases confidence and trust in partnerships

·         Increased stakeholder confidence

·         Greater adaptivity to changes in regulations

·         Protecting the social license to operate where ESG scrutiny is important

So why wouldn’t you?

Clearly, business managers are under considerable pressure to address a myriad of ESG issues whilst at the same time having to deal with other management responsibilities. It is easy to imagine a manager who, incentivised by annual earnings targets, might be distracted away from complicated and difficult issues that seem likely to reduce profits. Further, it is difficult for investors to know with certainty what is going on. They can be heavily reliant on general assessment of industry-wide risks and managements own commentary. In the absence of laser scrutiny, it can be tempting to leave uncomfortable facts in the dark.

Act now or repent at leisure

In the current environment companies need to recognise that ESG issues in the supply chain now represent a considerable financial risk if mishandled. Furthermore, if unethical savings are being made that are fundamental to the business plan then it is probably best to address them now rather than waiting for the inevitable public scrutiny.

If you would like to know more about our Responsible Investment service, please contact Chris Redman at 0203 750 1810.

Chris Redman, Chartered FCSI

Investment Director and Head of Responsible Investments - 8th October 2020