Organizations have been feeling pressure from investors, consumers and other stakeholders to embrace sustainable business practices and focus on environmental, social and governance (ESG) issues for some time. And although ESG issues are not yet a reporting requirement, there are signs that this is changing. In February this year, the Securities and Exchange Commission (SEC) in the U.S. appointed a Senior Policy Advisor for Climate and ESG. In March, the SEC announced creation of a Climate and ESG Task Force in its Division of Enforcement. The task force will develop initiatives to identify ESG-related misconduct. In May, U.S. Senators Tina Smith and Patty Murray and Representative Suzan DelBene introduced a bill to clarify that retirement plans can consider ESG factors in investment decisions. Meanwhile, in the European Union, Sustainable Finance Disclosure Regulation went into effect in March.
Regulation will likely bring similar rigor to ESG reporting as Sarbanes-Oxley legislation (SOX) brought to financial reporting. A variety of frameworks for scoring ESG performance already exist, including those provided by the Global Reporting Initiative, the United Nations’ Sustainable Development Goals and the Sustainability Accounting Standards Board. Even while regulations and reporting expectations are still taking shape, organizations and their suppliers are jumping on the ESG bandwagon and preparing to comply with stakeholder demands, even absent current regulatory imperatives.
Supply chain ESG in earnest
Supply chain sustainability is critical as organizations take a look at their ESG practices and reporting and as authorities move toward ESG regulation. With an interest in how goods are made, packaged and distributed, stakeholder perceptions extend beyond organizational boundaries to include suppliers, contractors and other third parties. In fact, ESG considerations such as origin of raw materials, waste management, energy consumption, diversity and inclusion, and fair pay are mainly supplier-related for many organizations.
Most businesses don’t yet have measurable, auditable and reportable ESG company data that regulations will likely require, and have even less data about their suppliers. Even purchasing organizations that do consider sustainability might not have built formal sustainable sourcing criteria into their sourcing decisions and are likely not tracking suppliers’ ESG performance over time. They may be missing out on the opportunity to capitalize on the benefits that should come from these ESG activities being reported.
Until recently, ESG reporting often originated from corporate communications or investor relations. With formal regulation widely anticipated, finance functions will want to take a leadership position in ESG reporting and work with their procurement counterparts to determine material issues stemming from the supply chain and vendor ecosystem. Beyond company ESG scores, suppliers’ ESG score can have important downstream effects on the financial condition and operating performance of the company.
Of course, where suppliers are concerned, ESG requirements must be balanced with central questions about cost and availability of supply. But many organizations already consider the “intangible” factors in their third-party risk management, such as business ethics, anti-competitive practices, labor practices, diversity and pay. It is possible to adjust sourcing, vendor management and third-party risk management practices to address suppliers’ ESG performance risks by (1) formally building sustainable sourcing criteria into sourcing decisions, (2) considering whether technology could support ongoing management of suppliers’ ESG information, and (3) asking new and existing suppliers questions about their own ESG programs, such as:
- Do they monitor ESG performance and report on it? Where does their data originate and what internal controls ensure its reliability?
- Have they adopted an ESG scoring framework?
- Does the quality of their ESG reporting align with the purchasing organization’s ESG reporting?
- Does the supplier focus on ESG reporting as a check-box exercise, or is it integrated with their corporate strategy?
- If a supplier doesn’t issue ESG reports, are there competitors that do?
It is not too early for CFOs and purchasing organizations to prepare to report on the ESG impacts of their suppliers’ practices. Setting up an ESG reporting structure (modeled on the financial reporting structure) will foster positive change in the provision of goods and services. There will be those organizations that see ESG reporting as a box to check to meet a compliance obligation. And there will be those who recognize that sustainable practices translate into reliable revenue streams and superior employee and customer retention. Enhanced transparency about ESG throughout the supply chain encourages organizational maturity – including maturity in sourcing, vendor management and third-party risk management practices.
It is not too early to register for our upcoming webinar, “Leveraging ESG Principles to Build a Sustainable Supply Chain,” part of Protiviti’s ESG webinar series. To reserve a space, click here.