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How to Build ESG Into Your Supplier Risk Management Program
Supplier risk management (SRM) and environmental, social and governance (ESG) programs have become increasingly important to companies in recent years due to the growing complexity of supply chains and the heightened awareness of potential fallout from ESG issues in the supply chain.
This post defines SRM and ESG, examines how ESG influences supplier risk assessments, and discusses tips for incorporating ESG considerations into your SRM program.
What is Supplier Risk Management?
Supplier risk management, SRM, is the process of identifying, assessing and mitigating risks in a company’s supply chain. These risks can arise from various sources such as natural disasters, political instability, cyber threats, operational failures, and of course pandemics such as Covid 19. Companies must have effective SRM strategies to ensure that their supply chains are resilient and can withstand any physical or digital disruptions that may occur. Disruptions can cause significant financial losses, reputational damage, and legal liability.
What is ESG?
ESG, or environmental, social and governance, refers to a set of criteria that investors and stakeholders use to evaluate a company's impact on the environment, society and a company’s governance. In recent years, businesses have recognized the importance of ESG factors and the impact they can have on the bottom line.
How are SRM and ESG Related?
Overall, ESG factors are becoming an important consideration in an SRM strategy, and businesses that take a holistic approach to managing these risks can build more resilient, sustainable and responsible supply chains. ESG factors are directly related to SRM because they can impact a company's supply chain risk profile. For example:
- Environmental factors such as climate change and resource scarcity can impact the availability and cost of raw materials, transportation and energy.
- Social factors such as labor practices, human rights and community relations can impact a company's reputation and brand.
- Governance factors such as corruption, ethics and transparency can impact a company's legal and regulatory compliance.
By incorporating ESG factors into assessing supplier risks, businesses can identify and mitigate potential risks that can impact their supply chain operations. For example, a company that sources raw materials from a region with a high risk of climate-related disruptions may choose to diversify its suppliers to reduce its exposure to these risks. Similarly, a company that prioritizes ethical labor practices may choose to work with suppliers that have strong human rights policies.
Incorporating ESG factors into SRM can also have broader benefits for businesses. By addressing environmental and social concerns, companies can enhance their reputation, attract new customers, and improve their social license to operate. By prioritizing good governance, companies can reduce their legal and regulatory risks and improve their transparency and accountability.
Three Steps to Incorporate ESG into Your SRM Program
1. Focus on resilience
In the wake of the COVID-19 pandemic, many businesses have prioritized supply chain resilience. This involves building flexibility into supply chains, diversifying suppliers, investing in redundancy and backup systems, and developing contingency plans. If a supplier fails to live up to your company’s acceptable ESG thresholds, you must have the flexibility to change suppliers.
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2. Prepare for increasing disclosure and transparency requirements by assessing suppliers against sustainability and social measures
There is an increasing emphasis on disclosure and transparency in ESG risk management. Businesses are expected to disclose information about their ESG practices, risks and performance to stakeholders, including investors, customers and regulators. Transparency is becoming increasingly important as investors seek to make informed decisions about where to invest their money and as consumers demand more information about the companies they buy from as well as the third parties that they rely on.
Take climate change, for example. Recent regulatory reporting requirements, such as the European Union Corporate Sustainability Reporting Directive and the U.S. Securities and Exchange Commission, attest to its importance. Companies are likely to increase their efforts to mitigate the impact of climate change, such as reducing their greenhouse gas emissions, transitioning to renewable energy, and investing in climate adaptation measures – and reporting on progress.
Social issues, such as diversity, equity and inclusion (DEI), human rights, and labor practices, are also expected to receive greater regulatory emphasis in ESG risk management. Companies are likely to focus on improving their social performance, such as promoting diversity and inclusion in the workplace, and protecting human rights throughout their physical and logical supply chains. Regulations such as the EU Corporate Due Diligence Draft Directive and the Modern Slavery Act of 2015 have provisions requiring companies to attest to fair labor practices in their supplier chains.
Of course, don’t ignore cybersecurity. With more data being shared across supply chains, cybersecurity is becoming a major concern. Companies need to protect their own data and ensure that their suppliers are also taking adequate measures to secure their systems and data from compromise and/or disruption. The General Data Protection Regulation (GDPR) includes such provisions.
3. Consider how technology can automate ESG assessments and monitoring
Technology will play a significant role in ESG risk management in the future. Companies are likely to use technology to collect and analyze ESG data, monitor ESG risks, and identify opportunities. For example, predictive analytics will become more important in SRM as companies seek to identify and mitigate risks before they occur. Predictive analytics can be used to forecast risks based on historical data (such as ESG violations), identify emerging risks, and simulate the impact of potential disruptions. Other technologies such as blockchain are being used to enhance transparency and traceability in supply chains.
Next Steps: Download Our Seven Stages to a More Proactive Supplier Risk Management Program White Paper
ESG will become more closely integrated with supplier risk management (SRM) as companies seek to manage risks related to environmental and social issues in their supply chains. This will require companies to adopt a more holistic approach to supplier risk management that considers the broader impact of their operations on the environment and society.
To measure your current supplier risk management process against best practices, download Seven Stages to a More Proactive Supplier Risk Management Program or request a demo today.
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