The importance of the supply chain in the ESG impact

Supply chains are increasingly under the focus of environmental, social, and governance policymakers. And rightly so, as they represent a large part of a company’s impact on ESG.

On average, supply chains account for about 41% of a company’s impact. However, the proportion rises to 59% in the case of a company’s adverse environmental impact, according to the study conducted by Scope, which analyzed 1,600 companies in the MSCI World index.

Popular pressure, concern among legislators and regulators, and investor demand create a virtuous circle for supply chains to be put at the front and center of any assessment of the sustainability of companies.

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ESG impacts in Germany

An example of this is Germany, where the government is considering a bill that would commit medium and large enterprises to regularly monitor and report on the ESG impacts of their supply chains. 

This is the latest sign of growing concern in Europe about the environmental and social impacts of companies beyond their own activities. France’s Duty of Care Act (2017) and the Netherlands’ Child Labor Due Diligence Act (2019) were the first pieces of European legislation to oblige companies to consider and report on environmental and/or social standards at suppliers. However, the impact of any new supply chain legislation on companies will be uneven for two main reasons.

Differences by sector

ESG impacts on the supply chain vary greatly across sectors. Supply chains in the food sector account for 88% of ESG impacts, compared to only a small impact on services and mining. In addition, the more complex the supply chain, the more difficult it is for the end producer to track greenhouse gas impacts through raw material suppliers. 

To take, in the case of the German MSCI companies, the ESG supply chain impacts are very relevant for engineering and automotive companies like GEA Group and Volkswagen, but much less so for a service company like SAP.

The stakes for all companies are high for two reasons. First, the German bill proposes fines for non-compliance. Second, investor demand for truly sustainable investment opportunities – assets managed in funds that follow ESG criteria currently exceed $1 trillion in the US – will help companies that demonstrate sustainable, low-impact supply chains to attract new capital.

How the new ESG legislation will affect companies will vary considerably, even if only the so-called ‘bottom-up’ supply chain is considered (the way a company manufactures its products and services) which is the focus of this analysis.

Some companies get little added value from suppliers, which ensures that the ESG impact is low. Others rely heavily on products manufactured by external suppliers. Even a company that requires a limited number of inputs from external suppliers may depend on an intermediate product that is loaded with ESG risks. The complexity of the supply chain is also relevant. The more steps involved in a supply chain, the more difficult it is for the end producer to track the impact of the raw material.

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(Featured image by Domenik Kowalewski via Unsplash)

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First published in Funds&MARKETS, a third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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