ESG and the Sustainable Economy - The Ethical Supply Chain
In recent years, supply chain risk management has received more attention in the context of investing with a focus on ESG and the sustainable economy. Specifically, efforts to address social issues, such as modern slavery and human rights abuses, in global supply chains have been prominent, both as a means of mitigating risk and as a proactive way to enhance brand reputation. Driving forces behind these efforts include consumers, shareholders, non-governmental organizations, and other advocacy groups calling for action.
Jurisdictions around the world have enacted or proposed legislation requiring companies to disclose their risks, policies, and proactive steps relating to modern slavery, such as forced labor and child labor, in their supply chains. Two types of legislation are emerging. The first type is disclosure-based requirements, essentially requiring companies to publish statements identifying what actions, if any, they are taking to address modern slavery in their supply chains. Examples of this type of legislation include the California Transparency in Supply Chains Act and the United Kingdom’s Modern Slavery Act. The second type of legislation goes further and imposes an obligation on companies to engage in human rights diligence in their supply chains. France’s duty of vigilance law and the Netherlands’ child labor diligence law are good examples.
However, legislation is only as good as the enforcement mechanisms that uphold it. While earlier laws lacked meaningful enforcement mechanisms, relying largely on naming-and-shaming lists and public image-related motivation as incentives for companies to take action, more recent legislation has included stronger penalty provisions, including the potential for civil fines, criminal sanctions, and disqualification of directors. For example, the New South Wales (Australia) Modern Slavery Act provides for financial penalties up to AU $1.1 million.
Litigation is also a business risk for companies that fail to meet established standards. Consumer class actions, human rights litigation by victims, and suits to enforce compliance with modern slavery and disclosure laws have become increasingly common. Higher insurance premiums, supply chain disruption, and related business continuity issues are additional tools to exert pressure that may be available in some jurisdictions. In the United States, goods produced with child labor or without payment of minimum wages can be enjoined from shipment under the Fair Labor Standards Act, and goods being imported to the country can be held at the border if they were produced with forced or child labor. These real business risks can have a meaningful financial impact on a non-compliant company when enforcement measures are taken.
It is challenging to determine how to assess these risks and the adequacy of measures companies are taking to prevent them. Without a uniform standard or set of criteria to consider, companies, investors, and fund managers are left to create their own policies and investment criteria relating to ESG matters and the sustainable economy. While the consequences of failing to meet any one stakeholder’s criteria may result in reputational and some commercial damage to a company, one stakeholder’s requirements are generally not enough to persuade a critical mass of supply chain participants to open up their activities for scrutiny, let alone change their operations. Thus, reliable, broadly applicable metrics for detecting and reporting supply chain risks are necessary to have a material impact. Corporate pressure in this area has been building, and we anticipate that it will increase in coming years, particularly as technology solutions, such as blockchain for tracking supply chain actions, become more broadly available.