Commentary

Confidence through Transparency

Ian Spaulding, CEO of LRQA, says digital tools and analytics can play a major role in improving investor oversight of ESG risks.

Last year we saw evidence that human rights and child labour issues are impacting supply chains operating in the US and Europe, as well as those based in developing nations. This exposed significant gaps in the way that organisations currently monitor, identify and address social violations in a rapidly changing risk landscape.

At the same time, the progression and enforcement of laws such as the US Uyghur Forced Labor Prevention Act and the EU Corporate Sustainability Reporting Directive (CSRD) are driving improved transparency on both human rights and carbon emissions throughout global supply chains.

These combined trends are making ESG reporting and disclosure integral to corporate governance. The good news, for responsible investors, is that improved digital tools and data management, including machine learning, are now enabling companies and regulators to consistently monitor, report on and mitigate these risks.

Three areas in which we expect to see the greatest gains in 2024: predictive supply chain mapping; traceability; and Scope 3 emissions tracking.

Supply chain mapping

Supply chain management has fundamentally changed in recent years, thanks to an increasingly complex operating landscape. Conflict, economic disruption and political uncertainty are forcing many companies to be more agile in the way they source goods and services.

Suppliers also find themselves under pressure to deliver, sometimes leading to corners being cut and standards dropping, at the expense of worker wellbeing. Many are small companies with low margins, struggling to make ends meet in a tough economic climate.

In this environment, companies and regulators must become increasingly vigilant. New approaches to auditing and inspection can increase visibility of supply chains and establish faster, more agile methods of ensuring control over quality and safety.

As processes and operations digitise, enabled by faster connectivity and the internet of things, the way we use data and machine learning to monitor, analyse and predict risk will become increasingly important. Data-enabled tools are now able to aggregate data on a regional and global scale, allowing for a more predictive approach to risk mapping: establishing where future risk is more likely to occur, and where it isn’t.

Such tools can also support supplier screening, which involves identifying any changes in supplier risk profiles, allowing for timely risk mitigation.

Traceability

Alongside these advantages, however, comes the need to ensure data is accurate and verifiable, as well as protected by cybersecurity maintained throughout the supply chain. This data can be verified against global standards, such as ISO 14064 and AA1000, and approved by schemes such as CDP, an independent not-for-profit organisation that runs a global disclosure system.

For predictive tools to be effective, a more collaborative approach to data sharing and verification must be fostered with suppliers, improving visibility and traceability.

The Global Trace Protocol Project seeks to address such challenges by increasing downstream tracing of goods made by child labour and forced labour. The project is designed to address the barriers created by complex, opaque and shifting supply chains, resulting in the development and sharing of open, accessible and replicable tools to improve traceability, visibility and due diligence.

Closing Scope 3 gaps

Innovations in supply chain data sharing will also help companies to address the forthcoming challenge of Scope 3 emissions reporting, as mandated in the EU’s CSRD legislation.

Most companies still have huge gaps in understanding their Scope 3 emissions. There is also a big knowledge gap at the supplier level.

Integrating carbon into existing responsible sourcing and compliance programs will create significant efficiencies in collecting and verifying this data. Suppliers will need awareness raising, training and incentives to understand what data is required and why.

As this comes together, we’ll hopefully see more banks and investors offering more sustainability linked loans to suppliers to support with emissions reductions. This has been challenging in the past as there is a data gap on emissions, or because data may be collected by businesses, but unverified by third parties. Credible data will be critical to giving investors greater confidence in future.

More frequent reporting

Whether monitoring for human rights risks in a rapidly shifting supplier landscape, or ensuring progress against carbon reduction targets, a greater frequency of reporting and disclosure would help companies, investors and regulators to identify, mitigate and address ESG risk before it impacts operations, reputations and business performance.

Digitised operations, improved upstream data sharing from suppliers and powerful analytics tools can allow for monthly, or even real-time monitoring by directors. To assist predictive risk management, more frequent public disclosures should also be encouraged – with companies reporting on risk more than just once a year and at least quarterly for their investors and on company websites.

Looking ahead

2024 is set to be a pivotal year for organisations globally to leverage innovation in data and analytics, to improve strategic decision making and build more resilient, sustainable, and socially responsible supply chains. For legislators, companies and their investors, ensuring that data is reliable, verifiable and consistently up to date will provide greater confidence in ESG standards in a rapidly shifting global landscape.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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