Anahita Thoms has spent years cautioning clients about the dangers of not doing due diligence on suppliers. Her efforts are finally paying off.
“We’ve seen double the amount of interest in this topic in the past two years than we did the previous five,” says the lawyer who runs Baker McKenzie’s international trade practice in Germany. “It’s not just about the legal risk, but the commercial and reputational risk.”
After years of neglect, companies and their investors are now having to ask more awkward questions about their suppliers — addressing what Nikolai Badenhoop, a fellow at the European University Institute, describes in a recent paper as “a blind spot of the green finance debate”.
The answers, however, are often difficult to come by.
To properly address supply-chain risk, companies need information about the carbon footprints, biodiversity impacts, and working conditions of suppliers which, for a big multinational, can number in the “tens of thousands” according to Thoms. They will often be based in parts of the world where information may be scant, and labour and environmental laws far removed from European standards.
Marie Navarre, head of sustainable research at Allianz Global Investors, thinks events such as the Covid pandemic and Russia’s invasion of Ukraine revealed how woefully unprepared the corporate world was for a big supply chain shock — but may, in turn, help address some of the information gaps.
Shortfalls in the just-in-time model, where supply chains have to be as efficient as possible in terms of delivery times and cost — often regardless of the political, social and environmental risks — are now clear for all to see.
“These two events have properly tested the supply chains of many companies and sectors for the first time, prompting significant expansion of the depth and breadth of internal and external supply chain audits,” Navarre says. “The measurability of supply chains has developed significantly in the last two years and [that] will continue.”
Along with law firms, the Big Four accounting firms, tech firms, and rating agencies offer advice to those wanting to invest in companies with greener supply chains. Navarre’s team uses data from analytics firms such as MSCI, Sustainalytics, Moody’s-Vigeo, ISS ESG, S&P Global Trucost and RepRisk to accompany its own research. “We use multiple providers since each tends to have specific areas of strength,” Navarre said. “The data is diverse and [offers] different coverage.”
The onus on European firms to invest more time and resources into supply chain due diligence will rise as the continent’s lawmakers — who have increasingly led the way on setting rules to bring about a greener economy — look to raise standards.
In Germany, a new supply chain law comes into force at the start of next year. Companies with at least 3,000 workers must put in place systems to check whether or not their suppliers are abusing human rights, at the risk of fines of up to €8mn or 2 per cent of annual global turnover.
“The authorities will want to know if you’ve acted on red flags,” says Thoms. “If one of your suppliers is in Bangladesh, for instance, and you are a clothing manufacturer, you are expected to ask more questions than if you’ve been working for the past years with a reputable business in Japan.”
Brussels is also working on a corporate sustainability due diligence directive. This would require any EU business with more than 500 employees and a global turnover of €150mn to come up with a strategy to manage environmental and human rights standards across their supply chains, and ensure their business model is compatible with the limiting of global warming to 1.5C, in line with the Paris Agreement.
While the US has legislation requiring companies based there to ensure their suppliers do not use forced labour, the measures taken by European lawmakers are pioneering in their scope.
Once the EU’s proposal is finalised — something that is expected to occur in 2023 — and becomes an EU act, the next step is for each member state not only to pass the legislation nationally, but also to task an official body with monitoring compliance.
Badenhoop believes the EU directive will help place supply chains “front and centre” of the green finance debate — and could have an impact far beyond Europe.
The prevalence of mobile phones may also make data easier to come by, meaning “information about supply chains can be gathered quickly and to an arguably higher standard,” says Tom Adams, co-founder of data firm 60 Decibels.
However, Thoms says the capacity to compile and analyse data is still not good enough. “When it comes to due diligence, we need better digital tools to manage it.”