Corporate sustainability challenges across the global supply chain

Environmental, social, and governance (ESG) disclosure requirements are changing around the world. Governments and regulatory authorities are tightening up existing compliance requirements and releasing new mandatory regulations to ensure companies understand their obligations with respect to environmental and social issues. Companies are having to report the impact of their actions — not just for the operations under their control, but also across the global supply chain. 

The problem is that reporting on these issues is by no means simple. Let’s delve into the details to see what challenges ESG reporting poses for organizations around the world.

Changing ESG requirements: Emissions disclosures

Environmental issues are front of mind within the ESG landscape — and for many businesses, that typically means carbon emissions. Supply chain emissions include emissions from the upstream and downstream value chains. Companies are becoming obliged to disclose emissions throughout their supply chains. For industrial manufacturing companies especially, these changes are critical in terms of climate-related disclosures. Authorities around the world are strengthening climate change-related disclosure requirements and mandating companies report on direct and indirect emissions.  

The Environmental Protection Agency (EPA) defines ‘indirect’ (Scope 3) emissions as those resulting from the activities of assets not owned or controlled by the reporting organization but that the organization indirectly affects in its value chain. Scope 3 emissions include all sources not within an organization’s Scope 1 and 2 boundaries. Identifying and calculating emissions from all three scopes is critical in measuring companies’ carbon footprints. Many industries and sectors will soon be increasingly subject to these climate change obligations and Scope 3 emissions requirements. The long-promised US Securities and Exchange Commission’s (SEC) climate-related rule proposal will require all publicly listed companies to report Scope 3 emissions as part of their annual financial disclosures. Industrial manufacturers, along with other companies within their scope, will have to disclose emissions throughout the supply chain, including those occurring for each product’s lifecycle. The proposed rule is unclear as to how companies should collect, analyze, and report data from third parties with any degree of accuracy. However, if enacted, these disclosures must be submitted along with additional environmental and financial information at the end of the financial year. It’s highly likely that this will be difficult to report in time because of the inherent complexities of gathering the required data.  

The European Union’s (EU) Corporate Sustainability Reporting Directive (CSRD) requires companies within its mandated scope to report Scope 3 emissions from 2025. These emissions include eight types of upstream emissions and seven downstream emissions. 

• Upstream emission examples: Purchased goods, services, and business travels, capital goods, fuel. 
• Downstream emission examples: Processing of sold products, and transportation and distribution. 

The European Sustainability Reporting Standards (ESRS) adopted ESRS E1, Climate Change Reporting Standards on 31 July 2023. These standards contain requirements and guidance on how and what to report. 

A critical reception: Issues with ESG disclosure — and some possible solutions

In both the US and the EU, sustainability and ESG disclosure proposals have been criticized in some quarters. Issues such as the volume of data to report, data complexity, and ill-defined methodologies have all been raised. Some companies are finding it extremely complicated to set up emissions targets across the entire supply chain system. Even those companies who are already reporting some of this information may need more time to be ready for mandatory disclosure. 

It’s important to note that the indirect emissions of one company are the direct emissions of another. These requirements incentivize companies to select business partners carefully and be clear about what information they’ll require from them. Companies may need external technical help and ensure sufficient internal resources are available to assess their supply chain. This could also be an opportunity to evaluate and switch to lower-emission options.  

Companies must focus on strategic approaches and be vigilant about developments related to Scope 3 emissions. As reporting and emission-reducing requirements are expected to become more stringent in future, supply chain partners will need to work together to determine the best emission reduction avenues and proactively establish sustainable supply chains.

The S of ESG: Social disclosures and supply chain practices

Supply chain practices that focus on social issues are also subject to increasing sustainability and ESG disclosures around the world. There’s a growing understanding that the production or distribution of products used in one part of the world could have a significant social impact or violate human rights elsewhere. In addition to determining the impact of products within the organization, responsible corporate behavior will be required throughout the global supply chain. 

It’s always been challenging for companies to ensure due diligence in their supply chain – including industrial manufacturers. It takes a lot of monitoring and resources to verify that suppliers are meeting regulations and best practices related to human rights or environmental concerns, especially regarding second- or third-tier suppliers. For example, the use of child labor is explicitly banned in most jurisdictions, however there are still concerns in certain geographies and sectors that these practices may not have been eradicated. Similarly, the issue of water pollution is among the chief concerns linked to health issues in India, it’s believed that a significant amount of this pollution is due to industrial practices.  Collecting data and exercising transparency throughout the supply chain will go a long way to making these issues more identifiable, visible, and open to scrutiny, even though there may be difficulties to begin with as these requirements take time to become more established.  

Just as with environmental issues, there are now also disclosure reporting requirements for social issues. The EU’s proposed Corporate Sustainability Due Diligence Directive will require companies to manage both the social and environmental impacts of their supply chains. The proposal suggests that companies with over 500 employees and worldwide revenues exceeding 150 million Euros, and high-impact companies with 250 employees and worldwide revenues of over 40 million euros should be subject to sustainability disclosures under this directive. This is perhaps best viewed as an opportunity for companies to prevent, mitigate, and begin to eradicate practices within the supply chain that violate human rights, such as employment of child labor, or pollution that affects the health of people in the vicinity.

Delivering better ESG management and sustainability

Compliance with legislation relating to sustainability and ESG issues is measured by the transparency, depth, and detail of information disclosed. The general message on both environmental and social issues is that companies will need to focus on efficient data collection throughout the supply chain, keeping in mind that they’ll now need to have their data and reporting independently assured. Companies will need to review their due diligence procedures, establish policies, re-evaluate suppliers, implement monitoring systems, and maybe even find alternate suppliers who mirror their objectives. As well as focusing on the risks, companies now have the opportunity to align their operations with their sustainability goals.