Supply chain risk management and assurance are critical to identify and reduce risks and protect companies from legal and reputational harm.

By Sara K. Orr, Kristina S. Wyatt, and Julia S. Waterhous

Potential environmental, social, and governance (ESG) issues posed by suppliers in increasingly complex supply chains can increase reputational risks to an organization. Corporate supply chains generally include every company that comes into contact with a particular product or service. In other words, the “supply chain” refers to the series of steps and processes involved in the production and/or distribution of goods and services. This can include direct and indirect suppliers, manufacturers, distributors, and retailers, and may involve companies and individuals all over the world.

As Latham & Watkins Counsel Sara Orr discussed at the 2019 Sustainability Investment Leadership Council Conference, many ESG factors can impact corporate supply chains, including environmental practices, energy usage, social responsibility, human rights, child labor, trade security, anti-bribery, health and safety, conflict minerals, and product quality assurance. Risks might impact companies across industries and geographies, or they might be industry- or country-specific. For example, unsafe working conditions and forced labor may be found in many industries, but food security fraud — i.e., the deliberate mislabeling of food products — is unique to the food industry.

Legal Requirements in the United States

Certain legal mechanisms attempt to apply governance principles to address supply chain risks. In the United States, legal requirements generally are limited to disclosure obligations. However, interest in ESG is growing, as demonstrated by the 2010 “conflict minerals” provision set forth in Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The provision requires certain companies to conduct due diligence into the source and chain of custody of specified minerals to determine if the minerals originated from the Democratic Republic of the Congo or a surrounding area. Impacted companies are required to file a Conflict Minerals Report with the Securities and Exchange Commission. As another example, the California legislature passed the California Transparency in Supply Chains Act of 2010 (SB 657) to combat slavery and human trafficking in supply chains. The law requires certain companies to publicly disclose what steps they are taking to prevent such abuses in their supply chains, in an effort to help consumers make more informed purchasing decisions.

Legal Requirements Worldwide

Concerns over ESG supply chain issues are trending globally, and jurisdictions outside the United States have even more stringent disclosure policies. For example, the European Union requires companies based in the EU with more than 500 employees to disclose corporate policies on environmental and social issues, including due diligence processes on relevant supply chains in order to identify, prevent, and mitigate existing and potential risks. In 2017, France enacted a law requiring certain large companies to establish and implement a plan for conducting ESG diligence in their supply chains. China, too, recently mandated ESG disclosure obligations.

Private Compliance Mechanisms

In addition to legal compliance mechanisms, private environmental governance has also emerged as a distinct driver of supply chain management. For example, some large retailers require their suppliers to meet ESG metrics to address human rights and social sustainability issues, among others, by using their own sets of standards and conducting supplier audits. And some corporate industry groups set supply chain standards that go beyond the applicable legal requirements.

Conclusion

By addressing non-conformities, corporations can build supply chain resiliency. A recent study found that corporations that implement ESG changes in their supply chains — including those that strive to meet or exceed industry sustainability standards in order to win business — receive economic benefits. Best practices for ESG-specific supply chain auditing and management include reviewing the state of supplier contracts, scorecards, and audits. Companies should also identify sustainability risks specific to particular countries, sectors, and products to inform their development of ethical sourcing strategies. Finally, companies should stay abreast of legal and regulatory developments that may pose more stringent disclosure requirements or other actions.

Latham will continue to monitor developments in this area.