Q&A: The Future of Supply Chain Risks Beyond Climate

What are the most prevalent risks that are emerging within supply chains, and how can we measure these?

The financial industry has been zeroing in the DNA of global supply chains beyond critical suppliers. Increasingly, mapping the full spectrum of cross-border relationships has captured information gaps beyond the traditional KYC assessments. In fact, the depth of today’s supplier relationships is as such that it can help define the economic and societal importance of trade in every intermediate jurisdiction it touches, beyond the place where the final good originates from before reaching the consumer. Let’s not forget that over 70% of international trade relies on global value chains connecting raw materials, parts and other components with servicers across the globe. The viability and resilience of each participant in the web of trade relationships is economically important in ensuring that the delivery of the final product takes place as expected by the consumer. The OECD initiative on global value chains (GVCs) describes it quite nicely: “Think for example of a smart phone assembled in China might include graphic design elements from the United States, computer code from France, silicone chips from Singapore, and precious metals from Bolivia. Throughout this process, all countries involved retain some value and benefit from the export of the final product. But much of this value added throughout the international supply chain is invisible in traditional trade statistics, which attribute the full value of a good or service to the last country in the chain that finalised production.”

When we start positioning supply chains as part of GVCs, three emergency risk categories are likely to emerge:

1. Hyperactive ecosystem. There is an increasing number of organizations that offer niche transparency and traceability services for supply chains across virtually any geography and any sector of the economy. Nevertheless, historically traceability vendors have been focused on specific industries and replicating the same successes to other product or service categories poses some challenges. Comparability of offerings in terms of value add to existing product platforms may come under pressure.

2. Advances in digital technologies aligned with the EU Digital Product Passport (DPP) directive. Regulatory action on DPPs have created a healthy opportunity for new solutions to be brought to market over the next two years. As we have seen with other digital technologies, the problems caused by the lack of interoperability of tools – in software and infrastructure terms – calls for a more in-depth due diligence with respect to the product and supplier data being captured and made available to the public. It also reflects the inevitable organizational cost of switching from a vendor to another, and that the perceived value that largest providers in the supply chains analytics ecosystem may be able to capture as they are willing to invest larger pockets of capital in meeting reporting requirements across jurisdictions.

3. Localized tools for global networks. The OECD Due Diligence Guidance for Responsible Business Conduct adopted in 2018 provides a common framework for multinational and government entities to promote transparency on environmental and social governance considerations when it comes to assessing responsible business conduct. The reality is that the most basic EH&S (environmental, health and safety) standards are not the same across industries and geographies and risk to further penalize supply chains in emerging market economies where, for example, the dialogue and acceptance of business practices in labour markets is set by local customs that are not easily translated in more standardized processes.

In light of recent global events, how are sanctions impacting supply chains?

One data point is quite clear: the World Bank expects 1% of global GDP to be affected by sanctions. Despite the deteriorating macroeconomic environment exacerbated by the COVID crisis, sanctions have contributed directly to keeping fuel prices elevated, to ongoing supply shortages of basic goods, to ongoing logistical challenges in key transportation hubs and millions in lost revenues for many commercial businesses. These are just a few of the unintended, multi-lateral consequences that economic and trade systems designed in bilateral terms yield.

Usually bucketed as legal and reputational risks, sanctions have been historically positioned as bilateral enforcement actions and therefore treated as a matter of compliance with the terms outlined in the sanction with respect to all people and all entities involved. They may affect existing commercial arrangements as well as the unwinding of transactions. They are not designed with a GVC framework in mind. For that reason, they lack the power to systematically affect supply chains within a specified timeframe. The recent sanctions as a result of the Ukraine-Russia unrest took months to ripple through international supply chains beyond the energy and agricultural commodities market. Their primary, lasting impact is the likely switch in the direction of consumption and the rebuilding of more diversified procurement cycles. As the Association of Supply Management puts it “ Approximately 90% - 95% of some product SKUs, are directly sourced from one country”. Therefore, it’s easy to see how sanctions are likely to populate numerous scenario tools in the strategic planning of organizations as they will continue to promote the development of a more localized, geographically closer web of relationships with the purpose of preserving the quality of goods offered in the domestic marketplace.

What jurisdictional and cultural disparities do we see within global supply chains? How can we manage these?

Financial institutions have experienced quite a number of jurisdictional and cultural hurdles in addressing issues as simple as reporting frameworks for GHG emissions and GHG accounting standards. PCAF (The Partnership for Carbon Accounting Financials) is the only industry effort where I have seen a more proactive approach by its 340+ member organizations to develop a common body of knowledge on carbon emissions from the lens of financial entities. For example, on the topic of financed emissions or insurance-associated emissions and capital markets facilitated emissions. The 2nd Edition of the Standard will be disclosed in early December and is set to include new GHG accounting and reporting methodologies ranging from sovereign bonds to emission removals as well as the concept of insurance-associated emissions.

Beyond compliance with this type of reporting standards and the extent of the “greenwashing” allegations that may emerge from it in a few years, the roll out of new digital technologies may leave behind product categories where transparent procurement practices may not be verifiable. That’s where the most challenging cultural disparity I see emerging could end up playing the largest role: policy making in support of transparent procurement decisions.

How does GHG reporting incorporate human rights considerations and other social impacts?

I wish there was a straightforward answer to that. While due diligence efforts surrounding human rights abuses are well established, GHG reporting will need to incorporate a wider set of health and safety standards. For example, the linkages between the climate change and biodiversity continue to find the support of new scientific evidence. The step between that evidence and public dissemination of product-level information regarding environmental degradation of natural ecosystems on human health may be stalled by commercial anxieties and litigation fears.

This article first appeared in the CeFPRo Connect Insights (December 2022) and reflects the author's remarks for the ESG Congress USA. The platform aims to connect industry experts through thought leadership content and timely news content. Center for Financial Professionals (CeFPro) Connect members will have unlimited access to CeFPro's unparalleled library of resources, including: iNFRont Magazine; Research reports; Filmed presentations; Insights and much more.