Environmental, social and governance risks (“ESG risks”) have been on the rise in recent years. In fact, a 2015 study by the World Economic Forum found that nearly two-thirds of respondents believe that overlooked ESG risks are a major threat to global economic stability.
So, what exactly are ESG risks? They can be broadly defined as any risks that arise from environmental, social or governance issues. These issues can include climate change, human rights abuses, corruption and bribery.
ESG risks are often seen as “non-financial” risks, but they can have a significant financial impact on companies. For example, if a company is found to be using child labor in its supply chain, it could face significant reputational damage — which could lead to a loss in customers and revenue.
Fortunately, there are steps that companies can take to reduce their exposure to ESG risks. In this blog post, we’ll discuss three specific ways to reduce ESG risks for vendors and suppliers.
Perform Thorough Due Diligence On Prospective Vendors And Suppliers
The first step in reducing ESG risks is to perform due diligence on prospective vendors and suppliers. This due diligence should go beyond simply checking references — it should also include research into the vendor’s or supplier’s business practices.
For example, if you’re considering doing business with a supplier that sources materials from Africa, you would want to research whether or not that supplier has been accused of participating in human rights abuses. If you find that the supplier has been accused of such abuses, you would then want to consider whether or not the supplier has taken steps to address those concerns.
If you’re unable to get comfortable with a prospective vendor or supplier’s business practices, it’s probably best to move on to another option.
Implement Strong Contractual Protections
Once you’ve selected a vendor or supplier, it’s important to put strong contractual protections in place. These contractual protections should minimize your exposure to ESG risks. Some of the contractual protections that you may want to consider include:
- A “no tolerance” policy for child labor or forced labor
- A requirement that the vendor or supplier comply with all applicable environmental laws and regulations
- A requirement that the vendor or supplier establish and maintain an anti-corruption compliance program; and/or
- A requirement that the vendor or supplier establish and maintain procedures for identifying and managing conflicts of interest
Regularly Monitor The Vendor Or Supplier Relationship
Once you have contractual protections in place, it’s important to regularly monitor the relationship with your vendor or supplier to ensure that those contractual protections are being honored. Monitoring can be done either internally or externally — but it should be done on a regular basis. Some things that you may want to look for when monitoring the relationship include:
- Changes in ownership or management of the vendor or supplier
- Changes in the vendor or supplier’s corporate structure
- Changes in the vendor or supplier’s business model
- Negative media reports about the vendor or supplier
- Rumors about potential problems at the vendor or supplier; and/or
- Changes in the behavior of employees at the vendor or supplier (e.g., increased absenteeism)
If you notice any of these changes, it may be indicative of larger problems at the vendor or supplier — which could put your company at risk. As such, any changes should be investigated immediately.
ESG risks are real and they can have a significant financial impact on companies. Fortunately, there are steps that companies can take to reduce their exposure to these risks — including performing due diligence on prospective vendors and suppliers, implementing strong contractual protections and regularly monitoring vendor and supplier relationships. By taking these steps, companies can minimize their exposure to ESG risks and protect their bottom line from potential losses.
