Key Takeaways:

• ESG has evolved from Corporate Social Responsibility (CSR) into a comprehensive framework that addresses environmental impact, social responsibility, and governance. It has become essential for modern businesses to meet regulatory demands and investor expectations.
• A significant portion of a company's carbon footprint, often 80-90%, originates from its supply chain, making it crucial for companies to apply ESG rigor throughout their entire supply chain to attain compliance - and even go beyond.
• Understanding key ESG-related terms, such as materiality, greenhouse gasses, and the differences between Scope 1, 2, and 3 emissions, is vital for effectively managing and reducing a company’s environmental impact.
• Global regulations and investor focus on sustainability are driving companies to adopt more rigorous ESG practices, particularly in combating forced labor and managing greenhouse gas emissions, ensuring compliance and ethical operations across supply chains.
• Sustainable and ethical business practices also result in significant operational efficiency and cost savings for companies, from energy efficiency to increased productivity and more.

Introduction

ESG (Environmental, Social, and Governance) is a framework that has evolved from Corporate Social Responsibility (CSR) and has become integral to modern business practices. ESG focuses on companies' environmental impact, social responsibility, and governance structures. 

While some form of social or philanthropic focus has existed in business for decades, there has been an increased spotlight on ESG and sustainability in recent years for multiple reasons:

• Various global regulations introduced new requirements for businesses to meet, with continued legislation expected
• Many investors, stakeholders, and customers expect companies to focus on ESG to combat climate change and ensure universal human rights
• Sustainable practices make smart business sense and increase operational efficiency over time
• Protecting the environment, practicing business ethics, and safeguarding workers are necessary for business sustainability in rapidly evolving marketplaces 

There is a common misconception that ESG practices are costly and offer little return on investment, leading to a lot of cynicism about the need for such business practices. However, the opposite is true when a company looks at ESG as an investment. For example, managing emissions and adopting renewable energy sources require a cost upfront, but will pay off midterm by reducing operational costs and enhancing the company’s reputation. 

So where does the supply chain fit in? For companies to fulfill ESG regulations, policies, and expectations, they must ensure the same rigor is applied to their entire supply chain. For example, 80-90% of a company’s carbon footprint exists in their supply chain. 

It’s also important to note that ESG is not only for large corporations. Any size company, including small businesses, can benefit from implementing ESG practices by accessing new markets, attracting investors, satisfying consumer demand for sustainable products, and more.

In this blog, we’ll examine a brief history of ESG, key terms, risks, and emerging trends. In our next few posts, we’ll dive further into ESG risks in the supply chain and best practices for managing those risks.

A Brief History of ESG 

The principles underlying ESG are not new; they evolved from the earlier practices of CSR. For instance, in the late 19th and early 20th centuries, companies like Cadbury and Unilever were already implementing practices that would be classified under ESG today. These companies recognized the importance of improving their workers' lives and ensuring that their business operations did not harm the environment.

The term "ESG" itself emerged more recently as companies and investors sought to address the broader impact of business operations on society and the environment—and from an outside-in perspective, the risks posed by social and environmental factors on the stability of the business. Unlike CSR, which often operated on a voluntary basis, ESG is increasingly becoming a requirement for companies, driven by regulatory demands and investor expectations.

While CSR often focused on individual initiatives, ESG is a more comprehensive approach, encompassing broader environmental, social, and governance issues at the operational level. The evolution from CSR to ESG signifies a shift towards more structured and measurable practices that are now crucial to business success in multiple ways. 

In addition to attracting investment, satisfying compliance requirements, and improving brand reputation, ESG adoption can also increase operational efficiency and save companies money. Many organizations have realized that sustainable and ethical approaches to business have a significant positive impact on the bottom line. For example, optimizing use of resources and adopting renewable options results in waste reduction and more energy efficiency, both of which lower operational costs. Another example is in labor costs and efficiency: workers who are treated fairly tend to be more productive and stay longer with a company, and companies find it easier to attract and retain a workforce in competitive labor markets.

Key Terms Related to ESG

Terminology related to ESG can be confusing, as there is overlap in some key terms but also important distinctions.

• ESG: Shorthand for environmental, social, and governance, ESG is a set of standards and practices related to an organization’s environmental and social impact on their local and global community. It’s largely used by the investment community to determine an organization’s risk and valuation. 
• Sustainability: Though the terms “ESG” and “sustainability” are often used interchangeably, there is an important distinction. The goal of corporate sustainability is conducting responsible business practices to minimize harm to the environment or society. ESG, meanwhile, is a broader concept that encompasses not only sustainability but other criteria that businesses use to create policies and measure performance.
• Governance: The system of rules, practices, and processes by which a company is directed and controlled. It encompasses the mechanisms that ensure the company’s accountability to its stakeholders, including shareholders, employees, customers, and the broader community.
• Social: The Social aspect of ESG refers to how a company manages its relationships with its employees, suppliers, customers, and the communities in which it operates. It focuses on the impact a company has on society and the ethical standards it upholds in its interactions with people.
• Materiality: Materiality refers to ESG issues that are significant to the company and its stakeholders, considering both financial impacts on the business as well as broader social and environmental consequences. Materiality helps a business prioritize ESG programming and investments to maximize impact and mitigate core risks.
• Greenhouse Gasses (GHG): GHGs refer to gasses like carbon dioxide, methane, and nitrous oxide, which contribute to global warming and are critical factors in environmental risk assessments. It’s important to note that many interchange the term “GHG” with “carbon footprint,” but greenhouse gasses actually encompass more than just carbon. Organizations of all sizes produce greenhouse gasses, largely through the burning of fossil fuels like coal, oil, and gas. Current regulations primarily focus on carbon but are increasingly looking at methane as well, given the intensity of its environmental impact.
• Scope 1, 2, and 3 Emissions: When evaluating an organization’s greenhouse gas emissions, those emissions can be separated into different categories:
  • Scope 1 emissions are those that a company directly produces at its location(s).
  • Scope 2 emissions are indirect emissions from the electricity and other energy that the company buys. 
  • Scope 3 emissions are all other indirect sources of greenhouse gasses related to a company’s operations, largely produced throughout the company’s extended supply chain (e.g., purchased goods and services). Scope 3 emissions are particularly important to understanding the supply chain’s impact on a company’s environmental footprint and are the focus of many regulations

List of ESG Supply Chain Risks 

1. Environmental Risks:
   1. Carbon footprint produced by the full extended supply chain
   2. Environmental impact of sourcing materials globally
   3. Potential damage to natural ecosystems from supply chain activities
   4. Compliance with environmental standards and regulations
2. Social Risks: 
   1. Human rights violations, including child labor and poor working conditions
   2. Labor rights issues, such as fair wages and safe working environments
   3. Community impact and social responsibilities of sourcing practices
3. Governance Risks: 
   1. Corruption and bribery within the supply chain
   2. Transparency and accountability in business operations
   3. Legal compliance and adherence to global standards and regulations

Emerging Trends & New Regulations

Recent trends indicate a growing emphasis on ESG due to increased awareness and demand for sustainable business practices. ESG is now seen as essential for both multinational corporations and small businesses. There is also a significant global investment in managing emissions and climate preparedness, which has become crucial for businesses seeking capital.

The "triple bottom line" concept, which considers the impact of business operations on people, planet, and profit, is gaining traction. Businesses are recognizing that sustainable practices not only help protect the environment but also create value for shareholders through energy efficiency, waste reduction, reduced material costs, fewer business disruptions, a more productive workforce, a more reliable supply chain, and more.

Furthermore, new regulations, particularly concerning forced labor, child labor, and greenhouse gas emissions, are pushing companies to adopt more rigorous ESG practices. Regulatory trends are shaping the future of ESG, particularly with the rise in forced labor due to labor shortages exacerbated by climate change and socio-political shifts post-pandemic. New and stricter anti-modern slavery laws across countries like Canada, Australia, and France are forcing companies to be responsible for and reassess their entire supply chains. Additionally, there is a heightened focus on greenhouse gas emissions, waste reduction, and carbon reporting, driving a shift towards a circular economy.

These regulations are not just limited to local operations but also affect global supply chains, making compliance more complex and crucial. Companies are under increased scrutiny to ensure their operations are not only legally compliant but also ethically sound.

Conclusion

Incorporating ESG into the supply chain is no longer optional but a business imperative. As global awareness of environmental and social issues increases, companies must ensure that their supply chains are not only efficient but also sustainable and ethical. The good news is that this shift rewards those making strides to stay ahead of the curve. By adopting ESG practices, companies can increase profits, mitigate risks, enhance their reputation, and create long-term value for all stakeholders.

In our next post, we’ll further explore ESG risks that may be hidden within your supply chain.