Menu

Putting the S in ESG: resources for responsible supply chains

Published on 24 Aug 2022

Author:

Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.

Since the industrial revolution, we have seen a continuous effort in creating new policies, regulations, and frameworks to establish social safeguards, like ensuring better conditions for employees. The first of the Factory Acts (1833) established regular working days in the textile industry, prohibited children under nine years of age from working, and limited the working hours to 9-12 hours per day depending on the worker’s age. Few areas of regulation, if any, have received more attention and provision in the last 200 years than the protection of workers.

In recent years, a business’s social impact has gained more traction and gone beyond the welfare of employees, increasingly considering the satisfaction of corporates’ stakeholders beyond financial returns. Despite the effort, the unchecked economy still fails in maintaining socially ethical supply chains. Unethical employment practices are still being uncovered, such as the recently documented forced labor in the cotton and textile industries in the People’s Republic of China.

These abuses show that human resources, too, can fall victim to the global supply chain and uncontrolled working environments. This ever-growing number of regulations and policies promoting even higher employment standards call for transparent and effective monitoring and implementation, even beyond standards.

When a company wants to build up a solid business case and become a leader in the social aspect of the ESG (Environment, Social, Governance) framework, there is a myriad of resources from which they can find inspiration. ESG issues can arise in any supply chain. For all organizations, it is imperative to ensure that there is a robust process to identify and manage issues in their supply chain and to have active governance, risk management, and remedial processes in place.

UN, EU documents related to the Social pillar of ESG

ESG made its first appearance in the United Nations global compact (UNGC) report on “Who Cares Wins –Connecting Financial Markets to a Changing World” in 2004 (IFC, 2004). The former UN secretary-general had invited a joint initiative of financial institutions “to develop guidelines and recommendations on how to better integrate environmental, social, and corporate governance issues in asset management, securities brokerage services, and associated research functions”. This document made the ground for the UN’s Principles for Responsible Investment (PRI), which offer a menu of possible actions for incorporating ESG issues into investment practice. The Principles are voluntary and aspirational, developed by investors, for investors.

The Global Sustainable Development Goals (SDGs, 2015) and its implementation plan, the 2030 Agenda for Sustainable Development – adopted by all United Nations Member States – recognize that ending poverty and other deprivations must go hand-in-hand with strategies that improve health and education, reduce inequality, and spur economic growth – all while tackling climate change and working to preserve our oceans and forests.

Documents dated back in the sixties, such as The European Pillar of Social Rights and its associated Action Plan; the EU Charter on Fundamental Rights; and the European Convention on Human Rights form the EU’s secondary sources on social topics. However, the European labor market has gone through fundamental improvement in the last 200 years. In its 2020 report on Employment and Social Development in Europe, the European Commission presents one of the most pressing needs for social investment: poverty reduction. Nearly one quarter (24%) of the EU working-age population have found themselves below the at-risk-of-poverty threshold at some point during the last 4 years. The suggested structure of the EU Social taxonomy consists of three objectives, each of which addresses a different group of stakeholders: decent work (including for value-chain workers); adequate living standards and wellbeing for end-users; inclusive and sustainable communities and societies.

Materiality

Before we dive into ratings related to the social dimensions of business impact, we have to look into how “materiality” –known from financial reporting is implemented in the ESG framework. The concept of materiality originated for identifying risks that require disclosure within the legal realm but with the advent of ESG principles, it proposes ample future opportunities for competitive differentiation, growth, and profitability.

Prominent standard-setting organization, Sustainability Accounting Standards Board (SASB), uses the equivalent definition of materiality that is used by the Securities and Exchange Commission (SEC). Materiality signifies and reflects sustainability issues that are relevant for investors, stakeholders, and decision-makers. The materiality analysis is a strategic business tool helping organizations in taking their first step and in moving in the direction of ESG scores and a starting point to emphasize certain social issues that hold consequential economic effects on organizations.

What does the practice look like? How does a business set and implement social safeguards?

We are going to touch upon different ESG rating agencies (SASB, GRI, Refinitiv, GRESB) who have worked to define a list of KPIs to evaluate the social impact of business activities and assess the ability of their governance to manage relevant social issues.

SASB and the Global Reporting Initiative (GRI) have been built on the existing frameworks for social issues in ESG. The GRI social category includes Labor practices and decent work, Human rights, Society, and Product Responsibility. The SASB (2018) framework classifies ESG issues into five dimensions (Environment, Social Capital, Human Capital, Business Model, and Innovation, Leadership, and Governance) and twenty-six general issue categories monitor Labor practices, Employee health and safety, Employee engagement, and Diversity, and inclusion among many others (SASB Materiality Map).

ESG rating organization, Refinitiv, uses four categories in the Social pillar: Workforce, Human rights, Community, and Product responsibility. The workforce score measures a company’s effectiveness in terms of providing job satisfaction, a healthy and safe workplace, maintaining diversity and equal opportunities, and development opportunities for its workforce. The human rights score measures a company’s effectiveness in terms of respecting fundamental human rights conventions. The community score measures the company’s commitment to being a good citizen, protecting public health, and respecting business ethics. The product responsibility score reflects a company’s capacity to produce quality goods and services, integrating the customer’s health and safety, integrity, and data privacy.

The GRESB (Global Real Estate Sustainability Benchmark) Real-Estate Assessment also takes social safeguards very seriously. In its assessment, each indicator is allocated to one of the three ESG dimensions of which social indicators are related to the entity’s relationship with and impact on its stakeholders and the direct social impact of its activities. Indicators are grouped around Management, Performance, and Development. In its management subcategory, 35% of indicators are associated with the S of ESG while 21% of the Development and 11% of the Performance indicators are reflecting on social issues.

Corporate Knight’s annual ranking of the world’s 100 most sustainable corporations is based on a rigorous assessment of nearly 7,000 public companies with revenue over US$1 billion. Among their indicators, non-male boards and executives ratio, racially diverse among boards ratio, and CEO-average worker pay ratio is assessed. What can drive better company engagement than growing transparency and an increase in market value? Global trends already show that socially motivated investors have goals of not only maximizing the returns but also of aligning their investments with their social impacts.

Conclusion

By now, it’s not only financial institutions and investors that are keeping an eye on the latest ESG news. The urge to rapidly increase the flow of capital towards sustainable investment is articulated in the EU Green Deal, under the slogan of “leave no person and no place behind”. Establishing equal, inclusive workplaces and ensuring ethical employment all along corporate supply chains goes beyond regulatory expectations and trigger economic value growth. Bloomberg Intelligence (2021) reports that the ESG-focused portfolios manage close to $40 trillion in 2021 and are expected to increase by 30% by 2025.

This article was written by Annamária Virág, Sustainability Consultant at Schneider Electric.

References