Should asset managers be concerned about ethical supply chains?

Ethical supply chains have been an issue for asset managers for many years. There have long been concerns, for example, about China, where a large proportion of the silicon needed for solar panels is produced and millions of Uyghur and ethnic Kazakh women have reportedly been subjected to forced labour and coercion.

But, for many in the industry, while there is an appetite for a more ethical supply chain, often money talks – and securing a supply chain with a certifiable ethical supply chain is not possible.

ESG reporting

Environmental, social and governance (ESG) requirements have become part of the "business as usual" reporting cycle and something that investors often insist upon. For many, ESG will be a core foundation of their business. Some of this has been driven by specific legislation. For instance, many English companies have been under an obligation in recent years to analyse and report on their supply chains in accordance with the Modern Slavery Act. However, an even greater focus on these issues can now be expected.

The EU is expected to implement its Corporate Sustainability Due Diligence Directive (CSDDD) by the end of 2024. All companies within its scope will have to implement due diligence measures to identify, end, prevent, mitigate and account for negative human rights and environmental impacts of their actions.

Big steps

These additional obligations are a big step up from the existing Modern Slavery Act. German companies are already subject to obligations that are similar to the CSDDD. and have reported that the impact has been very significant.

While the CSDDD will only directly affect large EU companies initially – those with more than 1000 employees and a net worldwide turnover of €450 million. Non-EU companies may also be affected if they generate €450 million in the EU in the previous financial year.

Take heed

Asset managers operating in the EU will need to pay specific heed to the directive. For those only operating in the UK, while they may not be directly affected by the CSDDD, they are likely to be indirectly affected.

There is going to be a lot more scrutiny in commercial contract reviews around ESG protections. Businesses that are covered by the CSDDD will be carrying out due diligence on their supply chain, so that they can discharge their own obligations under CSDDD, and passing on their obligations down their supply chain. For non-obligated businesses, there will be a need to consider the additional cost of facilitating their supplier's compliance and factor this into the commercial arrangement.

Mind the gaps

Additionally, where a non-obligated business refuses to comply with supplier requests, then the obligated supplier will be forced to explain (in its CSDDD reporting) why it has gaps in its compliance and potentially "point the finger" at that business as the source of the gap.

This opens the door for reputational damage within the EU market. As with other reporting obligations, it is expected that the peer pressure by compliant organisations will drive better behaviours down the supply chain.

Osborne Clarke comment

The CSDDD will have a worldwide impact. There will be some additional costs and procedures, but that is likely to be a small price to pay for a better and more ethical energy generation industry. In short, asset managers will need to be focused on and concerned about ethical supply chains.