Due diligence and ongoing stewardship when engaging on supply chain risk

The aim of due diligence is to establish a performance baseline and determine if ESG supply chain risks are being acceptably managed.

Due diligence questions follow topics addressed at pre-assessment. They can be revisited during ongoing stewardship and asset management as a framework for discussions on performance targets and monitoring.

We do not expect perfection. We’re pragmatic and well aware of the challenges of making ESG work ‘on the ground’, especially when it comes to managing complex supply chains. However, we are also responsible investors and we do expect our GPs to put policy into practice. We expect to see evidence of ESG issues being tackled, because we know they can pose material risks for company supply chains.

Adam Black, Coller Capital

Engagement questions

The following questions are grouped into four categories to facilitate the understanding of the investee company’s management of their supply chain:

People
Process
Policy
Performance

The questions are not a prescriptive list and offer options to choose from, depending on the nature of the engagement.

People

Explain how your company has an adequate and competent resource to identify and manage supply chain ESG risk and opportunity?

In-depth questions:

At what level in the organisation are individuals with responsibility for supply chain ESG risk and opportunity management positioned?
Is the responsibility and accountability for supply chain ESG risk and opportunity management clearly defined in their job role?
How is their success measured?
Are there policies and procedures for material ESG risks and opportunities in the supply chain to be reported to senior management and the board? If so, please describe.
Does your sustainability lead have direct interactions with your procurement lead?
What are the qualifications/competencies of the individuals with responsibility for supply chain ESG risk and opportunity management?
How do you ensure that procurement and sustainability KPIs are complimentary and not conflicting?
Describe the training and other activities undertaken to ensure board members and senior management are competent regarding ESG risks. How frequently?

Process

How do you measure your direct suppliers’ performance on ESG issues?

In-depth questions:

Do you require ESG KPIs reporting from your direct suppliers? If so, can you provide examples? Do your contracts with direct suppliers allow you to audit specific ESG KPIs?
Do you require your direct suppliers to receive ESG reporting from their suppliers? Does your contract with your direct supplier require them to provide this reporting to you or allow you to audit compliance with this requirement?

Process

How have your direct suppliers (tier one supply chain) been identified and recorded with consideration to materiality of ESG risks? This would include the location, size and sector of the supply chain companies and the ESG risks associated with them.

In-depth questions:

How has the second-tier supply chain been mapped?
How have subsequent supply chain tiers been mapped? All the way to the primary source? Which tier does your knowledge and influence penetrate to?
What are the key transparency/visibility constraints in your supply chain? What efforts have you made to oversome these constraints?

Process

How do you actively engage with your direct suppliers on ESG matters that are material to those suppliers’ operations?

In-depth questions:

Does your procurement process include any ESG due diligence components? If so, which ones? If so, do you do so upon onboarding? How frequently thereafter?
How do you actively engage your supply chain to promote ethical behaviour?
How do you identify stakeholders, their interests, as well as their legal rights, and respond to their expressed concerns?
How do you ensure that you comply with legal requirements in all jurisdictions in which your organisation operates, even if those laws and regulations are not adequately enforced? Do you periodically review its compliance with applicable laws and regulations?
How do you ensure that where the law or its implementation does not provide for adequate environmental or social safeguards, you strive to respect, as a minimum, international norms? Please specify any international standards that you adopt in regards to this matter.
How do you ensure, respect and promote the rights set out in the International Bill of Human Rights?
How do you engage in collaborative initiatives with multi-stakeholders, aimed at managing ESG risks?

Process

How do your contracts with your direct suppliers take account of ESG issues that are material to those suppliers’ operations?

In-depth questions:

How are ESG issues taken into consideration when tendering new contracts with new suppliers?
Do you have long-term partnerships (three years +) with most of your supply chain members (ideally as a formalised contract but could be regular provision of services with no ongoing contract)?
On which terms do you primarily engage with your supply chain? (Multi-choice ranging from no-contract, short-term contact to long-term partnership)
Do your contracts with direct suppliers allow you to audit their ESG performance?
If minor breaches are identified, how do you work with your suppliers to rectify the issue(s)?
Do your contracts with direct suppliers provide for a termination right or other right in your favour in the event of material ESG non-compliance (e.g. corruption, human rights violation, environmental breach)?
How do you provide preferential contract placement with suppliers that have robust ESG risk management and performance (thus giving suppliers the confidence to invest in improvements)?

Adopting a policy is just the POLICY first step. That policy needs to be implemented, assessed for effectiveness and updated as necessary – it needs to become embedded in the culture of the company in order to be truly effective.

Amanda Wallace, JP Morgan Asset Management

Process

Do you have the contractual right to audit compliance with the ESG/sustainability policy statements relevant to supply chain?

In-depth questions:

How do you audit your supply-chain? (ranging from: not at all, desk-based, phone interview, in-person interview, on-site audit, unannounced on-site audit)

What percentage of direct suppliers do you audit, and how do you determine which suppliers to audit?

Do your audits include unannounced visits by independent auditors?

How often do you visit your tier one suppliers? And tier two?

What actions do you take when a (major or minor) non-conformity is found during audit?

Do you reward suppliers that improve their performance?

Does your direct supplier audit plan include any ESG components? If so, which ones?

Do you require your direct suppliers to report ESG incidents (e.g. health and safety incidents) to you? How frequently?

What percentage of your direct suppliers have performance above their industry averages? What percentage of your direct suppliers have performance below their industry averages?

Policy

Does your company have policy(ies) in place related to supply chain ESG risk and opportunity management?

In-depth questions:

Which standards/guidelines/codes of practice/ charter have you formally signed up to? Do you use these to evaluate your performance-relating ESG issues?
Do you have a supplier code of conduct? Does it include ESG issues? Is it aligned with the standards/ guidelines/codes of practice/charter that you have formally signed up to?
At what level of management are your code of conduct and policy(ies) approved and authorised internally? Does this include board-level oversight?
How are your code of conduct and policy(ies) communicated to your suppliers? In what languages are they available?
Do you require your direct suppliers to comply with your code of conduct when providing services on your behalf? Do you require your direct suppliers to comply with your ESG policies when providing services on your behalf?
How many/which suppliers agree to comply with your code of conduct and your ESG policies?
Do you review your direct suppliers’ policies and procedures? At onboarding? Annually? Do you have the contractual ability to audit their compliance with their policies and procedures?
What percentage of your direct suppliers have a robust policy covering ESG issues? What percentage have robust processes supporting their policy?
Do your direct suppliers agree that they will comply with human rights obligations, and if so, how are those obligations defined (e.g. UN Guiding Principles on Business and Human Rights)?
Do you require your suppliers to have the same requirement(s) of their supply chain as you do of them? Is performance reported back to you?
What confidential whistle-blower/grievance mechanisms do you have?
Do you require any independent third party certifications? Which ones?

Performance

Do you require your direct suppliers to report on environmental and social issues/events that could have significant impacts? (Material ESG issues and events)

In-depth questions:

How many of your direct suppliers report, either directly to you or publicly, on their material environmental and social performance indicators, for example, environmental and social initiatives or footprint (e.g. carbon or water footprint)?
How do you incorporate your engagement and performance of your supply chain in your own reporting?
How have you set relevant measurable performance targets internally associated with supply chain ESG risk management?
Have you developed a roadmap for ESG supply chain improvement?
Has your supply chain developed their own roadmap? Tier one, tier two, etc.

Performance

Have any of your direct suppliers had any claims made against them in the past five years regarding unfair wages, unfair hours, unfair working conditions or discrimination or other ESG issue?

In-depth questions:

Over the last five years, how many direct suppliers have you replaced due to ESG management concerns? Over the last five years, how many direct suppliers have experienced public reports of ESG failures?
Over the last five years, how many new supplier relationships have included ESG diligence?
Over the last five years, how many direct suppliers have you worked with to enhance their understanding and management of ESG concerns?