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November 22, 2021

Persistent social risks will further test post-pandemic resilience of supply chains

Jordi Lesaffer, Carlos Fletes, and Jimmy Greer
Moody's ESG Solutions
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Persistent social risks will further test post-pandemic resilience of supply chains

Social and human rights issues are under-considered supply chain vulnerabilities that have been highlighted and amplified by COVID-19. We expect these risks to become increasingly dispersed across the globe as intraregional trade connections tighten, with companies shortening their supply chains to make them closer to end-markets, and for these risks to garner more attention due to regulators strengthening supply chain reporting requirements. Post-pandemic resilience management of supply chains will depend on the ability of companies to integrate social risk management into their operations.

Social and human rights issues are under-considered supply chain vulnerabilities that have been highlighted and amplified by COVID-19. Our proprietary data shows that supply chain controversies have increased by 237% to an annual average of 185 over 2020 and 2021, up from an average of 78 cases per year between 2016 and 2019 before the onset of the pandemic. With many supply chains still suffering from severe disruptions, the pandemic will continue to have a pronounced impact on economies, workforces and communities. Order cancellations and refusal to pay suppliers led to many factory closures, dismissals of workers and – where factories stayed open – wage cuts and late payments. Despite the importance of workforces and communities in lower wage jurisdictions for multinational companies, they are often still not afforded the institutional support and enforcement of human and social rights that are enshrined in international charters. With the pandemic laying bare global reliance on fragile and just-in-time supply chains, we expect investors to demand better inclusion of social factors in future resilience planning, a stronger commitment to salient human rights issues and – where violations have taken place – appropriate remediation activities.

Going forward, we expect risks to become increasingly dispersed across the globe as intraregional trade connections tighten, with companies shortening their supply chains to make them closer to end-markets. Such risks are also likely to garner more attention due to regulators strengthening supply chain reporting requirements. According to our data, 71% of 466 supply chain controversies identified between 2016 and 2021 took place in Asia, reflecting the centrality of the region as a global manufacturing hub and relatively weaker labour rights protection [1].  However, tightening human rights legislation, due diligence requirements and increasing regulatory oversight in Germany, the UK, France, Netherlands, the US and the EU will likely heighten the impact of controversies further afield and result in enduring social supply chain risk impacts, as companies re-shore and near-shore their operations.

Figure 1: Location of controversies by region 2016-Nov 2021
Source: Moody's ESG Solutions

Specialised retail, food, technology-hardware and automobiles head the list of sectors most vulnerable to supply chain controversies, with almost 50% of all companies providing weak and insufficient responses to cases. Taking its size into account, coupled with low responsiveness to social supply chain controversies, we expect specialized retail to continue to perform poorly relative to other sectors.

Figure 2. Top 10 sectors most impacted by supply chain controversies 2016 -Nov 2021
Source: Moody's ESG Solutions

Companies that are seen to consistently violate human rights and forced labour conventions are exposed to heightened reputational and legal risks. Human rights and forced labour issues make up the majority of the controversies recorded. This is despite the prevalence of well-established social risk management and reporting frameworks for companies and their supply chains. Well-established conventions, tools and frameworks exist for managing and reporting on social issues in supply chains; for example, the UN Guiding Principles on Business and Human Rights, the Fundamental Conventions of the International Labor Organization, Global Reporting Initiative (GRI) and the UN Sustainable Development Goals. Despite this, human rights and workforce violations are high, suggesting that many companies lack quality monitoring, reporting and remediation systems.

We expect future developments in sustainability reporting standards at a global level to support better incorporation and reporting of human rights and labour issues. The recently established International Sustainability Standards Board intends to set out a global reporting baseline. Meanwhile the EU, in particular, is making significant progress, through the work of the European Financial Reporting Advisory Group (EFRAG) programme dedicated to the creation of the European Corporate Sustainability Standards – with GRI and human rights specialist Shift recently announced as project partners. We also expect that a proposed social taxonomy, set to be added to the existing EU sustainable taxonomy, will focus market attention and resources on improving disclosure of human and labour rights issues.

Figure 3. Social issues present in the supply chain controversies 2016 – Nov 2021
Source: Moody's ESG Solutions

Post-pandemic resilience management of supply chains will depend on the ability of companies to integrate social risk management into their operations. Some companies that have experienced supply chain controversies have taken proactive actions, such as engagement with supplier and external stakeholders; supply chain mapping; remediation and monitoring systems; external audits; and the adherence to sector specific stakeholder initiatives. Such steps will help to create good practices for addressing these challenges in the future.

Moody’s ESG Solutions provides insights and analyses on ESG themes and multi-stakeholder performance, climate-related risks and opportunities and global sustainable finance trends.
[1] Social risks identified in this report leverages Moody’s ESG Solutions’ Controversy Risk Assessment Screening that screens 10,000 entities for controversies across 38 ESG criteria.