Pressure is growing for firms to demonstrate that they are operating responsibly. Ryan Herman hears how formalising the supply chain audit and harmonising ESG reporting could be the missing pieces.
Profits with a purpose: that was how BlackRock CEO Larry Fink described the company’s decision to make environmental, social and corporate governance (ESG) an integral part of its long-term investment strategy. His statement to shareholders in January 2020 was an important first step. Then, in October last year, BlackRock led a shareholder revolt at the AGM of Proctor & Gamble, the world’s largest consumer packaged goods company. Two-thirds of votes were cast in favour of a proposal to force the group to look at a palm oil subsidiary company in its supply chain that, according to activists, was seizing land from farmers.
Shareholders also wanted Proctor & Gamble to provide reports on the environmental impact caused by using palm oil in some of its bestselling products. BlackRock was putting its CEO’s words into action. But there was a twist to the tale. Last month, shareholders turned the tables on BlackRock, pointing out it owned a significant stake in the parent company of that palm oil subsidiary. It appeared to be profiting from the very same supply chain that it was railing against.
Both sides of the story highlighted how investors are increasingly willing to ask ethical questions of companies. The growing importance of ESG reporting and clarity over supply chains is crucial to understanding whether companies practise what they preach.
Alan McGill, Global Head of Sustainability Reporting & Assurance at PwC, says that “three principal drivers” are behind the trend. “First, you may say for the first time investors are really engaging with companies around the ESG agenda,” he says. “They want to know more about what companies are doing, whether they know the risks in the value chain they operate. And they want to understand how resilient the business model around the organisation is, which brings out social issues as well.
“Second, you’re seeing a huge increase in government interest in ESG. A lot of that is happening around ‘Build Back Better’, and how the way that businesses operate needs to change. The UK government is looking to introduce a UK taxonomy. There’s the 10-point green recovery plan that was announced last November. There’s also the fact companies are being asked to report on climate change implications around the Task Force on Climate-related Financial Disclosures (TCFD) requirements.
“And there is civil society pressure as well. That’s influencing whether people buy goods and services from a company or if they even want to work there. The power of the internet and connected devices is helping businesses to get a better understanding of their impact on society.”
As well as the growing scope of TCFD requirements, the introduction of the Modern Slavery Act in 2015, designed to ensure British products and services could in no way be linked to human bondage, was a significant moment in the UK’s short history of ESG reporting. “It was a line in the sand,” says Stewart Juroszek CA, Head of Internal Audit and Business Risk at Young & Co’s Brewery, which has more than 200 pubs across the country. He says it is one of several pieces of legislation, including the Bribery Act of 2010, “which put the focus on companies to review their supply chain and make sure that it is fit for purpose. Ignorance is no longer an excuse.”
But there is a flaw at the heart of the Modern Slavery Act – there is no legal requirement for a company to monitor its own supply chains. “At the moment there is a degree of self-certification and it’s open to interpretation,” says Juroszek.
One of the most high-profile examples of just such a failure occurred last summer. Online fashion company Boohoo was found to be using “sweatshop” labour in Leicester to produce its garments. An investigation by The Sunday Times revealed that one of the company’s suppliers was paying workers £3.50 an hour, and had continued to operate throughout lockdown in conditions that put them at a high risk of contracting Covid-19.
Boohoo has since set up its own warehouse in Leicester, and recently suggested it may overhaul executive bonuses to link them to ESG improvements. Some good may come of the scandal, but it serves to demonstrate the weaknesses in the status quo. And those weaknesses go beyond the self-certification allowed by the Modern Slavery Act.
“More questions are being asked around social impact,” says Ali Aslam, Deputy Head of Internal Audit at global distribution giant Bunzl and member of ICAS’ Sustainability Panel. “But with ESG there is limited consistency and there is a tendency for false assurances; for instance, one company may spend two to three days auditing a particular supplier, another may spend a matter of hours.
“To give a different example, if you looked at certain clothing companies, focused on the annual report and their carbon emissions, those companies could be using LED lights in stores or warehouses and therefore can claim ‘our carbon emissions are down 10%’. But that won’t account for the fact 2,700 litres, or 900 days’ worth of drinking water, will go into making a T-shirt that has been imported from Sri Lanka and sold in a UK store. There will be footnotes in the reporting but the average person doesn’t check the small print.”
He adds: “Current legislation needs to be stricter. Also, right now, the majority of supply chain audits are focused on the social aspect rather than the broader governance and environmental impact.”
Setting the standards
So, what role can accountants play in improving the quality of ESG reporting and supply chain audit?
“They have the ability to hold a business to account,” says McGill. “For me, this is an important point about the relevance and importance of the accountant. There are great skills that can be transferred into these new emerging areas that need help around providing the quality of information required to inform key decision-making processes within the company.
“You also need to join up considerations. For example, the procurement strategy is typically about managing cost. How you manage that cost might not be the best outcome for the environment or for social outcomes within your supply chain.
“And where the accountant can help is by demonstrating where the broader value is, so potentially the procurement strategy isn’t focused solely on the financial cost.
“As you start to shine a light on some of these new areas, you can also show how much other value a business can create and the role it can play within society in terms of its purpose. One of the first things you should be asking yourself is how are you measuring your purpose and delivering on it. And the accountant is well placed to help the company on that journey.”
The main criticism of ESG at the moment is that the lack of any overarching framework can make things difficult to understand. Here, there is widespread agreement that some form of benchmarking is necessary for measuring and comparing impact.
“As a pub company, we take a lot of credit card payments and we have to be audited by the payment card providers,” says Juroszek. “There are checks and balances which are based on a uniform standard and a uniform audit checklist that they work to. It would certainly help if we could get to a similar universal standard in terms of what you should report in your supply chain and your environmental impact.”
But positive steps are being taken. As McGill explains: “The IFRS Foundation is trying to do exactly that and create a standard around ESG reporting. It is something that is desirable and can be achieved but is going to take a lot of will and effort to make it happen.”
It may sound idealistic at this stage, but for businesses to demonstrate that they’re taking ESG seriously, it’s ultimately about everyone working towards a common goal. Or, as Aslam says, “Collaboration is so important. It’s only by talking to each other and learning from each other that we can improve.”