The growing importance of supply chain transparency

Global supply chains continue to be a top concern for governments and investors alike, and they will be an area of focus for our Sustainable Investment team in 2024. Geopolitical tensions and lingering effects of COVID-19 shutdowns continue to highlight the fragility of our highly intertwined global economy and the need to understand and fortify links along industry supply chains. 

The ongoing challenges also suggest that policymakers, investors, and issuers lack sufficient understanding of cross-company linkages and, as a result, may be unable to pinpoint supply chains’ weakest points. We believe greater transparency on these interconnections would enable investors to more clearly identify risks and opportunities. This clarity could also help companies forestall costly supply chain disruptions and mitigate the impact on suppliers of potential cost increases for raw materials, including carbon and water. Through our 2024 sustainable investment focus areas, we seek to better understand supply chains and how they might form tailwinds or headwinds for potential investments. 

Key areas of focus

The SI landscape continues to be shaped by an expanding opportunity set, growing consumer and investor interest, and an evolving policy backdrop. We believe companies will have opportunities to reduce costs, mitigate risks, and stand apart from competitors by demonstrating thoughtful supply chain management and providing clarity for stakeholders. For that reason, we aim to deepen our research in three key areas in 2024 — the low-carbon energy transition, biodiversity dependencies and impacts, and modern slavery —all of which have extensive, intricate ties to and dependencies on global supply chains. To continue to achieve our objective of unlocking long-term value and generating positive investment outcomes for our clients, we aim to concentrate much of our research and engagement activity in the coming year on these areas. 

Energy transition 

US Secretary of the Treasury Janet Yellen has highlighted that, “The flow of capital from carbon-intensive to carbon-neutral investments is probably the most dramatic and predictable economic shift in human history.”¹ As investors, we believe we need to understand companies’ plans for this shift so that we can make better-informed investment decisions. While regulations like the Corporate Sustainability Reporting Directive (CSRD) in Europe and California’s sweeping new laws, SB 253 and SB 261, will likely result in more consistent and comparable greenhouse gas emissions disclosures from companies over the next few years, fundamental research and engagement by investors can lead to insights about companies’ transition plans today.  

By meeting with companies to understand their low-carbon transition strategy and encourage supply chain transparency, we believe we can get a more complete assessment of the differences between companies within the same industry. Are a company’s processes more, or less, carbon intensive than those of its competitors? Is there potential for competitive advantages or the erosion of advantages based on how a company manages the carbon intensity of its supply chain? Is any part of a company’s business at risk of disruption due to changes in regulation or consumer preferences? By exploring these questions, we aim to deliver better investment outcomes for clients. 

Biodiversity

More than 50% of global GDP, or an estimated US$44 trillion in economic value, depends on nature and ecosystem services.² We see a growing market focus on companies’ considerations of biodiversity dependencies and impacts. 

Risks to biodiversity are another potential supply chain concern, given the importance of healthy ecosystems and raw materials, including water, minerals, and forestry inputs, to a range of industries. Today, most biodiversity measures do not pragmatically translate to financial metrics that investors can apply to their processes. Regardless, we anticipate that market participants may begin to require more and better information to help them assess and price biodiversity-related risks along supply chains. 

Near-term risk management may be critical as companies try to navigate emerging regulations and reputational considerations, while assessing the need (and their ability) to report on ecosystem exposure within their operational and supply chain footprint. In the medium term, companies may face potential input-price volatility and supply chain reconfigurations because of biodiversity dependencies. We believe that understanding the potential for these trajectories can help companies prepare and enable investors to make informed decisions. 

As a related matter, we also expect to see growing focus from the asset management industry on water scarcity and water management. Working with our climate-science partners at Woodwell Climate Research Center, we have started to discuss the development of a “water score,” akin to the climate physical- and transition-risk scores that we assign to portfolio companies today. Without abundant, reliable water sources, almost no ecosystem can remain heathy and capable of providing the services on which our economy depends. In our view, nature-based solutions are the key to achieving net-zero goals and climate resilience, given the close connections between natural capital and the earth’s climate. In 2024, we will be looking for investment opportunities in innovations that deepen the focus on a circular economy, resource efficiency, and resource stewardship that advances biodiversity preservation and climate-risk mitigation. 

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Modern slavery  

Modern slavery is an umbrella term that covers a set of specific legal concepts related to various forms of egregious exploitation including debt bondage, human trafficking, servitude, forced labor, deceptive labor recruiting practices, and child labor. This issue is a top concern for investors, as allegations of modern slavery in a company’s supply chain can result in financial losses, regulatory enforcement action, and/or lasting reputational damage. While every business is at risk of exposure to modern slavery, we believe companies can mitigate this risk through good policy, processes, and practice. 

In our modern slavery research and engagement efforts, we prioritize emerging markets companies given the extensive presence of modern slavery in the Asia Pacific and Asian subcontinent regions. Though limited data is available, as an active manager, we can have meaningful dialogues with companies to better understand their efforts to capture this information and have done so on many occasions. These discussions help deepen our understanding of an industry’s collective baseline and best practices to root out modern slavery. Our objective is to engage with companies to develop improved labor and human-rights-management programs — inclusive of their supply chains and business partners — and to provide transparency to investors about these programs. We believe having such programs in place can aid in the reduction of a range of financial risks for issuers. 

Emerging research topic

Responsible AI and cybersecurity: The expanding reach of AI poses a growing list of new challenges related to ethics and data security. While AI is a powerful, exciting tool that can propel productivity and accelerate innovation, it is an equally powerful mechanism for spreading misinformation with the aim of causing economic and/or national security chaos. Companies and governments will need to develop technological and governance capabilities that harness the power of AI while minimizing cyber threats and protecting data. We intend to research and develop emerging frameworks for evaluating the ethical considerations of AI adoption.

¹ Remarks by Secretary of the Treasury Janet L. Yellen at the Countdown Summit, 2021 United Nations Climate Change Conference (COP26), November 2021. | ² “Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy,” New Nature Economy series, World Economic Forum, January 2020.