Navigating environmental risk to supply chains –

Environmental risk impacts all industries that rely on a supply chain and risk is now a key driver of green finance and regulation with volatile climate conditions and complex just-in-time supply chain operations increasing the vulnerability of companies to disruption.

Increasing supply chain resilience is now a top strategic priority as raw materials, products, services, transport and food production can all be disrupted by the increasing effects of climate change. There are a range of sector-related risk impacts but all involve business continuity interruption related to extreme environmental events. Problems range from physical damage to workforce disruption, difficulty accessing materials to problems with shipping, inability to source ingredients, production downtime and overall unpredictability.

Climate-related risks are classified as hazard, acute and chronic. Acute risk can be cyclones, flooding and wildfire; chronic risk can be increase in mean temperature that impacts the agriculture sector or rise in water stress and extreme weather that is impacting industrial and food sectors.

Environmental risk to supply chains

“A major food and beverage producer recently decided to investigate the environmental risks they might be vulnerable to around the world and found they were facing water scarcity or some type of water issue wherever they were operating, issues they had not previously been aware of,” says Alexandra Mihailescu Cichon, executive vice president, RepRisk.

“Supply chain is where the risks are and it’s a major challenge. A large global organisation has many layers and the more layers, the less they know. They may have up to 100,000 suppliers and complexity is such that a big organisation might not know the name of a supplier company only the sector and country where they operate. This lack of information creates a major challenge in environmental risk assessment.”

EY teams survey found that visibility throughout the supply chain is the current top priority for industry with a critical need to assess risks, plan for disruptions and avoid them. Creating resilient sourcing strategies are also priorities with half of supply chain executives expecting better management of operational risks as a result of their ESG initiatives.

“Data from an environmental risk management platform can map a full range of risks on a global scale and present granular results on a dashboard to identify individual pockets of risk and support action and response decision-making,” Cichon explains. “Even with little or no key information from suppliers much can be done to identify and understand climate risks.”

The agricultural and food sector is already aware of the risks associated with climate change as are the energy sectors, says Veronique Mariotti, head of climate risk management at EcoAct. “Many nuclear energy plants are close to the sea so coastal erosion and flooding is a risk concern. In France there are problems with a lack of water with levels too low for nuclear plants’ cooling processes so they’ve had to be shut down. Lack of water is also impacting the hydro-electricity sector.”

Environmental risk involves more than the physical impact of extreme weather. The socio-economic status of a location will determine the conditions of manufacturing and supply chain workers, how companies operate and whether they are vulnerable to workplace issues or civil unrest and displacement.

Resilience through supply chain diversification

“After recent pandemic, supply chain and extreme weather disruptions companies have diversified their sourcing and transport mixes,” says Mariotti. “A company that was previously sourcing their manufacturing solely from China may now also be manufacturing in Taiwan, Vietnam or Latin America in order to mitigate risk of disruption. Nodes have multiplied and supply chains have become more complex so it can be much harder to address evolving risks.”

The issue is highlighted in Bangladesh where ten million people are displaced due to climate related flooding, impacting a range of key industries with the country a major producer of garments and footwear. “If you’re in the clothing industry and you’re not analysing the environmental and social risks and looking at diversification of your supply chain then you’re jeopardising your future business,” suggests Mike Penrose, co-founder of FuturePlus. “While some are being hit by severe flooding many areas of the Middle East, southern Spain, Portugal and southern France are at risk of desertification and, be it flooding or drought, supply chains are going to change.

“Climate impacts will have a dramatic effect on where you source materials and products with new legislation forcing more change with its own transition risks and these will only increase over time along with costs associated with the impacts of climate change. If you address the risks to your business now you will have done it cheaply. If you wait until you have to retrofit an entire business structure it will cost a great deal more.”

Climate risk finance and investment

Climate-related risk is driving a range of regulation that will have an increasing impact on business, industry and finance that powers the global economy. 92 per cent of finance leaders polled in a recent McKinsey survey cited climate risk-based regulation as one of the five most important forces impacting the financial industry in the next three years.

“Environmental risk is now actively considered by banks, finance and investment houses when considering the resilience of a business,” Penrose says. “Increasingly, without risk due diligence you might struggle to attract and retain finance. Investors are asking more often about climate risk as it is now plays a key role in their decision-making. If you have a complex enterprise you must now prove that you are doing adequate risk management and that climate and sustainability risks are factored into your reporting.”

Penrose, who has a master’s degree in risk management, adds: “Businesses that manage climate risk are more resilient and have a higher success rate. That’s why the finance sector is now factoring an understanding and approach to risk and why the value of resilient companies is rising and they attract cheaper credit and lower insurance premiums.”

Regulation is increasingly linked to risk

“The first wave of environmental regulation focused on reporting and disclosures, the second wave now impacting industry is focused on risk, impact and due diligence that delivers a new level of clarity and comparability,” Cichon explains. “Organisations must now show they understand their impact on the ground, that they understand the environmental risks to their business and are conducting due diligence to ensure they can manage and mitigate those risks. This is an important development because we have to move on from disclosures which only provide part of the picture when it comes to climate risks. You have to take a holistic view and forecast 10 to 15 years ahead to identify the real risks involved in climate change.

“Regulation has a strong role to play because it forces organisations to address the issues around climate risk, issues they did not previously consider important. It is easy to think that because something hasn’t happened in the past it won’t happen now. To protect your business you must model and project into the future to identify what is likely to happen.”

Mark Carney, when Governor of the Bank of England, said that any business that doesn’t take climate change seriously will not exist in ten years time.  The statement was true five years ago when he said it and now, with environmental risks increasing, his warning is even more prescient.

“Analysis does not make you less likely to suffer risk but it allows you to investigate material risks and then address and mitigate the likely impacts,” Penrose concludes. “You can’t change the reality of the world you can only change how you’re reacting to it and how you’re preparing for the future.”