Supply chain disclosure: FRC Lab insight

Introduction

The COVID-19 pandemic, as well as geopolitics, have created significant strains on borders and trade. Recent macroeconomic events have also demonstrated how global supply chains can be disrupted and the impact these disruptions can have on business. At the same time, evolving corporate, investor and consumer values are also impacting demand and changing the way many businesses operate. Combined with the growing demand and regulation for sustainability reporting and its focus on enterprise value, understanding the impact of supply chains is now more important than ever.

Given their role in creating long-term value for businesses, clear and concise disclosures on supply chains are key for investors. Investors are likely to look for information that helps them understand:

• the context of the supply chain. This means the size and scope, the nature and resilience of the businesses' supply chain, the extent to which sustainable procurement practices are embedded, and the impact on current and future operations, reputation, and brand.

• the impact of supply chain uncertainties, risks and opportunities on long-term value creation and the actions management are taking to address these.

This insight sets out some questions and resources that may be useful for companies to consider in preparing their reporting.

Access to raw materials and goods

There have been numerous disruptions and delays in recent months to global supply chains. The mismatch in supply and demand has also highlighted and exacerbated supply shortages. Investors want to understand the impacts of this on their investments and therefore the following information is likely to be useful:

• What raw materials and goods are critical to the business model in the short and medium term? How has the supply chain for these elements been impacted by global disruptions?

• What, if any, international or local restrictions exist that might impact a supplier's ability to deliver? For example, are suppliers based in areas impacted by active conflict, sanctions, or COVID-related restrictions? How concentrated is this risk?

• To what extent is the supply chain reliant on critical components? What risks do they pose and what mitigating actions are in place?

• What is the impact of inflationary pressures on the supply chain?

• What actions are management taking to actively monitor and manage these risks? How are longer-term impacts being considered and planned for?

Digital security, outsourcing and weaknesses in infrastructure

Digital technology is fundamental to many, if not most, business models. Many consumers and businesses alike now operate predominately online, making secure data transmission critical. Digital supply chains have physical components at risk of disruption. Geopolitical tensions may also increase the risk of cyber-attacks. Understanding the digital infrastructure, including the components in the external supply chain, that supports a business, and its resultant supply chain is critical. This means everything from the reliability and connectivity of hosted websites to cloud-based systems.

Some questions that may help investors to understand risks to digital supply chains include:

• What is the nature and scope of the company’s digital infrastructure and supply chain? Where are physical components located? Where is data hosted? Are there any local security risks? How easily can data be hosted elsewhere?

• How do suppliers and the company monitor for and mitigate against potential vulnerabilities?

• What plans exist to ensure continuity of hosted services, for example, the company's website, any cloud-based systems, such as finance, payroll, data management or logistics systems?

• To what extent is the digital supply chain reliant on critical components? What risks do they pose and what mitigating actions are in place?

Legal, ethical and reputational considerations

Geopolitical instability and conflict have created and, in some cases, exacerbated a number of legal and ethical considerations. Likewise, changing consumer and stakeholder values, for example, on sustainability, may also give rise to additional supply chain considerations. Both are areas that investors are increasingly concerned about, given their potential impact on business models and strategies. From a supply chain point of view, investors may be interested in understanding the following:

• How does the company assess its suppliers and owners? How do they take into account potential legal and reputational risks and what mitigations are in place? Consider, for example requirements in relation to modern slavery which may have both legal and reputational impact.

• How do they monitor ongoing relationships with suppliers, including relying on external parties for verification?

• When changing suppliers, is the change consistent with wider business cultural values, for example, ESG commitments? Could there be unintended consequences? For example, a new supplier may result in scope 3 emissions increasing, despite net zero commitments. How will the company mitigate against these risks?

Putting it all together

Supply chains are often a key part of a company's strategy for creating long-term value. While not all companies will be materially impacted by macroeconomic factors or changing consumer behaviours, for those that are, investors will want to understand how the company has assessed the related risks and opportunities. Providing a connected and clear story, which provides information on governance and processes, the nature and approach, as well as any relevant scenarios planning information will help investors in understanding this impact.

This is the first of the FRC Lab’s insights into current market issues. You can find out more about the our current projects and how to get involved on the FRC Lab page.