PAI Partners: Defending human rights in the supply chain

 

Attention to ESG matters lies at the heart of PAI’s investment policy. Our commitment to responsible investment is central to our activities and is fully integrated into our policies, processes and outcomes.

We believe that the supply chain is the next ESG frontier for General Partners (GPs) and that it is at the heart of the ecosystem that embraces all stakeholders (GPs, Limited Partners (LPs), and portfolio companies).

Why ESG matters in the supply chain

Addressing human rights in due diligence goes beyond regulatory compliance and obligations towards investors, portfolio companies and the communities in which they operate. It is a basic duty of care that contributes to a society in which we want to live.

In a globalised world, companies’ supply chains have become more and more complex. The geographical fragmentation or sourcing from multiple suppliers at each tier of a product’s value chain can generate business continuity risks and impact value. More importantly, violations of human rights and, specifically, of labour rights (forced labour, indecent working conditions for insufficient wages, violation of trade union rights, etc.) are more likely to occur and go undetected at different stages of production. This threatens a company’s ability to comply with the law and safeguard its reputation.

The more a company is dependent on its supply network and external resources such as its subcontractors, the more vulnerable it becomes, the harder it is to assess ESG risks, and the more control of the entire chain is necessary. The Covid-19 pandemic has evidenced the limitations of such a pattern and its vulnerability to disruption. Therefore, supply chain mapping and assessment has shifted from an optional parameter to a core subject of general management.

Supply chain sustainability-related risks become a reality when they (i) jeopardise a company’s ability to maintain its social licence to operate, (ii) prevent the company from protecting its brand value from reputational damages whilst meeting investors’ and stakeholders’ expectations, and (iii) render human rights assessment mandatory through soft and hard laws (code of conduct / regulation).

Better management of supply chains and their inherent risks, when properly and transparently identified, presents opportunities for growth and increased productivity. For example, by creating efficiency across supply chains, a company can better meet evolving customer and business partner requirements, innovate for a changing market and enjoy a reduction in material costs.

How we integrate ESG into the supply chain

The ESG team at PAI set out to write a supply chain sustainability guide dedicated to private equity and its main actors (LPs, GPs, and portfolio companies) which is available on our website.

The first step is a risk analysis of the target or a recently acquired company. We have developed expertise in four core sectors: business services and distribution; food and consumer; general industrials; and healthcare. Risk mapping will largely depend on the sector and related ESG topics. The criteria used by our ESG team are based on analysis and integration of several international standards, which we have adopted (e.g., SASB, DJSI, MSCI, CDC, TCFD) and are focused on four pillars:

• Social;
• Environment;
• Governance; and
• External stakeholders.

At this stage, PAI uses sell-side research, public benchmarks, public information from internet searches, sustainability reports from peers and interactions with the management of the targeted company. This equips us with the preliminary information to start mapping the potential supply chain-related risks.

The second step includes an expert call with the CEO and / or an on-site visit. We take a deep dive into the supply chain, identifying the sourcing and supply chain strengths and weaknesses. This analysis can be illustrated through the implementation of a sustainability roadmap, which may include specific requirements for the target company’s industry, sustainable and sourcing certification standards, in-house supply chain and sourcing standards and compliance with supply chain-related codes of conduct.

 

At the due diligence phase, we ask the company the following questions:

The final step is to engage with the portfolio company regularly, offering insights on new regulation (for instance, the duty of vigilance directive at the EU level), sharing best practices with other portfolio companies or introducing them to relevant software solutions and advisers.

Who to engage?	What to engage them on?
Board representative(s)	Should set guidance for the company on ESG management.
C-suite level; including CFO, CEO, COO	Demonstrate leadership commitment.Useful to get appropriate level of attention/resources/commitment.
Procurement decision makers	Able to answer the more technical questions on supply chain management.
General counsel	A helpful perspective on supply chain issues related to regulations/ compliance/liability/risk assessment.
Sustainability/ESG professionals	Holistic view on the various stakeholders engaged on the topics (e.g. clients/customers/competitors/communities/civil society NGOs/E&S consultants).
Quality management professionals	Provide overview of systemic management processes and systems that may incorporate or be relevant to supply chain management of ESG risks. This may include the audit function.
Impacted stakeholders and their representatives	Help assess performance of the company’s ESG risk management.

Figure 2: Due diligence in practice

Example: Advancing supply chain sustainability at the portfolio company level

All portfolio companies go through an ESG onboarding process at acquisition and ESG criteria are integrated in the build-up of the value creation plan. As a key part of the ESG pre-acquisition due diligence, we worked closely with Ecotone to analyse its supply chain, with a focus on risks and the quality of management. Post-acquisition, we continued to work with Ecotone to monitor and drive new initiatives while simultaneously developing existing best practices.

Ecotone’s risk mapping

Ecotone manufactures and distributes organic food products, focusing on six core categories: dairy alternatives; ‘sweet in between’ (healthy sweet alternatives); vegetarian meals; hot drinks; breakfast cereals; and bread and biscuit alternatives.

When Ecotone undertook a materiality risk assessment of their first-tier suppliers, they looked at risks from an ethical perspective, such as food fraud, forced and child labour and minimum wages. They assessed the ethical risks of the entire value chain per sector and country and developed risk scores with the assistance of an external consultant.

The risk mapping considered:

• The centrality (i.e., the severity, how it may impact business), and
• The proximity for the business (if an ethical issue were to occur, what are the first brands at risk)

Based on the rating, Ecotone could decide where the main focus was required in terms of supplier engagement, site visits, food analysis and audit.

Ecotone participates in several multi-sectoral standards, such as Sedex (one of the world’s leading ethical trade membership organisations, working with businesses to improve working conditions in global supply chains), and encourages its suppliers to participate by submitting data on the Sedex platform, as that ensures minimum standards for responsible sourcing are met.

Interconnected with Sedex is Ecotone’s Good Buy programme, which aims to enhance supplier transparency. It takes extensive time and resources for suppliers to participate in standards such as Sedex, especially raw material suppliers. Ecotone stresses the importance of site visits – not only from an audit perspective, but also to establish invaluable relationships, which hopefully trickle down the value chain.

Ecotone also partners with Fair Trade, and Fair for Life, contributing to consultations on new standards, stressing human rights issues and working conditions such as minimum wages and contracts for temporary workers. Ecotone recognises that human rights issues are ones not generally identified with formal audits but through other ways such as whistleblowing.