Why Traditional ESG Scores Fall Short for Supply Chain Monitoring in Regulatory Landscape

Companies worldwide are facing a new reality: the need to actively monitor their supply chains for sustainable and ethical business practices. This shift is driven not only by Environmental, Social, and Governance (ESG) regulations in Europe and the United States but also by increasing consumer demands for businesses to operate in ways that do not harm the environment or its people.

In Europe, the development of ESG regulations is often top-down, with nations creating rules in response to European-level directives. Examples include the German Supply Chain Act, the UK Modern Slavery Act, and the Norwegian Transparency Act. In contrast, the process in the United States and Canada is bottom-up, with significant regulatory initiatives emerging at the state level, such as the California Transparency in Supply Chains Act and the New York Fashion Sustainability and Social Accountability Act. Given these varying regulatory frameworks and initiatives (Figure 1), organizations operating internationally face a substantial challenge in striving for compliance with all the different regulations and their nuances.

Figure 1: Examples of National/Federal ESG Regulations in Europe and North America

With the implementation of these new regulations, the regulatory landscape for ESG has become increasingly crowded for companies operating internationally. This drives the need to monitor supply chains across borders for ESG violations and take action if needed.

Traditionally, companies have relied on third-party ESG rating service providers to monitor ESG violations in their supply chains. These agencies typically evaluate thousands of entities using hundreds of ESG indicators to determine scores. This process relies primarily on qualitative human research, supplemented by computer-driven models and self-declared questionnaires.

While analyzing ESG scores to determine if there are no violations in a supply chain is straightforward, solely relying on these scores has drawbacks, which we explore in this blog.

Drawbacks of Utilizing ESG Scores for Supply Chain Monitoring

Despite comprehensive methodologies, current ESG scores have drawbacks that negatively impact companies that use them to monitor their supply chains.

Companies are not always required to disclose ESG information

In the United States, companies have no regulatory requirement to disclose their ESG metrics in financial reports. Nonetheless, some companies proactively undertake this responsibility on their initiative, voluntarily reporting their ESG performance.

Example of voluntary disclosure of ESG scores: Sustainability Accounting Standards Board (SASB)

According to a report from the Website PlanA, in the United States, the Sustainability Accounting Standards Board (SASB) currently offers industry-specific standards to help companies disclose material and financially relevant sustainability information to investors¹⁰. Although these guidelines are not mandatory, they are increasingly recognized and adopted by US corporations seeking to meet investor demands for ESG data that can inform investment decisions.

ESG Scores are Backward-Looking and Infrequently Updated

Additionally, ESG reports typically come out only once or twice a year, often resulting in outdated scores by the time they are released. These infrequent updates mean that most sustainability reports and ESG Scores are issued retrospectively and need to reflect the most current information. As a result, companies may have to rely on outdated information for a significant portion of the year.

Self-Reporting Mechanisms Issues in the Real World

Furthermore, ESG scores rely partly on self-reporting mechanisms or companies’ assessments of their ESG practices. This can lead to inconsistencies and potential ‘greenwashing,’ which occurs when companies exaggerate or misrepresent their environmental and social performance to appear more sustainable and ethical than they genuinely are. These discrepancies undermine the reliability of ESG scores and mislead stakeholders about companies’ actual ESG practices.

Example of Self-Reporting Mechanisms Issues: B Corp

Earlier this year, the BBC highlighted ongoing controversies surrounding certification processes like B Corp. Critics argue that the certification, which heavily relies on self-reporting, is flawed and lacks transparency. Instances such as Nespresso receiving B Corp certification despite its poor human rights record and Brewdog losing its certification after allegations of a “culture of fear” among workers highlight these issues¹¹.Matthew Cotton, professor of public policy at Teesside University, pointed out that the sheer volume of different certification schemes has confused consumers about their legitimacy, contributing to greenwashing. Robert Strand, executive director of the Center for Responsible Business at the Berkeley Haas School of Business, noted, “Certification is increasingly viewed as one part of a broader strategic approach to sustainability rather than the endpoint. Companies need the help of other tools to better ensure the safety of their supply chain in the present world.”

Limited Scope

Lastly, according to Statista, approximately 330 million companies are globally¹². This staggering figure highlights the immense complexity and scale of the global business environment. Given the sheer number of companies, it is unrealistic to expect that Environmental, Social, and Governance (ESG) scores currently cover every single entity.

Towards a More Comprehensive ESG Strategy

As companies navigate the complex landscape of ESG regulations and strive to maintain sustainable and ethical supply chains, it’s clear that relying solely on traditional ESG scores may not be enough. The limitations in data disclosure, the backward-looking nature of ESG scores, and the potential for greenwashing all contribute to the need for a more dynamic and comprehensive approach to ESG risk monitoring.

Our next blog explores how adding an “outside-in” perspective through adverse media monitoring can enhance your ESG risk analysis. Discover how Owlin’s advanced platform offers real-time insights to help your business avoid potential ESG violations and maintain compliance.

Sources

European Commission, 2024, Corporate Sustainability Due Diligence
Norton Rose Fulbright, 2024, The German Supply Chain Act Overview and Practical Challenges for Companies
Unpacking the UK Modern Slavery Act 2015 Eight Years On, 2023, Linklaters
Putting the Dutch Child Labour Due Diligence Act into Perspective, 2019, Erasmus Law
Norway’s Transparency Act: What you need to know, nd, Sedex
All You Need to Know about France’s Corporate Duty of Vigilance Law, 2024, Worldflavor
The California Transparency in Supply Chain Acts, 2024, State of California Department of Justice
Challenges of New York’s Fashion Act and Those Helping to Prepare for it, 2024, Fashion United
FAQ on Canada’s New Modern Slavery Act, 2024, Crowe
All ESG and Non-financial Reporting Regulations in the U.S., 2024, PlanA
BBC, 2024, As greenwashing soars, some people are questioning B Corp certification
Estimated Number of Companies Worldwide from 2000 to 2021, 2024, Statista