Social and governance failings in supply chains

In 2021 we predict

At least 1 FTSE 250 company will suffer a 20% day-on-day fall in its share price as the direct result of press coverage of 'social' or 'governance' failings in that organisation’s supply chain.

The picture in 2020

• Increased awareness of diversity and inclusion (“D and I”) issues as a result of the impact of the Black Lives Matter movement and the COVID-19 pandemic. This has increased focus on the ‘social’ element of the ESG framework, increasing employee engagement, expectation and challenge on issues relating to culture and D and I.
• Other ‘social’ and ‘governance’ issues, including the protection of personal data and the prevention of fraud and corruption, have been emphasised by the pandemic, governments’ responses to it and mass working from home.
• In the UK in particular, labour market issues took centre stage following allegations of widespread breaches of the minimum wage and potential modern slavery issues at Boohoo suppliers in Leicester. The report led to a day-on-day tumble of 23.4% in Boohoo’s share price (and 40.8% over a week) and prompted a number of major asset managers to divest.
• Criticism of ESG rating agencies has increased following the Boohoo incident. These agencies provide ESG or sustainability ratings and are relied on by many market participants. However, they have long been criticised on the basis of inconsistency across the industry and the use – by some agencies – of methodologies that have left some companies with high scores despite operating in industries that a common-sense approach might have suggested were not particularly ESG friendly.
• This criticism was perfectly illustrated by Boohoo, about whom several rating agencies had issued glowing scores. That fact goes some way to explaining why so many ESG funds were invested in Boohoo, which – as one of the standard-bearers for the fast fashion industry – would never have been an obvious paragon of sustainability.

Looking ahead to 2021

• At least 1 FTSE 250 company will suffer a 20% day-on-day fall in its share price as the direct result of press coverage following from human rights, employment conditions or criminal compliance failures in its supply chain.
• Asset managers will come under increased pressure to divest from companies that are regarded as socially irresponsible.
• We will see short-selling attacks on listed companies with problematic supply chains.
• Regulators, most particularly the FCA, will increase their focus on ‘social’ and ‘governance’ issues. Implementation of corporate reporting on these matters will likely lag behind that for climate-related products, but we expect the FCA’s increasing focus on sustainability in general will prompt investigations relating to the ‘S’ and ‘G’ in the ESG framework.
• Increased focus on, and awareness of, D&I will lead to complaints about D&I issues (including historical complaints, as we saw in the case of #MeToo), in particular in relation to D&I strands that have received an increase in recognition and understanding this year.

What does this mean?

• Increasing regulatory interest is likely to prompt an increase in investigations and enforcement in this area.
• Corporates will need to invest further in compliance, culture and due diligence to make sure that the reality of their social footprint reflects their CSR statements. AMIFs are indirectly exposed to the same risks and must ensure appropriate CSR due diligence is carried out on those companies in which they invest.
• The increasing responsiveness of the markets to ‘social’ failings considerably increases the visibility of and costs arising from such issues. This will increase both regulatory and litigation risk linked to ESG disclosures and statements.
• Parallel proceedings are likely. Listed companies under investigation may face shareholder claims, most likely for failure to disclose under s90/90A FSMA, in much the same manner as has been seen in relation to more traditional ‘governance’ issues such as bribery and corruption.