Supply Chain Governance: Managing Third-Party ESG Risk in Australia

Supply chain governance is increasingly central to ESG risk management. Organisations are accountable for ESG practices throughout their supply chains—labour practices, environmental compliance, business ethics. Supply chain risks include labour exploitation, environmental damage, conflict minerals, forced labour, and corruption. For Australian businesses, supply chain governance is both a legal obligation (Modern Slavery Act) and an ESG imperative.

This article explores supply chain governance frameworks, third-party risk management, due diligence, and remediation strategies. For broader governance context, see our article on enterprise risk management and ESG. For governance structures supporting supply chain oversight, see our article on ESG governance frameworks.

Supply Chain ESG Risks

Labour Risks

Supply chain labour risks include:

• Child labour or forced labour
• Excessive working hours or unsafe conditions
• Denial of freedom of association or collective bargaining
• Inadequate wages or benefits
• Discrimination or harassment

These risks are highest in developing countries with weaker labour regulation.

Environmental Risks

Supply chain environmental risks include:

• Illegal logging or unsustainable forestry
• Mining damage to ecosystems
• Pollution and waste mismanagement
• Water and soil contamination
• Failure to comply with environmental laws

Governance Risks

Supply chain governance risks include:

• Bribery and corruption (particularly in government procurement)
• Conflict of interest or self-dealing
• Tax evasion or regulatory evasion
• Fraud or misrepresentation

Modern Slavery Act and Supply Chain Governance

The Modern Slavery Act 2018 (Cth) requires entities with annual consolidated revenue exceeding AUD 100 million to report on risks of modern slavery in operations and supply chains, and actions taken to address risks. The Act creates mandatory governance obligations for larger organisations.

Modern Slavery reporting requires organisations to assess and disclose:

• Modern slavery risks in supply chains
• Actions taken to address risks (due diligence, monitoring, remediation)
• Effectiveness of actions
• Remedy mechanisms for victims of modern slavery

Supply Chain Governance Framework

1. Supply Chain Mapping and Risk Assessment

Organisations should map supply chains and assess ESG risks:

• Supply chain visibility: Identify direct suppliers, secondary suppliers (suppliers to suppliers), and critical dependencies
• Risk identification: Assess geographic risks, sector risks, supplier-specific risks
• Risk prioritisation: Focus governance efforts on highest-risk relationships
• Baseline assessment: Current supplier ESG practices and compliance

Many organisations struggle with supply chain visibility, particularly in complex global supply chains.

2. Supplier Code of Conduct and Requirements

Organisations should establish supplier codes of conduct articulating ESG expectations:

• Labour standards (no forced labour, child labour, discrimination)
• Health and safety standards
• Environmental compliance and practices
• Business ethics (anti-bribery, anti-corruption, conflict of interest)
• Right to audit and verify compliance
• Remedy mechanisms for violations

Codes should be communicated clearly and integrated into supplier contracts.

3. Supplier Due Diligence

Organisations should conduct due diligence before engaging suppliers:

• Financial assessment: Ability to sustain fair labour practices and environmental compliance
• ESG assessment: Current practices and commitment to improvement
• Regulatory compliance: History of regulatory violations or enforcement
• References: Experience with other customers regarding ESG performance
• Third-party assessments: Third-party ESG ratings or audits

4. Supplier Monitoring and Compliance

Organisations should implement ongoing monitoring of supplier compliance:

• Audits: Regular on-site audits of labour, health and safety, environmental practices
• Assessments: Third-party ESG assessments or audits
• Compliance metrics: Performance indicators for health and safety, environmental impact, labour practices
• Grievance mechanisms: Processes for workers or other stakeholders to report concerns
• Continuous improvement: Engagement with suppliers on improvement plans

5. Remediation and Corrective Action

When compliance violations are identified, organisations should:

• Assess severity: Determine nature and extent of violation
• Immediate action: Stop immediate harm (stop child labour, ensure safe conditions)
• Root cause analysis: Understand why violation occurred
• Corrective action plan: Develop plan for remediation and prevention of recurrence
• Monitoring: Monitor implementation of corrective actions
• Escalation or termination: If supplier is unwilling or unable to remediate, escalate or terminate relationship

6. Stakeholder Engagement and Transparency

Organisations should engage stakeholders on supply chain governance:

• Supplier engagement: Partner with suppliers on ESG improvements rather than punitive approaches
• Transparency: Disclose supply chain risks and responses (e.g., Modern Slavery Act reports)
• Traceability: Where material, provide traceability of products to source
• Stakeholder voice: Enable worker and community voices in supply chain governance

Challenges in Supply Chain Governance

Supply Chain Complexity and Visibility

Many organisations struggle to gain visibility into extended supply chains (suppliers’ suppliers). Technology solutions (blockchain, track and trace systems) can enhance visibility but require investment.

Competing Pressure on Suppliers

Price pressure from customers can incentivise suppliers to cut costs through reduced wages or environmental compliance. Organisations must balance commercial terms with ESG expectations.

Limited Supplier Capacity

Smaller suppliers may lack resources for ESG compliance. Organisations should provide technical assistance and capacity building rather than solely requiring compliance.

Key Takeaways

Supply chain governance is essential to ESG risk management. Organisations are accountable for ESG practices in supply chains. The Modern Slavery Act requires governance and disclosure for in-scope entities. Effective supply chain governance requires supply chain mapping and risk assessment, supplier codes of conduct, due diligence, ongoing monitoring, remediation for violations, and transparency. Organisations should partner with suppliers on improvements rather than solely enforcing compliance.

Frequently Asked Questions

What is the difference between a supplier code and a contract?

A code of conduct articulates standards and expectations. Contracts are legal agreements establishing commercial terms. Both should be aligned, with contracts referencing or incorporating the code.

How can organisations audit suppliers in high-risk countries?

Organisations can conduct on-site audits, engage third-party auditors, use technology for monitoring, establish grievance mechanisms, or partner with industry consortiums conducting joint audits.

What should organisations do about suppliers failing to meet ESG standards?

First, assess whether improvements are possible through technical assistance and corrective action plans. If supplier is unwilling or unable to remediate serious violations, terminate the relationship. Document decisions for Modern Slavery Act reporting.

Does supply chain governance only apply to manufacturing?

No. Service providers, logistics companies, software vendors, and other service providers also have ESG risks. Supply chain governance principles apply across all sectors.

How should organisations balance price and ESG in supplier selection?

Organisations should factor ESG into supplier selection criteria and total cost of ownership calculations. ESG compliance prevents costly incidents (environmental damage, labour disputes, regulatory action).

Who is responsible for supply chain ESG governance?

Responsibility is shared across procurement, operations, compliance, and legal teams. Board and management should oversee governance framework. Procurement teams typically implement daily management.