Recently announced agreements have the potential to redraw global supply chains, spurring greater scrutiny from investors.
Free trade agreements that have been on hold for years, and at times decades – such as the EU’s long-awaited Mercosur accord – are being eagerly passed and promoted by the so-called “middle powers” in an attempt to counterbalance US tariffs on imports.
The yearly World Economic Forum meeting in Davos provided an opportunity for policymakers and investors to grasp the profound changes set to arise from them, including a repositioning of global supply chains.
It was no coincidence that many of the announcements in Switzerland centred on the enhancing and strengthening supply chains for the minerals needed to power cleantech technologies, factoring in the mining sector’s well-known environmental, social and governance challenges.
Shifts in trade policy, combined with a rise in extreme weather events and cyber-attacks, can potentially have significant repercussions for investors’ portfolios.
This is spurring investors to ask companies to implement detailed contingency plans to protect their investments from supply chain disruption occurring from multiple risks, arising at the same time.
The last few years have brought a greater focus on food security, energy security and climate-related supply chain issues, says David Owen, Founder of consultancy Saltmarsh Economics. He recommends investment teams to have a dedicated professional looking purely at supply chains, to assess how quickly investee companies can adapt to a rapidly changing environment.
Vitaliano Tobruk, Supply Chain Industry Practice Lead at Moody’s, agrees investors are engaging more deeply on how exposed companies are to trade, climate and operational risks. They are on the lookout for reduced exposure in critical locations, diversified sourcing and continuity plans that allow companies to operate effectively when systems or infrastructure come under stress, he says.
Financial materiality
Ultimately, investors care about supply chain disruptions because of how they affect financial performance, says Sapna Amlani, Supply Chain Co-lead at Moody’s, adding that supply chain resilience is becoming a test of “cash-flow durability” rather than a back-office logistics issue.
Instead of relying on merely stated plans, investors are now looking for concrete evidence of how companies have performed during real disruptions, says Amlani. This includes inquiring about financial metrics such as liquidity buffers, covenant headroom, and the capital required to reconfigure supply chains.
Wider supplier distress, exposure to trade restrictions or sanctions, cyber incidents, and reliance on vulnerable logistics corridors also form part of the bigger picture, she adds.
Supply chain vulnerabilities include dependence on finite and increasingly volatile natural-resource inputs, notes Nicole Rycroft, founder of non-profit Canopy, which campaigns against deforestation. “Business-as-usual sourcing is becoming more expensive, more volatile and riskier as the supply basket shrinks due to climate impacts, demand competition rises and regulations in key markets tighten,” she adds.
Regulators are increasingly alert to the financial impacts of supply chain disruptions too.
Owen from Saltmarsh Economics notes, for instance, that the European Central Bank has stepped up its research on supply chain vulnerabilities and is incorporating climate change risks into credit ratings, despite the ongoing rollback of EU green legislation, which includes the dilution of the Corporate Sustainability Due Diligence Directive.
He also believes large asset owners and managers are in a position to push companies to address supply chain resilience more closely, impose behavioural change or, as a last resort, threaten divestment.
Rycroft from Canopy argues investors should reward companies that deliver credible transition plans, covering both operations and supply chains, and price in the risk where plans are vague or absent. Specifically on deforestation, Rycroft adds investors should prioritise companies that are actively reducing reliance on virgin forest sourcing, increasing recycled content, and diversifying their fibre basket.
Scenario analysis
In addition to direct engagement with company boards, experts encourage investors to also do their own homework to stress-test their portfolio.
Mitigation from supply chain risks typically involves investors diversifying correlated exposures, avoiding hidden concentrations, and favouring issuers with proven contingency capabilities rather than aspirational plans, notes Moody’s Amlani.
Firms with diversified trade exposure, pre-qualified alternatives and the ability to respond quickly while maintaining labour and environmental standards are a better fit for portfolio protection, adds Moody’s Tobruk.
Specific stress-testing is also being introduced to better assess the exposures faced by asset owners.
“Scenario analysis helps us better understand what the future might look like and what impact this could have on our investments. We take these outcomes into account in our investment decisions,” said a spokesperson for Dutch pension provider AGP.
According to Tobruk, the most valuable tests indicate whether contingency plans can be executed in practice or whether companies may face costly trade-offs when multiple risks arise at the same time. Using operational indicators, performance data and analytics can help reveal where resilience is genuine and where sustainability risks may intensify under pressure, well before these challenges show up in financial results, he adds.
The value of scenarios analysis lies in translating operational disruption into financial outcomes, such as impacts on margins, EBITDA, cash conversion cycles, and liquidity, says Amlani. This then needs to be assessed alongside other metrics such as time-to-recover, availability of alternative capacity, and feasibility of substituting inputs, she adds.
Given the complexity of risks linked to existing supply chains, the stakes are high for both companies and investors, requiring great oversight and preparation.
“Some eventualities will likely never occur but planning for them should be part of your risk management approach,” concludes Owen.
