Trade wars have made Europe and the US ‘higher risk’ markets – and it’s all to do with labour, says LRQA

Over the past few years, national security concerns posed by an overreliance on China for green energy components have ushered in a new era of “homeshoring”, or bringing production closer to home, in the United States and Europe.

Under US President-elect Donald Trump, who has declared tariffs “the greatest thing ever invented”, an expansion of existing trade wars is expected. On his first day back in office, he already plans to impose a 25 per cent tariff on imports entering from Canada and Mexico, in a bid to halt the flow of drugs and migrants, as well as an additional 10 per cent tariff on all Chinese products.

While the implications of a renewed global trade war in the form of price spikes and shortages of products for businesses and consumers globally have entered mainstream discourse, its impact on labour risks has flown under the radar, said Kevin Franklin, chief growth officer and managing director of the advisory business unit of global assurance firm LRQA.

In the last three to five years, geopolitics has really come into force, particularly trade wars. This has led to a need for lower cost manufacturing in developed markets like Europe and the US, and a greater reliance on migrant workers,” said Franklin.

He added that companies in these countries – once deemed “low risk” – often employ undocumented workers on “shadow working hours”, where they work on third shifts late at night when there is “less visibility”.

“Those workers are often not paid correctly, maybe have their passports retained and, in some cases, there could be child labour involved. We’ve seen these risks becoming much more visible and present in Europe and the US, in particular,” said Franklin.

Over the past two years, media outlets have exposed some of these instances of forced labour in the US. But Franklin said that LRQA started seeing these risks appear in the data collected on its supply chain due diligence platform EiQ as early as about five years ago.

Its most recent environmental, social and governance (ESG) risk outlook report found that forced labour risks have worsened in 53 countries, including Australia, China, India, the Netherlands, the US, and the UK. These risks were calculated based on non-compliance with the International Labour Organisation’s forced labour indicators, which include illegal recruitment fees, retention of identity documents, forced overtime, restriction of movement, and wage withholding.

Despite increasing regulations to weed out forced labour across supply chains worldwide, such as the European Union (EU)’s forthcoming Corporate Sustainability Due Diligence Directive (CSDDD) and the US’s Uyghur Forced Labour Prevention Act, LRQA found that transparency levels have worsened over the past year in developed countries like the US, Japan and Canada.

The Birmingham-headquartered company was established as an independent business from Lloyd’s Register’s Business Assurance & Inspection Services division in 2021. LRQA is now wholly owned by an investment fund managed through Wall Street giant Goldman Sachs’s asset management arm.

The firm onboarded Franklin upon acquiring Elevate, a Hong Kong-based supply chain sustainability solutions provider, in 2022, in order to enhance its existing ESG and supply chain quality assurance capabilities. It now operates across multiple sectors in over 150 countries, providing assessment, advisory, inspection and cybersecurity services. “We’ve added a few other acquisitions since then, and will be adding more as part of our growth journey to be the world’s leading provider in the risk and assurance space,” he said.

Eco-Business sat down with Franklin to discuss how businesses in Asia – which remains a “high risk” geography –can prepare for upcoming EU-driven regulations to address ESG risks across their supply chains, and why he expects harsher penalties to come for sustainability auditors, after corporations and investors.

To start, could you share more about LRQA, its main ESG-related services, and why it is growing its presence in Asia?

LRQA is a global risk and assurance provider that focused on [removed heritage reference as suggested] five big solution areas: responsible sourcing; the net zero transition; product integrity, which also includes food safety; management systems; and cybersecurity. For each one of these five areas, we deliver an end-to-end ecosystem of risk and assurance. 

What we do covers different aspects of ESG. Some of our net zero transition work is on carbon verification and accounting around science-based target setting. But another big chunk of it is around inspection work in the renewables space. So we do a lot of on-site assessment work, both for management systems and asset-level inspections in wind, solar and hydrogen, for example. 

Our company is primarily made up of deep technical experts and engineers in the respective sectors and standards. We do a lot of ISO 14001, 14064, 45000 and 50000 certifications [internationally recognised standards for environmental management systems, greenhouse gas accounting, occupational health and safety and energy efficiency plans, respectively] which are all ESG-related management systems. 

LRQA has a global footprint, but historically, LRQA has been primarily a Europe-led business. With the addition of Elevate, we’ve been able to focus more on Asia which has growing importance as a hub for global supply chains and a critical role in addressing the evolving challenges of sustainability and risk management. Our three key growth markets comprise Asia Pacific [which includes Greater China] and is arguably our single biggest focus from a growth perspective, followed by the Middle East, because of its capital and energy, and North America, because we’re still relatively underrepresented there.

What are the main drivers of demand for LRQA’s services that you’re seeing in this region?

Renewable energy is a huge growth engine for us, from both an assessment, inspection, and also an advisory and consulting perspective. We’re doing a lot more in wind, hydrogen, and solar, led by our work in China, all the way through to Australia and New Zealand. Second is the automotive sector, which is a massive growth area – particularly in China, where there are increasing standards and certification requirements. The third big area is food safety. The fourth is ESG, which has grown across all of our service lines, especially our advisory services in Asian markets like Japan, Malaysia, and South Korea.

ESG advisory is still quite small in China, but there’s a huge amount of growth opportunity due to new requirements around stock exchange regulation and reporting. As China rolls out its net zero ambition, they have started to impose carbon accounting requirements for loans, for example. Because they have a lot of policy continuity, they’re likely to enforce these regulations with a stronger will than other geographies.

When did you start seeing this surge in interest? Is it mostly driven by top-down regulations?

We’ve really only seen significant growth in the last three to five years. I think a lot of this is driven by non-Asian regulations, like the CSDDD, the Corporate Sustainability Reporting Directive (CSRD), the EU deforestation law, Carbon Border Adjustment Mechanism (CBAM) and the Uyghur Forced Labour Prevention Act. These have put a lot of pressure on our clients. A large percentage of our clients are multinational corporations that have supply chains in Asia or Asian businesses exporting to Europe or the US, in which case they need to comply with these regulations if their revenue exceeds a certain threshold. 

Ironically, I would say a number of those regulations that are driving the ESG agenda have come as part of the trade wars, as a response to the perceived unfair advantage that Asia may have in terms of a low-cost manufacturing environment.

So the main drivers are more from the EU’s regulations, rather than domestic regulations?

Exactly. The domestic ones, like the disclosure requirements from the Singapore or Hong Kong stock exchanges, aren’t as stringent, while some regulations from Europe go much deeper. 

What are the estimated costs involved in complying with CBAM and other EU regulations for Asian exporters to the EU, and how do they differ across industries and jurisdictions?

Prior to these regulations, the requests for ESG assurance were typically project-driven and context-specific and would maybe involve an ISO 45000 or 14001 certificate. These regulations now require an end-to-end due diligence type approach.

One of the first templates for this was the United Nations’ Guiding Principles on Business and Human Rights in the early 2010s, which was a risk-based assessment; there weren’t any expectations for businesses to do everything all at once. Businesses are now expected to take a risk-based approach and focus on the most material issues, which is different from before, when it was one thing at a time. 

Because so much of the world’s manufacturing is happening in Asia – which is still somewhat of a “high-risk” geography – it does impact businesses here significantly.

Now, the challenging thing is it also impacts businesses in other regions, like the US and Europe, because it’s a legal requirement for them to disclose. But often, those are big retailers or apparel brands with the resources. Certainly, if they plan well and have years’ worth of warning – which they typically have – they can allocate the resources to disclose.

But in Asia, it’s trickling down into businesses that are less prepared, less forewarned, less trained and with less expectations to do this, and likely operating on quite tight margins.

For those businesses, how would you usually advise them to get started with responding to these new regulations?

The first ingredient is openness and transparency. What I mean by that is not coming into it defensively. I’ve worked in sustainability for 25 years and I initially saw a lot of this in Europe, which is where I started. I moved to Asia eight years ago, and I’ve definitely seen a lot of this here over the last eight years. There’s a big opportunity that comes from being open, transparent, and willing to engage to address issues, which is harder than it sounds. 

Step two is having some kind of gap analysis. You need to understand where you are as a business today versus what the requirements of the regulation or your customers might be. So that “diagnostic piece” is critical to building a programme of work to roll out. 

Typically, most regulators and customers are looking for progress and engagement. It’s the same when we engage directly in supply chains and we find problems. We push our corporate clients to incentivise their suppliers to address issues by working collaboratively, rather than telling them there will be penalties or that they will be removed as a supplier.

Which are the trickiest industry supply chains to trace in Asia, and why? How is LRQA working to address these challenges?

They are all in the raw material space, like cotton, palm oil, seafood, and minerals. These are the really difficult supply chains, not just because they are raw materials, but because they are often multi-tier or blended supply chains.

Take cotton used in apparel for example. There are multiple layers that you need to work through, and each of those layers has a vested interest in withholding information about the layers before it as there’s probably a competitive advantage in cost and pricing. So you’re going through gins, spinning mills, all the way back to the farms. This can be complicated and requires a lot of engagement in an open and transparent manner with suppliers. 

It’s the same for minerals – many of them are also in remote regions, like farms, not in city centres, so they’re less visible to the public eye. Or if it’s seafood, it’s out to sea, making it difficult to track. 

To try to address them, we have designed much more rigorous audit tools and protocols. We can now collect more information about, for example, wages, working hours, worker demographics, and the languages that they speak, helping us to better understand their risk exposure. We also utilise worker surveys segmented by gender to hear from workers directly about, for example, whether they are being discriminated against or if they’re being underpaid. 

So part one is having better tools when you’re on site. Part two is leveraging and using data, analytics and technology a lot better. We have built a platform called EiQ, which includes all of our audit results and findings, from the deployment of tools to corrective action plans.

We also have an adverse media scanning tool integrated into EiQ called Sentinel that scans supplier names and looks for information that may be in the public domain. There is a lot more of that today than there ever was in the past. In China, you have a lot of cities and provinces that have online grievance mechanisms or public lists where workers can report discrimination or wage issues. That kind of information can be used to flag a risk at lower tiers of the supply chain. 

There are also large-scale data aggregation tools that you can build to map out supply chains. Some of that is linked to bill of lading data [a legal document issued by a carrier in the form of a receipt to a shipper detailing the type, quantity, and destination of the goods being carried], which is often public domain. We’ve actually also had a large US government-funded project to look at building a traceability protocol similar to the Greenhouse Gas Protocol, called the Global Trace Protocol, as there is currently no uniform standard for traceability.

How confident are you that the increase in disclosures and traceability will lead to improved sustainability performance?

I’m confident that the increase in transparency will pay off. I’m not necessarily confident it will solve climate change, if that’s your real question. I’m a lot more sceptical, because I still have a big question: is it going to be too little too late?

Having said that, I think the only way to incentivise continuous improvement is through more transparency and accountability. We need more consistent and effective enforcement of regulations from regulators in the region. I think it’s coming for the greenhouse gas space, because it is increasingly linked to financial disclosures, as we are seeing more penalties being imposed for financial improprieties.

Without transparency or penalties, no one will go to companies like Malaysia’s national oil company Petronas and say, “Hey, you need to reduce this, we’re holding you to account. If you don’t do X, Y and Z, there will be a penalty that looks like this.” We need the regulators to push harder. Oil and gas giant BP made commitments decades ago and still haven’t transformed their business models. Instead, we waited for China to provide low-cost solar and wind production. 

A lot of those companies are not publishing their Scope 3 emissions. Many companies are publishing Scope 1 and 2, but only estimating – not fully quantifying – Scope 3 emissions. They are not investing to understand what’s really happening in their supply chains, which results in transparency gaps.

There are still many companies that are not reporting at all, let alone just Scope 1 or 2. We need to start holding people accountable for what they are reporting – it’s not enough to just say we’ve done the report. You have to come up with a plan to reduce emissions and achieve your science-based targets. But you can’t have that feedback loop without transparency. It’s a fundamental starting ingredient, which is why stock exchanges require it as the first step. But following through with the next steps of verification of emissions is critical.

On the topic of verification – with Big Four audit firms continuing to dominate the ESG assurance market with a slew of acquisitions, how is LRQA differentiating itself in an increasingly crowded market?

We spoke earlier about the kind of changing definition of assurance. Verification is just one part of assurance – it checks and confirms that the data being published is “accurate”. But there are different levels of verification.

While LRQA has been doing this since the 2000s, it’s actually quite a small part, maybe 5 to 10 per cent, of our overall business. Verification and reporting come at the end of the due diligence process. The dominant players in that space today would be more of the Big Four. 

But what separates us is deep technical expertise. We’re not a management consultancy. We’re not a financial auditor. Because we have engineers who would do the verification work, we’re probably one of the leading players in verifying the emissions in the oil and gas sectors, where verification is critical. So we work with companies like Shell, Petronas and so on.

Secondly, we have people on the ground in operations and supply chains; we have teams that go out to factories in China, Vietnam, Bangladesh, Pakistan or across Europe.

Thirdly, we’ve invested a lot in data collection over the last two decades. So we have over 15 years of data we’ve collected from 60,000 facilities a year. This means that each year, we’re collecting hundreds of millions of data points that feed into the EiQ platform, which supports clients end-to-end. 

Ultimately, it’s the ability to combine advisory with a data-driven risk module, as well as to support on-the-ground transformation and assessment that makes us unique and different.

Why have ESG risk scores, especially labour risks, worsened across many countries in the past year, despite more countries mandating ESG compliance?

Part one of the answer is that geopolitics has led to home-shoring, which has led to companies looking for lower-cost labour and relying on migrant workers.

Part two is that because we’ve had a lot more technological advancement – there are new tools, like machine learning and artificial intelligence – and more of this information has become visible in the public domain. That wasn’t viable seven years ago. Some investigations by universities or journalists have figured out some of those links, where they’ve looked at things like trade records to link and connect shipments from source to endpoint to then make strong arguments. 

Much of this has also then led companies to request audits in those countries. When I started working on responsible sourcing 15 years ago, a large percentage of my clients at that time did not audit in the US or Europe. They just considered them “low-risk” regions and only audited in Asia. But over time, data has shown that those regions are “high-risk”. Now that audits have started, they’re finding more issues – so we’re in this perpetual cycle of more visibility, more compliance, and therefore, more visibility. That needs to be completed until we have stronger regulations and those issues are resolved.

2024 has been a record election year, with the US President-elect Donald Trump returning to office. Do you foresee more geopolitical rifts in the year ahead and how will they factor into ESG risks in supply chains?

Firstly, trade wars will likely continue. For a large part of the last 40 years, we lived in a very unique world where there was only one superpower. But in the 1990s, after the USSR collapsed, the US remained. The Cold War dissipated and the world was flooded with the US’s policy, positioning and media. It became the world’s sole superpower.

That has now changed. Whenever you’re in a position with multiple superpowers, you end up with trade wars and conflicts of some form because they impact national sovereignty. So that won’t disappear in our lifetimes, for sure. 

Secondly, I think we’re going to see trade wars feeding through to a lot more stringent regulations, with enforcement leading to more companies called out for greenwashing and poor accounting. There will be fines for the corporations themselves and potentially also for auditors or verifiers. What we’re currently seeing with PwC in multiple geographies for poor accounting practices, for instance, hasn’t really impacted the ESG space yet. But it’s the next thing to come – penalties for failing to attain ESG assurance. 

We’ve started to see some kind of penalties for investors who have used poor-quality data, so that is going to self-correct as well. The incoming European regulation around ESG ratings will have a big impact on the credibility of ESG data. Once the methodologies for that data are published publicly, which is part of the requirement, investors and regulators will have more ability to decide what they do and don’t use to drive investment and regulatory decisions. 

These will all come as part of the trade wars, global economic pressures and attempts by governments to seek additional income through imposing fines, penalties, and taxes. So we need to get our ships in order.