Moody's: The Cost Impact of ESG Supply Chain Regulations

As the global regulatory environment tightens, organisations face increasing operational costs and complex compliance demands linked to climate risks.

According to Moody’s 2025 ESG Outlook, these evolving ESG regulations are crucial in reshaping the financial sector by connecting rated debt to greater exposure to environmental and labour-related risks.

“Policymaker and investor focus on environmental and labour practices in supply chains ... will raise operational and compliance costs as well as regulatory and reputational risks,” Moody’s warns.

The implication for companies that do not meet these emerging standards is severe, exposing them to financial penalties, reduced credit ratings, and reputational damage.

Regulations tighten on sustainability

From 2025 onwards, European firms will find themselves navigating through a thickening web of regulations.

The Corporate Sustainability Reporting Directive (CSRD) and the EU Deforestation Regulation will require businesses in the European Union to report extensively on their sustainability practices.

By 2027, obligations will expand under the Corporate Sustainability Due Diligence Directive (CSDDD).

The introduction of the EU’s Carbon Border Adjustment Mechanism (CBAM) adds yet another layer of complexity.

This regulation requires suppliers to declare their carbon emissions which nudges European importers towards suppliers with lower carbon outputs.

In parallel, China is broadening its Emissions Trading Scheme (ETS) to reduce carbon emissions within domestic sectors and the US is considering similar measures.

These regulatory adjustments are heightening costs associated with compliance, reporting and restructuring of supply chains.

Suppliers of commodities like cocoa and palm oil, which are particularly targeted by EU’s deforestation rules, face pronounced vulnerabilities, especially in emerging markets.

As scrutiny from investors, consumers and regulators intensifies, supply chain transparency becomes more crucial.

To maintain contractual relationships, suppliers must invest in mitigating social and environmental risks, increasing their operational costs further.

The rise of plastics and packaging regulations

While emissions and deforestation dominate ESG discourse, plastics also represent a significant challenge.

Despite the stalling in finalising a global plastics treaty in December 2024, the EU has moved to implement stricter recycling requirements under its updated packaging directive.

By the years 2025 and 2030, companies in the consumer goods and beverages sectors will need to meet elevated recycling targets and adhere to new limits on single-use plastics.

These changes mean higher costs for waste management and investment in sustainable packaging.

However, there is a silver lining for manufacturers already utilising recycled materials, as demand for recycled content is poised to grow, potentially stimulating market expansion.

Linking debt ratings to climate risks

Moody’s credit analysis highlights how ESG factors are increasingly influencing credit assessments.

Out of 12,610 entities monitored, ESG characteristics have adversely affected the ratings for 17% of issuers, with 3% experiencing substantial credit downgrades.

Another 26% face limited risks currently, though these are expected to escalate over time.

Industries like automotive, power and heavy industry, all of which are exposed heavily to climate risks, are under growing financial strain.

Conservation of natural capital and the use of agricultural land are emerging as key themes in decarbonisation strategies.

Moody’s environmental heat map has identified 16 sectors with high or very high carbon transition risks, encompassing companies with a cumulative US$5tn in rated debt.

While emerging economies struggle to fund their transition, advanced economies, buoyed by robust green technology markets and substantial policy support, have an advantage.

Clear definitions of transition finance could further bolster investor confidence, mitigating fears of greenwashing and fostering growth in green and labelled debt markets.

As regulations continue to evolve, swift and strategic adaptation is imperative for businesses.

Navigating through the complexities of stricter supply chain rules and escalating climate risks demands not just strategic investments but also robust commitments to sustainability.

With climate considerations now integral to credit ratings, the stakes for businesses continuity and success have never been higher.

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