Compliance risk: a guide for apparel companies of all sizes

March 19, 2021

Compliance is often thought about as something businesses have to do. But we see it as a good to be aspired toward, for it helps to shape a company’s reputation and can protect it from unwanted attention. For these reasons, compliance risk – also known as integrity risk, which describes more explicitly its ethical dimension – should be a primary concern for manufacturers and suppliers of all sizes in the apparel industry. 

Strictly adhering to industry laws and regulations, as well as your company’s own internal policies and practices, is essential to minimise the occurrence of legal penalties, financial forfeiture and material losses. In this article, we will break down what compliance risk is, introduce examples of where these risks can materialise and discuss how to develop an effective compliance risk framework. 

What exactly is compliance risk?

Simply put, compliance risk is potential exposure to the range of financial losses and legal consequences that arise from failing to meet internal policies or regulatory requirements. While it is easy to think of compliance risk strictly in terms of legal obligations, it has a wider scope. Below are some of the key areas where such risks can materialise:

Regulatory environment

Regulatory environment describes the laws that are relevant to an industry, in this case apparel. They can be far-reaching, touching on everything from how a manufacturer manages its environmental impact to the ways a business must disclose its business practices. Keeping a pulse on the priorities and concerns of your industry’s regulators is key to understanding whether or not you are compliant at any given time.

Natural environment

This describes the risks associated with mismanaging your company’s impact on the environment. Examples include the illegal polluting of local water sources and the volume of carbon emitted through your operations. Taking care to analyse your environmental footprint can help with both aligning with industry best practices as well as anticipating future regulations.

Operational environment

Operational environment describes all the various aspects of your business operations and whether they are in accordance with relevant regulations and company policies. You may think of your quality standards and whether or not your products meet the minimum expectations for your industry; or corrupt practices like bribery and fraud and the legal implications of these behaviours on your firm; or haphazard processes that may hinder your ability to carry out your contractual obligations to customers or business partners; or your working conditions, which may put your workers at risk of harm if equipment is old or hours are too long.

Social environment

Social environment describes the impact of your business on your human resources. This means adherence to codes of conduct concerning issues like sexual harassment and discrimination in the workplace. The prevalence of these kinds of issues is sometimes called ‘conduct risk’, indicating that the way your employees and colleagues act toward each other and your clients and business partners matters in terms of your risk exposure.

Technological environment

This describes the kinds of technology common in your industry and the risks associated with using it inappropriately. For example, with so much data now being stored and analysed for decision-making, there has been an uptick in rules around data privacy and protection. With higher standards now widely implemented it is important to ensure, if you are collecting and using data in any way, you are aware of how to handle it compliantly. 

Spotlighting supply chain compliance

Effective supply chain management is essential to the flourishing of apparel companies. But for it to be effective, they need to be sensitive to the compliance implications of their decisions.

For example, COVID-19 has had obvious long-term impacts on the apparel industry. It has resulted in widespread financial strain and general business uncertainty, with many firms turning to ‘survival’ techniques like cost cutting to stay afloat. Not discounting the necessity of these measures in some instances, it is also important to remain aware of how these decisions may look from a compliance perspective. 

QIMA, a leading supply chain compliance solution provider, found that companies with a survival mindset are more likely to prioritise cost cutting over sustainable sourcing and push their suppliers to meet tight deadlines for high-demand products such as PPE. To fulfil these expectations, suppliers and manufacturers may begin to overlook otherwise unacceptable working conditions and labour policies, giving rise to ethical trespasses like unsafe workplaces and forced overtime.

Ethically speaking, this kind of pressure can create long-term problems, which have been found to exacerbate during times of disruption and transition. In Q3 2020, QIMA’s ethical auditors recorded factory scores 4.5% lower compared to the same period in 2019, with around 62% of factories in need of rectification across a variety of issues, from health and safety to waste management. 

All of which is to say that an ethical supply chain is also often a compliant one. While all enterprises have legitimate business needs, the short-term gains of cost cutting and pressuring suppliers may have unintended and undesirable long-term consequences in terms of your ethical compliance. 

Consumers and buyers worldwide are more aware of compliance than ever before. They are paying more attention to where clothes come from, who is involved in the manufacturing process, and the social and environmental impact of fashion. Most of all, a growing number of people are happy to pay extra for ethically sourced products. 

“Compliance was thought to be the reason for testing, monitoring and adhering to industry norms and needs. It is very scientific and describes a task to meet a certain standard. However, some apparel companies and brands are using compliance as the new ‘tip of their spear’ by turning it into a Business Social Compliance Initiative in the way goods are made and sourced,” says Peter Warner, Advisor at eco-friendly footwear brand Allbirds. Peter also held senior roles in Global Sourcing at Nike, Gap and Kohl’s

“These industry leaders are heralding true supply change in an old supply chain, in order to meet the rising demands of consumers who care about where and how their clothes are made. This need for visibility and transparency has inspired apparel companies to make their ethical fashion efforts a crucial part of their branding.”

Managing compliance risk effectively

The incentive to invest in compliance is strong. Research from Osborne Clark, an international legal practice, found that reducing reputational risks was the most important driver for investing in legal compliance capabilities, followed by promoting an ethical stance and minimising legal liabilities. These motivations suggest that effective compliance risk management not only protects your business from losses but also enhances its perception in the market. 

The first step in managing against compliance risk is developing a framework, the purpose of which is to help you understand the breadth of your risk exposure and the likelihood of a risk event occurring. Below are four elements to consider in developing your own framework:

Obtain input from key team members across your organisation. This is this most important element because without sufficient information and feedback about where your firm may be exposed to risk it will be impossible to accurately assess your exposure. 

Identify the ‘owners’ of specific risks. This is to increase transparency around who to go to for which risks and to streamline the process of implementing and tracking the progress of mitigation strategies. 

Keep your compliance framework flexible. Because the sources and severity of the risks facing your business will change over time, it is important to remain adaptable in how you identify risks and plan for their mitigation. 

Repeat your risk assessments regularly. To ensure you remain aware of emerging compliance issues and new areas where risks may materialise, it is important to view risk assessments as a recurring exercise.

Compliance risk management has a variety of benefits and can protect companies from adverse legal, financial, business and reputational outcomes. In the apparel industry, this means keeping a close eye on how your supply chains are being managed and your factories are operating as well as how well you are adhering to internal codes of conduct and external laws and regulations. 

To help our customers with this, Serai has partnered with QIMA, a leading provider of quality control and supply chain compliance solutions for global brands and retailers.  

QIMA can help your business verify the quality of your apparel products, protect your customers and ensure your products meet requirements through comprehensive product inspections, laboratory testing and certification services. Independent audits assess your suppliers’ compliance with key social, environmental and safety standards, and provide companies like you with an accurate picture of the conditions at your supplier factories.

The data helps you gain visibility over your supply chain, and the insights support your business decision making. Managing complex apparel supply chains has never been tougher, but Serai and QIMA are here to help.  

For more information about Serai, check out how it works, or sign up here and start connecting with buyers, suppliers and manufacturers from around the world.  

If you’re interested in learning more about QIMA and how they can help your business, click here

Sources: Qima, Ibid, Osborne Clarke, Deloitte.