Companies around the world are increasingly under pressure to create more transparency in their supply chains. Both consumers and investors are becoming more concerned with knowing how products are made. This implies taking a closer look at workers' rights and how they are being treated, at companies all along the value chain. The EU's draft legislation aims to provide clarity on how to foster sustainable and responsible corporate behaviour throughout global value chains.

Although the directive has not been approved by the European Parliament and the Council, there is already initial information on the requirements companies need to prepare for.

Which companies will the new EU rules apply to and what are the requirements?

The directive will apply to large EU limited liability companies and distinguish between two groups:

For Group 2 the rules will start to apply only two years after Group 1.

The legislation takes into account the company’s own operations, its subsidiaries and the value chains. The requirements will be the following:

• integrate due diligence into policies;
• identify actual or potential adverse human rights and environmental impacts;
• prevent or mitigate potential impacts;
• bring an end to or minimize actual impacts;
• establish and maintain a complaints procedure;
• monitor the effectiveness of the due diligence policy and measures;
• and publicly communicate on due diligence.

Put into practice: German Act on Corporate Due Diligence in Supply Chains

As one of the first countries in the European Union, Germany has already started implementing the directive into national law. The German Act on Corporate Due Diligence in Supply Chains comes into force on 1st January 2023 and includes specific obligations for companies that have been adapted from the EU Directive. For instance, companies will be obliged to establish a risk management system and conduct risk analyses, adopt a policy statement of corporate human rights strategy, and anchor preventive measures. Failing to comply with legal obligations, could imply fines, which could sum up to 8 million euros or up to 2 percent of global annual sales.

Examples from companies in high-impact sectors

The upcoming EU directive, as it comes into force as part of the German law in 2023 will particularly impact companies that operate in high-impact sectors, such as textiles/fashion, agriculture, and the extraction of minerals. Considering the German market, there are companies that are already well prepared for the upcoming requirements.

Adidas: Disclosing its Global supplier list and monitoring third-tier suppliers

Since Adidas, the biggest European sportswear brand, has outsourced the majority of its production, it is essential for the company to closely monitor the labor conditions and environmental standards in local factories. The company has taken measures to provide a high level of transparency throughout its value chain. Part of Adidas’ approach is detailed workplace standards and independent and unannounced audits by third parties. It is remarkable that the company also fully discloses its Global supplier list.

To address the risks in the lower tiers of their supply chains, Adidas monitors its third-tier raw material suppliers. The company also published a list of its second-tier wet process suppliers, including dyeing and finishing of materials. As a result, Adidas demonstrates significantly more transparency than most of its competitors, who generally only disclose information about tier 1 suppliers.

METRO: Focusing on reducing deforestation in the company’s value chain

Food trade and food production is also considered a high-impact sector. One of the biggest German sector-players is METRO, a food and non-food wholesaler active in over 30 countries across Europe and Asia. Regarding environmental protection in the supply chain, one of METRO’s focus areas is to reduce deforestation in its value chain, for instance through its palm oil procurement policy. By 2023, the company aims to use only 100% sustainable palm oil on RSPO-level Segregated or Identity Preserved in METRO’s own brand products. Furthermore, METRO focuses on sustainable soy sourcing by collaborating with its supply chain on challenges like deforestation and social issues.

Three recommendations to prepare for the upcoming legislation
 

1. Map potential risks and impacts: carry out a risk mapping or another form of assessment to identify areas of potential risks in the value chain, especially if your company operates in emerging markets or high-risk countries. This process should contain the identification of actual or potential human rights issues (e.g., forced labor, human trafficking, child labor) as well as groups at risk of human rights issues (e.g., women, migrant workers, local communities). To identify the most material environmental impacts, conducting lifecycle and impact measurement and valuation assessments is a valuable starting point. This should reveal the probable impact of the company along the value chain.
2. Set up the due diligence process: when the potential risks have been identified, strategies and measures should be developed to see if the risks are materializing, and where. A detailed supplier evaluation process for new suppliers as well as a re-evaluation for existing suppliers should uncover the compliance of human rights and environmental standards throughout the company’s value chain. This process should also include verification through (on-site) audits.
3. Prevention, mitigation and corrective action: if actual impacts on human rights and major environmental issues exist, strategies, targets, and KPIs should be developed for guidance on ending or at least minimizing the impacts. Mitigating a risk implies taking actions to reduce the likelihood that a potential negative impact will occur. If there seem to be risks at a supplier level, it should be addressed, or where required relationships should be reconsidered and/or ended. Furthermore, integrate a complaints procedure that ensures the reporting of and dealing with misbehavior, especially regarding human rights, based on a detailed process.

The downloadable European Commission factsheet at the top of the page contains more information about the upcoming EU directive.

Get in touch for more information

Will the new EU Directive impact your organization? Contact Johana Schlotter at johana@finchandbeak.com or +31 6 28 02 18 80 to find out how Finch & Beak can support you in preparing well for the upcoming EU directive and improving your ESG performance.

^{Photo by Shayan Ghiasvand on Unsplash}