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Last month, the European Commission proposed a directive which will have wide-reaching implications for companies and their supply chains. The Corporate Sustainability Due Diligence Directive comes on the heels of several national legislations (such as the French Corporate Duty of Vigilance Law and the German Supply Chain Due Diligence Act) that, if implemented, will make it mandatory for companies in the EU to uphold human rights and environmental standards in their entire supply chain.
The Corporate Sustainability Due Diligence Directive requires companies to uphold international human rights and environmental standards in their supply chain, including those on child labour, modern slavery, and occupational health and safety. In addition, it puts a strong focus on environmental issues and, amongst other things, will require alignment with the 1.5°C climate scenario set out in the Paris Agreement.
The proposed directive will provide some measure of standardisation across national borders, effectively levelling the playing field. Affected companies within the EU will have to operate by the same set of rules, thus preventing competitive advantage based on labour or environmental exploitation. In practice, this would prevent companies from outsourcing externalities - a frequent outcome where large and complex supply chains are involved and where ethical commitments stop short of the supply chain. Under this law, companies can no longer claim ignorance of bad behaviour happening down their supply chain.
Specifically, the directive will affect companies with more than 500 employees and a net turnover exceeding €150 million as well as those in resource-intensive sectors with more than 250 employees and €40 million net turnover. This applies to all qualifying companies incorporated in the EU as well as international companies operating in the EU market with the same turnover thresholds.
The proposal will be debated by the European Parliament and the European Council before reaching a final decision. Once transposed, non-complying companies will face fines and potential legal action by stakeholders most likely to be set at the national level. The German Supply Chain Due Diligence Act, for example, foresees fines of up to 2 percent of the annual turnover of a company.
Managing risks in the global supply chain is notoriously difficult. Traceability poses an additional challenge and transparency becomes increasingly elusive the further down the supply chain you go. If the proposal comes into force, companies will have to conduct a risk analysis as part of the due diligence process for their entire supply chain, including indirect suppliers, thereby preventing violations before they happen. They must also demonstrate a monitoring and mitigation plan for the potential risks identified.
Regulators will look towards global benchmarks to assess compliance. In an effort to comply, companies will first assess and benchmark themselves against frameworks for supply chain sustainability such as the UN Global Compact’s Ten Principles for business. Though the assessment criteria of the proposed act remains unclear at this stage, we can expect alignment with global ESG frameworks, with reporting being the primary way to demonstrate compliance. Performance data particularly those on freedom of association, grievance mechanisms, policies, and workplace conditions, would predictably become the object of deeper scrutiny. The required alignment with the Paris Agreement will also have a direct effect on the adoption or climate disclosures such as TCFD.
As companies work together with supply chain stakeholders to adjust to the changes concurrently, we also expect to see a convergence in global benchmarks towards standardisation of criteria and data metrics, which will benefit companies and regulators alike. Regardless, data is and will remain king, and the sooner companies streamline their ESG data management approach, the better prepared they will be to adapt to this piece of legislation.