Why the German Supply Chain Due Diligence Act is just the first step
On June 25th 2021, the strive to ensure more socially and environmentally sustainable business practices reached a new level. That day, the Bundesrat, the German upper chamber of parliament, approved the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz), which is now set to enter into force on January 1st, 2023.
The aim of this law? To better protect human rights and the environment in a global economy by obliging German companies of a certain size to perform better due diligence on their supply chains. This is no longer a voluntary CSR activity, but required by law, and companies who do not comply risk facing penalties.
This law follows a trend towards more sustainable and responsible practices that has been pushed by both the market and similar laws in other countries. It also has the potential to pave the way for more thorough, generally accepted due diligence - not only in Germany but across the European Union and further afield. While the law is not as encompassing as many have hoped, or feared, it is lifting due diligence from what in many cases was merely a “nice-to-have” to a legal obligation.
In a previous article, we examined Germany’s new supply chain law and gave an overview of the ongoing debates, focusing on the different arguments around the circulating drafts, and who was arguing for and against a (strict) law.
This time around we’ll be looking in more detail at what is required from German companies and their (international) suppliers, what the implementation might look like in practice, and what’s potentially on the European legislative horizon.
What the law entails
The German Supply Chain Due Diligence Act is built along the three pillars of the United Nations Guiding Principles on Business and Human Rights - governments’ and companies’ duty to protect and respect human rights, and the right of victims to access legal remedy.
The German Supply Chain Due Diligence Act protects a wide range of human rights, from child and forced labor, to labor rights such as freedom of association, and adequate salaries. Crucially, it also includes protection against excessive negative environmental impacts, such as causing harmful soil change, water pollution, harmful noise emission, or excessive water consumption.
Who it applies to
From 2023, the German Supply Chain Due Diligence Act will apply to all German companies with more than 3,000 employees, employed in Germany and from 2024 onwards, this benchmark will be lowered to companies with 1,000 employees.
What is required
Operationally, at the most basic level, companies will have to implement a Declaration of Principles. This Declaration must contain:
- A description of the company’s risk management process
- The most important risks identified
- The expectations a company has from their suppliers
Companies are also required to implement a risk management process and assign designated responsible personnel. Company management - the CEO, Director, or equivalent - has to be informed about the process by the responsible personnel regularly, at least once per year.
At least on an annual level, or when the company is implementing significant changes like the launch of a new product line, companies have to conduct a risk analysis, both of their own and their direct suppliers’ operations.
Companies also need to establish preventative measures, such as capacity building or sales and procurement strategies that are informed by the findings of the risk analyses. Additionally, countermeasures need to be in place, to react appropriately to violations at their own site, or their suppliers' sites. This can include working together to jointly eliminate the violation, temporarily ceasing business relationships, or, in the worst cases, terminating the relationship.
In particular, companies have to provide a sufficient grievance mechanism. The contact information has to be public and all submitted grievances have to be dealt with anonymously. Both employees, and external witnesses have to have access to this communication channel. . Once a year mechanism must be accessible to direct and indirect suppliers and be audited once a year to ensure its efficacy.
In general, the suppliers of suppliers do not have to be included in the due diligence processes, unless a company has substantiated knowledge about possible violations of human rights or environmental obligation at indirect suppliers.
Who is enforcing the law
The Federal Office of Economics and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle - BAFA) is responsible for the implementation and enforcement of the law in Germany. If affected parties assert to the BAFA that their rights are being violated or directly threatened by a company's failure to fulfill its due diligence obligations, the BAFA must take action and investigate whether a violation has occurred and work to ensure that the company eliminates it. Anyone whose most basic human rights (such as life or limb) have been violated, may authorize a competent German trade union or non-governmental organization to take legal action to enforce their rights.
What about non-compliance
While there is no direct civil liability, companies can be fined by the BAFA, based on the severity of the offense as well as the total turnover of the company. The fines are based on a company’s size, as well as the severity of the violation, but at a maximum, this is capped at 2% of the global average annual turnover. This would be for companies with more than 400 million turnover, in the case of not acting on known deficiencies, at their site or a supplier’s. In addition, if a fine is 175.000 EUR or higher, the fined company will also be excluded from public tenders.
The BAFA will publish a yearly report on the related activities and findings, including the type of infractions and countermeasures taken to remedy them. The report is also to include an analysis of the reports submitted by the companies, although the companies will remain anonymous.
The contractual realities
The main goal of the German Supply Chain Due Diligence Act is to ensure that profits in Germany are not subsidized by human rights abuses and environmental degradation elsewhere - companies, therefore, have to make sure their supply chains are clean and fair.
Millions of people worldwide live in misery and poverty, because basic social standards like the prohibition of forced- and child labor are disregarded. 79 million children worldwide work under exploitative conditions: in garment factories, mines, or coffee plantations - also for our products.
Ministry for Economic Cooperation and Development
The law's core rationale is thus that companies that benefit from this - even unknowingly - have a responsibility to address and remedy such wrongs. So practically this means that the law intends to push German companies to know their supply chains and manage the human rights and environmental risks therein. And getting a better understanding of their supply chains and human rights compliance will include requiring their suppliers to share more information with them.
As we’ve described above, evaluating a supplier’s compliance with a Declaration of Principles is part of the law. The most feasible way to do that would be to incorporate that in the companies’ contractual framework. Complying with the stipulations of the Supply Chain Due Diligence Act would thus become a contractual requirement for the supplier, even if the supplier is not based in Germany or is below the number of employees threshold.
If this exercise is carried out consistently, every company along a supply chain would be expected to ensure compliance with - and contractually pass on - the stipulations of the Supply Chain Due Diligence Act down to the source of the raw material.
How can suppliers prepare
As a consequence, data about a product's provenance, as well as a supply chain's human rights compliance, will be an inextricable part of the sale of a product if it's destined for indirect or direct suppliers to the relevant German industry. This means that companies who directly or indirectly profit from access to German markets would benefit from transparency about their own production methods and sustainability process, since that is a way not only to distinguish their products in the market, but also to meet the compliance expectations required to sell into the respective supply chains.
So that means suppliers should also start to collect information about their supply chains and - if necessary - work with their business partners to improve their human rights and environmental records. If not done already, now is also the time to start instituting the according policies and procedures at the own operations. It takes time to build a culture of compliance, and since it will be a prerequisite for doing business, it better be done thoroughly.
All because of one law?
Of course in a world where supply chains - or rather, supply networks - are global, intransparent, and often desired to remain this way by key actors, it isn't a realistic expectation that one law would bring about change overnight.
However, it’s not just legal requirements that would push companies in a sustainable direction, markets are moving in that direction, too. In the case of minerals and metals, Robert Friedland, founder and chairman of Ivanhoe Mines, recently predicted that in the future, commodities won’t just be sold anonymously anymore: “There will be no one price for copper, there will be no more one price for gold, ...everything will be priced in relation to its ESG components.”
Germany’s new law is simultaneously following this trend, and blazing the trail for it. And looking at the legislative horizon, there is more to come.
The bigger picture
Germany is not the first country to have passed a law on supply chain due diligence, and it will certainly not be the last. Already in 2015, Great Britain passed the Modern Slavery Act, which includes “Transparency in Supply Chain Provisions”, requiring companies with a turnover higher than GBP36 million to publish statements on the actions they take to avoid human trafficking and slavery happening in their business and supply chains. France passed a Vigilance Law (“Loi de Vigilance”) in 2017, which mandates French companies with more than 5,000 employees in France, or 10,000 worldwide, to adopt plans in order to address risks around human rights, occupational health and safety, and environmental damage in their supply chains. Lastly, in 2019 the Netherlands adopted their Child Labor Due Diligence Law which will, once it enteris into effect in 2022, require Dutch companies to inspect their supply chains for child labor. If they find any instances, they are required to prevent it.
In the United States, there are also notable instances: The California Transparency in Supply Chains Act of 2010 requires disclosure of measures taken against slavery and human trafficking, and the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) was the first law to mandate due diligence on the provenance of tin, tantalum, tungsten, and gold - the so called 3TGs. (Here’s an overview of the Dodd-Frank Act and its recently passed European counterpart, the EU Conflict Minerals Regulation.
So the German Law fits well in the overall trend. From a European perspective, it can only be an individual piece of a continent wide puzzle anyway. What companies have repeatedly pointed out in the course of the legislative process is the need for a level playing field. And in an economic zone as integrated as Europe, this can only mean that there need to be provisions on a EU wide level.
In March this year, the EU parliament adopted the Resolution of 10 March 2021 with recommendations to the Commission on corporate due diligence and corporate accountability. In it, the Parliament sets forth recommendations for mandatory due diligence and corporate accountability directives. Among the requirements raised in the document are a monitoring of a company’s direct and indirect adverse impacts on human rights and the environment, as well those of their business relationships. Policies and findings have to be published. Companies will also have to provide grievance mechanisms and are subject to penalties or may be held liable in case of infractions. Overall, the draft seeks to harmonize the standards across the common market - the level playing field companies were asking for.
Despite the likely delays in the process, and the inevitable back-and-forth regarding the law’s strictness and scope, it is all but guaranteed that some sort of legislation will eventually come into force. It has the potential to be another big step in expanding the need for proper supply chain due diligence. Such a law would fit the European Union’s image of trailblazing sustainability and human rights, and, with any luck, not only at home but around the globe.
The earlier, the better...
The message is clear: major economies are no longer able to ignore the scarring impacts that wealthy nations’ industries have on the less privileged corners of the world. Of course it will be a step-by-step process that some find too demanding, some painfully slow. In any case, the legal requirements and market trends are calling for thorough processes for due diligence to be established, the earlier the better.
What will be required first and foremost is data about good’s provenance. For companies downstream, this will mean investing in getting to know their supply chains and managing risks related to their supply chains. For the mid- and upstream players, this rising customer demand for visibility and transparency opens a whole new opportunity: Delivering data with their product, thereby augmenting it's value - and moving from selling anonymous commodities, to trusted components and products.
Interested in how to best comply with the law? Our team is always happy to discuss which supply chain due diligence data you could capture and how Product Passports can communicate it along your supply chains. Get in touch here.
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