The business responsibility: due diligence in global supply chains
Slowly but steadily, it is clear that the concept of due diligence – essentially meaning ‘reasonable care’ – is here to stay. The EU legislative proposal on Deforestation, the existing EU Conflict Minerals Regulation and expected Commission proposal on a Corporate Governance Directive all integrate a strong responsibility on the side of business operators to identify, address, mitigate and (sometimes to remediate) severe human rights and environmental impacts.
But what exactly is the definition of responsible supply chains? Whereas the process of due diligence follows a structured approach, the breadth and depth of risk management as part of responsible business conduct in global supply chains depends on many factors. particularly exact scoping and impact of key ingredients that will determine how business will operate in global supply chains become more and more clear. The new legislative EU Policy initiatives increasingly blend between public and private responsibilities.
As a company active in international supply chains, how to determine the level of effort in due diligence? Businesses should take a general ambition, whilst operating in line with specific standards.
The general approach should follow the OECD instruction that due diligence should be proportionate to the company’s circumstances and context. This means that size, risk profile and particularities of the upstream supply chain determine the level of effort to be taken. This instruction is equally reflected in the European Commission guidance as part of it’s announced ‘Forced labour import ban’.
In addition, in order to meet the specific goal of compliance with several sustainability standards, businesses are tasked with a ‘benchmark’ of 1) industry-schemes to which they adhere (ie RMI in minerals, RSPO in palmoil), 2) Government legislation in source-countries and countries of presence (EU, US, other).
For example, under the new proposal for an EU Deforestation Law, companies wanting to put relevant products on the EU internal market, would need to submit a due diligence statement confirming that these are deforestation-free and have been produced in accordance with the relevant legislation of the country of production. Whereas currently proposed products are beef, palm oil, soy, coffee, cacao and wood, this scoping may change during the negotiations or following a review.
Two other aspects are key to any due diligence ‘risk management’ program at company level: risk assessment based on ‘red flags’, and the core responsibility to support suppliers across the supply chain in their due diligence efforts.
Based on origin determination, companies should take into account a set of ‘red flags’ that are complementary to the OECD Guidance, when assessing their operations and supply chains on forced labour instances. These ‘red flags’ can be general and company-specific and usually include; Country risk factors, plus additional red flags based on specific type of risk. For example; forced labour ‘red flags’ may include migration and informality risk factors.
Whereas companies are inclined to limit due diligence to ‘Tier 1’ suppliers, continuous supplier engagement is key of any ESG due diligence program. This means, companies are expected to support suppliers towards improved due diligence capacity and performance, as essential component to preventing and/or identifying and addressing ESG risks and impacts in supply chains. For example by supporting suppliers to implement agreed corrective action plans, including through financial support where appropriate.
Does it matter if products are imported from outside the EU, or EU-made? Mostly not, sometimes yes. The concept of due diligence applies – in principle- throughout the supply chain, hence would include ESG risk management on operations inside and outside the EU. As part of sustainability legislation, are products and services from outside the EU really treated in the same way as those produced in the EU?
The European Commission intends to legislate in line with WTO rules, which dictate that Governments cannot discriminate between imported and domestically produced products. However, in practice, the new EU approach to product and process measures (so-called PPM’s) essentially work as a non-tariff measure to all ‘high risk’ goods and/or services from outside the EU. By differentiating requirements between products from low-risk and high-risk origin, the risk is equally an ineffective implementation through loopholes of supply-chain shifting of high-risk product being exported from low-risk countries.
As part of the EU Conflict Minerals Regulation, the EU publishes guidance list on Conflict Affected and High Risk Areas (CAHRA). Whereas business remain ultimately responsible to identify what constitutes a high-risk trade, this (dynamic) list will equally lead business in conducting ‘enhanced’ risk management as part of responsible sourcing program.
As part of the EU Deforestation Law, companies sourcing products from ‘low-risk’ countries would have less burdensome requirements than other countries.
At business level; basic compliance or ‘beyond’?
For companies operating in global markets, the new EU approach to trade and sustainability will likely demand additional efforts and investments, from gaining better insights into supply chain origin, assessing (ESG) risks and impact and reporting on performance at yearly basis.
These efforts will depend per company, but will certainly include; gaining full traceability on its entire supply chain, setting policies and processes on responsible supply chains, understanding possible environmental, social and/or governance risks and reporting on these in line with (to be developed) sustainability reporting standards (or legislation). However, these business obligations are unique per sector and legislation.
Hence, the matter of ESG Due Diligence will likely move on the boardroom agenda in 2022.
Questions to be asked are:
• What will the EU agenda on trade and sustainability mean for our sector? Which concrete policy initiatives expected for 2022 will be relevant for our business?
• Which business obligations are to be expected, and what will they mean for our strategy and processes?
• How can we start with assessing our ‘readiness’ for responsible supply chain requirements, as a basis for developing a strategy and action plan? Can we initiate low-hanging fruit actions, such as joining industry standards and improving awareness on requirements, whilst preparing for longer-term improvements?
As the European Commission sets in stone sustainability expectations and obligations for companies, it becomes more and more clear that business of all sizes will need to step up efforts with regards to sustainability risk management in their supply chains.
Whereas most businesses are well organised to deal with customs and trade barriers (from tariffs to quality standards) – especially since Brexit – the new concept of ‘sustainability due diligence’ remains vaguely understood in most businesses. Key is to start with setting up a responsible sourcing strategy and action plan, with specific KPI’s (linked to reporting guidelines such as GRI and industry standards). Only through structural data collection, your company’s sustainability report can reflect findings on traceability, due diligence progress and risk management as well as negative and positive impact on the wider society.
Most notably, embedding pro-active and continuous risk management of social and environmental practices of your suppliers will become common practice when producing, processing, trading from and with the EU. Whereas companies can keep investments to a bare minimum through a ‘tick-the-box’ compliance approach to fulfill reporting requirements under the various legislative frameworks (Netherlands, France, Germany, and -likely- EU), the trend towards supply chain traceability and responsibility is set to further deepen in the years to come.