New European supply chain law enforces ethics and sustainability

The European Union’s attempt to force companies to adopt more stringent ethical and environmental due diligence in their supply chains looks as if it will finally be successful. After years of debate and negotiation, the EU Council voted to adopt the Corporate Sustainability Due Diligence Directive (CS3D) on March 15 2024. Members will now have two years in which to transpose the law into national legislation.

For some time it looked as if the directive would be blocked by a lack of German support. The FDP, a member of the ruling coalition, believed that it would provide additional burdens for business and asymmetrically impact German importers and exporters.

The directive means that large companies will be required to identify and address human rights abuses and environmental damage within their supply chains. Failure to do so will result in fines amounting up to 5% of global turnover.

According to law company, Herbert Smith Freehills, CS3D requires companies to carry out risk-based due diligence to:

  • integrate due diligence into their policies and risk management systems
  • identify, assess and (where necessary) prioritise potential and actual adverse impacts
  • prevent and mitigate potential adverse impacts
  • bring actual adverse impacts to an end, or minimise their extent
  • remediate actual adverse impacts
  • carry out meaningful engagement with stakeholders
  • establish and maintain a notification mechanism and complaints procedure
  • monitor the effectiveness of due diligence policy and measures
  • communicate publicly on due diligence.

It also requires those affected companies to develop a transition plan for climate change mitigation, aligning the companies’ strategies with climate neutrality targets and sustainability objectives.

At the end of 2023 Lara Wolters, an MEP with the Socialists & Democrats who led work in the European Parliament said, “Abuses such as child labour to extract cobalt [for] smartphones, rainforest degradation for soy ending up in our supermarkets, fruit pickers on European fields, these are just some of the examples of irresponsible business practices that now companies can no longer look away from.” However, her celebration was slightly premature. The legislation needed a qualified majority of 15 EU countries, a threshold which at one point looked impossible to achieve. Germany was joined by Italy, Sweden and a number of other member states in their opposition to the law. There was also pressure from non-EU countries as foreign companies are not exempt from compliance with the legislation.

Consequently, in order to get the law passed a number of concessions had to be made. The main difference between the draft version and the directive which was finally agreed related to the size of the companies affected. Legislators had originally hoped that the law would apply to companies with a turnover of more than €150 million and more than 500 employees. These thresholds changed to a turnover of €450 million and 1000 employees, substantially higher. The legislation also originally applied to smaller companies below this threshold in certain high risk sectors (so-called ‘carve outs’) but this was removed. The phasing of the implementation of the legislation was also changed. The largest companies (over €1.5 billion and more than 5000 employees) will have 3 years to comply (by 2027) whilst smaller enterprises will have until 2029. These dates depend on final approval in the European Parliament in April 2024.

Perhaps surprisingly, many businesses had thrown their weight behind the new law. Aldi, Bayer, Mars, Tchibo, Maersk and Nestle published letters calling on the German government to approve the directive.  The Cocoa Coalition stated, “We reiterate the critical importance of approving the CSDDD as soon as possible…Failure to do so would significantly undermine the establishment of a level playing field across the European Union, lead to a fragmentation of national approaches and result in a major setback to sustainability in global supply chains.”

EU legislators have had a difficult job in balancing ethical and environmental concerns with the additional costs that this will impose on businesses. In justifying these costs, the European Commission asserted that the directive would create:

  • Harmonised legal framework in the EU, creating legal certainty and level playing field.
  • Greater customer trust and employees’ commitment.
  • Better awareness of companies’ negative environmental and human rights impacts.
  • Better risk management and adaptability.
  • Increased attractiveness for talent, sustainability-oriented investors and public procurers.
  • Higher attention to innovation.
  • Better access to finance.

Many of these benefits will accrue from increased visibility of the supply chain which will allow companies to increase quality and enhance resilience.

Assessing the costs of the directive to European business, on the other hand, is more difficult. Many companies already have to comply with national legislation such as Germany’s ‘Lieferkettensorgfaltspflichtengesetz’ (LkSG) or France’s ‘loi de vigilance’. A survey by the EC found that about a third of companies already undertake due diligence of their supply chains under existing legislation.

Other concerns about the legislation relate largely to its potential ‘unintended consequences’. The directive will necessarily result in some companies changing their sourcing behaviour, raising the possibility that some manufacturing may be re-shored, a consequence which would deprive some emerging markets of economic growth opportunities. More likely, given the difference in wage rates, the directive will lead to the migration of production from emerging markets with lower ethical and environmental standards to those which comply with the legislation. This may be better in the long term for standards in the ‘Global South’ but it will inevitably bring about short term pain and there is always the possibility that Western manufacturers may be put off completely from investing in the region if they see the risk as too great.

Author: John Manners-Bell

Source: Ti Insight

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