In February 2022, the EU published a new draft directive on Corporate Sustainability Due Diligence, which would require large companies to take steps to assess and address ESG risks throughout their supply chains.
The draft directive, which is yet to be approved by the European Parliament and Council and transposed into national law, is sweeping in scope, covering risks associated with climate change, biodiversity, pollutants, hazardous waste, indigenous rights, clean water and air, deforestation, living wage, worker safety, freedom of association and religion, discrimination, human trafficking, child labor and slavery.
While some changes can be expected in the final text of the directive, there’s wide support for the law overall: The underlying resolution passed the European Parliament with a vote of 504 to 79. Even though the proposed directive is unlikely to enter into force for another two to four years, companies should take the following five steps to prepare now.
Find out if the directive applies to you. As currently drafted, the directive is aimed primarily at large EU companies, but many multinational and smaller companies will also be swept within its scope.
If your EU-based company has 500 or more employees and more than €150 million in turnover, congratulations: The Directive applies to you! Approximately 9,400 companies fall into this category.
In addition, if your EU-based company has 250 or more employees, more than €40 million in turnover, and operates in a “high impact sector,” you’re also covered, although you will have an extra two years before the law applies to you. Examples of covered sectors are textiles, agriculture, forestry, fisheries, oil and gas, and minerals. It’s estimated that 3,400 companies fall into this category.
If your company is not based in the EU but meets the above thresholds for turnover within the EU market for either high-impact or other sectors, you are also covered. An estimated 4,000 companies are likely to fall into this category.
Even if not explicitly covered by the directive, a tremendous number of small, medium and non-EU companies will find themselves subject to the rules, simply because they operate within a covered company’s “value chain.” The directive interprets the term broadly, covering all operations from source material to final market and disposal. If your company makes products that pass through Europe at any point, there are probably corporate sustainability directive obligations coming your way.
Map your risks now. Even though it will be a few years before the directive comes into force, companies should begin examining their ESG risks now. The French Ministry of the Economy has estimated that a good risk map will take most companies three years to complete. In addition, building agility within your supply chain to mitigate risk in the future will take time.
Smaller companies that find themselves in the supply chain of covered entities should expect to be asked for a lot of information about their operations. Now is the time to clean up any problem areas, bolster transparency, adopt strong ESG policies, and line up information to quickly and efficiently answer the due diligence questions that you can reasonably anticipate.
Examine the transparency of countries where you operate. In some countries, information about the operations of suppliers and buyers is reliable and relatively painless to acquire. In other regions, governments — or even cultural attitudes — may complicate efforts to learn about conditions on the ground. If employees’ answers are watched by government minders, it may be impossible for companies to rely on the due diligence information they collect.
Under the new ESG rules, supply chain clarity may matter just as much as supply chain cost when evaluating suppliers or where to locate operations. Tools that track risk across countries may be useful for planning.
Companies that find themselves within the supply chains of covered entities should examine their operations to facilitate maximum transparency and unfiltered access to information. Reassure the companies you work with that, in addition to strong policies on covered topics, you’re open to wide-ranging scrutiny and willing to fully cooperate with their due-diligence inquiries.
Build alternative and redundant pathways. Given all the supply chain disruptions over the last few years, building redundancy and flexibility into supply chains is just good business sense. This will be doubly true under the new ESG regime, as companies must be able to pivot seamlessly if issues are uncovered. Large companies with global suppliers should anticipate that they may have to walk away from some relationships. Building a network of alternative suppliers — particularly in regions with a strong rule of law — is smart corporate planning.
As too many companies discovered during the pandemic, lining up new suppliers takes time and patience. Companies that wait until the directive goes into effect to find additional options for key elements of their supply chains will find themselves at a significant competitive disadvantage.
Staff up. While many of the tasks required under the draft directive, including new policies, risk assessments and due diligence, are extensions of the tasks already completed by most companies’ compliance functions, the scale and scope of the directive will massively increase those obligations. Resources to address those obligations must increase as well.
Satisfying the EU directive will require additional person power and expertise in human rights and environmental risks. Ideally, those resources should be folded into existing compliance departments, leveraging existing capacities to assess and manage risk while increasing the compliance remit to address additional subject matter.
While the draft directive will continue to evolve during the parliamentary process, the main contours of the regulations are well known, and their anticipated impact is clear. Even though it will be years before companies are directly subject to its provisions, prudent companies will see that the process of preparing for the new regime will take years as well. Large and small companies, both within the EU and overseas, should take steps now to set themselves up for success under the new ESG landscape.
Josh Birenbaum is a research and policy analyst at Trace International.
Read more of SupplyChainBrain's 2022 Supply Chain ESG Guide here.
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