Analyst Insight: Regulatory pressure is intensifying globally to hold businesses accountable for sustainability in their operations as well as in their extended supply chains. Companies that vowed to make good on their sustainability pledge are now being scrutinized to deliver on those promises, as measured by their degree of regulatory compliance. 

Germany’s Supply Chain Due Diligence Act, effective in January, 2023, is a first-of-its-kind effort to require enterprises to validate efforts to prevent human-rights and environment-related violations in supply chains. It aims to prevent or end such supplier wrongdoing. The due-diligence requirement scrutinizes companies’ risk-management programs and levies penalties for violations, including fines of up to 2% of revenue, as well as exclusion from future government contracts. Companies that previously governed their suppliers merely by applying the same “code of conduct” as their own must now implement far more rigorous measures to enforce supplier compliance, or be subject to severe penalties.   

The Corporate Sustainability Due Diligence Act, adopted by the European Commission in 2022, constitutes similar legislation. It fosters sustainable and responsible corporate behavior throughout global supply chains, enforceable by EU supervisory authorities through imposition of fines, sanctions and compliance orders. 

Both laws require annual disclosure of related risk procedures, preventive measures, and remediation actions taken by companies for both environmental and human rights concerns.  Until now, most large public companies published ESG efforts on a voluntary basis. The new laws will mandate sustainability reporting for legal compliance. Furthermore, the EU has adopted a Corporate Sustainability Reporting Directive, which sets the standard for companies of all stripes to disclose the compatibility of their activities with the Paris Agreement’s goal of limiting global warming to 1.5 degrees Celsius. 

In the United States, the Securities and Exchange Commission has proposed to begin mandating climate-related disclosures in March of this year. Under this proposal, public companies are required to provide climate-related financial data, and report greenhouse gas emissions, including those from their supply chains, in public filings. Sustainability reporting isn’t just a feel-good self-promotion for companies, but a legal obligation to fulfill. 

Due to evolving regulatory pressures, companies must respond quickly to be ready when the laws take effect. Immediate actions should include assessing the potential impact of the regulatory and policy directives, devising a plan for complying with the laws, creating preventive measures and monitoring procedures, and applying due diligence broadly, including for partners and customers in the extended supply chain. 

Existing ESG standards frameworks such as the Global Reporting Initiative, Sustainability Accounting Standards Board and others overlap the upcoming regulations to a large extent.  Companies that already publish annual sustainability reports following these frameworks have a head start. Those that haven’t done so prior to 2022 can prepare a fresh report to begin. A good exercise is to compile and prepare data that’s material to companies’ business and sustainability goals as the end of the year approaches. A structured assessment to understand the gaps, from business risks to related data maturity, should underscore a strategy to be formulated in meeting regulatory requirements as well as benefiting stakeholders. 

Outlook: As the evolving regulations are finalized in 2023, expect companies to have greater transparency and consistency in disclosing sustainability-related performance and progress. Recently released Scope 3 emissions reporting requirements by the International Sustainability Standards Board is further evidence that more standardized reporting will cover extended supply chains. Companies must formulate strategies and action plans to be compliant and deliver enduring stakeholder values. It’s a matter of go green, or go home.