EU Supply Chain Act: Tough New Sustainability Standards That Could Impact UK Companies

Across Europe, organisations need to be guided by EU regulations when implementing supply chain compliance measures in order to deal with subsequent amendments. The new EU law will have far reaching consequences across the continent and it could potentially impact organisations in the UK.

The draft European Supply Chain Act requires EU companies to audit their suppliers along the entire global supply chain, including all direct and indirect business relationships.

The aim is to ensure compliance with applicable human rights standards and environmental protection in order to promote a fairer and more sustainable global economy as well as responsible corporate governance. Once the draft is approved by the European Parliament and Council, EU member states will have two years to transpose the Directive into their national laws.

• European companies as well as organisations from other countries operating in the EU with 500 employees or more with a turnover of at least 150 million euros are covered by the law. This affects approximately 17,000 companies.
• For high-risk sectors where the risk potential for both humans and the environment is especially high, the requirements of the directive must already be met by organisations with at least 250 employees and a turnover of 40 million euros. These include the textile and leather industries, agriculture and forestry, fisheries and mining. A transitional period of two years applies to these industries.
• Small and medium-sized enterprises are not directly affected by the law, but indirectly, e.g. as suppliers to large companies.
• The following legal entities are to be covered by this regulation: stock corporations, partnerships limited by shares, limited liability companies, regulated financial companies and insurance companies.

Affected companies must fulfill their corporate due diligence obligations along the supply chain with regard to human rights and the environment. In order to do so, the following steps must be implemented:

• Identify actual or potential negative impacts on human rights and the environment. Then take appropriate measures to prevent, mitigate and remedy them. (For high-risk industries, this should only apply to serious human rights and environmental violations within the respective industry).
• Due diligence must be integrated into company policies and management systems.
• Companies must establish a procedure for complaints and ensure everyone along the supply chain can access it.
• Transparent and public information on the fulfilment of a company’s due diligence obligations must be provided, including an annual report.
• Companies are obliged to control and monitor the effectiveness of these measures.
• If annual turnover exceeds 150 million euros, companies must align their internal policies with the Paris Agreement’s goal of limiting the planet’s warming to 1.5 degrees Celsius.

The due diligence obligation applies not only to an organisation’s own business activities or those of its subsidiaries, but equally to direct and indirect suppliers (provided it is an established or permanent business relationship) as well as the use and disposal of the goods produced.

Currently, it remains unclear how many companies in the UK will fall directly within the scope of the new EU legislation. However, it is certain that UK companies will have to follow its provisions. For example, the EU Supply Chain Law would impact a UK company generating turnover in the EU through export or the activities of a branch that meets the thresholds set out in Article 2 of the proposed legislation.

It could also impact UK businesses that export to EU companies that themselves fall within the scope of the proposed law. That would see regulated EU companies call on their UK counterparts to meet all outstanding requirements.

European companies have a responsibility to ensure that their suppliers do not violate human rights and environmental protection. Examples of violations include:

• Forced labour
• Child labour
• Inadequate health and safety at work
• Worker exploitation
• Environmental violations such as greenhouse gas emissions, pollution or the destruction of biodiversity or ecosystems

Europe’s largest economy passed its Supply Chain Duty Act or Lieferkettensorgfaltspflichtengesetz on 11 June 2021 but the EU Commission’s draft law goes far beyond it:

• More companies, with 500 and 250 employees, respectively, fall under the European regulation. By comparison, Germany’s law only applies to companies with more than 3,000 employees (and more than 1,000 employees from 2024).
• The EU directive requires companies to audit the entire supply chain and not only the direct suppliers as is the case with Germany’s law.
• The new EU regulation contains a civil liability for companies and affected parties can sue for damages in European courts.

EU companies are also held civilly liable under the Supply Chain Act if the violation of human rights or environmental protection was committed by a supplier with whom they work on a permanent or regular basis. Companies can be exempt from liability if they have concluded codes of conduct with trading partners and their compliance has been verified.

Companies must ensure compliance with the legal requirements not only for themselves and their subsidiaries, but also for their suppliers along the entire value chain, i.e., all activities related to the production of goods or the provision of services, including all upstream and downstream business relationships.

Affected companies must therefore check exactly where the supplied goods come from, how they were produced and what consequences this had for the environment and climate. In the case of imports from third-world countries, checking the entire supply chain may well prove a greater challenge.

In order to prepare for all the requirements of the new regulation in a legally secure manner, companies should conduct a continuous and comprehensible risk assessment. With the help of a flexible business partner audit as an integral part of the Compliance Management System (CMS), companies can simultaneously fulfil and document their due diligence obligations.

Another proven component of the CMS is a digital whistleblower system which fulfils the requirements of the new regulation for implementing a complaint system. With both tools, the responsible departments are adequately and legally prepared for the requirements of the EU Supply Chain Act.

Small and medium-sized enterprises are indirectly affected by the Supply Chain Act, because in the medium term, large companies will also oblige SMEs to review their supply chains and obtain assurances of compliance with due diligence requirements in the area of human rights and environmental protection.

However, this may well represent an opportunity for SMEs because the organisations clearly positioning and preparing themselves at an early stage will benefit from competitive advantages over their rivals. Nevertheless, this requires not only resources but also extensive know-how. Therefore, it makes sense, especially for SMEs, to rely on holistic solutions that digitally map these process and support them in complying with all requirements.

In order to relieve the burden on SMEs, the law includes various support measures, such as lending to SMEs remaining unaffected and, in addition, the costs of complying with the requirements being subsidies with state aid.

The signs were green from the beginning. In December 2020, all 27 EU member states spoke out in favour of a European supply chain law. In March 2021, MEPs adopted a legislative proposal on corporate accountability and due diligence. The EU Commission then prepared a draft and presented it in February 2022.

The next steps will see the proposal go to the European Parliament and the Council for approval. Experts nevertheless expect that it will still be debated intensively in the Parliament before the supply chain law is passed with possible new standards. This is likely to occur in 2023.

In the UK, a letter sent to the Chair of the House of Commons Business, Energy and Industrial Strategy Committee states that the UK governement does not intend to replicate the EU Commission’s proposal at this time. Officials consider that directors of UK quoted companies are already held to account on their management of human rights and environmental issues in their annual reporting.

There has been some criticism of the draft EU law, notably that it does not go far enough and still contains gaps.

One point of criticism, for example, is that many companies fall far below the threshold value and will not be affected by the regulation as a result. Another fear being voiced by non-governmental organisations is that lobbyists will have a great deal of influence at EU level and that the adoption of the law will either take too long in the end or be severely weakened.

Others fear an increasing burden for affected companies who have also suffered as a result of the Covid-19 pandemic, as well as an enormous amount of control and bureaucracy. Industry and business circles have also voiced concerns about competitive disadvantages due to too much regulation.

With millions of people working under inhumane conditions across the world where forced and child labour are the order of the day, this legislation is vital for protecting human rights and the environment. Wages below subsistence level are not uncommon while many people continue to work under life-threatening safety standards, suffering lifelong health consequences. The environment suffers as well, and this will have a devastating impact on the future and the livelihood of millions. Exploitation and environmental degradation remain an element of the supply chains of European companies.

The trend towards inhumane working conditions is growing according to the European Centre of Human Rights, particularly in China, where the problem is becoming increasingly widespread, according to Amnesty International.

• “25 million people are victims of forced labour” (Global Estimates of Modern Slavery)
• “79 million girls and boys are affected by exploitative child labour” (BMZ)
• “The wage share of a seamstress of a branded t-shirt is 0.6%”. (FairWear)