Supply chain compliance: a win for ESG sustainability or just more red tape?

The German Supply Chain Act (GSCA) and the EU's draft Corporate Sustainability Due Diligence Directive (CSDDD) are leading examples of the growing global movement for responsible ESG compliance obligations. Companies are obliged to undertake human rights and environmental due diligence to identify actual or potential risks to people and the environment.

The German forefront

The GSCA applies to companies with at least 3,000 employees (only 1,000 as of 2024) and their head office, main branch or statutory seat in Germany. In essence, it obliges in-scope companies to evaluate potential violations of human and environmental rights in their supply chain, to implement (or adapt) a compliance management system along with regular risk analyses, to draw up prevention and mitigation measures, to publish a policy statement, to set up a complaint system and to document compliance measures.

Importantly, the GSCA also affects non-German companies. As part of the due diligence processes of German in-scope companies, non-German entities must be prepared to provide their German customers with information on their supply chains. In some cases, they may also be obliged to actively minimise risks through contractually agreed codes of conduct. Foreign subsidiaries of in-scope companies are also part of the supply chain obligations. In any event, non-German companies are well advised to take a closer look at their supply chains and the risks they pose. It is prudent for non-German companies within German supply chains to implement appropriate compliance measures. Regular exchange – especially with direct suppliers – will be crucial, since processes can be coordinated, divided up and implemented more efficiently.

The EU is catching up

As part of the European Green Deal, the CSDDD as proposed by the EU Commission aims to set a horizontal framework for enhanced human rights and environmental protection. It should create a level playing field for companies within the EU and avoid fragmentation resulting from Member States' national approaches. The EU thus advocates for a stronger legal framework to oblige EU companies to shoulder their responsibility towards human rights and environmental norms in international supply chains. The CSDDD comes with developments around the Non-Financial Reporting Directive (NFRD), the Corporate Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR) as well as the Taxonomy Regulation.

Subject to the outcome of the legislative framework, the CSDDD is supposed to introduce mandatory human rights and environmental due diligence, and a duty for directors to set up and oversee the implementation of due diligence and to integrate it into the corporate strategy. In-scope companies would have to take appropriate measures to prevent or at least adequately mitigate potential adverse human rights and environmental impacts.

Do laws really help foster ESG sustainability?

Given the legal developments in Europe and globally, do these laws and provisions indeed help to foster ESG sustainability in supply chains or are they just more red tape? Opinions on this question vary dramatically.

On the one hand, the additional administrative burden requires businesses with international operations to devote a lot of money and human resources to compliance. In an economy battered by high inflation and geopolitical uncertainty, this is hardly a welcome development for companies. Lawmakers should therefore carefully assess the economic impact of ESG laws.

On the other hand, due to the legal framework already in place (or that will become effective shortly), companies are obliged to adapt to these ESG requirements, either because they are (or will be) in scope of the GSCA and/or the CSDDD, or because they are suppliers or customers of such companies. To that end, companies will have to develop their compliance and governance systems to meet all the new due diligence obligations.

It is therefore high time to prepare yourself! Evaluate whether your business may need to adapt to new ESG-related compliance obligations. Analyse your company's risk assessment from a supply chain perspective to identify if and how operations may be affected by supply chain compliance matters. Finally, adapt already existing compliance management systems. Make sure to look across the entire value chain or chain of activities, including subsidiaries.

Despite the additional burdens, supply chain compliance can also have commercial benefits, such as better reputation and the advantages in hiring and employee motivation that this brings.

author: Johannes Frank