Are Your Ready for the EU Supply Chain Law?

What is Corporate Sustainability Due Diligence Directive or the EU Supply Chain Law?

The Corporate Sustainability Due Diligence Directive (CSDDD) marks a pivotal moment in responsible business practices, addressing key aspects of sustainability, human rights, and environmental safeguards. This EU law mandates a comprehensive sustainability approach that goes beyond mere profit considerations, drawing inspiration from international frameworks such as the OECD Guidelines for Multinational Enterprises, UN Guiding Principles on Business and Human Rights, ILO-defined human rights conventions, and the UN Sustainable Development Goals.

The CSDDD is complimentary to the EU Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation and aims to foster a sustainable corporate behavior by holding companies accountable for managing social and environmental concerns not only across their own business operations but also throughout their entire supply chain.

Therefore, companies are responsible for ensuring that they, the users of their products, and their suppliers do not violate human rights, biodiversity, and the environment, for instance, by embracing fundamental workers’ rights or combatting climate change. The proposed measures are expected to surpass existing national regulations, such as France’s law on the duty of vigilance and Germany’s supply chain law.

The CSDDD carries the potential to profoundly influence numerous international companies. This impact extends not only to EU-based companies meeting defined criteria but also to non-EU firms of a certain size operating within the EU. Additionally, it places demands on businesses within the value chain of entities subject to these regulations, regardless of their size or operations, as long as they are part of the supply chain for EU-based enterprises. Consequently, engagement in a supply chain linked to the EU effectively extends EU standards to a diverse range of global companies.

The European Parliament endorsed the CSDDD as a negotiated text on the June 1, 2023. The next crucial step towards passing the Directive involves a “Trialogue” negotiation process that aims to iron out the differences between the suggested proposals. The policy is expected to come into force in 2024*. After the Directive is officially adopted, EU member states will have two years to transpose it into domestic laws.

Covered areas

To ensure that all applicable human rights and environmental laws are followed, the CSDDD adheres to the primary international standards. These standards cover only the specific rights and prohibitions listed in the proposal’s annex as well as any foreseeable human rights risks. The list includes labor rights, the prohibition of interference with freedom of thought, conscience, and religion, and the right to freedom of association, assembly, organization, and collective bargaining.

Who will be affected?

The EU Supply Chain Law procures the following companies*:

EU-based companies with more than 5,000 employees and at least €1,5 billion in net turnover have to comply by the end of July 2027.

EU-based companies with more than 3,000 employees and at least €900 million in net turnover have to comply by the end of July 2028.

EU-based companies with more than 1,000 employees and at least €450 million in net turnover have to comply by the end of July 2029.

Non-EU companies generating net EU turnover of more than €1.5 billion have to comply by the end of July 2027.

Non-EU companies generating net EU turnover of more than €900 million have to comply by the end of July 2028.

Non-EU companies generating net EU turnover of more than €450 million have to comply by the end of July 2029.

The EU Supply Chain Law will also indirectly impact small and medium-sized enterprises (SMEs) as suppliers of larger companies covered by the regulation.

What does a company captured by the law have to consider?

Below are the most noteworthy issues that a company must implement to fulfill the corporate due diligence obligations set out by the law:

Identify and address adverse impacts on human rights and the environment. For high-risk industries, focus on severe violations.
Company policies and management systems must integrate a process of conducting due diligence.
Companies must publicly report on due diligence annually.
Companies’ responsibility is to ensure that they implement effective measures to monitor performance.
Companies must establish a clear and accessible complaints procedure for all supply chain members.

Enforcement of interest

Directors’ duty of care: EU company directors would oversee due diligence requirements, and the proposed climate change requirements would be reflected in their variable remuneration. Therefore, member States of the EU would modify laws and regulations on directors’ duties. In adding human rights, climate change, and environmental impacts to their existing fiduciary duties. This expansion of the directors’ duty scope may enlarge the authority of EU governments to hold individual directors accountable for their companies’ operations. The exact details have yet to be negotiated by the EU parliament.

Civil liability: Companies who do not follow their obligations in preventing, stopping, or reducing any possible negative effects will be held accountable for the damages that occurred. This responsibility includes situations where their failure to act leads to negative consequences that could have been mitigated. Legal action over sustainability concerns against companies could undoubtedly increase under the CSDDD.

Supply Chain Challenges

The liability of the directive is not only enforced on the company’s main business and subsidiaries but also on any supplier or a sub-supplier whom they work with on a permanent or regular basis that might be targeted through violating human rights or environmental protection (i.e., all activities in producing goods or services, including upstream and downstream relationships). Organizations might be faced with these common challenges:

Collecting data can pose challenges as it extends beyond the standard operational framework. Organizations frequently lack the resources for robust data verification or third-party validation necessary for confident reporting.
Numerous companies contend with intricate and extensive supply chains, will have to introduce labor-intensive processes due to multiple tiers of suppliers.
Certain suppliers may be reluctant or unable to offer full transparency into their operations.
Compliance with the law can incur substantial costs, particularly for small and medium-sized enterprises.
Gaining a clear understanding of regulatory requirements and what does full compliance means for your company can be a complex task.
A company can be exempt from liability if it establishes codes of conduct with all its trading partners and its compliance has been verified.

How to get started

Whether you are directly or indirectly impacted by the regulation, to position yourself well for its upcoming mandatory requirements, it is important to start the preparation now. These are steps you should take to start your compliance journey:

Evaluate Your Supply Chain: The initial step involves assessing the supply chain to identify potential human rights and environmental risks. This entails pinpointing suppliers, subcontractors, and other business associates and evaluating their adherence to international standards and regulations.

Establish a Due Diligence Policy: Organizations are advised to develop a comprehensive due diligence policy outlining processes and measures for mitigating risks within their supply chains. This policy should align with legal requirements and be effectively communicated to all relevant stakeholders.

Implement Due Diligence Measures: Companies should execute due diligence measures to identify and address risks in their supply chains. This involves conducting risk assessments and audits, engaging with suppliers to ensure compliance, and implementing necessary risk mitigation measures.

Monitor and Evaluate Performance: Continuous monitoring and evaluation of due diligence measures are crucial to ensuring their effectiveness in risk mitigation. This includes tracking supplier performance and conducting regular risk assessments.

Publish Performance Reports: Transparency is key. Companies should publish comprehensive reports on their compliance with due diligence obligations. These reports should encompass descriptions of due diligence processes, identified risks, risk mitigation measures, supplier engagement, remedy measures, verification measures, grievance mechanisms, transparency, and management approach.

Engage with Stakeholders: Active engagement with stakeholders, such as customers, investors, civil society organizations, and affected communities, is essential to understanding concerns and expectations related to supply chain due diligence.

Seek External Support: Companies are encouraged to seek external support from consultants, auditors, and other experts to ensure compliance with legal requirements and enhance their due diligence practices.

To ensure adherence to regulations, we strongly recommend connecting with our expert team as we can offer 20+ years of valuable guidance to facilitate a smooth and compliant business operations. Reach out to us today to leverage our knowledge and ensure a successful and legally sound venture in the Chinese business landscape.

*This article has been updated after the formal and final approval of the directive by the EU Council on May 24, 2024. EU member states have to transpose the directive into national laws before the end of July 2026 .

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S.J. Grand is a full-service accounting firm focused on serving foreign-invested enterprises in Greater China since 2003. We help our clients improve performance, value creation and long-term growth.