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This white paper is Part I of a focus on supply chain due diligence and shines a light on this increasingly challenging and rapidly evolving environment. Part II of this white paper, to be released in July 2023, will outline best practices in supply chain due diligence and provide an overview of the most relevant regulatory regimes in various regions.
The surge of ESG due diligence regimes
The proliferation of supply chain due diligence obligations across Europe, North America and parts of the Asia Pacific region reflects enhanced efforts by regulators to create a level-playing field for corporations, drive accountability and mitigate harmful social and environmental impacts. Two main trends have given rise to the growing momentum behind these initiatives.
First of all, while many economic activities are per se fraught with risk, countless companies have been found to be embroiled in controversial business practices. It has, for instance, been estimated that globally 28 million people are trapped in forced labour. Among the industries most affected are manufacturing, construction and agriculture. According to an analysis by the World Business Council for Sustainable Development (WBCSD), ESG-related litigations have grown by 25% over the last three decades and they are increasingly linked to supplier malpractice. Regulatory due diligence frameworks and soft laws often provide the legal basis for cases brought against companies.
Secondly, outsourcing, subcontracting and specialisation have become the norm in many industries. An immense share of value creation thus occurs in highly fragmented and frequently opaque supply chains. This coincides with a growing realisation that supply chains often account for many companies’ major ESG impacts, particularly at lower tiers. Upstream suppliers provide raw materials, goods, product components and services and tend to cause a litany of social and environmental ills. Greenhouse gas emissions are a widely quoted example. Depending on the industry, upstream suppliers may be responsible for up to 90% of a company’s carbon footprint.
In the light of increased public and regulatory scrutiny, effective supply chain due diligence has become a strategic necessity for companies and helps to:
- Identify inadequate supply chain practices;
- Reduce the risk of supply chain disruptions;
- Safeguard compliance with ESG legislation;
- Improve supply chain sustainability and efficiency;
- Protect and enhance a company’s reputation;
- Avoid litigation and debarment from public tenders;
- Strengthen supply chain resilience;
- Harness opportunities for innovation
Ultimately, due diligence should pay heed to every step along the product life cycle, from raw materials procurement to consumer use and end-of-life.
READ MORE:
Supply chain due diligence part II/II – Navigating complex regulatory landscapes
Supply chain decarbonisation in the chemical industry – Tackling the next frontier
Empowering paint manufacturers amidst the challenges of microplastic pollution
Paint companies adapt to tightening environmental legislation
The ESG due diligence environment
Supply chain due diligence is essentially a systematic approach to risk management and about identifying, preventing, mitigating and remedying risks. In view of today’s highly complex supply chains, adverse social and environmental impacts can emerge from remote business ties at lower tiers and in far-flung places. Due diligence helps to make the unknown visible and provides guidance on how to deal with material risks and opportunities.
A wide range of ESG policies and frameworks are shaping the extent to which sustainability impinges on procurement and supply chain management. They include:
Soft laws and their principles often lay the foundation for regulatory ESG initiatives. They are predominantly applied voluntarily, but to make them enforceable they are now increasingly baked into hard law. Among the most notable standards and reference frameworks are:
- United Nations Guiding Principles on Business and Human Rights
- OECD Guidelines for Multinational Enterprises
- OECD Due Diligence Guidelines for Responsible Business Conduct
- ILO Conventions
- OECD sector-specific due diligence guidance
- Paris Agreement
- Convention on Biological Diversity (CBD)
Ultimately, companies are confronted with legislative sustainability requirements on many fronts and across a growing array of topics, product categories and industries.
Trends in supply chain due diligence
While jurisdictions around the globe are raising the bar on regulatory compliance, the EU is at the forefront of such efforts. The Corporate Sustainability Due Diligence Directive (CSDDD) is the most extensive piece of legislation to date and likely to set the tone for similar initiatives elsewhere (adoption of EU Parliament’s position on June 1, 2023, trilogue negotiations still outstanding). Overall, ESG requirements are becoming more and more complex and demanding. Some of the key legislative trends are:
- Soft law is shaping mandatory supply chain legislation;
- Stronger focus on sustainability action rather than mere supply chain mapping;
- Shift from risk to impact assessments and management;
- Focus on entire value chains and product life cycles;
- Continuously expanding range of compliance topics;
- Need for much greater supply chain visibility and data collection;
- Increasing need for stakeholder engagement and collaboration;
- Cascading effects of regulations resulting in much wider scope of companies affected.
In today’s highly interconnected and global economy, the impacts of due diligence regimes often extend beyond the targeted companies. As such, a survey by BME and IntegrityNext revealed that 87% of small and medium-sized companies not legally mandated to comply with the German Supply Chain Due Diligence Act (LkSG) have nevertheless decided to meet its requirements either partly or in full. Among the main reasons were their commitment to social responsibility, stakeholder pressure and the need to prepare for the CSDDD which affects smaller businesses than the LkSG.
The geographical ramifications beyond the jurisdictions launching legislative initiatives are equally notable. The European Corporate Sustainability Reporting Directive (CSRD), which stresses the importance of value chains, is a case in point.
It has been estimated that more than 10,000 non-EU companies will be subject to its disclosure requirements. This includes mostly US companies, but also businesses from Canada, the UK, Japan, Australia and further markets. Many due diligence schemes are likely to have similar implications.
How to approach ESG due diligence
It is imperative that companies rigorously study legislative developments in their key markets, while being mindful of the previously mentioned cascading effects. Companies not only need to analyse the applicability and scope of regulatory regimes, they should also assess gaps in their management systems and impacts on the business.
Challenges abound when it comes to ensuring effective due diligence. While responsibility for the topic should be enshrined at the top, the issue of cross-functional involvement should receive particular attention from the get-go: Sustainability, procurement, compliance, product, legal, sales and HR departments all have a role to play and should be empowered accordingly. Legal departments take centre stage in the early phases of any due diligence process. They can help disentangle some of the intricacies of new regulatory initiatives, for instance in the light of legal ambiguities. Besides, they exercise major influence over contracting processes, the development and enforcement of standards and the monitoring of supplier compliance.
Third-party ESG risk management is a continuous, iterative process. Approaches must be tailored to the particularities of any given legislation. However, companies can draw on generic frameworks or refer to established systems such as ISO 37301 for compliance management.
Above all, companies should pursue a proactive approach to due diligence to stay ahead of the game. It is usually best to err on the side of caution and do too much rather than too little. Ultimately, high degrees of supply chain transparency, also beyond tier 1, are needed to ensure effective due diligence and meet the increasingly stringent requirements of upcoming initiatives. Manual processes are commonly too cumbersome when screening highly complex supply chains. Advanced automated technical solutions should therefore be a main priority.
Overall, the following, widely quoted mantra can prove useful for third-party ESG risk management:
Think big, start small and scale fast
- Start with the bigger picture. Consider all relevant facets of risk exposure and the entire spectrum of regulatory regimes that may affect your business.
- Ensure a targeted approach to risk management and compliance in the beginning.
- Incrementally expand established processes and systems and build up your capabilities.
How IntegrityNext can help
At IntegrityNext we keep a close eye on the key regulatory developments around the globe. Our platform helps you to enhance visibility into your supply chain and screen your business partners against the most material environmental, social and governance risks.
Regulators continue to raise the bar on ESG compliance. At the same time, customers and investors are increasingly holding companies accountable for harmful impacts in both their own operations and supply chains. Comprehensive risk management has therefore become a strategic necessity for most businesses.
We facilitate more robust decision-making so that you are well equipped to meet due diligence requirements and improve your sustainability performance.
Email: contact@integritynext.com
Tel: +49 89 21540-5250
