Sustainability aspects incorporated to the supply chain

The role of ESG in supply chains

Over the past years and decades, there have been numerous reports of inhumane working conditions, child labour, non-compliance with labour protection regulations, or even serious environmental pollution at foreign suppliers of major companies, causing serious damage to the company (boycotts, bad reputation, deteriorating community relations). These types of abuses alone are an important reason to improve the sustainability of supply chains. Simultaneously, there is increasing pressure on companies to ensure that their supply chains are more sustainable and transparent in order to properly address their environmental, social and economic impacts, as required by the regulatory environment, at both a national and international level.

The Hungarian ESG Act

According to the ESG Act published on 22 December 2023, large companies and SMEs of public interest must, in addition to their own operations and those of their subsidiaries, also screen their suppliers from an ESG (environmental, social and governance) perspective and report annually on their findings.

The law requires companies to carry out a risk analysis of their suppliers at least once a year, and to put in place a risk management system to deal with any problems identified in relation to subcontractors. In addition, they must have all their suppliers complete a declaration of compliance with human rights and environmental protection requirements.

This task detailed above should be extended to suppliers of subcontractors, i.e. the obligation should be iteratively extended to the entire subcontracting system. If CSR or environmental obligations are breached at any point in the supply chain, the obliged company must work with the supplier involved to develop corrective measures. The companies concerned should also extend their complaints system under the Complaints Act to deal with breaches of social or environmental obligations and enforce this with their suppliers.

In addition, companies are required to develop their own ESG strategy along with an internal system to support it, and to publish an annual ESG report that proves compliance with sustainability due diligence requirements in the previous financial year and discloses crucial ESG KPIs. This ESG report may include the companies suppliers.

The law also imposes sanctions on subcontractors regarding these requirements. Inadequate ESG preparedness or non-compliance with ESG requirements of the companies concerned may lead to the suspension of supplier contracts for a period of 3 months or even their termination.

However, sustainability due diligence of suppliers also brings a number of benefits for companies, as it helps to create a stable and reliable supply chain that ensures business continuity and minimises the risk of environmental, social and governance (e.g. corruption) non-compliance.

Furthermore, companies in scope of the Act are also obliged to prepare their annual sustainability report using ESRS (European Sustainability Reporting Standards) to fulfil requirements described by CSRD (Corporate Sustainability Reporting Directive) of the EU.

The ESG Act applies to the following companies established in Hungary:

1. Large public interest enterprises for which any two of the following three indicators exceeded their respective thresholds at the balance sheet date of the financial year preceding the current financial year:

balance sheet total of HUF 10 000 million,
annual net turnover of HUF 20 000 million,
average number of 500 employees

Activities for the financial year 2024 are required to be presented in 2025 for the first time.

However, the Act's reporting obligations according to the CSRD will only apply to companies subject to the NFRD from 2024 (i.e., high public interest companies with more than 500 employees and a balance sheet total or net sales above the above thresholds).

2. Large enterprises which, at the balance sheet date of the financial year preceding the current financial year, had any two of the following three indicators above their respective thresholds:

balance sheet total of HUF 10 000 million,
annual net turnover of HUF 20 000 million,
average number of 250 employees

Activities for the financial year 2025 are required to be presented in 2026 for the first time.

3. Public interest SMEs for which at least two of the following three indicators exceed the size thresholds for micro-enterprises on the balance sheet date in the financial year preceding the financial year in which the ESG reporting obligation applies, i.e. the following thresholds:

balance sheet total of EUR 350,000;
annual net turnover of EUR 700,000,
average number of 10 employees

Activities for the financial year 2026 are required to be presented in 2027 for the first time.

Supply chain due diligence in the EU

Hungarian companies that export to companies in other EU countries are also not exempt from the due diligence obligations and their consequences. At the end of last year, the European Parliament and the European Council reached a provisional agreement on the Corporate Sustainability Due Diligence Directive (CSDDD), which aims to enhance environmental and human rights protection in the EU and worldwide.

It also gives those affected by the adverse human rights and environmental impacts caused by companies, or their representative NGOs and trade unions, the right to bring civil action, which could easily bring the culpable companies under scrutiny. In addition, the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz, LkSG) came into force in January 2023 with the same aim. The new legislation will affect many Hungarian companies supplying German companies, as it requires due diligence of the companies' entire supply chain, including risk analysis, for all companies with more than 1,000 employees as of 1 January 2024.

Developing ESG aspects of existing suppliers and prioritising more sustainable suppliers is therefore an essential task for sustainability-driven companies, as sustainability considerations built into the supply chain contribute to an ethical and sustainable outlook and regulatory compliance. In addition, it is important for companies in the role of suppliers to be able to meet the increasing expectations of their clients in this area.

ESG strategy and systems: the Hungarian ESG Act requires the establishment of an internal ESG system and strategy, which defines the organisational framework, goals and related tasks of the company's ESG development over several years. In addition, the establishment of a risk management and an ESG complaint handling system is also part of the requirements.

Risk analysis, measures & declarations: the Hungarian ESG Act requires annual and, where relevant, exceptional risk analyses to be carried out in the established risk management system. Preventative measures are required in case of significant risk, while corrective measures are also required in case of breaches of environmental and social obligations. In addition, direct suppliers must be obliged to declare their compliance with legal and environmental requirements.

Reporting and assurance: the Hungarian ESG Act also requires annual reporting on the fulfilment of ESG due diligence obligations, with mandatory assurance.

ESG services	Relevant part of the ESG Act	Business benefits that improve competitiveness
Providing legal and business advice on supplier declarations required by large companies on compliance with human and environmental requirements and their proper management in the supply chain	According to Section 13 of Chapter III./6. Common rules on due diligence obligations for sustainability purposes of the ESG Act, the company must act in respect of the sustainability risks it faces by declaring its direct suppliers.	By having supplier declarations reviewed by legal and ESG experts, the company requesting the declaration can avoid passing on more responsibility than necessary or including additions that are not commercially advantageous.
Advice on corrective measures in case of breaches of social or environmental obligations	Pursuant to Article 13 of Chapter III/6 Common rules on due diligence obligations for sustainability purposes and Article 20 of Chapter III/10 Corrective measures of the ESG Act, the company must identify, develop and implement corrective measures within its own business scope.	By remedying non-compliances as soon as possible through appropriate corrective actions can avoid major fines and customer boycotts, as well as the suspension and termination of customer contracts. As a result of a tightening regulatory environment and stakeholder expectations, customer companies are increasingly favouring suppliers that can easily and quickly remedy potential non-compliance.
Legal and professional support in the event of suspension or termination of a supplier’s contract.	Chapter 10 of the ESG Act Corrective measures 21 § 3) to 4) states the obligation to suspend or terminate business relations for a period of 3 months	With the right legal, business and ESG expertise, it is more likely to restore customer relationships that have been suspended or even terminated due to CSR and environmental non-compliance.