Why the German Supply Chain Due Diligence Act needs attention

Amid the wave of Environmental, Social, and Governance (ESG) regulations that require attention is the new German Supply Chain Due Diligence Act. This act, which took effect on January 1, 2023, demands due diligence and reporting concerning human rights and environmental impacts in supply chains. It has implications for UK organisations with employees in Germany, meaning UK companies not only need to meet the requirements, but be ready to act on any human rights or environmental issues uncovered. Importantly, the act is just one of several similar regulations that organisations will need to invest time and resources into in the next few years.

The German Supply Chain Due Diligence Act applies to organisations with over 3000 employees in Germany, with this threshold expected to reduce to 1000 employees on January 1, 2024. It applies irrespective of sector, revenue, or location of the company’s headquarters. The act demands companies have a deep understanding of the human rights activities and environmental implications of their tier 1 (direct) suppliers. In their tier 2 suppliers and beyond, it puts obligations on companies in the case of substantial knowledge of violations. Non-compliance fines could be as much as 2 percent of the company’s average global annual turnover. Of course, reputational damage and trust erosion are further reaching impacts.

The German act is one of a number that exist or are emerging in the corporate social responsibility space, including the UK’s Modern Slavery Bill and Green Claims Code, and the Norwegian Transparency Act. Importantly, the German act has also become a blueprint for the European Commission’s proposed Corporate Sustainability Due Diligence Directive (CSDDD). In a similar way to the German act, the CSDDD will require companies to understand, act on, and report on human rights issues and environmental performance across their supply chains. The threshold for companies needing to comply with the CSDDD is predominantly financial. It captures non-EU companies that have generated a net turnover of more than EUR 150 million in the EU in the previous financial year. It also captures non-EU companies that generate a net turnover of more than EUR 40 million in the EU, provided at least 50 percent of worldwide turnover is generated in a high-impact sector. Despite the CSDDD still being in review, efforts made to comply with the German act will help companies to prepare for its requirements.

Meeting the requirements of the German act will take dedication and resources from companies – in particular, those with extensive global supply chains. It can be difficult for companies with thousands of suppliers to unearth issues beyond their first-tier suppliers, whether those issues are poor labour conditions, child labour, or damaging environmental practices. It will take dedicated resources to register all suppliers in the chain, reach out to them for insights, and to remedy issues that are discovered. Some suppliers may be reluctant or unable to share data, either because they do not have this data on their upstream supply chain, or due to commercial sensitivities. Companies will need to raise due diligence and show evidence that this is ongoing through generation of ESG metrics, reporting, and prompt responses to breaches.

With significant work to be done to meet the German act requirements, here are five steps that can be taken to make the journey more manageable:

1. Understand the material impact of the supply chain
   The first step is to understand where the supply chain may have the highest concentration of issues when it comes to human rights or environmental damage. Companies need to understand those issues in their upstream supply chain and have a clear view on where those risks occur.
   
   
2. Prioritising impact
   With the material impact understood, consider where the most opportunity exists to make a positive change on human rights or environmental matters. This decision may be driven by where the business has leverage – perhaps due to volume of orders, spend, or close relationships – or where the company has the best chance to influence change.
   
   
3. Build relationships with suppliers
   To uncover any issues in the supply chain, there is little substitute for personal engagement with suppliers, and seeing first-hand how they operate. Personal relationships can make a significant difference if issues are found that need to be resolved. Engaging the support of a local NGO, or leveraging work already done by supplier co-ops into problem product categories (such as soya or vanilla) can make this more manageable. Of course, in extensive supply chains, technology can also play a significant role in ‘knowing the suppliers’.
   
   
4. Build clean databases
   Data collection is key to knowing suppliers, understanding material impact, prioritising activities, monitoring metrics, and reporting. If data is not complete, accurate, and well managed, compliance becomes difficult to achieve and demonstrate.
   
   
5. Be ready for reporting and scrutiny
   The German act expects organisations to continuously document the fulfilment of their due diligence obligations. Companies will also need to be ready for greater public scrutiny of their supply chain activities. With the CSDDD, there is potential for people impacted by human rights abuses or environmental breaches in the supply chain to take legal action against all companies in the chain. Demonstrating due diligence and acting on any issues discovered will be key to mitigating these potential risks.

While the German act is the current focus, UK companies will soon need to prepare for the EU’s CSDDD, so there is little time to waste. The important thing to remember is that the regulations are not asking for a ‘tick the box’ compliance exercise. Rather, they want organisations to deeply understand their suppliers, and make a genuine, positive impact on human rights and the environment. To find out more about the German act and how to meet the new requirements, join our webinar on April 19th. Information can be found here.