European Supply Chain Act – Key Insights

On 24 May 2024, the European Parliament passed the EU Supply Chain Act, requiring European companies to uphold human rights and environmental standards in their supply chains. The law targets exploitation, child labour and pollution, allowing victims to seek compensation and imposing fines of up to 5% of annual global turnover.

Many large multinational corporations have faced allegations of child labour in their supply chain. This type of human rights abuse, along with environmental destruction, has long been a hidden consequence of global sourcing.

The European Supply Chain Act, officially known as the EU Corporate Sustainability Due Diligence Directive (CSDDD), is poised to reshape the business landscape. With the legislation expected to push thousands of companies worldwide towards more sustainable practices, it’s time to delve into what this act entails, how it will affect businesses, and what they need to do to prepare.

What Is the Objective of the EU Supply Chain Law?

The European Supply Chain Act is designed to ensure that companies operating within the EU are accountable for the human rights and environmental risks associated with their supply chain activities. Essentially, it holds businesses liable for any violations that occur, not only within their own operations but throughout their entire supply chain, from direct suppliers to indirect suppliers.

The law is closely aligned with the EU Corporate Sustainability Due Diligence Directive (CSDDD), which establishes the framework for corporate sustainability. The CSDDD encourages companies to adopt responsible business practices that respect human rights and minimise their environmental impact. Both these directives work in tandem to ensure businesses conduct thorough due diligence when sourcing from global markets.

What Are the Obligations for Companies?

Companies operating within the European Union must comply with rigorous due diligence requirements under the European Supply Chain Act. This includes evaluating potential risks throughout their supply chains and procurement activities, drawing on the benchmark established by Germany’s Supply Chain Act for responsible sourcing and accountability.

Companies are required to identify, prevent and mitigate adverse human rights and environmental impacts including global warming throughout their overall supply chain, including indirect suppliers.

Their responsibility extends to the actions of their suppliers and subcontractors, aligning with the proactive measures outlined in Germany’s legislation.

To comply with the EU Supply Chain Law, companies must adhere to several due diligence obligations:

Due Diligence Requirements: Businesses are required to establish a robust due diligence process that identifies, prevents and mitigates any adverse human rights or environmental impacts within their supply chain.

Scope of Responsibility: Companies are not only accountable for their internal operations but also for their indirect business partners and suppliers. This means they need to assess risks throughout their global value chains.

Reporting Requirements: Transparency is essential. Companies must publicly disclose their due diligence efforts, outlining the steps taken to prevent and address risks. This new approach places significant responsibility on corporations to ensure they collaborate with ethical suppliers, regardless of their geographical location.

Who Is Affected by the EU Supply Chain Directive?

Not all companies are subject to the EU Supply Chain Act. The legislation applies to businesses based on their size and turnover. Larger corporations, particularly those with complex supply chains, are the primary targets.

Size and Scope: Initially, the EU Corporate Sustainability Due Diligence Directive (CSDDD or CS3D) targets companies with over 1,000 employees and a global turnover exceeding €450 million. Over time, this will expand to include smaller businesses.

Global Reach: The law does not solely impact EU-based companies; it also applies to non-EU companies with significant business activities in the European Union. Therefore, multinational corporations with business partners or operations in the EU will also need to comply as well.

Contradicting Numbers: Interestingly, the scope of the CSDDD has changed over time. Initially, it impacted companies with 500 employees and a €150 million turnover. After thorough negotiations, the final numbers were increased to 1,000 employees and €450 million. This shift caused significant debate as to which companies would fall under the new law.

When Will Companies Have to Comply?

Compliance with the European Supply Chain Act is structured in phases, gradually imposing obligations on companies based on their size, employee count and revenue. This phased approach ensures that larger corporations are targeted initially, with smaller businesses having additional time to adapt to the new regulations. The timeline for compliance is as follows:

Compliance Phases

2027: Large Enterprises (5,000+ Employees / €1.5 Billion Turnover)
The first wave of compliance begins in 2027, primarily targeting the largest of enterprises. These are companies with over 5,000 employees and an annual global turnover of €1.5 billion or more. Since these businesses typically have more complex supply chains and global operations, the impact of the law on them is expected to be significant. Large companies will likely face increased scrutiny, requiring them to develop comprehensive due diligence procedures to address internationally recognised human rights abuses, environmental risks and ethical sourcing.

2028: Mid-Sized Enterprises (3,000+ Employees / €900 Million Turnover)
The second phase, commencing in 2028, broadens the scope to include companies with at least 3,000 employees and a turnover of €900 million or more. While these businesses are smaller than the largest multinational corporations, they still operate across borders and face considerable supply chain risks.

2029: Smaller Enterprises (1,000+ Employees / €450 Million Turnover)
By mid 2029, enterprises with 1,000 or more employees and an annual turnover of €450 million will be required to comply. While these companies may not have as extensive supply chains like the companies in previous batches, they must still perform adequate due diligence, particularly if they operate in high-risk sectors such as manufacturing, raw materials or textiles.

Additional Considerations for Compliance

National Implementation Variations: Although the EU Supply Chain Act is an overarching directive, the specifics of how it will be transposed into national law will vary across EU member states. Companies operating in multiple EU jurisdictions must stay updated on the specific legal timelines and obligations for each country, as some may impose stricter regulations or shorter deadlines.

Early Preparation: Companies should not wait until the formal deadlines to start compliance efforts. Early preparation will be key in minimising disruptions to business operations and supply chains. This includes assessing existing CSR (Corporate Social Responsibility) policies and aligning them with the directive’s requirements, as well as incorporating sustainability KPIs into their business performance metrics.

Use of Technology for Compliance: Many companies, particularly larger ones, are expected to invest in supply chain management software and risk assessment tools to efficiently monitor and audit their global supply chain activities for potential risks. These technologies can automate due diligence processes and provide real-time insights into supplier performance.

Penalties for Non-Compliance: Penalties for failing to meet the directive’s standards can vary depending on the severity of the breach, ranging from financial penalties to potential legal liabilities for any adverse impacts caused. Large corporations are likely to face heavier fines and more public scrutiny, while smaller enterprises may receive warnings or lighter penalties, reflecting their capacity to implement compliance measure.

How Can Companies Prepare for the Supply Chain Act?

Preparation is key to avoiding non-compliance penalties. Here’s how companies can get ready:

Risk Assessment: Businesses must start by conducting comprehensive risk management across their entire supply chain, including indirect suppliers. This should encompass both human rights and environmental risks, ensuring that a robust risk management system is in place to identify, prevent and mitigate potential adverse impacts

Supplier Engagement: Companies need to establish a strong business relationship with their suppliers to ensure they meet the required corporate sustainability due diligence standards. Engaging suppliers early will help foster a business model that aligns with the new regulations.

Internal Policies and Procedures: Firms must implement a robust risk management system to monitor compliance throughout their supply chains. This includes establishing clear policies on responsible sourcing and ensuring that suppliers adhere to these practices.

Training and Capacity Building: Providing training to employees and management is essential to ensure that everyone understands their due diligence obligations under the new directive.

How Will the EU Supply Chain Directive Affect Companies Operating in Multiple EU Member States?

One of the most significant challenges for businesses operating across various jurisdictions is the potential for discrepancies in how national laws are implemented. Here are some key considerations:

Harmonisation and Consistency: The EU Supply Chain Law aims to create consistency in standards, thereby reducing the regulatory burden for companies operating across different EU member states.

National Implementations: However, variations may still arise as individual states adopt the directive, leading to potential differences in enforcement.

Challenges and Opportunities: Businesses may face increased administrative burdens as they navigate these differences. Nevertheless, this also presents an opportunity to develop a sustainable economy and gain a competitive advantage by leading the way in responsible business practices.

What’s Next for the EU Supply Chain Directive?

The EU Supply Chain Directive is evolving to address global challenges and promote corporate accountability, in line with the Paris Agreement‘s goals of mitigating climate change and promoting sustainable development. Expect amendments and updates as the legislation adapts to changing trends. International cooperation is also gaining momentum, aiming for harmonised supply chain laws worldwide, further supporting the objectives of the Paris Agreement.

Enforcement will be through administrative supervision by designated national authorities and civil liability for companies that fail to conduct due diligence. The European Network of Supervisory Authorities will foster a coordinated approach across member states, ensuring effective and consistent enforcement and contributing to the broader implementation of the Paris Agreement.

Conclusion

The European Supply Chain Act represents a significant step forward in ensuring corporate due diligence across global markets. By addressing internationally recognised human rights abuses and environmental damage in global value chains, the act aims to foster a more ethical and transparent business landscape.

Companies must begin preparing now and adapting their business models to meet these new challenges head-on. The future of supply chain management lies in sustainability and companies that embrace these changes will not only comply but also thrive in a more socially responsible global economy.