Realities and consequences of mandatory supply-chain due diligence

H+K Brussels’ Ties Lambermont and Thomas Vermeeren look ahead at the EU’s new due-diligence rules expected for October, which will make reporting on human rights and environmental issues obligatory

The EU is planning to introduce mandatory due-diligence reporting to assess environmental and human rights issues, which is likely to profoundly impact companies with global supply chains. The EC’s proposed EU Directive on Sustainable Corporate Governance is expected in autumn. But what is the EU considering and how will it affect businesses? What are the next steps and what’s the European Parliament’s (EP) position?

Multinationals have long been encouraged to voluntarily take responsibility for their supply chains. It was hoped that this voluntary approach would suffice, but researchers and civil society groups have repeatedly said it is not enough. Mandatory frameworks have already been adopted in the EU for some sectors, and many stakeholders have been calling on the EU to adopt mandatory due-diligence legislation for all.

In April 2020 EU justice commissioner Didier Reynders said the European Commission (EC) would propose mandatory due-diligence legislation in 2021, and true to its word draft legislation is expected in October. The draft is expected to be based on United Nations Guiding Principles on Business and Human Rights (UNGPs), the Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy (ILO MNE Declaration), and the OECD Guidance for Responsible Business Conduct (OECD Guidance). It is intended to create a level playing field and bring legal clarity to companies operating in the EU. It is also expected to establish enforcement and sanction mechanisms, civil and legal liability for companies, and access to remedy.

A mandatory due-diligence system will impact many sectors, especially those with operations in Africa, Asia and South America. During a recent German Economic Institute (IW) roundtable Lucrezia Busa, a member of Reynders’ cabinet, told industry leaders the measures would cover human rights and environmental due diligence, two areas she said legislation would be most needed and effective. Busa said a fragmented national approach would disadvantage the EU and why the EC wants a uniform standard. The focus she said is on prevention rather than on remediation of harm, saying that the EC’s approach is all about mitigating risks. Based on this approach she said the Commission was considering supporting SMEs with several measures.

Busa said national governments’ policing of the rules would be critical in making it a success. And while the proposed legislation would not cover specific products in principle, she said that did not mean some sectors would be excluded: she specifically mentioned working conditions and environmental issues in mining industries in Africa and textile sectors in Asia. Industry leaders expressed appreciation for the EC’s perspective that the EU should not reduce trade with African and Asian partners – which could leave the door open to third countries to fill the gap with lower working standards – but expressed concerns about reputational risks, as it remains unclear how the rules would be implemented.

Once published the draft legislation will go to the EP and Council where it will be assigned a lead committee and rapporteur and working group respectively. Both institutions can suggest amendments, which will then be negotiated to arrive at a final version of the text.

The EP has long advocated for a stronger legal framework on sustainability in international supply chains and will likely support robust due-diligence obligations. The EP wants the directive to be in line with international standards, including OECD Due-diligence Guidance for Responsible Business Conduct, which provides plain-language explanations of due-diligence recommendations and provisions. It could even propose stronger measures than those in the EC’s draft legislation. The EP’s position is that the directive should apply to large companies, all publicly listed SMEs, and high-risk SMEs operating in the internal market, whether established in the EU or not. This may become a friction point with the EC – on 29 June a Commission official said SMEs may be spared mandatory due-diligence checks, instead establishing a collective mechanism or independently auditing.

The EC’s mandatory due-diligence initiative is one aspect of a move to embed sustainability commitments into trade. That push is mainly coming from the EP, so whether there will be broad alignment among the EP, Council and EC remains to be seen.

The question whether this legislation will constitute a competitive advantage or disadvantage for EU companies will also be hotly debated. Mandatory due-diligence rules would have to equally apply to third country companies doing business with the EU for European companies not to be disadvantaged. And how is the EU going to put in place a practical and pragmatic framework, flexible enough that it can be applied and tailored to different industries and business sizes? And what enforcement mechanisms to ensure compliance will be put in place?

One thing is clear: the EU wants to lead by example to set the global standard.