Sustainability Directive in Europe

Momentum is increasing, with this year seeing the introduction or enforcement of Sustainability laws concerning Operations through supply chains. The laws may initially only relate to large businesses, but if they are your customers, their Procurement people will be asking questions, so you will need to ask questions of your suppliers, wherever they are located.

The European Council has recently approved the Corporate Sustainability Due Diligence Directive (CSDDD or CS3D ) for businesses operating within the EU. Sustainability in the EU applies to environmental, climate change, and human rights matters and due diligence refers to a business identifying, managing and mitigating risks in value chains.

The Directive mandates that due diligence by companies: “should take appropriate steps to set up and carry out due diligence measures, with respect to their own operations, those of their subsidiaries, as well as their direct and indirect business partners throughout their chains of activities”.

The Directive will commence with EU registered companies and non-EU companies companies operating in the EU that have more than 5,000 employees and €1.5 billion in turnover. They will commence reporting in 2027. This activity will extend to companies with 3,000 employees and €900 million turnover in 2028 and to companies with 1,000 employees and €450 million turnover in 2029. While the number of affected businesses is small, the impact will be felt through their extended supply chains, as each Tier of supplier is required to provide information to satisfy the reporting needs of the customer’s customer.

This is emphasised in the Directive: “The chain of activities should cover activities of a company’s upstream business partners related to the production of goods or the provision of services by the company, including the design, extraction, sourcing, manufacture, transport, storage and supply of raw materials, products or parts of the products and development of the product or the service, and activities of a company’s downstream business partners related to the distribution, transport and storage of the product, where the business partners carry out those activities for the company or on behalf of the company”.

Directive connections

The CSDDD is a part of an integrated set of Directives for the EU that will have an influence on Sustainability legislation and company behaviour in other parts of the world.

The Corporate Sustainability Reporting Directive (CSRD) is the mandate for standards reporting that commences in 2025. The first reports within the European Sustainability Reporting Standards (ESRS) are due in 2025. The ESRS has an emphasis on each business reporting the actions taken to improve its Environment, Social and Governance (ESG) risks.

It is expected that the CSDDD and CSRD will work in tandem across companies doing business in the EU. The CSDDD provides mandatory due diligence that companies must implement regarding environmental impacts and human rights along their supply chains; the CSRD is the vehicle by which companies will report their relevant supply chain Sustainability activities, commencing in 2027.

Sustainability laws in Asia Pacific

A recent report in Eco-Business discussed implementation in the Asia Pacific region of the UN International Sustainability Standards Board (ISSB) requirements. Australia, Hong Kong, Japan, New Zealand, Philippines and Singapore have proposed mandatory Sustainability reporting rules. The consistent adoption of ISSB standards across the region is intended to provide a low risk of regulatory arbitrage by affected companies.

The countries of Asia Pacific will “be broadly consistent in terms of the overall timing of adoption and prioritising climate-related disclosures”, but will differ in timing concerning “what needs to be disclosed by when and by companies of different sizes and in different sectors”. New Zealand was the first to adopt the standards in 2024; Australia will have the largest reporting cohort of about 20,000 companies in 2025 and Malaysia has commenced consultation in the country.

The major difference between the laws is that only Australia and New Zealand will require ‘external assurance’ concerning the disclosed environmental, social and governance (ESG) performance of an enterprise. However, Singapore has stated that it will study the experience of Australia and New Zealand before considering the implementation of ‘external assurance’.

Sustainability law in America

The Uyghur Forced Labor Prevention Act (UFLPA) became law in December 2021, but its implementation has been ‘low key’, with companies given a warning when found to be importing items containing materials or parts originating in the XUAR region of China.

The approach has recently changed. The most publicised infringement has been Volkswagen, which voluntarily disclosed to the U.S. Customs and Border Protection (CBP) that impounded vehicles contained a small electronic subcomponent that came from Xuar. A newspaper report stated that “Volkswagen was not aware of the origin of this electronic subcomponent; sourced by an indirect supplier further up its supply chain, until a supplier alerted it to the issue.” 

The intention of the UFLPA is to put the onus of due diligence on participants in a supply chain, through understanding and mapping supply chain risks. This must now happen, because even voluntary disclosure is not sufficient to avoid penalties, nor claims that the goods were produced by independent companies.

This is illustrated by the case of a California based cosmetics company, for violations of the North Korean Sanctions Regulations. The US Office of Foreign Assets Control (OFAC) determined that even though the violations were self-disclosed, the company:

• engages in a substantial volume of international trade
• compliance program was either non-existent or inadequate
• put substantial efforts into quality control with suppliers, but did not put equal efforts into regulatory compliance

The fine of nearly U$1m highlights the financial risks for companies that do not conduct supply chain due diligence when sourcing products internationally. The financial risks for non-compliance will also exist in Europe and the Asia Pacific region.

Supply Chains Network Design Map

To understand your organisation’s supply chains requires a structure that illustrates the flows of items, money, data and information. This is between the Nodes (for supplier inventory) and Links (for 3PLs, transport services and other Logistics Services Providers (LSPs)) along each supply chain in your organisation’s Network.

Developing the Supply Chains Network Design Map of your supply chains is the initial action recommended to address the laws and directives discussed in this blogpost. It is the necessary step to demonstrate that Procurement is able to “monitor, identify, address and remedy” Environment, Social and Governance (ESG) risks in the supply chains.