High Stakes : Why Supply Chain Due Diligence is a Growing Business Imperative in 2022

Supply chains
Don't be left behind in adopting the latest technology for greater accuracy in supply chain due diligence.
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June 15, 2023

Pandemic-Induced Risks in Global Supply Chain 

2021 was a complex year for business with many facing severe labour shortages that crippled production and stymied growth. The Confederation of British Industry, which represents 190,000 businesses, said 70% of companies were planning pay rises in a bid to tackle labor shortages, whereas Malaysia’s National Chamber of Commerce said the country is short around 500,000 workers, after hundreds of thousands of migrant laborers went home during the pandemic without being replaced. 

As a coping mechanism many businesses find themselves relying on temporary or outsourced labour. This is especially true in sectors with a high proportion of low-skilled, low-paid and precarious job roles such as agriculture, food processing and packaging, construction, and garment manufacturing. Workers in these sectors are also often more likely to be on atypical and temporary contracts, which provide a lower level of rights, protections and predictability of work and income. This may also increase employer non-compliance related to basic labour and employment rights. If not handled carefully, your business could easily get into conflict with the law on human rights. Indeed, it is not just the small and medium enterprises that have found themselves facing these human rights related risks (know more about ESG consulting).

Businesses with complex supply chains have also found themselves vulnerable to production disruption by upstream partners. This is especially true where there is high reliance on a few suppliers in one location. It is time to look further, trying to identify more companies from varying jurisdictions to serve as suppliers. 

Two years into the pandemic, many businesses are seeking to diversify their supply chains by adding more sources in different locations that are not vulnerable to the same risks. While this has proven to be an effective strategy to maintain business operations, the speed with which many companies are on-boarding new suppliers, may negatively impact their ability to undertake robust due diligence during the onboarding process. It also leads one to question how well most companies really know the labour and environmental compliance of their newly diversified and agile supply chains.  All about the climate reporting here.

The Rise in Human Rights and Environmental Due Diligence Legislation 

Undertaking robust mapping, risk assessment and monitoring of supply chain partners is taking on a new significance because of the rapid adoption of human rights and environment due diligence (HREDD) laws. Are the new suppliers omitted to adhering to international standards on human rights? Do their production lines do risk assessment and avoid harmful production processes? What about compliance to the emerging global standards on environmental, social, and governance management? These questions should be extended to other third party firms in the supply chains and their management.

Below are a few of the major recent developments showing the growing expectations, particularly within the EU and Americas, which will impact companies registered in these jurisdictions and their supply chain partners across the globe.

  • In March 2021 the European Union (EU) announced new legislation, which will make brands and retailers that operate in the single market liable for environmental and human rights issues in their global supply chains. The legislation was due this month but has been delayed to 2022.
  • In March 2021, the EU’s Sustainable Finance Disclosure Regulation (“SFDR”) came into force. The SFDR requires certain asset managers and Financial Advisers to make environmental, social, and governance (“ESG”) disclosures to potential and current investors. Financial sector actors have substantial leverage over a range of other sectors and business activities and are key for ensuring corporate respect for human rights at scale. 
  • In June 2021 the German parliament passed a new law that requires companies based in Germany or German-registered branches of foreign companies to conduct supply chain due diligence activities. The law requires these companies with more than 3000 employees to identify, prevent and address human rights and environmental abuses within their own and suppliers’ operations. As of 2024 the law will apply to companies with more than 1,000 employees.
  • In June 2021, the Norwegian Parliament adopted the Transparency Act. Among other things, the legislation will require multinationals doing business in Norway to (1) regularly conduct human rights due diligence, (2) publish an annual human rights statement and (3) respond to third party requests for information regarding adverse human rights impacts. The Act will take effect in July 2022.
  • June 2021 marked the tenth anniversary of the unanimous endorsement by the Human Rights Council of the United Nations Guiding Principles on Business and Human Rights (UNGPs). Their “Stocktaking Report” stated that one of the most remarkable developments of the last ten years is the fast-growing understanding of the need for legal requirements based on the Guiding Principles.
  • In September 2021, EU Commission President Ursula von der Leyen announced the European Commission's intention to introduce a ban on the import of products made with forced labour into the EU market. The policy/regulation, when finally implemented, is expected to have major implications on trade, especially for companies that rely on supply chains with little of no regard for labor-related laws.
  • In October 2021, the Intergovernmental Working Group on Transnational Corporations and other Enterprises met to discuss the third draft of a binding United Nation’s Treaty on Business and Human Rights.
  • In December 2021, the U.S. passed the “Uyghur Forced Labor Prevention Act" to ban imports from China’s Xinjiang region over concerns about forced labor. Previous Xinjiang-related Withhold Release Orders from the Custom and Border Protection (CBP), which targeted cotton products, tomatoes and some polysilicon products, only blocked goods if forced labor was suspected.
  • In December 2021, the Netherlands announced its intent to introduce its own national HREDD law.

In analyzing these developments, we have taken away a few learnings, which can help companies to better prepare themselves for the changing human rights and environmental due diligence landscape in 2022 and beyond.

Learning 1: Move from Voluntary Disclosure to Mandatory Action by Companies and their Suppliers

Earlier supply chain disclosure and transparency legislation required companies to disclose identified risks, as well as actions taken to address such risks, but without directing a change in conduct. Examples of such legislation include the SB657 California Transparency in Supply Chains Act (2010) and the United Kingdom’s Modern Slavery Act (2015). Critics of such acts argue they have little positive impact as companies are allowed to report that they are not undertaking any human rights due diligence. And despite persistent non-compliance by 40% of companies, no injunctions or administrative penalties have been issued to companies failing to report. 

More recently adopted laws including the new Norwegian and German due diligence laws mandate companies and their supply chain partners to undertake specific due diligence actions under the threat of penalty. The German law for instance comes with an obligation for in-scope companies and their direct suppliers to establish preventative measures. The act also holds in-scope companies accountable for any infractions in the entire supply chain, which will create further due diligence requirements for direct and indirect suppliers. Non-compliance comes with fines of up to €800,000, or up to 2% of their average annual global turnover and exclusion from winning public contracts for up to three years.

This shows that governments are increasingly mandating companies, and their supply chain partners to regularly conduct human rights due diligence across their supply chains while attaching fines to non-compliance. Due diligence can also help companies note third party partners or traders with poor records on environmental management. Such suppliers must be avoided to reduce the danger of penalties in line with the ever tightening laws on management and operation.

Learning 2: Aggressive Implementation of Forced Labour Bans are Affecting Companies’ Bottom Lines 

Second, forced labor bans are being used more aggressively by custom officials. Section 307 of the United States’ Tariff Act of 1930 (19 U.S.C. §1307) for example, prohibits importing any product that was mined, produced, or manufactured wholly or in part by forced labor, including forced or indentured child labor. U.S. Customs and Border Protection (CBP) enforces the prohibition. In the last two years, the CBP has ramped up its use of this enforcement tool, setting a record by issuing thirteen Withhold Release Orders (‘WROs’), detaining over $55 million worth of goods. 

In November 2021, a shipment of women's and children's clothing from China was also intercepted and held by the Canada Border Services Agency (CBSA), while $200M federal PPE contract with Malaysian rubber globe makers was put on hold owing to concerns over forced labour.  It marked the first time the Canadian federal government has implemented their forced labor ban, which was brought into effect in July 2020.

Forced Labour bans are negatively impacting the bottom lines of companies. Malaysian glove makers such as Top Glove Corp., Hartalega Holdings Bhd. and Supermax, lost more than half their market value this year, in part due to allegations of forced labour and halting of imports in both US and Canada.

Due diligence can act as armor, helping companies to stay clear of blacklisted firms. This could further amplify the risk of a brand’s image damage, causing a greater danger of consumer apathy.  For a company that will be caught up in relation with firms listed for labor-related malpractices, the future will be very bleak. 

Learning 3: Know the Whole Supply Chain – In Detail

As legislation begins to take hold, companies need to understand whether they are at risk of non-compliance – not just with their direct suppliers but also in the lower tiers of the supply chain. Yet most multinational brands and retailers do not know the identity, location, and relationships of sub-tier suppliers and or of labor contractors who may provide temporary or outsourced labour. According to Geodis’ 2017 Supply Chain Survey, just 6% of companies believe they have full visibility into their supply chains. Gathering the information to generate this increased visibility requires effort – significant time and staff resources although increasingly technology is being used to drive greater efficiency into the process.

Without visibility into the identity and location of supplier workplaces and labor providers, or detailed knowledge of the workforce composition, multinationals are hampered from taking steps to improve working conditions in compliance with the law and their own corporate Codes of Conduct. Indeed, they have no way to ascertain the conditions of work or level of respect for human rights at supplier facilities, which are not visible to them, much less remedy any violations of law or normative conduct that do exist.

To ensure due diligence across the supply chain, companies will therefore need to identify and confirm the business practices of their suppliers and subcontractors. This means moving beyond simply having a Supplier Code of Conduct and putting in place actual proactive measures to prevent harm. It also requires showing that where harm has been caused that there are systems in place to provide remedy.  To make sure suppliers follow the rules, companies should be asking for specific due diligence documents, including contractual clauses, codes of conduct or certification. Companies should not be relying solely on third-party audits as a way of ensuring compliance. Finally, companies must have a due diligence strategy document in which they publicly communicate their approach and show how it is integrated into their overall business strategy.

New Technology as a Solution 

Digitalisation and new technology tools hold the potential to provide unprecedented solutions to identify, address and eliminate human rights infringements and environmental challenges. Emerging tracking and software solutions hold the potential to decrease companies’ costs substantially when it comes to accounting for human and environmental rights in company operations and along global value chains. At the same time technology can be used to help companies get closer to the reality of the situation for workers on the ground or to improve the traceability and transparency of their supply chain.

Diginex, the impact technology company has recently released diginexLUMEN, an innovative new platform, which allows companies to undertake proactive monitoring and identification of salient human rights and environmental risks in their operations and supply chain. LUMEN facilitates the identification of hidden risks by mapping, collecting and verifying data on practices from a range of key actors including workers, suppliers and lower-tier suppliers. The platform triangulates the data collected and uses risk algorithms to help companies or others know where they should prioritize in-person monitoring and improvement efforts. It also provides sustainability reporting templates that allow users to create up-to-date and data-driven reports showing gaps and progress that can be shared with multiple parties across the supply chain. 

By providing companies with a multi-component tool that combines workers voice, supply chain mapping, due diligence documentation and risk assessment – LUMEN allows for an accurate, timely and complete understanding of high-risk practices, actors and locations. Direct and lower-tier suppliers are also provided with a practical tool to undertake their own due diligence while being given a roadmap for improvement. 

You cannot be left behind in adopting the latest technology for greater accuracy in due diligence. Please contact us at Diginex to learn more about diginexLUMEN


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