Due diligence: care for people and the environment in the supply chains
Chances are that the term due diligence already sounds familiar to you. In the context of acquisitions, outsourcing and investments, it refers to a close examination of potential risks involved in the other company. Traditionally, the focus has been on accurate and correct accounting to avoid bringing in unexpected debt or legal problems. But increasingly, financial analysts are also taking into account risks from other quarters: poor IT infrastructure, poor working conditions, vulnerability to climate change, resource depletion or insect pests, for example.
The European Union's Corporate Sustainability Due Diligence Directive (CSDDD) focuses the principles of that kind of risk assessment on human rights and the environment, and applies them to all large companies. A large company will have to actively look for the negative impacts resulting from its activities and those of all possible business partners operating in its supply chain (upstream). Downstream involves the distribution, transport and storage of its own products, but not the use of the product or service by consumers. And the company must examine both current impacts on people and the environment as well as potential future impacts.
Specifically? If a company finds problems such as child labour, exploitation, pollution or biodiversity loss in its supply chain, it will have to take action. The most serious impacts should be addressed first, then the less serious ones: this prioritisation should keep the approach feasible. So that means the company must actively engage its suppliers to take those steps.
On 5 July 2024, the directive was published in the Official Journal of the European Union. While the original European Commission text still explicitly used the term 'value chain' (activities related to the production of goods or provisionof services including all upstream and downstream activities), we now refer to the 'chain of activities'. Moreover, regulated financial firms are now only subject to the CSDDD for the upstream part of their activity chains.
These are some of the main obligations by the CSDDD:
Several European organizations, including the Commission, will elaborate practical tools to serve as guidance on how to comply with the obligations. Such 'guidelines' could, for example, take the form of 'model contractual clauses'. The European Commission will also provide guidance on specific sectors or specific negative impacts, as well as on the interaction between the CSDDD and other directives.
Europe also allows member states to impose fines on companies that commit infringements. Companies could also be held legally liable under certain conditions.
That depends on the phase:
Companies that have concluded franchise or licence agreements in the EU in exchange for royalties are also covered by the CSDDD. In that case, however, those royalties must exceed €22.5 million, and the company must have achieved a global turnoverof at least €80 million.
SMEs are in principle exempt. However, if they belong to the value chain of a larger company, they will be asked to make similar efforts. The directive therefore provides for additional support measures for SMEs.
The importance of respecting human rights and the environment is not just a matter of morality. We increasingly see companies' supply chains compromised by climate change, biodiversity loss, pollution, deforestation ... Social malpractices also pose a direct risk to a company's reputation and functioning, just think of the collapse of the Rana Plaza textile factory. In other words, due diligence is not an end in itself, but a tool to create a positive impact as a company.
By applying due diligence correctly, entrepreneurs also gain insight into the risks they themselves are exposed to and can take preventive action. This may involve company-level risk factors – think of a business partner whose company is not covered – but equally geographical, contextual, or sectoral risk factors. In conflict and high-risk areas, for example, human rights violations will be more frequent and more serious. Investors and consumers alike now expect this kind of risk management from companies, but they do not always have sufficient visibility into it.
An overview of the next steps:
Is your company yet to take its first steps in due diligence? Our consultants will be happy to assist you. Contact us at mail@pantarein.be.
