Value chain

Proposed EU value chain legislation will affect businesses around the world

American business owners and their accounting professionals might be surprised to learn of a proposed European legal regime that will have a major impact on global affairs. Their surprise can become a shock when they learn that the companies they own or serve will be subject to legal obligations or supply chain issues they never considered. Who, for example, might have expected a company to lose a long-standing export customer to an unnecessary production process up its supply chain, or to union disputes ?

This new legal regime will come from a European Union directive on compulsory due diligence in matters of human rights, the environment and good governance (see the European Parliament resolution of March 10, 2021). For convenience, it will be referred to below as the European Union Mandatory Due Diligence (EUMDD).

This article first summarizes the provisions and status of the EUMSD, then presents some scenarios of problems and possible responses, and ends with suggestions on what to do at this stage.

EUMSD provisions and statute

The scope and reach of this regime will be unprecedented. As currently foreseen, the proposed directive will apply to

  • Companies operating in the EU with:
    • more than 250 employees,
    • more than 50 million euros in annual turnover, or
    • a balance sheet total greater than 43 million euros; and
  • Companies that sell products or provide services in the EU internal market, provided that they are (i) listed on a stock exchange, (ii) small or medium “high risk”, or (iii) suppliers of financial products and services, even if they are based outside the EU, including the United States.

This legislation goes far beyond what most people consider “due diligence”. The proposal specifies:

Due diligence should be understood as the obligation to [companies] take all proportionate and proportionate measures and make efforts within their means to prevent negative impacts on human rights, the environment or good governance from occurring in their value chains, and address these impacts when they occur. In practice, due diligence consists [of] a process implemented by [a company] in order to identify, assess, prevent, mitigate, stop, monitor, communicate, justify, treat and remedy potential and / or actual negative impacts on human rights, including social, trade union and labor rights, on the environment, including the contribution to climate change, and to good governance, in its own operations and in its business relationships in the value chain.

Under the proposal, an affected business will have to:

  • Take measures to avoid negative impacts on:
    • human rights, including social, trade union and labor rights;
    • the environment, including waste generation, sustainable use of natural resources, pollution, greenhouse gas emissions, deforestation, biodiversity and ecosystems; and
    • good governance, including the fight against bribery, corruption and illegal electoral contributions.
  • Identify the actors of its “value chain”, including suppliers and subcontractors—not limited at first level downstream Where upstream-which present major risks. The value chain includes all of a company’s activities, operations, business relationships and investment chains, including entities with which the business has a direct or indirect business relationship, upstream and downstream, and which are either: (a) provide products, parts of products or services that contribute to the company’s own products or services, or (b) receive products or services from the company ”);
  • Ensure that value chain partners have policies in line with its due diligence strategy, through contractual clauses, codes of conduct, certified independent audits or otherwise; and
  • Check that subcontractors and suppliers are and remain in compliance with these obligations.

Unless an affected business believes it is risk-free, it will need to produce a “due diligence strategy document” in which it will publicly map its value chain and state the following:

  • his potential Where real negative impacts on human rights, the environment and good governance;
  • how it will stop, prevent or mitigate them; and
  • how it will prioritize these issues.

Not all businesses will be forced to take the same actions. Some flexibility will be allowed, but this flexibility will be subject to complicated rules.

This new regime will have teeth. EU member states will have broad enforcement powers. Sanctions can include significant fines, exclusion from government contracts and import bans. The proposal also contemplates extrajudicial remedies and civil liability.

This proposal for a directive enjoys broad political support. The European Parliament adopted the resolution of March 10 by a large majority. The directive aims to create a certain degree of uniformity and a level playing field between EU member states. There are already similar laws in force in France, Germany and the Netherlands, and other member states have considered them.

The proposed directive will likely be fully enacted and in force between next year and 2025. Sources indicate that the European Commission (the executive branch of the EU) and the European Parliament will likely adopt the directive in 2022 or 2023. Each member state of the EU will then be responsible for transposing the directive into its national law, which should be accomplished within two years, that is to say by 2025.

Hypothetical examples

Here are some hypothetical examples of the impact of the EUMDD:

Scenario 1. A publicly owned American social media company has clients, perhaps called “members”, in the EU, but no other presence there. It will be directly subject to the EUMDD and required to comply with all obligations imposed by the EUMDD.

Scenario 2. A large Spanish food processor buys palm oil from an American company, which it sources in Indonesia. The Indonesian supplier has a continuing history of deforestation. The EUMDD would likely require Spanish society to investigate deforestation (and related effects, if any, on climate change) and take appropriate action. Although American society is not directly subject to the EUMDD, it will be indirectly affected, due to the obligations imposed on the supply chain by the Spanish company under the EUMDD. In practice, the American company will be required to assist the Spanish company in order to maintain its activity.

Scenario 3. An American footwear company exports footwear to a large Italian clothing and footwear retail chain. The American company buys these shoes from a factory in Asia that uses unfair labor practices, possibly under local government policies that suppress ethnic minorities. The Italian company would likely be required by the EUMDD to investigate and take appropriate action, and the US company would be involved as a result.

Recommendations

The EUMDD is all about compliance and also about potential desirability. Companies that will be directly affected by this “due diligence” regime, and companies that wish to do business with them, should start preparing for it now.

The starting point for a business is to come to a preliminary judgment whether it will be affected by the EUMDD. Obviously, a business that exports goods or services to the EU will need to look into this, as will any business in the supply chains of those exporters. It is important to remember that the EUMDD targets “value chains”, not just supply chains.

If a company concludes that it has potential exposure to the EUMDD, it deserves priority attention. Drawing on risk management and compliance, EUMSD best practice will be to establish a program. If the company has a serious board of directors, EUMDD will deserve their attention. If the company already has a risk management or sustainability committee, the EUMDD can be assigned to it. (If not, EUMDD can provide the impetus to create one.)

If a business is affected by the EUMDD, it may choose to do as little as possible to be in compliance, or it may make a strategic decision to find ways to gain a competitive advantage from the EUMDD.

A formal plan will be in order. In fact, if a business is directly affected by the EUMDD, a “due diligence strategy document” will likely be required by law.

In the spirit of best practice, a business is well advised to install and implement a digital program to manage EUMSD, as it is used to manage governance, risk and compliance.

All of this will benefit from the advice and guidance of CPAs and consultants.

Allen Campbell, JD, is the founder and CEO of McAlan LC, providing information, advice and solutions in governance, risk and compliance (GRC) and environmental, social and governance (ESG). He can be contacted at [email protected] or http: //www.McAlan.com.