By Robin Hoenig, Head of the Trade Policy Competence Centre (Asia/ASEAN)
On July 22, 2021, the German parliament published the German Supply Chain Due Diligence Act (GDDL) in the Federal Law Gazette. This new law is Germany's first comprehensive and legally binding mechanism safeguarding human rights and the environment in supply chains. It heralds a new era of sustainable practices in manufacturing and sourcing. This article seeks to provide an overview of the regulation; explain why current due diligence practices often fall short in meeting the requirements of the law; and highlight some challenges companies experience when setting up GDDL-compliance.
The GDDL in a Nutshell
The law will enter into force on January 1, 2023, and will apply to companies with more than 3000 employees. In the subsequent year, on January 1, 2024, the scope of application would be extended to companies with 1000 to 3000 employees. These companies are required to exercise due diligence in their supply chains in accordance with international standards prescribed by several international conventions of the International Labor Organisation (ILO), the Minamata Convention on Mercury, the Stockholm Convention on Persistent Organic Pollutants, and the Base Convention on the Control of Transboundary Movement of Hazardous Wastes and Their Disposal.
Companies have to adopt appropriate and effective risk management across the entire supply chain, including the company’s ‘own operation,’ its subsidiaries abroad, direct suppliers, and - to a limited extent- indirect suppliers. If human rights or environmental risks are identified, companies must immediately adopt appropriate preventative measures. The law also requires companies to establish internal complaint procedures through grievance mechanisms that enable people to report potential risks or violations. As part of preventive management, companies must issue a statement on their human rights strategy. Companies are also subjected to annual reporting requirements on their compliance with the law. This report has to be made publicly available for at least seven years.
The Federal Office for Economic Affairs and Export Control (BAFA) would ensure the effective implementation of the law and holds a monitoring function. If a company refuses to cooperate in its investigation, BAFA can impose a penalty payment of up to EUR 50,000. If an enterprise was found to have violated its due diligence obligation under GDDL, BAFA could impose a fine of EUR 800,000, or up to two percent of the company’s annual turnover. Companies could also be excluded from public procurement in Germany for up to three years.
Current Due Diligence Practices: Working Toward Meeting the New Standard of Care
Most German companies have already adopted corporate due diligence as a standard of care for human rights and the environment. Some have done so because it is a legal prerequisite to sell goods and services in certain markets. Other companies have voluntarily adopted due diligence practices. This is either because companies are intrinsically motivated and have incorporated such commitments in their larger CSR strategy, or because they pursue commercial interests, such as better branding, marketing, and reputation.
However, there are still many companies that currently do not comply with the new regulation. This is because corporate due diligence is predominantly practiced in downstream supply chain segments, such as final product manufacturing, and less frequently in upstream supply chain activities, such as raw material extraction. Additionally, companies often only subject their direct suppliers to risk assessments, but do not cover indirect suppliers. This is because many global production networks are geographically dispersed and function-specialized. Geographical dispersion means that supply chain activity can occur across different nations that do not employ human rights laws or enforce a human rights regime that does not align with international standards. The functional specialization in value chains (specific cooperation, tiers of corporations, and even significant segments of national economies devote themselves to a particular task in the production chain for goods) has led to complicated supplier networks in manufacturing, where the production includes hundreds or even thousands of contractors and sub-contractors. Geographical dispersion and functional specialization have made it difficult -and for some sectors almost impossible- to fully trace the entire supply chain. In turn, companies apply corporate due diligence only to direct suppliers.
Lastly, the new law requires certain procedural requirements that companies need to establish. For instance, the law prescribes that companies are required to implement a grievance mechanism to enable all affected parties to report human rights violations. While large MNCs have already established grievance mechanisms as part of their CSR strategy, many have yet to develop such complaint procedures.
Challenges in Complying With the New Law
There is a myriad of challenges that companies face in complying with the GDDL. While the new law will likely create additional costs and bureaucracy for companies, the main challenge is the regulations’ legal ambiguity. To date, the scope of application of the supply chain law, e.g., on managing internal operations and upstream supply chain tiers, remains unclear, and several vague legal terms require clarification. For instance, the law refers to “adequate” implementation of due diligence obligations. The term “adequacy” is open-ended, and is supposed to give companies flexibility in adopting a due diligence approach. This creates risk from a compliance and legal perspective, as there may be discrepancies between the enterprise and the regulator on what action is considered “adequate.” Supply chain experts, therefore, urge the regulator and the implementing agency, BAFA, to provide clarification and clear guidelines that enable companies to develop and execute adequate compliance plans.
Another key challenge in complying with the regulation is the timeframe between publication and the law’s entry into force. The regulation was published in July 2021 and is set to take effect in January 2023. This gives companies 18 months to ensure full compliance with the law. Companies with complex supply chains have expressed concerns over the short deadline, claiming the timeframe does not suffice in developing and executing a compliance plan and setting up the necessary due diligence procedures. This, in conjunction with the legal ambiguity, could lead to companies not being GDDL-ready once the law takes effect.
Furthermore, there are political risks associated with conducting human rights due diligence. Human rights are a highly politicized topic, and several governments have cited their sovereign right to conduct their internal affairs without external interference. This makes it difficult for companies to conduct human rights risk assessments and flag non-compliance with human rights without potentially facing repercussions, especially when working with state-owned enterprises in overseas markets and competing in public procurement.
The new law does not take into account that some supply chains are not flexible: the production of certain products relies heavily on a few specialized suppliers or scarce raw materials, which can only be found in certain geographies. This makes it difficult for companies to take action if human rights violations are identified, and disengagement with suppliers is impossible. For instance, for magnets and magnet technology, the rare earth Neodymium is an essential component in the manufacturing process. There are two tiers in the Neodymium supply chain: the first tier is companies that process the rare earth; the second tier is Neodymium mines. Currently, China holds a monopoly in extracting Neodymium, accounting for approximately 80% of the global supply. These mines are owned by a handful of Chinese enterprises. Most Tier 1 suppliers are also Chinese enterprises sourcing from these mines. Therefore, there is no flexibility in the market to source processed Neodymium that does not originate from those mines.
Lastly, while the scope of the GDDL only applies to companies of a certain size, medium-sized companies are working toward achieving compliance. This is because the law is likely to trickle through the supply chain. If small companies are direct suppliers to companies covered by the act, they may be required to implement human rights due diligence processes through their contractual relationship. In turn, smaller companies may be required to build up corporate due diligence competencies. They may have to invest significant resources in GDDL-compliance to ensure that their larger clients maintain business relationships with them.
Source: Ticker 2022 Summer
