On January 1, 2023, the German Supply Chain Due Diligence Act went into effect, aiming to prevent and remedy human rights and environmental risk violations by German-based companies and their global suppliers. Although the new law is considered an important step towards a more comprehensive framework to tackle environmental, social, and corporate governance (ESG) related concerns, and a precursor to the pending EU supply chain law, the law has drawn a considerable amount of criticism from several domestic trade associations and companies both before and after implementation.
It will likely take several more months until the law’s full impact on supply chains in Germany and beyond will become clearer, however, affected companies are already facing related disruptions and are concerned about more.
German act will be implemented in two stages until 2024
The German law requires all relevant companies to uphold a set of responsibilities: Establish a risk management system; designate responsible person(s) within the company; conduct regular risk analyses; define preventive measures; take remedial action and establish a complaints procedure; and document and report any findings in an annual report.
Consequences for failing to comply with the regulations include fines of up to €8 million, or 2% of annual global turnover for companies with an average annual turnover of more than €400 million. Companies may also face exclusion from winning public contracts in Germany for up to three years.
As of January 1, 2023, the law affects all companies based in Germany with more than 3,000 employees, as well as non-German companies that have their head office, administrative headquarters, registered office, or branch office in Germany. It is estimated that approximately 700 companies fall within these parameters. From January 1, 2024, the threshold for adherence will drop to any company with 1,000 or more employees meeting the above criterium. As a result, about 2,900 companies are estimated to be impacted by 2024.
New due diligence requirements cause bureaucratic and financial hurdles
The new legislation has been hailed as an important step towards making sure that companies ensure the protection of basic human rights along their global supply chains; however, its critics have voiced several complaints over the past months. A major point of discontent is the large administrative framework companies need to implement to meet the new documentation and control requirements of the German Supply Chain Due Diligence Act.
Representatives of the Federal Association of Wholesale, Foreign Trade, and Services e.V. and the Association of German Chambers of Industry and Commerce criticized the detailed catalogue of questions companies are asked to fill out to prove that they adhere to the control requirements of the new law, which poses considerable challenges to companies of all sizes.
Other issues raised by affected organizations:
- Concerns about being forced to use additional workers or enlist the services of external contractors to meet the documentation and control duties bigger customers insist on as part of supply contracts.
- An unsustainable rise in costs for smaller suppliers which receive no financial compensation from customers to implement the needed bureaucratic structures.
- Suppliers with control processes already in place will likely face additional bureaucratic hurdles as the new law requires ongoing, detailed documentation on a wide range of ESG risks.
- Attempts to follow up on ESG-related abuses could be at risk of being buried under a wave of disciplinary warning letters triggered by administrative shortcomings
- Financial penalties could have far-reaching consequences along global supply chains as they increase the risks of significant financial stress and even insolvencies for smaller sub-tier suppliers, especially those already struggling with previous crises like the pandemic or the European energy crisis.
- Companies across the globe could face price increases, product changes, and supply delays as Germany-based suppliers may be forced to restructure parts of their supply chains to adhere to new due diligence regulations.
German law may impede the desertification of supply chains
The Federation of German Industries e. V., an umbrella organization of German industry and industry-related service providers that represents more than 100,000 companies, criticized a potential knock-on effect that could impact the structure of international supply chains.
According to the organization, the law could jeopardize attempts in some industries to diversify regional supply chains and reduce their dependencies on suppliers in the Asia-Pacific region. For example, the new due diligence requirements could exacerbate existing administrative and judicial obstacles that have already been making it difficult for German companies to invest in or expand business operations in Africa.
Proposed EU-wide law could be even stricter
The Initiative Lieferkettengesetz, an association representing civil society organizations, estimates that adjusting business operations will cost companies no more than 0.6% of total revenue, and could eventually become a competitive advantage as more governments, investors and customers shift their focus towards ESG issues.
Implementing administrative structures now could give companies a leg-up as discussions about a continent-wide supply chain law continue within the EU. The proposed Corporate Sustainability Due Diligence Directive would require EU and non-EU companies active within the trade bloc to monitor social and environmental issues along their entire value chain, including their own operations, direct and indirect suppliers, and services. With a threshold of 500 employees and €150 million of net turnover, which drops to just 250 employees and €40 million of net turnover in high-risk sectors including textile or mining, the directive would eventually apply to thousands of companies, affecting far more manufacturers than any existing national legislation.