German supply chain law ‘causing a stir’ with investors

From 1 January 2023 businesses must take responsibility for ESG risks in their supply chains

Germany has gone “further and faster” on ESG this month with a new law aimed at exposing human rights issues in supply chains.

The German Supply Chain Due Diligence Act, which came into effect on 1 January 2023, requires companies that are headquartered, or have a main branch, centre of administration or registered seat in Germany, and have more than 3,000 employees, to conduct a risk analysis to verify, document and monitor that suppliers comply with basic human rights and environmental standards.

If issues are found, measures such as audits, and passing due diligence obligations down the supply chain, can be taken, and The Federal Office of Economic Affairs and Export Control may impose a fine of up to €50,000.00. German companies that fail to comply with the new law also risk being excluded from German public contracts for up to three years.

“Germany is going further and faster on ESG than many other countries,” said Thibault Lecat, managing director of supply chain management consultancy Inverto.

“Large German businesses are effectively being forced to take responsibility for ESG risks in their whole supply chain – from now.”

The law is broadly in line with the UN Guiding Principles on Business and Human Rights and OECD guidelines for multinational enterprises, and other European countries such as the UK, France and Norway already have mandatory human rights due diligence legislation such as the Modern Slavery Act.

The EU is also planning to introduce even stricter legislation, Lecat said, requiring all large EU companies to conduct full ESG audits of their entire global supply chains, including indirect suppliers. This will affect EU companies of 500 or more employees and a turnover of €150m or more, and companies will be obliged to take steps to address any human rights abuses or environmental destruction in their supply chains.

Although the German Supply Chain Due Diligence Act is effective “from now”, many companies “have already carried out risk analysis in preparation for the Act’s entry into force”, Julia Grothaus, partner in Linklaters’ dispute resolution practice in Germany, said.

But she added the effects on companies’ investors might just be starting to be felt. “The Act has caused quite a stir in financial circles,” she commented.

“Banks, financial service providers and asset managers are increasingly being asked by their customers to provide contractual assurances regarding compliance with human rights and environmental rights with regard to their organisations and business activities. In addition, they must take the Act into account in their investment activities, as new risks arise for portfolio companies.”

For ESG investors, Grothaus added the new law will make more human rights and environmental information from companies available. It will facilitate screening investments for supply chain risk during pre-due diligence, as well as the due diligence itself. Once the investment has been made, the information will help to develop and implement strategies and tools for monitoring and supporting portfolio companies as they work to transform their sourcing programmes to meet even higher sustainability standards.

“However, these benefits are only as valuable as the quality and comparability of ESG data – a problem that remains unsolved to this day and poses major challenges for the business community as a whole,” she added.

The Act will be extended to all those with more than 1,000 employees from 1 January 2024.

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Natasha Turner

Natasha is global deputy editor at ESG Clarity, part of the Bonhill Group, and has been a financial journalist for six years. She has been shortlisted for Story of the Year and Investment Journalist of...