The formal guidance issued by the European Commission and the European External Actions Service (EEAS) on "Due Diligence for EU Businesses to Address the Risk of Forced Labour in their Operations and Supply Chains in July 2021 is yet another mark of the new legislative era." While the document is non-binding and, therefore, does not create any legal obligation for companies operating in the Single Market, interested executives and procurement leaders would do well to acquire a nuanced understanding of its contents.
Coming just four months after the European Parliament voted by a large majority to adopt an outline proposal for an EU Directive on Mandatory Human Rights, Environmental and Good Governance Due Diligence, the Commission/EEAS guidance represents the single most detailed account of EU regulators’ understanding of best practice in regard to forced labor due diligence. Indeed, the recent EU trade strategy made clear that the guidance is intended "to assist EU business in taking the appropriate measures" to address forced labor in their value chains as a means of "bridging the time towards [the introduction of] binding provisions" (P.14). Significantly, draft legislation for the Commission’s mandatory due diligence Directive is expected to enter the EU trialogue by the end of the year.
So what measures do the Commission and EEAS indicate that businesses should introduce to address instances of forced labor in their supply chains? And what insights can executives and procurement leaders glean from the guidance with a view to preparing for the impending introduction of a mandatory, EU-wide due diligence regime?
Below, we outline five key takeaways derived from the Commission/EEAS guidance that can help businesses plan for the forthcoming introduction of binding regulations.
1. Review & compare to identify gaps in current processes
The guidance embraces the OECD definition and framework of due diligence as "the process that businesses should carry out to identify, prevent, mitigate and account for how they address actual and potential forced labor risks in their own operations, supply chains and business relationships." Therefore, companies can productively review and compare the guidance framework against their current procurement policies, management systems, and related tools and practices to identify the main gaps that need to be addressed in anticipation of the introduction of binding regulations.
The below table outlines the six key due diligence practices stipulated in the OECD framework and suggests potential equivalent measures businesses can consider introducing to meet and exceed due diligence requirements.
2. Conceptualize due diligence broadly
Although the Commission/EEAS guidance, like most of the domestic due diligence laws enacted recently in Europe, targets the specific issue of forced labor, it is clear that companies will be required to think broadly in preparing for the introduction of binding regulations. It is notable, for instance, that the guidance encourages businesses to account for several intersectional policy considerations when conducting forced labor due diligence. This includes:
- Developing a capacity to apply gender-responsive due diligence practices
- Acknowledging considerations relating to the discrimination of ethnic or religious minorities in regions where suppliers operate; and
- Credibly obtaining and verifying information on the origin of raw materials, particularly when dealing with suppliers based in high-risk countries
Such thematic overlap reminds us that no aspect of procurement due diligence can be conducted effectively in isolation. Businesses operating international supply chains are exposed to multiple different forms of risk, encompassing a complex array of environmental, ethical and social factors, many of which are correlated, or at least overlapping. Forced labor due diligence must, therefore, be considered as just one aspect of - and should fit into - a broader supply chain sustainability program.
Recognizing the fundamental interconnectedness of businesses’ social, ethical and environmental impacts, it is significantly more efficient for buyers and suppliers to cooperate on a single, holistic due diligence assessment than it is to attempt to address specific issues, such as forced labor, in isolation. EcoVadis’ ratings methodology is unique in its capacity to account for the full complexity of international supply chain due diligence and, crucially, anticipates emerging regulatory trends in advocating a holistic conception of sustainability, encompassing environmental, ethical and social factors.
3. Organize due diligence on an ongoing basis
Due Diligence is not a “one and done” activity. The guidance urges companies to embrace such measures as part of "an on-going, proactive and reactive process aimed at achieving continuous improvements." Furthermore, the document is clear that, in the assessment of EU regulators, due diligence practices should extend far beyond companies’ top-tier suppliers and be applied vigorously throughout the entirety of the value chain.
It is essential, therefore, that companies start thinking about due diligence as a process that extends far beyond the supplier selection stage and plan relevant systems and processes to operate on an ongoing basis. In addition to obliging companies to track regulatory shifts and legislative developments across diverse regions and jurisdictions, such continual supplier monitoring will necessarily involve the integration of due diligence verification practices throughout the procurement workflow.
Businesses might, consequently, consider integrating due diligence assessment mechanisms into, for instance, the administration of:
- RFP/RFX tenders
- SRM systems and scorecards
- Contract clauses
- Contract reviews
- Incentive and recognition programs
Significantly, data derived from the 2021 EcoVadis Sustainable Procurement Barometer reveals that an increasing number of companies are already conducting due diligence throughout the supplier relationship. This trend can only be expected to accelerate as regulators increasingly push businesses to expand due diligence beyond the supplier evaluation stage.
4. Map your supply chain for "red flag" risk factors
Perhaps the most practical, actionable section of the Commission/EEAS guidance document pertains to best practice on the issue of forced labor due diligence. In addition to encouraging leaders to build institutional knowledge of forced labor issues and introduce specific protections for whistleblowers, the guidance is emphatic that companies should focus on identifying "red flags" (i.e., key indicators of risk) when scoping supply and value chains as part of due diligence.
Specific red flags for forced labor that are highlighted in the guidance include:
- Country risk factors (e.g. legal regimes outlawing peaceful strike action, countries with prison labor policies and programs, and countries that have not ratified the ILO’s fundamental conventions)
- Migration and informality risk factors (e.g. absence of written employment contracts, presence of informally employed workers and employment of migrant workers);
- Debt risk factors (e.g. existence of credit-arrangements and debt schemes for workers and incidences of physical or psychological abuse, violence or harassment).
Of course, knowing the "red flags" to look for is one thing; however, the practical task of identifying and monitoring critical risk factors throughout the value chain is significantly more complex. This is particularly the case in a circumstance when many companies lack a centralized database encompassing all their suppliers.
It is imperative, therefore, that businesses invest the resources required to create a comprehensive database of country and category risk profiles, incorporating appropriate category tags and spend amounts, in order to effectively map the kinds of risk factors identified in the Commission/EEAS guidance against their supply chains. This practice of risk mapping is essential to gaining visibility into the activities of suppliers and, consequently, facilitates the effective triaging and organization of due diligence assessment and monitoring activities.
EcoVadis' risk mapping services can help your company acquire the capacity to conduct effective continual supplier assessment and equip you with the knowledge and tools required to plan due diligence measures with confidence. In addition to ensuring that sustainability assessments, performance monitoring and on-site audits are effectively optimized, risk mapping helps limit your exposure to several key controllable risk factors, such as fines for regulatory non-compliance and brand damage arising from supplier incident.
5. Mid-size companies must pay heed to regulators
For a variety of economic and political factors, regulators have traditionally fought shy of imposing on small and medium-size enterprises (SMEs) the same due diligence obligations that have been applied historically to large companies. However, SME leaders should be cautious of assuming that the mid-size sector will be spared any regulatory burden under the terms of a forthcoming mandatory due diligence regime.
It is notable, for instance, that respondents to a recent European Commission consultation on sustainable corporate governance explicitly recognized the role of SMEs in delivering a sustainable transformation of the economy, and called on the EU to support the mid-size sector in developing due diligence capacity rather than providing regulatory exemptions. Furthermore, as the Commission continues its effort to reform the operation of financial markets in service of the sustainability goals set out in the Green Deal, there is increasing evidence that investors, including private equity firms who finance non-listed companies, are accounting for due diligence factors when determining investment practices in the mid-size sector.
Such developments make clear that investors and regulators are increasingly coming to focus on SMEs in an effort to expand sustainable corporate practice, and it is reasonable to expect this trend to shape the formulation of the EU’s mandatory due diligence regime. Indeed, data derived from the 2021 EcoVadis Sustainable Procurement Barometer is emphatic that, in the assessment of Procurement Leaders across regions and industries, the mid-size sector represents the next frontier of progress in the transformation of global supply chains, and it is striking that the new Commission/EEAS forced labor document calls explicitly upon all "EU companies to respect human rights, including labor rights, regardless of their location, size, sector, operational context, ownership and structure."
For a variety of operational, reputational and legal factors, therefore, there is a strong incentive for mid-size companies to get out in front of the regulators and proactively develop a due diligence capacity in order to more effectively navigate the increasingly complex and variegated legislative landscape that is emerging internationally.
Ultimately, the publication of formal Commission/EEAS guidance on forced labor due diligence is but the latest sign that the era of voluntary, self-regulation in respect of social and environmental impact is coming to an end. This point was underscored on the other side of the Atlantic in June, when the US Department of State issued an updated advisory (the “US Xinjiang Supply Chain Advisory”) to alert businesses to risks and considerations associated with forced labor and human rights abuses linked to the Xinjiang region of China. Business leaders, consequently, have a strong incentive to move ahead of the legislators and begin integrating sustainability into procurement processes in order to meet and exceed forthcoming compliance requirements.
The disruption to global supply chains affected by the COVID-19 pandemic underscored that sustainable businesses are resilient businesses and are significantly better placed than their competitors to mitigate risk and navigate crises. It is imperative, therefore, that companies come to regard the internationally expanding scope of due diligence legislation, not as a regulatory burden, but as an opportunity to build organizational resilience, mitigate liability risks and strengthen market perception.
Get in touch or find out more about how EcoVadis can help your company to keep ahead of the regulators and proactively build sustainability and resilience throughout your organization and supply chain.
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