The supply chain

Companies developing operations within the EU are increasingly confronted with sustainability regulations and other ESG-related issues. An important part of this concerns non-financial reporting, which requires companies to identify and report on their impact on (among other things) climate and human rights.

We are witnessing a shift from responsibility for the activities of one's own company and (legally) related entities, to a responsibility for the entire chain of companies that help the company market its products or services. 

In this article, we zoom in on the chain of activities, and the profound impact that particular concept has and will have for business.

• The Supply Chain: concept and connotation

  The term “supply chain ” (“value chain”, “chain of activities”) refers to the entire network of entities associated with an enterprise that are directly or indirectly involved in its activities, both upstream and downstream.
  
  These are entities that are involved in both the production of goods or the supply of services, and the distribution, transportation or storage of a specific product or service to a final consumer. This network includes the activities of various entities that may involve suppliers, manufacturers, transporters, warehouses, retailers and the final customers themselves.
  
  In a business context, “upstream” and “downstream” business partners refer to the entities involved in different stages of the production and distribution process of a company's products or services.
  • Upstream business partners are the entities that provide inputs to a company, including suppliers and manufacturers. They are involved in the initial stages of the supply chain and focus on raw materials, components and resources needed for production.
  • Downstream business partners are those involved in the later stages of the supply chain and help deliver products or services to end users. This group includes distributors, wholesalers, retailers and sometimes the customers themselves. These partners ensure that finished products reach the marketplace efficiently and/or effectively handle sales and customer interactions.
  
  The scope of the supply chain can vary widely depending on the industry and specific operational requirements, but generally includes elements such as sourcing of raw materials, production processes, inventory management, transportation of goods from manufacturers to distributors or directly to consumers (logistics) and order fulfillment.
  
  Since the Covid-19 pandemic, there has been a clear shift from focus on (reducing) costs to higher quality within the chain of operations. The pandemic revealed the vulnerability and opacity of global activity chains, leading companies to reevaluate cost-cutting measures that could compromise the strength of their supply networks. This alone has increased the focus on supply chains.
  
  But there is also a growing demand from investors as well as consumers for higher quality supply chains and products, and more transparency about where and how products are made.
  
  Technological innovations are furthermore making it increasingly possible to better track, analyze and control the composition and different elements of a supply chain, allowing companies to improve product quality through better monitoring and management practices.
  
  Finally, of course, there is also significant (European) regulation, which is increasing and in many areas, forcing companies to reflect about their chain of activities.

• Legal context and evolution: shift from the corporate group to the (activity) chain influenced by Europe

  The trend in regulation of (supply chains of) companies in Europe shows a clear shift from national to supranational approaches, with a growing focus on chain responsibility.
  
  Traditionally, national legislation focuses primarily on corporate groups or consortia within national borders, focusing on the legal and financial relationships between parent and subsidiary companies within the same corporate structure. These traditional regulations focus on such diverse facets as corporate governance, financial reporting, liability between entities within the same group and other internal matters. The primary goal here is to control dynamics within these corporate groups and protect minority shareholders and creditors.
  
  The European trend is now moving more toward broader chain regulation. Recent trends in European legislation emphasize transparency and accountability across entire supply chains that often span multiple countries and third companies.
  
  This is evident, for example, in the Corporate Sustainabilty Reporting Directive (CSRD - focus on reporting) and the Corporate Sustainability Due Diligence Directive (CSDDD - focus on due diligence), which requires companies to map their value chain (CSRD) and chain of activities (CSDDD), and not just the activities of their own corporate group.
  
  The ultimate goal is to ensure that companies operating in the EU market take responsibility for the impact their entire (global) supply chain has. This includes not only their own direct activities, but also how they influence and control their upstream and downstream partners. This covers all sister and subsidiary companies, and direct and indirect business partners of the company at the top of the chain.
  
  These guidelines will still need to be implemented into national law, further increasing the shift from responsibility for one's own corporate group to a company's entire activity chain at the national level as well.

• The Supply Chain in European regulations other than the CSRD and CSD

  The chain concept is further used in other European regulation: 
  
  • The NIS-2 (Network and Information Systems Directive 2, Directive (EU) 2022/2555 of the European Parliament and of the Council of 14 December 2022) requires companies to assess the cyber security of their entire supply chain, take measures to manage risks in the chain as well as work with suppliers to improve security.
  • The Conflict Minerals Regulation (Regulation (EU) 2017/821 of 17 May 2017) specifically addresses the mineral supply chain. Companies must trace the origin of certain minerals (such as tin, tantalum, tungsten and gold) and must conduct due diligence in their supply chain to ensure they are not using conflict minerals. It requires them to report on steps taken to ensure conflict-free supply chains.
  • The EU Deforestation Regulation (EUDR - Regulation (EU) 2023/1115 of Council of 31 May 2023) aims to stop deforestation in supply chains. Companies will have to demonstrate that products they place on the EU market have not contributed to deforestation, and thus due diligence must be conducted in the supply chain to verify the origin of products. The regulation requires some traceability of products throughout the chain.
  • On April 23, 2024, the European Parliament approved new rules allowing the EU to ban the sale, import and export of goods made with forced labor. This legislation will affect the supply chain in the following ways:
    • Companies must audit their supply chain for risks of human trafficking and forced labor.
    • Measures must be taken to prevent and combat human trafficking in the supply chain.
    • Reporting must be done on different steps taken to address and stop human trafficking in the supply chain.
  
  These European initiatives emphasize the importance of cooperation and transparency throughout the entire supply chain (or value chain or chain of activities), and the trend that has clearly and irreversibly taken hold in that regard.
  
  These initiatives require companies not only to look at their own activities, but also to take responsibility for what happens in their broader value chain, rather than just at the group level. In other words, these are explicit obligations to open one's eyes to what is happening at other companies.
  
  In terms of rules on control and monitoring - and thus responsibility for - a company's entire chain of activities, being a responsibility for both its own subsidiaries and direct and indirect business partners, the Corporate Sustainability Due Diligence Directive stands out head and shoulders above the other European initiatives.
  
  
  

• The Corporate Sustainability Due Diligence Directive (CSDDD)

  Introduction
  Due to its extensive scope, legal weight, global reach, focus on accountability at the deepest levels of the activity chain of a company, and alignment with international standards, the Corporate Sustainability Due Diligence Directive (CSDDD), with its corporate duty of “due diligence,” is currently the most relevant regulation that will shape how companies will need to manage their activity chains.
  
  CSDDD: short legislative history
  The CSDDD grew out of increasing global awareness and concern about human rights violations and environmental impacts within international supply chains.
  
  The initiative was inspired in part by existing national regulations such as the French Loi relative au devoir de vigilance des sociétés mères et des entreprises donneuses d'ordre of March 27, 2017 and the German Supply Chain Act or Lieferkettensorgfaltspflichtengesetz (LkSG) of June 11, 2021, but certainly also by a growing public and political plea for greater corporate accountability in (and outside) Europe.
  
  The CSDDD aligns seamlessly with the goals of the European Green Deal, a package of policy initiatives to help the EU with the green transition, with the ultimate goal of EU climate neutrality by 2050. The Green Deal takes a holistic and cross-sectoral approach: all relevant policy areas should contribute to the ultimate climate goal. This includes initiatives around climate, environment, energy, transport, industry, agriculture and sustainable finance, which are closely intertwined.
  
  Like most legislation, the CSDDD is the result of several compromises and underwent several changes during the process to balance the interests of different stakeholders - including businesses, NPO’s and EU member states.
  
  The main compromises related to defining the scope of the directive, the scope of the due diligence requirements - a duty of care on the part of directors to consider the impact of their decisions on sustainability issues, for example, was removed at a final stage -, and the enforcement mechanism to ensure feasibility in different business environments.
  
  Importance of the activity chain and mapping
  Not only will supply chain mapping become mandatory over time, it is crucial for companies to gain visibility and control over their operations.
   
  For companies, the integration of ESG factors from both strategic and operational perspectives will be important:. 
  • All companies will sooner or later want to invest in energy-efficient equipment. This reduces operating and energy costs in the long run and aligns with sustainability goals.
  • For (some) employees, flexible working hours or home- and remote working policies have been implemented to increase employee satisfaction and increase employee retention. In times of scarcity in the labor market, this can be a plus, although many companies are recently revisiting such measures. It remains to be seen how this evolves in concrete terms.
  • Community involvement of a company builds strong community ties and increases brand loyalty at the same time.
  • Transparent accounting practices and non-financial reporting help ensure that all (both financial and non-financial) activities are transparently recorded and help maintain stakeholder trust. This includes clear reporting on tax payments, profit distribution and reinvestment plans, but also reporting on ESG- matters.
  • Regulatory compliance and awareness of all relevant legal changes, such as changes in labor laws or safety standards are mandatory for any company that takes itself seriously.
  The inclusion of these ESG factors will not only support sustainability, but will also provide financial benefits such as improved efficiencies, enhanced reputation and compliance with legal expectations.
  
  In short, a company that does not adapt to changing circumstances is a company that sooner or later goes out of business. Those changing circumstances also apply to ESG-related issues.

• To whom does the CSDDD apply?

  Applicability to companies within the EU
  Companies incorporated in a member state of the EU will have to comply with all obligations of the CSDDD as soon as they fall under one of the following criteria:
  • The company employs more than 1,000 employees on average, combined with net sales (worldwide) of more than EUR 450 million, based on the last financial year for which financial statements were approved or should have been approved, or;
  • The company is the parent of a group of companies which together have reached those aforementioned criteria, based on the last fiscal year. For which consolidated financial statements were or should have been prepared, or;
  • The company has entered into franchise or license agreements in the EU in exchange for royalties with independent third-party companies, or is the ultimate parent company of a group that has done so. If these royalties exceeded EUR 22.5 million in the last financial year for which annual year for which annual accounts were or should have been prepared, the CSDDD (transposed into national law) will have to be applied.
  
  The CSDDD will only apply if the first two thresholds are exceeded in two consecutive financial years.
  
  

  Applicability to companies from third countries
  Companies incorporated outside the EU must also comply with all obligations of the CSDDD as soon as they fall under one of the following criteria:

  • The company has generated net sales in the EU of more than EUR 450 million;
  • The company has not reached the threshold above, but is the ultimate parent company of a group that did generate EU net sales of more than EUR 450 million on a consolidated basis;
  • The company has entered into franchise or licensing agreements in the EU in exchange for royalties with independent third party companies, or is the ultimate parent company of a group that has done so. If these royalties in the EU exceeded EUR 22.5 million in the last financial year for which financial statements were or should have been prepared, AND the same foreign company has net sales in the EU exceeding EUR 80 million in the last financial year for which financial statements were or should have been prepared, the CSDDD (transposed into national law) will have to be applied.
    
    

  Again, the Directive will only apply if the first two thresholds are exceeded in two consecutive financial years.
  
  Special regime for parent companies
  Parent companies that fall within the scope of the CSDDD but that do not engage in operational decisions and merely have as their main activity the holding of shares in operational subsidiaries may be exempted. This applies to both EU and non-EU companies.
  
  However, if a company wants to make use of this exemption in the capacity of a parent company, it must designate a subsidiary company established in the EU and meet all the conditions of the CSDDD Directive on behalf of the parent.
  
  Moreover, the parent company remains jointly and severally liable for the subsidiary's failure to comply with the requirements.
  
  Transitional rules for transposition into national law
  The previous thresholds are somewhat mitigated by the temporal entry into force of the CSDDD. This provides for a (very) long transitional period to comply with the set obligations.
  
  Each national member state will only have to take the necessary measures to transpose the directive by July 26, 2026 at the latest. And the application will be phased thereafter:
  
  Only as of July 26, 2027 will the member states have to apply the rules of the CSDDD to EU companies that had an average of more than 5,000 employees (instead of 1,000 employees) and a worldwide net turnover of more than EUR 1.5 billion (instead of EUR 450 million in the EU only) in the financial year before July 26, 2027;

  • Only as of July 26, 2027 will the member states have to apply the rules of the CSDDD to EU companies that had an average of more than 5,000 employees (instead of 1,000 employees) and a worldwide net turnover of more than EUR 1.5 billion (instead of EUR 450 million in the EU only) in the financial year before July 26, 2027;
  • Only as of July 26, 2028 will member states have to apply the rules of the CSDDD to EU companies that in the financial year before July 26, 2028 had on average more than 3,000 employees (instead of 1,000 employees) and global net sales of more than EUR 900 million (instead of EUR 450 million in the EU only);
  • Only as of July 26, 2027 will member states be required to apply the CSDDD rules to third-country companies with net sales in the EU exceeding EUR 1.5 billion based on the fiscal year before July 26, 2027;
  • Only as of July 26, 2028 will Member States be required to apply the CSDDD rules to third-country companies with net sales in the EU of more than EUR 900 million based on the financial year before July 26, 2028;
  • Only as of July 26, 2029 will member states have to apply the final CSDDD thresholds.
    
    

A very broad transition period is thus envisaged, which should allow companies to prepare both themselves, and their entire activity chain.

But what are now the concrete obligations for companies that fall within the scope of the CSDDD, and how does that translate concretely to their chain of activities? We will discuss this further in a subsequent contribution.