Companies Can't Be 'Flying Blind' to Supply Chain Diligence Rules, Advisers Say

Contractual language against forced labor may not be enough to meet increasing supply chain due diligence regulations, particularly as the EU implements its corporate sustainability due diligence directive (see 2202230073 and 2306010022), Ernst & Young advisers said this week. Although there is still debate about how broadly the bloc’s new rules will be scoped, the advisers warned companies against blinding themselves to rising government expectations.

Stephan Geiger, the firm's head of sustainable finance in Switzerland, said he’s seeing more procurement departments moving to set up compliance functions, particularly around sustainability issues. “There’s lots of regulation coming along with regards to supply chain due diligence,” Geiger said during an Aug. 31 webinar hosted by Ernst & Young. “Be prepared to have your story and to show what you're doing,” he said. “This question cannot be neglected going forward.”

The EU directive is expected to require large companies to conduct specific due diligence on their supply and value chains to address various environmental and social concerns. That includes forced labor, which is a “serious” issue in the textile industry and should be a priority for any fashion company, Ernst & Young Senior Manager Heidi Gysi said.

Gysi said companies in that sector shouldn’t “merely delegate” responsibilities to detect child labor “to their business partners in a contractual manner,” such as through a written code of conduct. “I'm not telling you that that's wrong altogether,” she said. “I'm just telling you that might not be enough.”

A company that relies on a code of conduct in a contract should at least “follow up on the actual adherence to the respective code of conduct,” Gysi said, “because otherwise the contractual obligation might remain empty promises.” She also said companies need to make sure their business partners and suppliers share the same definition of human rights, because that “understanding might vary throughout the globe.”

She also said fashion companies should consider doing more than sending out questionnaires to their suppliers to monitor their compliance with anti-forced labor requirements. “No one will admit to engaging in illegal practices right?” Gysi said, adding that companies should consider making on-site visits “to ensure that there's nothing there that shouldn't be there.”

Companies also can turn to independent third-party auditors to vet their suppliers, but “these audit reports are not beyond all doubts,” Gysi said, adding that suppliers are usually “informed about these audits in advance and do have time to hide the children.” Unannounced on-site visits may be “more powerful” to detect forced labor, she said.

In a survey during the webinar, 20% of audience members said they had detected “adverse impacts,” such as forced labor, in their supply chains. About 46% said they had not detected any adverse impacts, while 34% said “we have no clarity around potential adverse impacts.”

“For those belonging to category three, you're flying blind,” Gysi said. “I think you want to increase your transparency in your supply chain.”

Some companies may be “confident that their supply chains are mostly clean,” but Gysi said “there's always” some risk. “Adding transparency about the supply chain might feel like opening Pandora's box, because once you detect something, you have to take action,” she said. But “usually your gut feeling about your supply chain is more or less accurate.”

Another survey question asked: “Is your supply chain due diligence already embedded in your procurement process?” About 13% said no, 59% said yes and that they plan to increase their diligence, 6% said yes and they already have a “mature process” for all their suppliers, 3% said yes but only for a “few suppliers,” and 19% said they didn’t know.

Geiger said he wasn’t surprised that a majority of audience members said they plan to increase their diligence, adding that he has noticed more clients looking to bolster the compliance expertise within their procurement departments ahead of new EU rules. He said some employees in those departments “have not dealt a lot with this topic before, so they need to build up expertise and also their [information technology] systems” so they are not “blind” to potential risks.

Kelly Ching, also a senior manager with Ernst & Young, stressed that the new EU due diligence directive is still evolving, noting there’s “still a bit of debate” about whether it will capture downstream supply chains, including the end-uses and disposal of products, as well as upstream, such as business partners “that are not strictly an input to your goods or services.”

Questions also surround enforcement and penalties for noncompliance, she said, including whether civil liability should be applied only to cases of “intentional or gross negligence.” It’s also unclear how much responsibility the director of the company will have to implement the diligence rules.

Although it’s “still in its proposal forum, the EU is really leading the way on this topic,” she said. “This is not just an exercise in risk management. The supply chain requirements really need to be integrated into your existing compliance management system as a whole.”