Germany’s SCA: challenges and opportunities

August 2023  |  FEATURE | RISK MANAGEMENT

Financier Worldwide Magazine

August 2023 Issue

Globalisation has led companies to transfer many of their production processes to developing countries and emerging economies – a switch resulting in an estimated 80 percent of worldwide trade now being supported by global supply chains.

Of all of the major industrialised countries, none is as highly integrated in international supply chains as Germany. However, according to the European Commission and the German government, many companies do not sufficiently fulfil their responsibilities across global supply chains on a voluntary basis, with less than one in five German companies monitoring their foreign subsidiaries and contractors for human rights violations.

For this reason, the German government has been pushing for the adoption of EU-wide legal standards to establish fair global supply and value chains. To that end, on 1 January 2023, the German Supply Chain Act (SCA) was passed. This national legislation imposes extensive new obligations on companies based in Germany or with a branch office in Germany that employ more than 3000 employees (the size of the company is calculated based on the number of employees of all affiliated companies).

In summary, the aim of the SCA is to improve the protection of human rights all along global supply chains, preventing, for instance, child and forced labour and banning substances that are harmful to people and the environment. And with companies in Germany having a responsibility to help protect human rights too, they must ensure that fundamental human rights standards are respected in their supply chains.

“The foundation for the SCA was laid in 2016,” outlines Martin Schorn, a partner at Pohlmann & Company. “At that time, the German government launched the ‘National Action Plan for Business and Human Rights’ – legislation based on the United Nation’s ‘Guiding Principles on Business and Human Rights’ – to contribute to more socially-just globalisation.

“In addition to judicial and extrajudicial remedies, corporate responsibility is the core of the plan,” he continues. “However, a survey of businesses revealed that only one fifth of all German enterprises with more than 500 employees sufficiently met their due diligence obligations along their supply chains. This was the reason for the federal government to adopt binding legislation.”

Key provisions

With the changes introduced in the SCA likely to have a significant impact on companies within its scope, those affected need to assess and improve their practices in order to meet the compliance challenges posed by the legislation.

The key provisions of the SCA require companies to: (i) establish a risk management system; (ii) designate a responsible person or persons within the company; (iii) conduct risk analyses for direct suppliers; (iv) issue a policy statement; (v) lay down preventive measures; (vi) take remedial action if there are breaches of human rights or environmental provisions within the supply chain; (vi) establish a whistleblowing procedure; and (viii) document and report.

Moreover, these provisions will pose compliance challenges on an unprecedented scale – particularly for multinational German companies with business activities in high-risk countries – with significant penalties lying in wait for non-compliance. These potentially include periodic penalty payments of up to €50,000 in administrative enforcement proceedings or fines (fines can amount to up to €8m or 2 percent of a company’s global revenue) and exclusion from public procurement procedures for a maximum of three years.

“The SCA has already been enforced by the supervisory authority, so companies are expected to comply with the law,” adds Mr Schorn. “German companies will not only lay a clearer focus on selecting and monitoring their direct suppliers but will also demand that they monitor their supply chain and forward the human rights obligations set forth by the SCA to their suppliers, even if they are not directly affected by the Act.”

However, while some of the required measures, such as the appointment of a human rights officer, can be implemented easily, others, such as the obligatory risk analysis, will likely require a somewhat greater effort by companies.

“Companies should carefully analyse the requirements of the SCA, taking into account the Q&As published by the Federal Office for Economic Affairs and Export Control (BAFA),” suggests Hannes Lubitzsch, counsel at Norton Rose Fulbright LLP. “They should also follow the guidelines which BAFA has issued regarding some of these obligations, in particular regarding risk analysis and the grievance mechanism.”

Future application

On 1 January 2024, the SCA will extend to companies with head offices or branches in Germany with 1000 or more employees, expanding further the number of entities compelled to address human rights and environment-related due diligence issues in their supply chains.

“The SCA is not just a soft law,” contends Mr Lubitzsch. “Non-compliance with its due diligence obligations can entail not only reputational damage but also significant fines. We also know that BAFA has already commenced enforcement actions and requested from a number of companies confirmation that the first measures have been taken. I am therefore confident that companies will address the relevant issues in their supply chains.”

A long-overdue piece of legislation, the SCA brings significant changes to how businesses in Germany operate, with new requirements for risk management and compliance processes. By addressing any potential risks directly, companies can continue to operate successfully within Germany and beyond.

© Financier Worldwide

BY

Fraser Tennant