Movement across borders: regulating global supply chains

June 2024  |  FEATURE | RISK MANAGEMENT

Financier Worldwide Magazine

June 2024 Issue

Given the nature of the global economy, particularly since the pandemic, global supply chains have been in a state of flux. They have experienced unprecedented challenges in recent years. US-China trade tensions, maritime piracy and geopolitical strife in Europe and the Middle East, among other factors, have dramatically affected the movement of goods across borders.

Shifting supply chain dynamics

Geopolitical factors, among others, have forced organisations to rethink the composition and location of their supply chains. The recent crisis in the Red Sea, which resulted in shipping delays and a spike in costs, is one example of how global events can take a toll on offshore production and lead companies to reassess their operations.

Reshoring – moving manufacturing back to the countries where the goods are sold – has surged in popularity over the last 18 months. Reshoring is currently being embraced by 69 percent of manufacturers in the US, according to research by Medius, with Mexico an increasingly popular location. The production line positioning of US imports has grown more upstream, which indicates some reshoring of these stages.

Companies are reshoring to improve product quality and consistency, take advantage of local tax incentives, and cultivate a skilled workforce closer to home. More will continue to weigh the benefits and risks involved.

Direct US sourcing from China has decreased in recent years, with low-wage locations, such as Vietnam, offering a popular alternative. The signing of the US-initiated Indo-Pacific Economic Framework (IPEF) is another step in this direction. The agreement will attempt to promote new economic activity and investment between its member states – Australia, Brunei, Fiji, India, Indonesia, Japan, the Republic of Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand, the US and Vietnam.

For the US, a goal of the IPEF is to establish a network of “trusted partners” in Asia to reduce its reliance on China. It includes a proposed supply chain agreement which pledges to coordinate actions to anticipate and mitigate supply disruptions and to develop ways to respond more effectively and expediently to acute supply chain crises.

Intensifying ESG expectations

Meanwhile, more and more stakeholders, from investors and consumers to employees and regulators, expect companies to meet their environmental, social and governance (ESG) commitments across their supply chain. This includes issues around human rights and climate change arising not only in their own organisations, but also within their suppliers and other business partners. There are rising demands for transparency and accountability from suppliers, with ESG practices a key measure of corporate social responsibility. The financial and reputational costs of neglecting ESG compliance can be significant.

This can pose challenges for organisations, particularly large multinationals with vast, complex supply chains. Many businesses have limited visibility into or control over aspects of their supply chain, especially links located in emerging markets. Such opacity limits awareness of any supplier activities that negatively impact the environment, the workforce or society.

2023 marked a notable shift for legislation tackling slavery in supply chains around the world. Stricter reporting requirements and accountability mean international businesses now face a complex landscape, juggling diverse regulations to ensure compliance.

Asia-Pacific has the highest number of people in forced labour globally at 15.1 million, according to the International Labour Organisation. With so much manufacturing centred in the region, companies that rely on Asia-Pacific products and labour must be vigilant. Clear policies should be in place to ensure acceptable conditions exist across all stages of production, including for suppliers and other business partners further down the chain.

Adopting and implementing ESG practices in supply chains can also improve operational efficiency. By investing in green technologies, such as renewable energy sources, companies can reduce their carbon footprint and save money on production costs tied to non-renewable resources. Responsible resource initiatives can help to mitigate risks related to environmental disasters, labour laws and other potential ESG violations.

An expanding regulatory net

The web of ever-evolving supply chain regulations can cause companies headaches. Depending on the size of the supply chain and the number of countries it encompasses, organisations may find themselves overwhelmed by the sheer volume of obligations. Companies are under increasing pressure to ensure compliance with regulatory updates and policy requirements across jurisdictions.

A number of countries are planning to enact new or updated laws to safeguard people working at every stage of a supply chain. These changes will make due diligence processes mandatory, impose more obligations and stricter penalties on businesses, and create new enforcement bodies.

The most comprehensive of the new wave of ESG-focused initiatives will be the EU’s Corporate Sustainability Due Diligence Directive (CSDDD), ratified by the European Commission in 2022. The directive was presented to the European Parliament for approval in June 2023, with a provisional deal reached in December 2023.

The directive requires both EU and non-EU companies operating in the EU to take responsibility for the environmental and social impacts of their value chains, including those of suppliers and their sub-suppliers and other business partners, imposing fines of as much as 5 percent of global turnover if abuses are identified.

After the CSDDD is formally adopted, EU member states will have two years to transpose it into their national laws. The directive will impact those companies with over 500 employees and a turnover exceeding €500m, in addition to non-EU based companies generating over €150m in turnover from operations in the EU. Though companies within the financial services sector, as well as small and medium-sized enterprises (SMEs) are currently exempt, they may face indirect impacts due to the requirements imposed on larger companies in their supply chains.

The CSDDD will also introduce duties for directors and senior managers to implement and oversee due diligence processes and to integrate them into the company’s strategy. Directors and officers will have to consider the impact of their decisions on human rights, climate change and the environment in fulfilling their duty to act in the best interests of the company. They will also need to set out climate change transition plans to ensure that their business models are consistent with efforts to limit global warming to 1.5 degrees Celsius.

The EU Corporate Sustainability Reporting Directive (CSRD) mandates that large EU organisations operating in the bloc must report on their human rights and environmental impact. From 1 January 2024 onward, companies are required to assess their direct and indirect influence on these crucial areas. Initial reports under the CSRD will be due in 2025. In time, the directive’s scope will widen to include companies with over 250 employees and a turnover exceeding €40m, EU-based SMEs and non-EU businesses with a turnover of over €150m in Europe.

In terms of human rights, the EU initiatives build on recent legislation such as the UK Modern Slavery Act of March 2015 and the Australia Modern Slavery Act of January 2019.

Germany also has its Supply Chain Due Diligence Act, which came into effect in January 2023. German companies with over 3000 employees must establish, implement and update due diligence procedures, as well as monitor human rights violations in their own operations as well as those of direct suppliers both at home and internationally. If a company doing business in Germany becomes aware of a possible violation of human rights by an indirect supplier, it must perform a risk analysis and respond accordingly.

In Canada, the Supply Chains Act, which came into effect in January 2024, requires companies and government institutions to publish an annual report detailing their actions to mitigate the risk of forced and child labour in their entire supply chain. These reports must be publicly accessible and prominently displayed on the company’s website. Failure to comply can result in significant fines and compliance orders, with potential penalties for disseminating misleading information.

Mitigation measures

Companies must keep abreast of the most pressing global regulations impacting their business. They need to implement transparency and accountability measures into the corporate compliance programmes covering their supply chains.

Mitigating ESG risks in supply chains is challenging, as companies down the supplier tiers of course have interrelationships with other organisations. The deeper those chains go, the more likely that violations may arise. ESG issues often involve lower-tier suppliers and subcontractors, where employee exploitation often goes undetected – particularly where women, migrants and children are involved.

In addition, boosting ESG performance can be expensive for smaller and medium-sized organisations. Integrating innovative technologies, conducting audits and training suppliers often requires significant investment.

But there are steps companies can take to mitigate such challenges. First is to gain a full understanding of the supply chain across all its layers, from end to end, including trade flows, countries and suppliers involved. Transparency is key.

The next step is to identify potential ESG risks. By tapping into company data, as well as publicly available information, companies can develop insights into supply chain intricacies. Country-specific import and export data can be used to identify source countries with potential issues, for example.

But obtaining accurate and reliable data on ESG factors across the supply chain can be a major challenge. Data collection processes may be inconsistent or unavailable. The absence of metrics and standards for measuring ESG makes it difficult for organisations to benchmark and compare performance among supply chain partners.

Vendor self-assessments can be used to designate vendors for approved supplier lists, as well as reward those that develop best practices around ESG. Calculating risk scores allows organisations to assess ESG risks in factories, distribution centres and warehouses up and down the supply chain. Periodic audits and reviews can improve supplier performance, especially for smaller vendors.

Companies should be able to prove they uphold ethical standards across their supply chain, from labour policies and human rights impacts through to environmental performance. If not, they risk reputational damage and potential customer boycotts. Accordingly, it is important to collect accurate performance data for reporting to stakeholders.

Responsible practices

Conflict in Europe and the Middle East, natural disasters around the world, inflation-driven economic volatility, energy crises and other geopolitical tensions have increased the vulnerability of global supply chains.

At the same time, escalating scrutiny by investors, consumers and the media puts companies under more pressure to uphold responsible sourcing and ethical labour practices. Consumer boycotts and legal challenges may face organisations that fail to adequately monitor their global supply chain.

Accordingly, companies need to place compliance at the centre of their approach. They must ensure that they only work with suppliers that meet current ESG regulations and demonstrate responsible business practices.

© Financier Worldwide

BY

Richard Summerfield