ESG (Environmental Social Governance) has already become an important topic in responsible corporate governance. Globally, there is a rapidly growing body of legislation that requires companies to take action and report on their ESG efforts comprehensively. Multinational corporations have a far-reaching impact on labor conditions in their supply chains. By conducting due diligence to uncover human rights abuses and environmental risks in supply chains, they can put pressure on their suppliers to improve their workers' working conditions and comply with environmental standards.

New obligations in Germany took effect on January 1, 2023

Many industrialized countries, including Germany, France and the Netherlands, have enacted laws requiring companies to comply with due diligence requirements when monitoring their supply chains, rather than relying on voluntary measures. The Supply Chain Due Diligence Act (“LkSG”) came into force in Germany on January 1, 2023. It initially applies directly only to companies with at least 3,000 employees. From 2024, the scope of application will then be expanded so that companies with 1,000 or more employees will be covered.

The draft law obliges the covered companies to establish mechanisms to identify human rights and environmental violations. Comprehensive risk analyses must be conducted and risk management systems introduced or supplemented with a view to potential violations. Furthermore, the law requires a policy statement on the company's own strategy, which specifies in more detail how the new obligations are to be handled. If the risk systems give cause for concern, the companies must take preventive measures as well as remedial action. Complaint procedures must also be established for those affected by violations. Employers must, as part of their comprehensive documentation and reporting obligation, publish and send to the relevant authorities annual business reports on the fulfillment of these obligations.

Relevance for suppliers

The effects are already being felt, however, by companies that do not themselves meet the thresholds or do not work with suppliers—namely, if the companies themselves are suppliers. Although these companies are not directly implicated in the LkSG, they are confronted with the increased requirements that their customers place on the supply chain as a result of the law. The obligations of the LkSG include the performance of a risk analysis. This involves companies having to establish transparency with regard to their production and supply chain in order to be able to identify where there are particularly high risks in terms of human rights violations and environmental concerns. To do this, they must review the business areas of suppliers. This applies both in existing business relationships and when placing new orders. Passing the risk analysis thus becomes a decisive competitive factor.

The explanatory memorandum to the draft law refers here to on-site visits to production facilities and discussions with employees and their representatives as examples of how information can be obtained. In the first step, however, many companies use extensive, standardized questionnaires. If a supplier company is confronted with such a questionnaire for the first time, it can take some time to process it because the necessary information is not always available and must first be determined. The resulting time pressure can be prevented by establishing regular maintenance of a collection of LkSG-relevant information. The questionnaires are sometimes prescribed by international parent companies or contain industry-specific features. In our consulting experience, however, we have found that a large number of questions or topic areas are asked in almost all of these questionnaires and can therefore form the basis for such a collection.

Typical contents of questionnaires

The recurring questions can essentially be assigned to the following topics, which are also predominantly oriented to the contents of the duties of care standardized by the LkSG:

• Basic data of the company
• Strategy on ESG issues in general
• Human rights
• Occupational health and safety
• Environmental issues
• Own supply chain management

Basic data of the company

Relevant basic data for each company includes the address, the number of (temporary) employees, the designation of affiliated companies, information on shareholders or owners and management bodies, and the industries or sectors to which a company belongs.

Strategy on ESG issues in general

Here, companies can provide information on their general ESG strategy and thus show, if applicable, that the topic is deeply rooted in the corporate culture. Typically, an employer would answer in the affirmative to the following regularly occurring questions: Is there a designated position/person who deals with ESG issues? Does the company regularly publish reports on ESG and/or sustainability issues? Is there a code of conduct and related training for employees? Is there a formalized grievance procedure? Is the company or its processes/production procedures certified and if so by which body?

Human rights

Similar questions are also asked with regard to the observance of human rights: How are the responsibilities and accountabilities for respecting human rights anchored in the company? Are there guidelines in this regard and which human rights are covered by them? How does the company ensure that no human rights are violated? Are employees regularly trained on these topics? How are human rights violations dealt with, and are there formalized complaint channels?

Occupational health and safety

The topic of occupational health and safety relates in particular to compliance with local occupational health and safety laws. Are there company guidelines to ensure compliance? Are safety equipment and first aid measures available to employees? Are employees trained on a regular basis?

Environmental issues

Is the consideration of environmental issues in the company covered by a policy? Are environmental issues covered by a certified management system? Which aspects are covered by it? Are employees regularly trained on these issues? Are hazardous substances used in the company? Does the company have special procedures in place to effectively prevent or respond to emergencies or operational accidents that could affect the (health of the) local population and to respond efficiently to such cases?

Own supply chain management

In cases where the supplier in turn has its own suppliers, the question must be answered as to whether the company reviews its key suppliers, subcontractors, joint venture partners and other important business partners with regard to their commitment to social, human rights, environmental and human rights issues.

Projects of the European Union

At the EU level, the European Commission adopted a proposal for a directive on corporate sustainability due diligence (CSDD) on February 23, 2022. Then on December 1, 2022, the European Council of Ministers published its negotiating position. With regard to the scope of application, the directive’s plans take a somewhat different approach than does the LkSG. A distinction is made between EU companies and non-EU companies operating in the EU. EU companies are to be covered if they have more than 1,000 employees and a worldwide net turnover of €300 million. For non-EU companies, a net turnover of €300 million generated in the EU shall be sufficient.

In terms of content, the planned CSDD also goes beyond German law in some respects: for example, it explicitly refers to compliance with the 1.5°C target under the Paris Climate Agreement.

The negotiating position achieved has given the Council Presidency a mandate to start negotiations with the European Parliament. Their commencement now represents the next step. Once the directive has been finally adopted, the member states will have two years to transpose it into national law. By then at the latest, adjustments to the LkSG will be necessary and companies on the client and supplier sides will be confronted with additional requirements.

Conclusion and Recommendations

Due to the listed implications, companies that are not (yet) directly subject to the scope of the LkSG’s application should also check to what extent they are nevertheless affected as a supplier company now or in the future, and prepare themselves by obtaining information in good time and, if necessary, making adjustments to production conditions.