How can Swiss companies set up robust, sustainable and responsible supply chain due diligence processes?

Part 4: The Age of Greenwashing series addresses how to identify and mitigate greenwashing risks from a broad range of perspectives.

In brief

• Building robust and resilient supply chains is of strategic importance for every business in the green and digital transformation. It goes hand in hand with avoiding adverse environmental and social impacts
• A just transition requires responsible business conduct due diligence and supply chain transparency avoiding greenwashing

What is one of the lessons learned from the recent Covid pandemic and Russia’s invasion of Ukraine? There is a high dependency on our supply chains and that building long term climate-resilient and sustainable supply chains is more important than ever.

An increasing number of companies are using systematic due diligence as a tool to identify risks and opportunities in their value chain and build resilience against sudden changes. At the same time, companies face market pressure to act sustainably and avoid unwanted reputational risks towards consumers and investors who are becoming increasingly aware of greenwashing. In this green and digital transformation, many stakeholders demand a just transition. Companies are expected to demonstrate best efforts avoiding adverse impacts and actively assess and document how they are exposed to issues such as child labour and conflict minerals. Identifying adverse impacts in value chains is a journey with challenges. It will become easier once more companies exercise proper due diligence, and thus more data is available on adverse impacts.

In this context with the counterproposal to the Responsible Business Initiative, Switzerland introduced a non-financial reporting duty (comply or explain) for large companies on impacts on human rights issues. Based on the implementing Ordinance on Conflict Minerals and Child Labour (“VSoTr”), further companies may fall into scope of specific due diligence obligations. They apply to companies that sell goods or services if there are reasonable grounds to suspect that they were produced with child labour, as well as to companies importing or processing minerals or metals above a certain threshold into Switzerland containing tin, tantalum, tungsten or gold (“3TG”) originating from conflict-affected and high-risk areas. In essence all companies will have to assess (and document) whether and how they are impacted by the specific supply chain due diligence duties of the VSoTr. These requirements are applicable as per fiscal year 2023. Large companies in scope of the generic non-financial reporting obligation will have to consider their external communication in the corresponding non-financial reporting to be published in 2024. A minimum assessment and documentation will also be required by smaller companies. Whether specific due diligence requirements apply will be elaborated in the Swiss specific part of this article below, but first, we will look at the international developments that have triggered the Swiss regulation in the first place.

International developments regarding supply chain due diligence

The concept of human rights due diligence was originally developed in the OECD Guidelines for Multinational Enterprises which extended the application of due diligence to environmental and governance topics. Together with the OECD Guidance on Responsible Business Conduct and sectoral guidance these standards are a blueprint for various global supply chain regulations regarding the avoidance of negative externalities (e.g. UK and Australia Modern Slavery Acts, California Transparency in Supply Chains Act, Transparency Act in Norway). The regulations differ slighthly in scope and requirements but, typically, the adverse impacts addressed include human rights issues (e.g. forced labour, child labour, inadequate workplace health and safety, exploitation of workers) and environmental impacts (e.g. greenhouse gas emissions, pollution, biodiversity loss, ecosystem degradation).

These internationally recognised frameworks set out practical due diligence steps to help companies identify, prevent, mitigate and account for how they address actual and potential adverse impacts in their operations, supply chains and other business relationships. The concept of due diligence is also embedded in further international recommendations such as the ones of the International Labour Organisation (ILO).

Current EU proposal: CS3D

France (Loi relative au devoir de vigilance, 2017) and Germany (Lieferkettensorgfaltspflichtengesetz, 2021) have introduced horizontal cross-sector due diligence laws, other member states (Belgium, the Netherlands, Luxembourg and Sweden) are planning to do so, and the Netherlands has introduced a more targeted law on child labour (Wet zorgplicht kinderarbeid, 2019). Overall, this has led to a fragmentation and undermining of legal uncertainty on which frameworks to apply.

On 23 February 2022, the Commission adopted a proposal for a Directive on corporate sustainability due diligence (“CS3D”) to come up with a harmonized cross-sector corporate due diligence framework. The aim of CS3D is to foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance. This should ensure that businesses address adverse impacts of their actions, including in their value chains inside and outside Europe. CS3D will also be applicable to third country groups with business exposure in the EU.  On 1 December 2022 the Council agreed its negotiating position. We mainly refer to this current CS3D proposal, but also make reference to topics where further heavy debate is to be expected.  

The due diligence process set out in the current proposal of CS3D should cover the six steps defined by the OECD Due Diligence Guidance for Responsible Business Conduct:

1. Integrating due diligence into policies and management systems
2. Identifying and assessing adverse human rights and environmental impacts
3. Preventing, ceasing or minimizing actual and potential adverse human rights, and environmental impacts
4. Assessing the effectiveness of measures
5. Communicating
6. Providing remediation

Companies should take appropriate steps to set up and carry out due diligence measures, with respect to their own operations, their subsidiaries, as well as their direct and indirect business partners throughout their so-called chains of activities. Companies are not required to guarantee that adverse impacts will never occur or that they will be stopped. However, they should instead take appropriate measures which can reasonably be expected to result in the prevention or minimisation of the adverse impacts under the circumstances of the specific case. Account should be taken of the specificities of the company’s business operations and its chain of activities, sector or geographical area in which its business partners operate, the company’s power to influence its direct and indirect business partners, and whether the company could increase its power of influence.

CS3D: Chain of activities including downstream supply chain

The new proposal of CS3D now refers to “chain of activities” rather than value or supply chain. According to the current proposed definition, this covers activities related to the production and supply of goods or provision of services by a company, which should encompass activities of direct and indirect business partners that design, extract, manufacture, transport, store and supply raw material, products, parts of products, or provide services to the company that are necessary to carry out the company’s activities. Also, the chain of activities should cover activities of direct and indirect business partners that distribute, transport, store and dispose of the product, including, inter alia, the dismantling of the product, its recycling, composting or landfilling, where those activities are carried out for the company or on behalf of the company.

As regards financial institutions the applicability of downstream activities is debated, but shall e.g. also only include the activities of: (i) legal entities receiving directly lending, provision of guarantees and commitments from the financial institution as well as (ii) policy-holders and insured parties under insurance contracts concluded with the financial institution. In these cases, financial institutions would have to work with their clients to address potential adverse impacts on the environment and human rights in particular.

CS3D: Priority areas of high-impact sectors

The priority areas of companies should be risk-based and focus on high-impact sectors with the most significant business conduct risk exposure.

Currently CS3D high impact sectors include:

Textiles and fashion

The manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear.

Agriculture and fashion

Agriculture, forestry, fisheries (including aquaculture), the manufacture of food products and beverages, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages.

Mineral Extraction

The extraction of mineral resources regardless of where they are extracted from (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).

It is being debated whether energy, construction, financial services and technology sectors should also be added to this list of high impact sectors.

VSoTr: Scope of applicability

In essence every company must assess and document whether and how the VSoTr is applicable to its specific business model.

Swiss companies are exempted from the specific due diligence obligations of the Implementation Ordinance on Conflict Minerals and Child Labour if they already respect certain international standards as a whole and refer to them in their non-financial report. For conflict minerals due diligence obligations, companies are exempted if they already implement the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas or the EU Conflict Minerals Regulation. With respect to child labour, this would be the case if they already implement the ILO Conventions No. 138 and 182 on Child Labour and either the ILO–IOE (International Organisation of Employers) Child Labour Guidance Tool for Business or the OECD Due Diligence Guidance described above.

Specific supply chain due diligence obligations apply to companies importing 3TG minerals and metals into Switzerland or processing in Switzerland above a minimum threshold similar to the EU Conflict Minerals Regulation. Companies are required to at least document their assessment of potential exposure to such activities. If they are above the thresholds in the VSoTr further due diligence requirements with regard to traceability must be complied with as set out further below.

Regarding child labour, a three-fold test applies:

1. Child labour supply chain due diligence does not, with the exception of (very) obvious cases, apply to SMEs, defined as companies that are below the two of the following thresholds in two consecutive years: (1) 250 full time equivalents, (2) balance sheet of CHF 20 million or (3) turnover of CHF 40 million. 
2. Large companies are also excluded from due diligence obligations if they can show that the countries from which they obtain goods and services are low-risk countries regarding child labour. A low risk is presumed if a country is listed as ‘Basic’ in the UNICEF Children’s Rights in the Workplace Index. 
3. The remaining large companies are obliged to conduct due diligence only if there are reasonable grounds for suspecting child labour.

VSoTr: Scope of Swiss supply chain requirements with regard to child labour

The specific child labour due diligence requirement applies to companies that sell goods or services if there are reasonable grounds to suspect that they were produced using child labour. In other words, this excludes downstream activities that could otherwise fall in scope of the OECD guidance and the current CS3D proposal if using a risk-based approach. However, in this context it must also be noted that large companies still have a comply or explain ESG reporting duty regarding human rights issues (incl. child labour). A general statement about human rights issues is required and it must also be made transparent whether they are doing anything in this regard or not.

VSoTr: Appropriate Compliance Management System

We would argue that a basic Compliance Management System (“CMS”) is required for every company to identify and assess whether respective risks of adverse impacts exist in the first place. If specific supply chain due diligence duties apply according to VSoTr, it must also be demonstrated that an adequate CMS is implemented. In a first step this requires the establishment of a supply chain policy. Companies must e.g. communicate with the public and their suppliers about their conflict minerals and/or child labour policy and include it as part of their code of conduct in contracts with suppliers.

This requires procurement to consistently capture the “made in” information and further “know your supplier” / “know your business partner” information. 3TG mineral and metal importers, for example, must indicate and document the name of the supplier, the country of origin and the volume and date of extraction of the minerals. If the minerals or metals originate from a conflict area, additional information is required such as the mine of origin, the locations where minerals are consolidated, traded or processed as well as all taxes or other payments made in relation to the minerals.

For products for which there are reasonable grounds to suspect that they were produced with child labour, the duty to establish a traceability system requires that companies describe the product and list the name and address of the supplier as well as of all production sites or service providers of all components of the product along the entire supply chain.

Last but not least, companies must identify and evaluate risks based on their supply chain and tracing system and adopt a broader CMS plan to reduce the identified risks to the extent possible. Again, international OECD guidance can help to identify appropriate mitigation measures.

How to strategically manage the transformation

In line with similar US public policy the EU with its proposed Critical Raw Materials Act is creating a critical raw materials ‘club’ for all interested countries to ensure access to a secure and sustainable supply of critical raw materials enabling countries to meet climate and digital transformation objectives.

This geostrategic positioning is based on the insight that the decarbonization of economies drives growing global demand for minerals and metals. For instance, EU demand for rare earth metals is expected to increase six-fold by 2030 and seven-fold by 2050. For lithium, EU demand is expected to increase 12-fold by 2030 and 21-fold by 2050.

Today, European countries heavily rely on imports, often from a single third country, and recent crises have underlined strategic dependencies and high vulnerability based on potential supply disruptions from countries or continents (e.g. China and Africa). The ultimate goal of EU policy is to diversify supply chains and e.g. increase to at least 10% extraction, 40% processing and 15% recycling in Europe and decrease concentration risk to no more than 65% dependency on one country.

Summary

Companies are well advised to think about their supply chains strategically. Improved transparency regarding dependencies, risks and opportunities will allow them to better maneuver the green and digital transformation ahead. While they amend their supply chain due diligence processes, they can also take the opportunity to identify other adverse impacts on their supply chains more generally. There are many difficulties to identify and mitigate value chain risks linked to human rights or environmental impacts but given the growing demand and the dependency on certain regions in the world, both a too cautious “hands-off”- as well as a risky “close-your-eyes”-strategy will not succeed.

This blog post is part of our Age of Greenwashing series. Read more about greenwashing below.