Ann-Evelyn Luyten, Economic Affairs Officer at the World Trade Organization, explores the EU’s new Supply Chain Due Diligence Regulation and how it will impact the sustainable development agenda.
The EU’s lacklustre approach to enforcing sustainable development commitments in its FTAs
As the sustainable development agenda, encompassing labour rights and environmental protection, becomes increasingly important in EU trade policy, the EU includes a dedicated Trade and Sustainable Development (TSD) Chapter in its Free Trade Agreements (FTAs). To enforce these obligations on its partners, the TSD Chapters provide a separate and bespoke dispute settlement mechanism to the rest of the FTA.
However, this mechanism does not explicitly provide any right for a party to unilaterally suspend tariff concessions when another party fails to comply with sustainable development commitments. This is in stark contrast to the broader Dispute Settlement Chapter, which usually stipulates that a complainant is entitled to suspend obligations arising from any relevant provision at a level equivalent to the nullification or impairment caused by the violation. As a result of this discrepancy, the EU is unable to effectively enforce the labour rights and environmental protection obligations in its FTAs.
However, the European Commission’s upcoming legislative proposal on mandatory supply chain due diligence could tackle this problem, by better enabling the enforcement of sustainable development commitments.
The EU’s new Supply Chain Due Diligence Regulation
TheCommission is currently preparing a legislative proposal that includes mandatory human rights and environmental due diligence obligations for companies, to promote sustainable corporate governance. This was announced by Didier Reynders, EU Commissioner for Justice, in April 2020. After a period of stakeholder and public consultations, the Commission aims to submit its legislative proposal in the second quarter of 2021.
Although Commissioner Reynders explained that the Regulation will include a “mandatory, inter-sectoral and enforceable mechanism with the possibility of sanctioning companies that fail to monitor violations of human rights and environmental rules in their supply chain”, no further concrete details have yet been published.
However, the Conflict Mineral Regulation, which mandates supply chain due diligence for trade in certain minerals and metals from conflict-affected areas, serves as a useful guide in assessing the likely nature of the new Supply Chain Due Diligence Regulation.
Firstly, the scope of the Conflict Mineral Regulation is narrow. It applies directly to between 600 and 1000 EU importers, and indirectly affects about 500 smelters and refiners of the minerals. In contrast, the new Regulation is likely to apply to companies in all economic sectors. However, Commissioner Reynders indicated that there will be a difference in due diligence requirements for small and medium-sized enterprises (SMEs), compared to large companies.
Secondly, under the Conflict Mineral Regulation, EU importers must comply with the following supply chain due diligence obligations: (i) management system; (ii) risk management; (iii) third-party audit; and (iv) disclosure. These obligations are broadly aligned with the OECD Due Diligence Guidance for Responsible Mineral Supply Chains. The new Regulation is likely to impose similar obligations and expand on them. This means that companies will most likely be obliged to (i) establish strong management systems; (ii) identify and assess risks in the supply chain; (iii) design and implement a strategy to respond to identified risks; (iv) carry out an independent third-party audit of supply chain due diligence; and (v) report annually on supply chain due diligence.
Finally, the Conflict Mineral Regulation does not provide any specific rules, penalties or sanctions for infringement. Rather, sanctions are to be decided and enforced by national authorities, which weakens EU-wide enforcement. To overcome this weakness, the new Regulation is likely to elaborate specific sanctions and provide strong enforcement mechanisms. If the Regulation adopts civil liability, for example, this could make company directors individually liable for breaches of the Regulation. Furthermore, if the sanctions targeted not only suppliers but also carriers and end-users of goods and services, this would strengthen the enforcement capabilities.
Enforcing sustainable development commitments via the new Supply Chain Due Diligence Regulation
The new Regulation could enable enforcement of the labour rights and environmental protection commitments vis-à-vis third countries more successfully than the toothless TSD Chapters of EU FTAs. As mentioned above, the TSD Chapters do not provide a strong enforcement mechanism and are not designed to target companies directly (but rather foreign governments).
Under the Regulation, non-EU suppliers based in the EU, or non-EU suppliers offering goods or services in the EU, will be indirectly forced and incentivised to adhere to high standards of labour rights (under the ILO Convention) and environment protection (under the Paris Agreement) to be able to trade with EU companies. This is because EU companies will be obliged to follow a broad range of supply chain due diligence obligations, requiring them to ascertain whether their non-EU suppliers adhere to adequately high labour rights and environmental protection standards.
If EU companies work with non-EU suppliers who do not respect these sustainable development standards, they could face sanctions and penalties in the future. This means that EU companies will put pressure on non-EU suppliers to adhere to labour rights and environment protection.
Accordingly, the Supply Chain Due Diligence Regulation could provide a strong incentive for non-EU suppliers to abide by labour rights and environment protection, since failure to do so could damage their business and trade with EU companies. This was not the case under the TSD Chapters.
However, this raises two issues. First, non-EU suppliers could view the new Regulation as another type of protectionist measure, as it restricts their access to the EU market. The EU will need to communicate with its trading partners to address this concern. Moreover, EU companies who rely on a limited number of non-EU suppliers for specific goods or services could face difficulties in finding alternative suppliers, if and when their existing non-EU suppliers do not respect sustainable development commitments. It will be important for the Commission to provide guidance on how EU companies should respond in this particular situation.
The Regulation will have huge implications on companies operating in the EU, regardless of where they are based. While the Supply Chain Due Diligence Regulation will primarily target EU companies, it also indirectly affects and could change the behaviour of non-EU suppliers. This makes the Regulation an efficient tool to ‘enforce’ sustainable development commitments, which have been inadequately enforced under the TSD Chapters of EU FTAs. However, it remains to be seen how the EU will implement and enforce this ambitious new proposal, and most importantly how non-EU suppliers and governments will respond.
Note: The views expressed in this post are those of the author, and not of the UCL European Institute, nor of UCL.