Corporations, LLCs & Partnerships

Risk in the Supply Chain: Proposed Laws Seek Unprecedented Transparency

7 Min Read By: Elaine Wood, Brad Dragoon, Emily Butler, Dave Curran, Madhuri Pavamani July 12, 2022

Less than two decades ago, “the concept of supply chain transparency was virtually unknown” and it was commonplace for managers to be unaware of a supplier only two steps upstream in the production process.^[1] This narrow approach to global production, where companies were only conscious of their direct suppliers, has gradually been replaced as consumers and regulators demand companies widen their purview into their operations. Two new proposed laws may force companies in the US and EU to provide unprecedented transparency into their production partnerships and account for impacts incurred throughout their supply chain. Never has it been more important to “Know-Your-Supply-Chain.”

In January, two members of the New York State government, backed by a coalition of fashion and sustainability non-profits, unveiled the Fashion Sustainability and Social Accountability Act (or “Fashion Act”). If passed, this law would make New York the first state to “effectively hold the biggest brands in fashion to account for their role in climate change.”^[2] The Fashion Act does not only pertain to climate impacts but also seeks to address ethical sourcing and due diligence in supply chains. Similar legislation with broader implications has been proposed in Europe—a year prior to the announcement of the Fashion Act, the European Union unveiled its directive on Mandatory Human Rights, Environmental and Good Governance Due Diligence (the “EU Directive”).

Recent legislation governing the fashion industry in the US tells a story of ad hoc protections: California’s Garment Worker Protection Act and Federal Uyghur Forced Labor Prevention Act were designed to address specific labor-related concerns. In the absence of comprehensive regulations, companies have been tasked with addressing Environmental, Social, and Governance (ESG) matters independently.^[3] While a number of EU Member States, notably France and Germany, have implemented targeted laws relating to modern slavery and human rights, these, similarly, do not address the larger social and environmental impacts of the apparel sector.^[4],^[5]

Both the Fashion Act and the EU Directive aim to be more comprehensive, acknowledging gaps in existing regulation while focusing on the risks that stem from suppliers and third-party vendors. Lawmakers on both sides of the Atlantic are finally acknowledging complexities of global supply chains, and for the first time holding companies accountable for the environmental and societal impacts at each stage of the production process, even in segments that are not under their direct control.

The Fashion Act would apply to apparel and footwear companies operating in New York State with global revenues of at least $100 million. These companies would be required to map a minimum of 50% of their supply chain and, importantly, to identify where in this chain the largest social and environmental impact is made. Companies which fail to adhere to these disclosure requirements could face fines of up to 2% of annual revenue over $450 million, which will be paid to a community fund administered by the New York Department of Environmental Conservation. The Fashion Act also provides for the creation of a public list of noncompliant companies to be published by the New York Attorney General’s office.

Similarly, the goal of the EU Directive is to address the fragmentation of regulations in the region. Until now, as in the US, there has been a lack of harmonization between legal frameworks, and countries have been tasked with developing their own guidelines. For example, the Corporate Duty of Vigilance Law was adopted by France’s Parliament in 2017 and applies to companies with more than 5,000 employees operating in the country.^[6] But other EU Member States have not developed national rules related to corporate sustainability, including Finland, Austria, and Belgium.^[7]

In comparison to the Fashion Act, the EU Directive applies more broadly, though the requirements are currently opaque. Specifically, the EU Directive applies to all EU companies with more than 500 employees and turnover of €150 million (approximately $163 million), unless the company is involved in an industry where the risk of exploitation is higher, like fashion or agriculture, in which case it applies to companies with more than 250 employees and turnover of €40 million (approximately $43.5 million). The EU Directive asks companies to integrate due diligence procedures to identify adverse human rights and environmental impacts and develop programs to monitor the effectiveness of those procedures. Companies will also be mandated to establish a procedure for processing complaints, and “publicly communicate due diligence.”

Compliance with the EU Directive will be overseen by national administrative bodies appointed by EU Member States. Penalties for noncompliance appear more severe than those laid out in the Fashion Act, and include fines, exclusion from public tendering and procurement opportunities, import bans, and other administrative sanctions or civil liabilities.

The differences between the two pieces of legislation highlight some of the challenges in defining and developing rules when it comes to ESG. The scope of the EU Directive, for example, is larger and more encompassing, applying to companies both inside and outside the fashion industry. In contrast with the Fashion Act, the EU Directive does not specify the standards it seeks to protect, instead referencing international treaties like the Paris Agreement, the Universal Declaration of Human Rights, and International Labour Organization’s core conventions.^[8] This means that “companies must take appropriate measures to prevent, end or mitigate impacts on the rights and prohibitions included in international human rights agreements, for example, regarding workers’ access to adequate food, clothing, and water and sanitation in the workplace” and are required to take measures to “prevent, end or mitigate negative environmental impacts that run contrary to a number of multilateral environmental conventions.”^[9] The EU Directive does not explicitly entail a mapping component, but it can be argued that adherence with the terms of the Directive will require at least some mapping by covered companies.

Both the Fashion Act and the EU Directive are likely at least a year away from implementation. Currently, the Fashion Act is with the New York Senate’s Consumer Protection Committee, but it must pass both houses of the state’s legislature and be signed by the Governor before becoming law. Similarly, the EU Directive is currently circulating as a draft and still needs to be approved by the European Parliament and the European Council. This gives companies time to implement new controls in expectation of these laws’ passage so that they are not scrambling to remain in compliance with complex due diligence and disclosure requirements. Businesses affected by either or both of these proposed laws should begin developing third-party due diligence programs that incorporate three important components: supply chain transparency, identification and management of country and sector risks, and monitoring through data analytics.

Beginning to enact these programs now will be critical as once the Fashion Act is signed into law, companies will have only one year to satisfy the mapping mandates and 18 months to meet the disclosure requirements. It is unclear what the implementation timeframe looks like for the EU Directive, but it is expected that the Directive will be adopted in late 2022 or early 2023. Typically, countries have up to two years to transpose EU directives into national law, which means companies could see binding legislation enter into force as early as 2023.^[10]

In a deeply interconnected world, unknown risks within a firm’s global supply chain or network partnerships can hinder even the best-intentioned internal ESG strategies and lead to legal and regulatory ramifications due to evolving rules regarding labor conditions, corruption, and environmental protections. In this way, both the Fashion Act and the EU Directive are emblematic of growing public and regulatory interest, and it would be wise for companies, regardless of their size and industry, to begin to take steps to understand the impacts associated with their supply chain, as we can be sure that these pieces of legislation represent the beginning of a movement towards transparency and informed choices.

By Elaine Wood, VP Risk, Investigations & Analytics Practice at Charles River Associates; Brad Dragoon, Principal Risk, Investigations & Analytics Practice at Charles River Associates; Emily Butler, Consulting Associate at Charles River Associates; Dave Curran, Co-Head of ESG at Paul Weiss; and Madhuri Pavamani, Director of Sustainability & ESG at Paul Weiss.

By: Elaine Wood, Brad Dragoon, Emily Butler, Dave Curran, Madhuri Pavamani July 12, 2022

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