The importance of integrating policy to shore up supply chains

A game-changing tsunami of supply chain legislation in the pipeline in Europe is set to transform the social and environmental demands on Vietnam companies providing goods, materials, and services for European markets or companies with European operations.

Nick Wood-Senior advisor, FTI Consulting

The far-reaching ramifications of the pending new laws will sweep right through Asia-Pacific, which sits at the heart of the global supply chain with Vietnam likely to be among the most impacted as an increasingly popular destination for foreign investment that in 2019 accounted for two-thirds of its export turnover.

The looming changes have been set out by the European Commission in its proposal for a corporate sustainability due diligence directive, presented to the European Parliament (EP) in February this year following a period of public consultation.

The draft directive sets tough standards of disclosure and operation across the entire supply chain including indirect suppliers and contractors. It covers all aspects of worker rights and conditions of employment in line with international conventions covering human rights, forced labour, child labour, migrant labour rights, freedom of association, and a safe and healthy working environment free of discrimination.

The list of international environmental standards includes a requirement for a business strategy that will limit global warming to 1.5^oC in line with the Paris Agreement where company emissions are significant or a principal risk.

It goes far beyond existing legislation across European countries, building on the UN’s Guiding Principles on Business and Human Rights as well as the Guidelines for Multinational Enterprises and Responsible Business Conduct, and aligning with internationally recognised human rights and labour standards. The difference is that all these voluntary standards will be, in effect, mandatory.

Demonstrating competence

The directive is now being reviewed by the EU Council and the EP with a final position expected in the second quarter of next year. After further negotiation, commentators are estimating it will be adopted at the earliest at the end of 2023. Member countries then have two years to turn it into national law.

It is hard to predict how many changes will be made in the next 18 months of negotiation but compromises have already been introduced by the council that will give companies between three and five years to implement following legal adoption depending on the size of the company. EU ministers last week voted to exempt banks and investment funds as they did not have direct supply chains. Whether these revisions will change again in negotiation with parliament is an open question but the core thrust of the directive for accountability right through the supply chain is expected to remain.

Under the current draft, companies will be required to demonstrate that they have identified, prevented, mitigated, and accounted for external harm from human rights and environmental impacts along the entire supply chain.

That means Vietnamese suppliers will be expected to show they have matching standards in place backed up by effective management and operational processes that ensure those standards are implemented. A governance structure to monitor and provide assurance annually is also required.

They must integrate due diligence into their policies, and have a system to identify adverse impacts and plans in place to prevent or stop those impacts. They must also have a whistleblowing procedure for complaints that meets EU standards.

In addition, they need to ensure their own suppliers and service providers are doing the same, many of which are small- and medium-sized enterprises poorly resourced and equipped to adopt new standards. This means that the new laws will be a major step up for all companies along the supply chain from top to tail.

With the lack of transparency and inconsistency of standards in supply chains across Asia-Pacific, the change that is coming will require a major reset in the relationship between customer and supplier with a focus on increasing transparency through the entire supply chain and aligned social and environmental standards and commitments. It will also mean tough discussions about how to pay for the changes and support suppliers with resource limitations.

Illustration photo, Shutterstock

Willingness to act

The EU directive will likely be under Vietnamese government scrutiny soon, if not already, because of the potential risk to the country’s economic growth and influence on national legislation.

When the changes happen, it will be under the unrelenting gaze of non-governmental organisations (NGOs) that are active in monitoring and targeting companies in Asia-Pacific over human rights and other social issues in the supply chain with major successes that have closed off export markets to target companies and impacted business and reputation.

NGO success in closing down exports to the United States for major Asia-Pacific companies demonstrates that the increasing scrutiny goes far beyond Europe across the Americas, where a major factor has been an increasing willingness to act on existing forced labour legislation. The Customs Bureau and Protection banned more than $480 million of imports last year due to forced labour compared to just $50 million the year before.

Some of the highest-profile bans have been directly the result of NGO reports alleging human rights violations in the supply chain. These bans in some cases have lasted more than a year while companies sought to satisfy the bureau.

It also shows NGOs are increasingly influential and effective in driving government action alongside the global trend of growing shareholder activism, often in collaborative cross-border networks. In Vietnam, the high dependence on manufacturing, which accounts for 86 per cent of national exports, is helping drive economic growth, which was above 6 per cent in the first quarter this year and is projected to be matched in 2023. Its largest export sector is electronics, where it was the world’s 12^th largest exporter in 2019, covering TVs, computers, cameras, and mobile phones.

It is the world’s second-largest exporter of ready-made garments employing more than 2.7 million people and delivering 23 per cent growth in 2021. Footwear exports are up 13 per cent and machinery by 10 per cent. It was also the world’s second-largest coffee exporter behind Brazil last year, an industry that earned $2.8 billion so far this year.

Along with other Southeast Asian nations, Vietnam is attracting new investment from multinational companies seeking to reduce dependence on China supply chains and diversify. One of Vietnam’s attractions are labour costs among the lowest in the region despite a 6 per cent increase in the minimum wage introduced earlier this year.

Vietnamese companies have in theory time to get ready for the EU changes. In reality, many European-linked companies are already assessing risks, reviewing their supply chains and evaluating the preparedness of current suppliers to ensure they are best placed when the change becomes law.

When the change comes, they will already want to be working with the best suppliers in their supply chain. Vietnamese companies ahead of the sustainability curve with due diligence processes and plans that differentiate themselves from competitors across the region will be the major beneficiaries.

The views expressed herein are those of the author and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals.