A more evidence-driven approach to supply chain due diligence is needed as human rights and environmental risk come into focus, writes Elke Biechele.
The 27th of May 2021 may become a historical date. Germany has agreed to put in front of parliament what is dubbed “the toughest law of the EU” against the exploitation of people and the environment.
The new law (Lieferkettengesetz in German) allows for hefty fines starting at several hundred thousand euros if their contractors abroad are found to breach human rights or environmental rules. The fines go up to 2 percent of the company’s annual revenues. For some of the largest German companies this could mean billions of euros in fines per incident, similar to what we have seen in the banking world for major breaches.
Under the new law, companies will be held responsible for every step in their supply chains from the raw materials to the finished product. “This law protects workers from exploitation across sprawling supply chains and protects human rights across the world,” Finance Minister Olaf Scholz said in March. “In future, it will be clear that ‘Made in Germany’ also means respect for human rights.”
France and the UK have similar laws in the making, and so has the EU and US. Fuelled by global climate protection movements, this train is now rolling and will be unstoppable.
Why Asia needs to worry
What is happening in Germany is the beginning of an unstoppable trend across industrialised nations, the main consumers of goods produced in Asia. Asia is the centre of supply chains for industrialised nations and currently is too opaque to pass the required due diligence necessary to comply with this law and those that will soon cover the EU and US.
Banks conduct trade finance business predominantly with only the largest and most reputable of corporations. Corporations with extensive supply chains in Asia run the risk of violating these laws as it would be difficult for them to have complete oversight over their complex supply chains. For instance, a car manufacturer may receive parts from a supplier in China who in turn has outsourced components to be produced in Cambodia.
To what extent is the parent company obligated to understand criminal activity such as human slavery or environmental crimes happening within the whole supply chain? Credit risk assessments and financial crime risk due diligence frameworks and methodologies are on the verge of needing a complete overhaul.
Germany imports over EUR 1 trillion of goods, with China being its largest trading partner. China outsources production lines to other Asian countries, particularly Southeast Asian nations through the silk road initiative.
Large scale de-risking
Comparing this situation with the credit crisis in 2008, at pre-credit crisis levels, banks were allowed to trade pretty much with anyone in the world. It was of little problem. Now, with intensified due diligence and strict financial crime compliance regulations, banks have stopped access to finance for nearly 100 countries, which brought economic shocks and poverty to those nations that were de-risked. China, India, Turkey, Brazil and Russia became the key trading partners to those nations.
Fast forward, with this new German supply chain protection law in effect by 2023 for the largest companies in the EU’s strongest country economically, things will change structurally again – and with a high potential of sudden economic shocks. Banks and corporations alike will need to take this law seriously or they will face a new generation of regulatory fines, further reducing their capabilities to compete in the market.
Following the fintech revolution in 2014, large chunks of banks’ businesses fell into the hands of fintechs and challenger banks as traditional banks were not prepared. The example of Barclays Bank shows a tumble in its share price by a staggering 74 percent since the credit crisis, 34 percent of which occurred since 2014, the birth of the fintech revolution.
The bank’s share price is now trading at 1996 levels and one wonders how many more crises banks can survive without being prepared. The global trade finance market is expected to grow to USD 10.4 trillion by 2026, demonstrating the potentially severe impact to companies Germany’s new regulation may have. The shock to banks when they need to de-risk yet again may just be unprecedented.
The supply chain protection law starting in Germany may fuel the next banking crisis, and it may be one that is potentially larger than ever. The time to prepare is now.
How to prepare
The current supply chain structures are opaque, complex and designed with many loopholes in place. Long purchasing chains, co-mingling with authorised and non-authorised patches of land for agricultural production – these are just some examples of the complexity any supply chain supervision will face.
The origination of goods from impoverished countries is met with a lack of digitisation, significant levels of corruption and a lack of data sharing by governments. So how do firms perform accurate and safe due diligence?
The immediate response of any compliance officer would be to assess companies through compliance frameworks, the availability of policies and internal supervision. This streamlined self-certification approach will no longer be sufficient. Any traditional compliance process will require a deep understanding into the workings of the supply chain which will be costly and time-consuming to obtain and may outstrip the business opportunity.
Without a more evidence driven approach to supply chain due diligence, more stringent requirements such as those imposed by Germany’s new law could trigger large scale de-risking wherever complete oversight over supply chains is not possible.
Fortunately, the issue of supply chain protection could largely be solved using technology. Luckily, technologies have advanced significantly and provide vast opportunities to ensure supply chains are getting more transparent, traceable and supervise-able.
A tomato could in theory now be on blockchain with clear traceable origins. Data analytics is able to rapidly analyse petabytes of information to enable the depth of due diligence required. Compliance software could handle all self-certification information and also perform the data analytics required to independently verify human rights and environmental protection adherence.
Companies specialising in data provision should start collecting data now. Large organisations, banks and supply chain heavy businesses should start investing into software and tools that provide certainty on the risks they face in their supply chains.
What the public sector should do
Governments could be at the forefront to secure their country’s place in the supply chain of the future. Driving forward the digitisation agenda to allow even rural areas to be digitally connected would be of great support to local farmers supplying their goods to the world. Sharing of information such as (data protected) social security information alongside import and export data would be of great use.
Supply chain governing bodies and associations could engage in ensuring due diligence is carried out for their members. Further building up of Public-Private Partnerships (PPPs) would be the ultimate protection.
A seemingly uneventful passing of a law in Germany may have started a massive train rolling. We need to learn from previous crises that occurred in the not-so-distant history to anticipate what we need to do today. There is no time for complacency. Where companies are still licking their wounds from the Covid crisis, more is just around the corner.
Slave labour and environmental negligence have been the backbone of our consumerism for the past three decades since globalisation started and even before. What is necessary now to protect our climate will be far reaching. Laws such as the Lieferkettengesetz will require deep changes to the way our goods are produced and the way we consume. Corporations, banks and businesses in general will need to be prepared or they risk becoming names of the past.
Elke Biechele is CEO of RisikoTek, a provider of financial crime detection technology and software.