In this article, we will examine the implications of the European Union’s recent sustainability legislation for businesses in the global supply chain. We make the case that by adhering to the sustainability principles promoted by the EU’s legislation, businesses around the world can position themselves for success in the European market of the future.
A 2022 study by the CDP revealed that supply chains generate 11.4 times more carbon emissions than companies’ direct emissions. While companies need to find ways to eliminate the emissions of their operations (Scope 1) and their purchased energy (Scope 2), they must also support the reduction of all the other indirect emissions upstream and downstream in a their value chains, known as Scope 3 emissions. However, Scope 3 decarbonization via supply chain emission reductions is a challenging task that requires the active engagement of stakeholders and collaborative work. If you are interested in delving further into the topic, I recommend reading the Science Based Targets Initiative’s (SBTi) free guide, Engaging Supply Chain on the Decarbonising Journey, which they developed in collaboration with World Wide Fund for Nature (WWF).
As a forerunner in sustainability, the EU has introduced several legislative acts, including the Corporate Sustainability Reporting Directive (CSRD), the Carbon Border Adjustment Mechanism (CBAM), as well as—most recently and still pending final approval by the European Parliament next month—the Corporate Sustainability Due Diligence Directive (CSDDD). These legislations are aimed at driving reductions in carbon emissions and ensuring respect for human rights across global supply chains. While these legislations may pose some initial challenges, they also present significant opportunities for companies to improve their sustainability performance and gain a competitive edge in the EU market.
Understanding EU legislation promoting sustainable business
The Corporate Sustainability Reporting Directive (CSRD) mandates that large companies operating in the EU (or with significant subsidiaries within the bloc) disclose comprehensive information about the sustainability of their operations and strategy and demonstrate progress towards the commitment to transition to carbon neutrality made by all countries under the Paris Agreement. It requires all large companies and listed SMEs to publish reports on their activities in ESG (environmental, social, and governance) terms according to the European Sustainability Reporting Standards (ESRS) and to move toward integrating sustainability metrics into financial statements.
CSRD updates and replaces the EU’s Non-Financial Reporting Directive (NFRD) and expands mandatory non-financial—i.e. ESG—reporting from a wider range of companies than before to go beyond measuring financial risk and include companies’ impact on the world around them. Significantly, it requires companies that fall within its scope to map, engage with, and report on the impact of partner companies throughout their value chains. This means that companies whose size or location would exclude them from full mandatory reporting will still need to provide data under the CSRD and ESRS to comply with the requirements of their in-scope clients and partners. We published a few articles by my colleague Yannick Poullie last year on the CSRD, what it means for SMEs, and the meaning of the central terms of the CSRD and ESRS. I recommend that you read these now to understand better how this new law introduces requirements that affect SMEs in the supply chain regardless of whether they are subject to mandatory compliance.
The Corporate Sustainability Due Diligence Directive (CSDDD) was adopted by the European Commission on February 23, 2022, and accepted by the EU’s member states in the European Council on March 15, 2024. Its main goal is to ensure companies are accountable for their role in promoting sustainable development worldwide, focusing on human rights and environmental protection within company operations and management. This incoming directive is essentially the enactment and enforcement in EU law of existing but non-binding international commitments under the UN Guiding Principles on Business and Human Rights.
The directive requires large companies to disclose their potential environmental and human rights impacts across their operations, supply chains, and subsidiaries. It applies to EU companies with over 1000 employees and a net turnover of €450 million, as well as non-EU entities with a similar turnover generated in the Union. The implementation period will be 3 to 5 years and will roll out in stages based on the size of the company. It is expected that around 5,400 companies in the EU will need to comply with these reporting requirements. The directive is currently awaiting final approval by the EU Parliament in April.
The CSRD and CSDDD are supposed to complement each other, and larger companies would need to comply with both. While the CSDDD focuses on companies implementing due diligence measures to address environmental and human rights impacts within their supply chains, the CSRD is a reporting directive and is aimed at ensuring companies report comprehensively on their sustainability in a standardised way and make progress towards long-term collective goals.
The Carbon Border Adjustment Mechanism (CBAM), which already came into effect on 1 October 2023, is designed to counter the risk of so-called “carbon leakage” and operates by imposing a charge on the embedded carbon content of certain imports. Carbon leakage occurs when companies move carbon-intensive production abroad to countries where less stringent climate policies are in place, or when local products get replaced by more carbon-intensive imports. CBAM aims to put a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU and encourage cleaner industrial production in non-EU countries. It ensures that the carbon price of imports is equivalent to the carbon price of domestic production, so the EU’s climate goals are not compromised. The CBAM will be fully implemented from 2026, and until then, a transitional phase is in effect from 2023 to 2026. This gradual introduction is in line with the phasing-out of free allowances under the EU Emissions Trading System (ETS) to support EU industry’s decarbonization.
What must the supply chain do to comply with EU sustainability legislations?
Here I will examine some of the measures that companies in the global supply chain should take in light of each of the legislations I’ve discussed above.
- For CSRD: Companies should proactively ensure that they have robust ESG reporting processes in place to comply with the CSRD. Companies should consider adopting existing internationally recognized frameworks—for example, the Sustainable Development Performance Indicators (SDPI) or the Global Reporting Initiative (GRI) standards—and align them with or adopt the European Sustainability Reporting Standards (ESRS), to guide their reporting efforts. They should also prepare to be audited on what they report, as the CSRD introduces the requirement of assurance, aka sustainability auditing.
- For CSDDD: Companies should implement and prepare to participate in due diligence measures that help identify, end, prevent, mitigate, and account for negative human rights and environmental impacts. Adopting one of the robust and internationally recognized ESG reporting frameworks mentioned above will provide companies with high-quality documentation that can help with the process of due diligence compliance and auditing. Companies should also consider adopting internationally recognized frameworks such as the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights to guide their due diligence efforts.
- For CBAM: Companies should assess the carbon footprint of their products and supply chains to identify areas where they can reduce their carbon emissions. They should also consider investing in cleaner production methods and technologies to reduce their carbon footprint.
Apart from CBAM, CSRD, and CSDDD, many other legislations are also relevant in terms of sustainable business practices for companies in the EU market’s supply chain. My colleague Haritha Mukundan has written a blog entitled ‘Sustainability reporting in 2024: what businesses need to know’ that is also worth reading for an overview of the evolving landscape of EU sustainability legislation and policy.
Understanding and implementing actionable measures to align with EU legislation within the global supply chain can be a challenging task, especially for SMEs. The following section offers some strategies to help companies effectively navigate these compliance challenges.
How can SMEs in the global supply chain overcome challenges posed by the EU’s sustainability legislation?
To avoid negative impacts from the requirements of CBAM, CSRD, and CSDDD, companies in the global supply chain need to be proactive. Here I offer a step-by-step strategy that companies can apply to take coherent action and comply with the wide range of interrelated EU legislations.
- Understand and align with the requirements of legislation: It is essential that SMEs in the global supply chain fully understand the requirements of the various pieces of legislation affecting them to ensure that they are compliant. Therefore, companies need to understand the scope, reporting requirements, and timelines to comply with relevant legislation.
- Adopt ESG reporting and prepare to be audited: Start reporting now and conduct sustainability auditing to assess the company’s current practices and identify areas needing improvement according to the growing body of EU sustainability legislation. ESG reporting and auditing can help companies understand sustainable business practices and identify gaps in reporting or due diligence efforts and address them accordingly.
- Implement a sustainability framework: Implement a sustainability framework that aligns with international standards and guidelines. This framework can provide guidance on how to adopt best practices and help to demonstrate the company’s commitment to sustainability and due diligence efforts.
- Engage with stakeholders: Engage with stakeholders like suppliers, customers, and investors but also wider society to ensure that they are aware of the company’s sustainability impact and efforts. This engagement can help build trust and enhance the company’s reputation.
- Invest in sustainability: Invest in sustainability initiatives and technologies to reduce your carbon footprint and improve your business practices. The investment will not only help meet the requirements of legislation but will result in a competitive edge, as sustainability becomes a higher priority and a critical criterion to bid successfully for contracts with EU companies.
By taking these measures, companies of all sizes across the global supply chain can overcome the challenges posed by the EU’s sustainability legislations like CBAM, CSRD, and CSDDD. In addition, these measures can have a broader positive impact on sustainable exporting to the EU region. The potential benefits include:
- Meeting EU market demands and customer expectations: As sustainability becomes increasingly essential for both B2B and B2C commerce at all levels of the EU, companies in the supply chain of EU companies that demonstrate excellence in applying ESG principles and a genuine commitment to sustainability will be better positioned to meet market demands and gain a competitive edge.
- Mitigating risks associated with non-compliance: Proactively adopting sustainable practices can help companies and SMEs avoid potential risks associated with non-compliance with legislation like the CBAM, CSRD and CSDDD.
- Enhancing brand reputation: Implementing sustainable practices can improve brand image and reputation, increase customer loyalty, and attract new markets.
Final notes
- The EU’s CBAM, CSRD, and CSDDD are using legislation to drive a transition to sustainable business practices that will extend throughout global supply chains.
- Having awareness and understanding of EU legislation is crucial for large companies and SMEs alike to identify what they need to do to comply with relevant regulations and enter or remain within the supply chain of EU companies.
- Although complying with new legislation may pose some initial challenges for companies in the global supply chain, the potential benefits are significant.
- By actively engaging with them, companies can improve their brand reputation, better manage risks, and gain a competitive advantage in the EU market.
If your SME has not yet fully understood the EU sustainability legislation and what it means for your business, we encourage you to reach out to us. Join us on this transformative journey. Together, we can create a world where businesses thrive, communities prosper, and our planet flourishes.
