Prashant Mara and Pratik Bakshi
Germany joined the likes of Australia, Canada, France and Italy, at the start of 2023, it brought into effect the German Supply Chain Due Diligence Act (“LKSG” or “the Act”), which looks at ensuring better social and working conditions for workers, and control environmental liability of businesses.
Four months on, we see the first complaint filed under the LkSG. The European Center for Constitutional and Human Rights (“ECCHR”), the National Garment Workers Federation (“NGWF”), and the African Women’s Development and Communication Network (“FEMNET”) recently filed a complaint under the LkSG against Amazon, IKEA and Tom Tailor for failure to comply under the new Act. They have claimed lack of safety checks of the companies’ suppliers that amount to “a violation of corporate due diligence” under the Act. It is the first complaint to be issued under the Act, which could see firms face fines of up to 2% of their global turnover if they fail to identify and prevent human rights and environmental impacts in their supply chains.
This complaint, and the eventual action that the German authorities will take on the complaint, may potentially have a domino-effect and give rise to several such complaints against global conglomerates. What’s also interesting to note is that except for Tom Tailor, the other two corporations listed in the complaint are not German-headquartered companies, but only have had significant German operations so as to cross the applicability threshold. The applicability of the LkSG is therefore more global than it may seem.
Will corporations now transition from outsourcing to onshoring or nearshoring?
LkSG in a way looks at providing protection to workers in foreign countries, who may not receive such protections from their domestic laws and regulations. However, it is not necessarily a reason for celebration for suppliers in such countries, because meeting the new rules their German customers' demand is tough. The complexity and expensiveness of audits in emerging markets, may also make German companies re-think their outsourcing strategy, and move back production to countries closer-to-home, where it might be relatively easier to ensure compliances. For instance, France has seen a decline in import from low-income countries since they passed a due diligence law in 2017.
Not just the LkSG, German and other western corporations were already considering reshoring since the coronavirus pandemic paralysed the global supply chains. However, it’s easier said than done. Eastern and Central Europe which is the next best bet for nearshoring doesn’t either have the most stable economic and political climate, because of the Russia-Ukraine tensions. Moreover, reshoring will at best be a long-term plan, and not something which can be done immediately, because of contractual obligations, and risks of business disruption etc. For instance, Germany announced last year that it is re-looking at its trading policies with China, reduce dependence on Chinese raw materials, batteries and semiconductors and being less “naïve” in its trade dealings with China. However, come 2023 and Germany’s import from China grew by 21%, and it became its top trading partner for the seventh year in a row.
This does not mean that China will see a similar trajectory in the future. The dependency on China may decline, but it will take years before it achieves anywhere close to 100% independence from sourcing. Moreover, even if corporations are able to reshore most of their manufacturing operations, more often than not, they will still have to depend on indirect suppliers from such countries for supply of certain components, which will bring them back into the purview of the LkSG.
Making supply chain due diligences more effective is the only answer.
Corporations should look at investing in ethical sourcing, and should work with their suppliers in achieving those objectives together. We have compiled a compliance checklist designed to help you move beyond a mere ‘check the box’ approach, to instead promote responsible business practices by identifying sourcing ‘hot spots’ in your supply chain.
Try answering these questions with respect to your supply chain in India. This should give you an idea of what risks may exist, and to prioritize mitigation measures.
A. Hotspots indicative of human trafficking
Are you aware of the composition of your work force? Certain groups are more vulnerable to exploitation than others, such as migrants, women, children and illiterate workers.
How are the workers in your supply chain recruited? Recruitment agents play a key role in human trafficking. Workers are often offered promising jobs (for a large fee payable by the worker) that turn out to be exploitative.
Has your supplier maintained a complete and accurate data bank containing the details of the workers and benefits paid to them? If the data bank is not readily available on request and if the supplier takes time to respond to your requests for this data (say, more than 1 week), it may be indicative of improper practices.
Are the workers living in temporary, unsafe and unhygienic accommodation? Temporary accommodation that is unsafe and unhygienic is often a sign of migrant labour, which increases the possibility that they have been trafficked.
Are there ‘high security’ measures at the supplier’s facility? High security measure at the supplier’s facility and/or living locations (e.g. opaque windows, boarded up windows, bars on windows, barbed wire, security cameras, etc.) could indicate the existence of human rights abuse.
B. Hotspots indicative of forced labour
Do the workers have alternate employment opportunity in the area where the facility is located? If the facility is located in an area with limited alternate employment opportunity, the risk of forced labour increases.
Are the workers contracted (as opposed to employed) in large numbers throughout the supply chain? Contract workers are more susceptible to exploitation. There is limited formal structure in place to manage their rights.
Is there a formal complaint procedure and who is responsible for handling the complaint procedure? Absence of complaint receipt and redressal procedure in facilities/establishments may suggest a work environment with unacceptable working conditions. If the complaint procedure is handled by the HR department, are you confident about the results being communicated to you?
Is the system of payment cash-based or bank/digital? Payments made at the discretion of the employer in cash, without any detail of rates, hours worked etc., may indicate forced labour. Lack of payment records and management structures increases the risk of forced labour.
Are you told that workers are suffering from persistent injury/illness? Signs of dehydration, heat stroke, sleep deprivation, injuries, sanitation-related illnesses, etc. among the workers at the supplier’s facility may be indicative of forced labour.
C. Hotspots indicative of child labour
Do you see a large number of young workers in the facility? The presence of a large number of young workers increases the possibility of children (below 14 years of age) being part of the workforce. This can be due to management negligence or (worse) complicity.
Is a certain section of workers paid very low wages? It is easier to pay young workers less because they are less likely to complain than adults.
Are the young workers employed in hazardous/labour intensive profession? You should be extra cautious if your supply chain involves hazardous work or is labour intensive and you see a large number of young workers being employed.
Have inspections been conducted by the regulatory authority under child labour prevention regulations, and are you aware of their findings? Children may be concealed from labour inspections, records produced do not represent the actual age and their ages are raised arbitrarily to make them eligible for employment. Have you compared the records submitted to the authority with the one maintained by the supplier?
Are there schools close to the supplier’s facility? Lack of schools in the vicinity of the facility is an indication of children/young workers being part of the local labour force. The risk increases if the workforce is predominantly migrant.
D. Hotspots indicative of discrimination
Are female workers being paid lower wages for equivalent hours of work compared to male workers? This is fairly common, unfortunately, besides being illegal. Records showing different wage figures for women should be investigated.
Are some workers on fixed term contracts while others are permanently employed? Absence of indefinite employment contract (subject to normal retirement) facilitates arbitrary termination and deprives workers of job security, pension, healthcare benefits and gratuity.
Are there practices to keep certain workers ‘separate’? Existence of separate eating arrangements or recreational activities may indicate cast e/ religion based discrimination. Tracking trends in promotions and salary raises is a useful tool to analyse whether certain castes or classes face discrimination.
Is there unfair treatment to women in case of pregnancy? Women leaving the workforce (even “voluntary resignations”) during pregnancy or post pregnancy is a sign of unfair treatment deserving further investigation.
Is there a robust process to prevent and investigate harassment? Review supplier’s policies to ensure compliance with anti-harassment laws and meet the committee members and ascertain their suitability and training.
E. Hotspots indicative of substandard health and safety facilities
Are accidents common in your suppliers’ facilities? A high incidence of accidents points to a poor safety philosophy. Note that accidents are also grossly underreported. You may need to look to other metrices for this (such as workdays lost, disability payments etc.)
Are the workers exposed to occupational hazards and suffering from occupational disease? A high number of health issues being reported from the workforce is an indication that they are being exposed to hazardous work conditions. Payment records may be useful here, if they show pay outs made to workers for accident, injury, etc.
Are the facilities using upgraded technology / equipment as part of their safety procedures? Lack of upgraded safety equipment is an indication that health and safety is not a high priority matter for the management.
F. How can you mitigate these risks?
Supply chain mapping: Identify risk hot spots in your supply chain using the checklist above as a base and audit practices for compliance with local and international legislations.
Whistleblowing procedure: Ensure that the organisation has appropriate whistleblowing and non-retaliation procedures that allows workers to report anonymously or to talk with someone other than their supervisor or HR.
Risk assessment: Conduct a risk assessment to determine which parts of the business and which of your supply chains are most at risk. This should include a review of any existing compliance policies, contractual provisions and supply chain relationships.
Action: Work with legal counsel to determine what further actions and resources are required to prevent, monitor and mitigate against any risks that are identified in the business and/or its supply chain.
Contractual risk mitigation: Ensure that supply contracts contain adequate contractual protection including warranties, reporting requirements and audit rights.
Site inspection: Consider introducing site inspections (both scheduled and spot checks) to the extent not already undertaken.
Engagement and capability building: Engage with the supplier management to increase awareness and understanding of health and safety risks in the supply chain at all levels.
Following these best practices in any ESG due diligences and related investigations can go a long way in not just helping you comply with the German Supply Chain (Due Diligence) Act, but promote good governance in the organisation as a whole, and be future-ready for any other global legislations.