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Investors grapple with fine potential from new German law

By: Annalise Toberman

01/09/2021

Companies with human rights violations anywhere in their supply chain may have to pay penalties of 2% of turnover, posing a new ESG threat to investors.

Investors in German companies will soon have to place greater scrutiny on the supply chains of those businesses, following a new law passed in the German Bundestag.

Passed in June 2021, the Act on Corporate Due Diligence in Supply Chains will force German companies – and foreign companies with branches in Germany – to ensure that their supply chain is free of human rights violations.

Such violations may include the use of child labour, forced labour and slave labour. Although watered down from its original draft after much lobbying from industry associations, the law is being viewed as a ‘paradigm shift’.

Why is it needed?

Voluntary company measures were proving insufficient. Late last year, a German government survey found over 80% of German businesses were not fulfilling their due diligence responsibilities on human rights. It is hoped the new Act will correct this.

It forces companies to take on greater responsibility for their supply chains, especially abroad where less monitorisation can lead to violation and abuse.

Gerd Muller, the German Minister of Economic Cooperation and Development said many problems stem from industrialised nations outsourcing some production roles to developing countries, which can undermine the minimum standards that wealthy societies demand.

Companies will be required to publish annually a policy statement on respect for human rights, carry out risk analyses and employ appropriate mitigation and corrective measures to counter the risk with their business products or services.

Dangers to investors

The Act, which will come into force on 1 January 2023, will initially only apply to companies with more than 3,000 employees, but will encompass any with more than 1,000 by 2024, affecting 4,800 companies in Germany alone. Those companies that fail to comply could face fines up to 2% of their annual turnover or exclusion from public tenders for up to three years.

These regulations will encourage fund managers and investors alike to consider more carefully where they place their capital. Human rights violations such as poor or exploitative working conditions have been, and continue to be, a huge reputational risk to companies.

Some German companies will hope to benefit from the disclosures as they take measures to protect workers, increasing the sustainability of their supply chains. During preliminary debates, 50 companies including ice cream manufacturer Ben and Jerry’s had called on the government to strengthen the law, and align the rules more closely with the UN’s Guiding Principles.

It comes as executives in companies increasingly believe sustainable supply chains are key to profitability, either through gaining a competitive advantage, mitigating or avoiding future risk, or cultivating consumer trust and thus encouraging investment.

However, other companies face having to rearrange their business models entirely or swap out whole supply chains.

Big names affected

One report from the German government found that under the new supply chains act several, notable German companies would have to end their business activities in the Chinese region of Xinjiang due to human rights violations among their Chinese suppliers.

These businesses include major names such as car manufacturer Volkswagen, sports giants Adidas and Puma and household names like Bosch and Siemens.

It is the automotive and extractive industries, including oil and gas companies that have the potential to suffer most from the new disclosures. Many of them rely on cheap labour abroad as part of their supply chains.

In recent years, the conditions of mining in Africa for cobalt and bauxite — materials required for the manufacture of electric vehicles and their batteries — have attracted media scrutiny amid concerns over human rights abuses.

Cobalt mining in the Congo had been found to use child labour, little to no safety measures and forced some miners to dig with their hands. Similarly, it was found that bauxite mining companies in Guinea had expropriated farmlands without adequate compensation and caused water scarcity in nearby communities. The new due diligence regulations will make it harder for German companies to ignore these human rights violations in their supply chains.

Red tape and additional costs

As well as the disruption to supply chains, though, many companies have raised concerns about the Act leading to increased red tape. According to a survey by the Leibniz Institute for Economic Research (ifo), 43% of the participating companies say they expect “negative effects” from an increase in bureaucracy or documentation.

Right-wing politicians, lobbyists, and trade bodies were also displeased with the possible sanctions. CEO Joachim Lang of The Federation of German Industries (BDI) said the sanctions could be a major problem and the regulations would mean “incalculable risks” for German companies.

Several charity and human rights watch organisations were unhappy with the watered-down regulations, noting that companies would only have to take specific measures if they had substantiated knowledge of potential abuses. Likewise, the lack of regulation for indirect suppliers or civil liability was not welcomed.

Despite concerns among some opposition parties that these new due diligence regulations would give advantage to German competitors, the EU is considering similar regulations and standards to be applied across all its nations.

German businesses hope the EU regulations will align with Germany’s own new regulations, yet campaigners worry that the new EU regulations will be watered down similarly to their German counterpart. The EU legislation, already pushed back, is expected to be presented in the autumn of this year.

Research in Finance is conducting a study of fund selectors in major asset management markets across the continent. The Research in Finance European Fund Selector Study (EuroFSS) is a new six-monthly study designed to help asset managers track investment trends at a pan-European and country-level, offering insights on fund picker attitudes. To find out more contact Richard Ley, Toby Finden-Crofts or our lead researcher on the project Annalise Toberman.

Annalise Toberman

Annalise has spent her working life intensively researching B2B and B2C audiences in the financial sector. A keen qualitative researcher, she has conducted hundreds of interviews across advisers, DFMs, fund houses, platforms, pension providers and consumers.

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